Asset Financing: Leasing on Loans
Asset leasing provides unique alternatives to traditional financing for companies to obtain the necessary equipment for their operations. The lease of assets 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, simplify 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 like car or apartment leases, in that the lease payments are made for a set term outlined in the contract. The company does not include the equipment as an asset on its balance sheet, in the same way that a tenant cannot list their apartment as their 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 is over, and use assets for projects they normally can’t do. For example, a real estate company may use a two-year operating lease for copiers. At the end of the term, the company would not have to worry about remarketing and selling the used copiers, they can simply be traded in for new machines. This also avoids the need for increased maintenance costs as equipment ages, as sometimes maintenance/warranty costs can be included in lease payments.
Using an operating lease can help a small or start-up business get what it needs to undertake larger projects and hopefully increase revenue. A construction company may choose this to win a bid on a large job, instead of possibly 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 a portion 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 payment 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 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 the tangible assets that the business can continue to use or sell for cash.
These leases can include special financing options to further help businesses obtain the assets needed to generate income while keeping costs and overhead low. Financing programs, such as 90-day deferred or 90-day equal cash, will give a business the option to use equipment and generate income for three months before lease payments start; or an alternate 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 in order 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 payment/interest expense until a later time.
It’s not entirely uncommon to have a nearly customizable payment option on a capital lease. These options are used for specific industries that may experience large changes in revenue over the course of a year, such as seasonal businesses. These options may allow for a lower payment, or even no payment, during down periods of a season and the continuation of regular amounts beginning at a particular time of year.
