Leasing equipment is a popular way for small businesses to acquire the assets they need to operate without purchasing these items upfront. While this can be a cost-effective strategy to foster growth, it’s important to understand all the details and options available before entering into a lease agreement.
The differences between capital and operating leases can be confusing but nonetheless it’s important to know the different nuances involved to help you make the right choice for your business.
Below, we’ll outline the differences between a capital and operating lease, along with the benefits associated with each. If you still aren’t sure if one of these options is best, you can consult with an experienced lender like Team Financial Group to help determine your next step.
Many Businesses Take Advantage of Both Types of Leases
There are a number of key differences to note if your business is trying to determine if it wants to use either an operating lease or a capital lease.
Operating leases
Operating leases are similar to renting, with lease payments treated as operating expenses. Lessees can obtain and use assets for a set period of time, but there is no transfer of ownership rights. Common assets for operating leases include technology, vehicles, and office equipment.
Capital leases
Compared to operating leases, a capital lease are treated more like a loan and would be considered debt. Assets are owned by the lessee rather than the lessor and typically are used for equipment that will be kept long term. To be classified as a capital lease, these conditions must be met:
- A transfer of ownership at the end of the lease period
- A bargain purchase option for the asset at the end of the lease term
- The lease is equal to or greater than 75% of the estimated useful life of the asset
- The present value of the lease payments is greater than or equal to 90% of the asset’s fair market value
The accounting treatment between an operating lease and capital lease is also handles differently. For operating leases:
- Payments are considered operational expenses
- Assets are not reported on the balance sheet
- Depreciation cannot be claimed on leased assets
For capital leases, which sometimes are referred to as “finance leases”:
- Interest payments are considered operating expenses
- Assets are included on the balance sheet with loan amounts included as a liability
- Depreciation can be claimed on assets
Depending on your equipment requirements, your business may choose either an operating or a capital lease — or maybe even a combination, depending on the types of assets you need.
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Which lease is right for your business? Well, it depends.
There are a number of benefits associated with both operating and capital leases that might influence the decision-making process for your business.
Here are some of the advantages of using an operating lease:
- You’ll have more cash flow flexibility to update or replace equipment because payments are typically lower than capital leases.
- Since you have an option to return assets after a set period of time, the risk of obsolescence is greatly reduced.
- Accounting is frequently easier because leased items don’t need to be included on your company’s balance sheet.
- Lease payments are tax deductible.
Meanwhile, the benefits of a capital lease include:
- You can claim depreciation, which helps reduce taxable income.
- Interest expenses can also reduce taxable income.
- Opportunities to include 100% of the purchase price into the financing.
- Allows you to spread the purchase out into payments rather than paying a lump sum up front
Here’s an example that might resonate: You could use an operating lease for a copier or other technology for your office, while a capital lease may make more sense for a bulldozer or telehandler if you are in the construction industry. Ultimately, the decision is very unique to your business and all considerations need to be taken into account when determining which is best for you.
Related: Purchasing Used Equipment? Use This Checklist Before You Buy
Contact Team Financial Group to Learn About Your Equipment Financing Options
Need assistance determining which type of financing lease option makes the most sense for your business? We can help you learn more about a capital vs. operating lease and determine if one is right for you. We also specialize in offering fast and flexible equipment financing for a wide range of small businesses.
Call Team Financial Group today at 616-735-2393 or fill out our contact form to talk with a financing expert. If you’re ready to apply for financing, fill out our short online application and we’ll get the process started.
The content provided here is for informational purposes only. For personalized financial advice, please contact our commercial financing experts.