What Are Finance Leases?
A Finance Lease is a type of equipment lease where the customer also known as the lessee, rents an asset for most of the items useful life.
Finance Leases are sometimes known as Capital Leases.
One key feature of Finance Leases is that the customer takes on most of the risks and rewards of ownership [I.E maintenance costs and fluctuations in value], but never actually owns the asset.
What this means in practice, is that a Finance Lease looks and feels a lot like a Hire Purchase, but they’re different on the balance sheet.
How Do Finance Leases Work?
Finance Leases consists of a primary rental period, where the monthly payments will add up to the full cost of the asset plus interest [hence their other name, Capital Leases] Once the primary period is up, the asset will normally be the end of its useful life. At the end of the primary lease period, you will usually have three options:
- Continue to use the asset in a secondary lease period – often with cheaper payments
- Sell the asset and keep a share of income from the sale
- Return the asset to the lessor
Finance Lease Or Hire Purchase?
For many businesses, choosing between a Hire Purchase and a finance lease comes down to financials and accounting. With Hire Purchase you normally have to pay VAT upfront, whereas with a Finance Lease you can spread the cost of VAT over the monthly payments.
An important thing to note about Finance Leases is that the lease period will be for most of the asset’s useful life, so its normally more of a long-term commitment compared to Operating Leases.
Why Choose A Finance Lease?
- Some companies choose hire purchase because the assets show on their balance sheet
- Others would prefer to show an asset as an operating cost and offset rentals against their profit, and so a finance lease would be the better option