Asset leasing provides unique alternatives to traditional financing for businesses to obtain the equipment necessary for their operations. Asset leasing is done as an operating lease or a capital lease. Each option has its own effect on the company’s balance sheet, but both give the company additional options to finance the assets needed to expand its business, streamline processes and generate revenue. In general, financing with a lease is much easier and faster than financing a traditional loan through a bank.
Operating leases are agreements for the use of assets and do not give the business entity any ownership rights. Operating leases are more akin to car or apartment leases, in which lease payments are made for a set term outlined in the contract. The company does not list the equipment as an asset on its balance sheet, in the same way that a tenant cannot list his apartment as his own property.
The benefits of an operating lease are that it can allow businesses to save money on maintenance costs, get new equipment after the term expires, and use assets for projects they normally can’t do. For example, a real estate company may use an operating lease for photocopiers for a period of two years. At the end of the term, the company would not have to worry about remarketing and selling the used copiers, they can simply be exchanged for new machines. This also avoids the need to increase maintenance costs as equipment ages, as maintenance/warranty costs can sometimes be included in lease payments.
Using an operating lease can help a small or new business get what it needs to take on larger projects and hopefully increase revenue. A construction company may choose this to win a bid on a large job, rather than potentially spending tens of thousands of dollars on heavy equipment that can only be used for that particular project. A business could use a short-term lease (perhaps a year) for the equipment needed to complete the job, while paying only part of the cost of that machinery.
Capital leases are sometimes called finance leases because they give a business the same ownership rights as financing with a traditional bank loan. The equipment obtained through the lease is recorded as an asset of the company and the balance of the lease is reported as a liability. A key benefit of capital leases is that they are easier to obtain than traditional loans and have a variety of repayment options. This allows small or new businesses, with little or no credit, to obtain financing that may not be available to them through traditional means and flexibility in repayment options. Apart from being recorded on the balance sheet, capital leases differ from operating leases in that they typically have longer lease terms.
Capital leases allow businesses with weak credit or no credit to increase their business credit while obtaining the assets needed to expand operations and increase revenue. At the end of the lease term, the business would have ownership rights to tangible assets that the business can continue to use or sell for cash.
These leases may include special financing options to further help businesses obtain the assets needed to generate revenue while keeping costs and overhead low. Financing programs, such as 90 days deferred or 90 days equal to cash, will give a business the option to use equipment and generate income for three months before lease payments start; or an alternative option to purchase the equipment outright and avoid finance charges if capital is available.
Another financing option is the use of residual payments, or balloon payments, that are due at the end of the lease term for the entity to own the asset. The residual option allows for lower monthly payments over the lease term, making the asset more affordable and therefore deferring the full cost of the interest payment/expense until a later time.
It’s not entirely uncommon to have an almost customizable payment option on a capital lease. These options are used for specific industries that can experience large swings in revenue over the course of a year, such as seasonal businesses. These options may allow a lower payment, or even no payment, during off periods of a season and continuation of regular amounts beginning at a particular time of year.