When you need to purchase or lease something for your business, your first thought might be to buy it outright. But this isn’t always the best way to go, especially if you’re a small business with little capital on hand.
There are plenty of situations where leasing can make more sense than buying, but it pays to know the difference between a finance lease and an operating lease so that you know when one will work better than another for your business. With the help of this finance vs. operating lease guide, you’ll have everything you need to make an informed decision about which option works best for your business needs.
The Difference Between Finance Leases And Operating Leases
A finance lease and an operating lease are both leasing agreements that allow you to use property, equipment, etc. However, the main difference between them is the length of the agreement. A finance lease has a longer term than an operating lease.
The total cost of owning the item over its useful life can be amortized over the agreed-upon period in monthly installments. For this reason, a finance lease may be more advantageous for those with large purchases because it will spread out the payments evenly over time. Click here to read further.
In contrast, someone who needs only one piece of expensive equipment may not want to avoid going through all the trouble and risks associated with financing the purchase on credit just so they can pay less each month. An operating lease may be better for these types of situations.
Another major benefit of an operating lease is that it does not require any down payment or security deposit from the lessee. However, if you decide to terminate your leasing contract early, there will likely be some form of penalty fee involved.
A finance lease typically requires at least two years of payments before the final buyout option becomes available. When comparing a finance lease vs. an operating lease, think about what type of agreement would work best for your situation.
The Benefits Of Each Type Of Lease
The two types of leases you need to consider when leasing equipment are an operating lease and a finance lease. An operating lease involves paying the full cost of the asset over the term, while with a finance lease, you only pay for the depreciation on your asset.
As you can see from these examples, each type of leasing has its benefits and drawbacks. You should consult an expert if you have questions about which type of leasing is best for your company. An operating lease typically doesn’t offer a residual value guarantee.
Operating leases usually require lower down payments than finance leases and shorter contract terms than most loans. However, they may not provide tax deductions as some assets depreciate in value. They also don’t allow you to purchase the property at the end of your contract as a finance lease does.
If you want more control over the property, then an operating lease may be better. If this sounds confusing and you just want someone else to take care of it all, then maybe a finance lease would work better for you!
How to decide which type of lease is right for your business
The difference between the two types of leases is that with an operating lease, you’re essentially renting the equipment and can return it at any time, while with a finance lease, you’re buying the equipment and are locked into paying the loan back. If you’re unsure which one to choose, there’s no harm in considering both.
For example, let’s say you have enough money to pay for an outright purchase of $10,000 but don’t want to tie up all your funds if you need them elsewhere. Consider looking at leasing first because it only costs $3,000 – less than half what the purchase price would be – and if you decide later on that it was worth purchasing, then this gives you some extra capital.
Conclusion
Finance leases provide tax benefits and the option to purchase the asset at the end of the lease. Operating leases are cheaper than purchasing an asset outright and do not include any tax benefits, but they do offer flexibility in terms of what assets can be leased.
There may be situations where getting an operating lease is better than buying. For example, if there are one-time start-up costs that will last only a year and there will not be any ongoing expenses associated with the equipment, then an operating lease might make more sense. It’s always worth talking to your accountant before making this decision.
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