Asset Financing: Leasing Over Loans
Asset leasing provides unique alternatives over traditional financing for businesses to obtain the necessary equipment for their operations. Asset leasing is done either as an operating lease or a capital lease. Each option has its own effect on the company’s balance sheet, but both give a business extra options to finance assets needed to expand their business, simplify processes, and generate revenues. Typically, financing with a lease agreement is much easier and faster to do than traditional loan financing through a bank.
Operating leases are agreements for the use of assets and do not allow the business entity any rights of ownership. Operating leases are most like automobile or apartment leases, where the lease payments are made for a set term described in the agreement. The company does not list the equipment as an asset on its balance sheet, the same way 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, obtain new equipment after term expiration, and use assets for projects that they may not typically be able to do. For example, a real estate firm may use an operating lease for copy machines on a two year term. At the end of the term, the firm would not have to worry about re-marketing and selling the used copiers, they can simply be traded up for new machines. This also avoids the need for increasing maintenance costs as equipment ages, as sometimes maintenance/warranty costs can be included in the lease payments.
The use of an operating lease can help a small or new company get what they need in order to take on bigger projects and hopefully grow revenue. A construction company may choose this in order to win a bid on a large job, rather than spending possibly tens of thousands dollars for heavy equipment that may only be used for that one particular project. A firm could use a short-term lease (perhaps one year) for equipment needed to complete the work, while only paying a portion of the cost of that machinery.
Capital leases are sometimes called financing leases because they give a company the same rights to ownership as financing with a traditional bank loan. The equipment obtained through the lease is recorded as a company asset and the lease balance is reported as a liability. A key benefit of capital leases are that they are easier to obtain than traditional loans and have a variety of payment options. This allows for small or start-up businesses, with little to no credit, to obtain financing that may not be available to them through traditional means and flexibility in pay back options. Other than their recording on the balance sheet, capital leases differ from operating leases in that they typically have longer lease terms.
Capital leases allow firms with weak or no credit to build up their business credit while obtaining assets necessary to expand operations and increase revenue. At the end of the lease term, the business would have ownership rights to tangible assets that can continue to be used by the business or sold in order to gain cash.
These leases may include special finance options to further help businesses gain assets needed to generate revenue while keeping overall costs and expenses low. Financing programs, such as 90 days deferred or 90 days same-as-cash, will give a business the option to use equipment and generate revenue for three months prior to the start of lease payments; or an alternate option to purchase the equipment outright and avoid finance charges if capital becomes available.
Another finance option is the use of residuals, 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 for the lease term, making the asset more affordable, and thus deferring the full cost of payment/interest expenses until a later time.
It is not completely uncommon to have an almost customizable payment option on a capital lease. These options are used for specific industries that may see large swings in revenue over the course of a year, such as seasonal businesses. These options may allow for lower, or even no payment, during down times of a season and continuation of regular amounts starting at a particular time of the year.