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What is a finance lease?
If you don’t have the cash to purchase equipment, and you are looking for a way to borrow the funds, a finance lease can be the solution.
A finance lease, sometimes also called a capital lease or a sales lease, is a form of leasing where the finance provider, usually remains the legal owner of an asset — while you pay to hire it.
Finance lease — considerations
A finance leasing company is referred to as a lessor, while the business receiving finance is called a lessee.
With a finance lease, businesses are normally responsible for maintenance costs and may (or may not) benefit from fluctuations of an assets value (i.e. businesses take on some of the economic risks and rewards of ownership).
Although it is a lot like a hire purchase, the key point with a finance lease — is that you do not actually own the asset. As a result, it doesn’t appear on your business’s balance sheet.
Finance leases are typically reserved for assets intended to be used to the end of their useful life. Accordingly, it is more of a long term commitment — when compared to other leasing options like operating leases.
There may be tax benefits for the lessee to lease an asset, rather than buy it, and this is often the primary reason for seeking a finance lease.
Finance leases are popular agreements for companies that require commercial vehicles (vans, cars etc.) — where contract hire is not appropriate.
How does finance lease work?
A business interested in a finance lease would approach a leasing company. If accepted for financing — the lease would consist of a primary rental period. During this rental period, your monthly payments will add up to the full costs of acquiring the asset — interest would also be charged.
At the end of the primary rental period — the asset will be close to the end of its useful life. You would then have three options — as to how to proceed:
- Return the asset to the leasing company
- Continue using the asset through a secondary leasing period
- Sell the asset and benefit from a share in the resulting proceeds
Benefits of a finance lease
- Set regular payments — instead of buying an asset outright
- Flexible repayment options — tailored to your cash flow
- Potential to keep on using the asset at the end of the lease
- Tax advantages — rentals are usually corporate tax deductible
Limitations of a finance lease
- Financing is secured against the asset — failure to repay may result in repossession
- You might not own the asset at the end of the lease
- You are usually responsible for maintenance
- Usually requires a long term commitment
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