From The Mortgage Experts: The Finances Behind Leasing Explained

Are you a business owner? To manage a successful business, it is important to have all the equipment necessary to provide value for your staff and customers. But not every company starts up with sufficient capital to acquire these materials. Moreover, buying assets for your business can be costly.

Whether it is an office equipment, a new plant, printers or even furniture, buying materials for a business can impact your cash flow or credit lines significantly.

Not too long ago, business owners traditionally applied for a loan at their local bank or financial institution. However, restrictive lending practices and restricted lending in some banks have made borrowing a less attractive option. Today, most businesses, particularly small and medium-sized ones, prefer leasing as a financing solution for asset acquisition.

What is leasing, and how does it work?

A finance lease is a contractual agreement where a leasing company (lessor) buys the business asset needed by the customer (lessee). The lessee then makes a commitment to repay the capital cost of the asset along with accruing interests at a specific rate over a given tenure- it could be monthly, quarterly or annually.

The lessor bears the cost of the equipment and the accompanying VAT, while the lessee pays the VAT on rentals. The lessee can claim VAT on rentals from the revenue, provided they are VAT registered.

Some financial institutions offer leasing arrangement for acquiring business assets. However, it is always important to research interest rates that are suitable for your returns.

Differentiating operating lease from financial lease

A common misunderstanding in asset finance and contract leasing is being able to tell the difference between an operating lease and a financing lease. In general account practices, an operating lease is defined as “any lease other than a finance lease”. This description is hardly sufficient, so we shall explain further for better understanding.

While all the risk and rewards from buying and hiring the equipment is transferred to the lessee (or customer) in a finance lease agreement, the operating lease does not work in this way. It will typically run for less than the full economic life cycle of the equipment and the lessor will expect the equipment to have a resell value at the end of the operating (lease) period.

Essentially, the lessee (customer) can claim ownership of the asset at the end of the finance lease tenure. In an operating lease, it is the lessor (sponsor) who retains ownership of the asset after the agreed term. It is often leased out or sold to someone else.

Why leasing?

Leasing an equipment comes with several advantages. Besides, it is a flexible, cost-efficient way to acquire an equipment without paying the full value at once. Some of the benefits of finance leasing are:

  • Working capital is not locked down in the depreciating assets
  • You get to reserve cash and credit lines for other projects
  • You don’t have to pay the cost of VAT upfront
  • Lease expenses are an acceptable cost against Corporation Tax

If you are planning to get an expensive but necessary equipment, using a finance lease may be a suitable way to begin.