When purchasing equipment, or perhaps a business vehicle, it’s important to understand the difference in lease options. Not all equipment should be purchased! Leasing can be a smart option for the small business owner. Don’t think so? Fortune 500 companies do it. Why shouldn’t you?!
Let me explain the difference between the two lease types.
An operating Lease is a contract that allows for the use of an asset, but does not convey rights of ownership of the asset. Meaning, you don’t really own the asset you are leasing. An operating lease is not capitalized; it is accounted for as a rental expense in what is known as “off balance sheet financing.” For the lessee, you are able to expense the full amount of the payment, but not depreciate the asset (because it’s not your asset). For the lessor, the asset being leased is accounted for as an asset and is depreciated as such. Operating leases have tax incentives and do not result in assets or liabilities being recorded on the lessee’s balance sheet, which can improve the lessee’s financial ratios.
Have you heard of the Debt to Equity Ratio? It’s an important ratio banks look at as well as Venture Capital firm when looking to acquire companies. Operating lease payments are on the Profit and Loss, not the Balance Sheet. This improves this important ratio.
A Capital Lease is Capital lease is a lease agreement in which the lessor agrees to transfer the ownership rights to the lessee after the completion of the lease period. Capital or finance leases are long term and non cancelable in nature. You may have heard the term “Dollar Buyout Lease”. This refers to the $1 buyout amount at the end of the Capital Lease when the transfer of ownership occurs. Savvy companies will use a capital lease to expense the payments and then structure the payment amount to where they only owe $1 at the end of the lease term.
Contact us to learn how we can help you determine the right lease for your business needs.