Operating Lease Solutions
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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.
Operating lease details
| Feature | Details |
|---|---|
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 |
Upgrade options | Yes |
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. |
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
The main difference between an operating lease and a finance lease is what happens when the lease term ends. With a finance lease you generally have the option to pay off and own the asset by making a final residual payment. 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.
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.
However, operating and finance leases differ in terms of what the lease payments are covering. Finance lease payments only cover the asset itself (allowing you to build up equity in the asset), whereas with an operating lease 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.
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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Operating lease frequently asked questions
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Can I break an operating lease before the end of the term?
Generally you have more flexibility to end your lease prematurely with an operating lease compared to a finance lease. However, there may still be break costs on an operating lease if you terminate the agreement early.
What business assets can I lease?
An operating lease can be used for more or less any type of business asset or equipment. However, most commonly it's used for relatively low value, short-term assets, such as IT equipment, furniture and specialist tools.
Can I modify the equipment?
Any modifications would need to be made prior to the lease starting. The cost of the modifications will typically be factored into the lease repayments.
What is the difference between an operating lease and a finance lease?
Primarily the difference between the two types of lease are what will happen at the end of the lease term. With an operating lease, you will either return the rented equipment, or negotiate new terms with your lender at the end of your existing loan contract.
What is an example of an operating lease?
One of the most popular examples of an operating lease is in acquiring IT assets, such as laptops or cellphones. These are often financed through an operating lease as doing so allows the borrower to upgrade the equipment throughout the term.
What happens at the end of an operating lease?
At the end of an operating lease, you will generally return the asset to the lender, who may then lease the assets to another business. This is one of the clear benefits of an operating lease, where there is no responsibility of the borrower to maintain ownership or dispose of the asset at the end of the lease term.
Is a car lease an operating lease?
You may be able to acquire a vehicle through an operating lease. However, it's generally more common for businesses to purchase vehicles and finance them through a secured loan known as a chattel mortgage. This still offers flexibility at the end of the finance term.
Written by
Loans Expert
Shaun McGowan
Reviewed by
Editor
Sean Callery
