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What is an operating lease?
An operating lease gives a business access to assets it needs to use but does not need to own. You make a regular payment for access to the asset, but the leasing company retains ownership over it.
An operating lease is generally used for short-term, low-value assets — e.g. laptops or other IT equipment. It provides options for upgrading and re-leasing the asset at the end of the lease that are not available through a finance lease.
- Asset value: Low
- Lease period: Short
- Ownership benefits: None. Ownership of the property is retained during and after the lease term by the lender.
- Responsibility: Lender
- Running costs & admin: The lender is responsible for all associated costs, which are often included in the lease repayments.
- Accounting & tax: Whether or not the leased asset needs to be listed on the business’s balance sheet will depend on the value of the asset and the lease duration. Lease payments may be tax-deductible.
- Upgrade options: Yes
How operating leases work
With an operating lease your business pays for ongoing use of an asset. But unlike most other ways of acquiring and asset (e.g. a business loan), you can commonly upgrade the equipment within the lease period.
This is highly beneficial for businesses leasing the likes of IT equipment, as these types of assets often become obsolete within a few years.
Below are some of the other main aspects of how an operating lease works:
- Cost-effective finance for equipment with a short lifespan
- The business can’t sell or modify the asset without the lessor’s permission
- When the lease expires, the terms of that lease are void. The business will often need to renegotiate another lease under new terms
- Your lease payments will generally be tax-deductible
- You cannot claim depreciation on the asset during the lease
- You are only renting the asset and there is no guarantee of ownership or the option to purchase at the end
- Can be more expensive than other finance options if maintenance and servicing costs are included in repayments
Operating lease vs finance lease
Operating lease
With an operating lease there is no ownership option. At the end of the lease, you either return the asset to the leasing company, or renew the lease for a new term. During the lease term, the payments cover use of the asset, maintenance and operating costs. You may find operating leases have higher repayments to account for servicing and maintenance.
Finance lease
Finance lease payments only cover the asset itself (allowing you to build up equity in the asset), while running costs for the asset must be covered separately. Because of this you may have lower payments during he lease term. You generally have the option to pay off and own the asset by making a final residual payment.
Whichever option you choose, a lender will buy the asset from on your behalf, and will then rent it to you in exchange for regular payments. In most cases, you’ll be able to get a tax deduction for your lease payments.
How to use an operating lease for your business
Businesses generally use an operating lease for assets that may quickly become obsolete — such as computers and IT equipment — and when it is more beneficial to upgrade the equipment regularly than own it outright.
Operating leases are also used when a business wants to include all costs for asset rental in its regular repayments. Using an operating lease will ensure you aren’t caught out if something malfunctions or needs to be repaired, and offers a more accurate forecast of repayment amounts.
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