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Tata Capital > Blog > Equipment Lease > Operating lease vs financial lease: everything you need to know

Equipment Lease

Operating lease vs financial lease: everything you need to know

Operating lease vs financial lease: everything you need to know

You want to scale your business, and your company plans to expand its production facilities. But you are not too sure about the market demand and economic viability of investing in a new production unit. Or you want to buy equipment without disturbing your cash flow or taking a loan. 

Leasing would be the ideal solution in such circumstances because there are many leasing structures to suit the different needs of emerging businesses.

Scenario 1:

You could take manufacturing equipment on lease. You pay the lessor a certain amount for a short period based on a lease agreement/contract. At the end of the specified period, the ownership of the equipment remains with the lessor.

Scenario 2:

You could opt to pay for using manufacturing equipment for an extended period by signing a lease agreement/contract. However, at the end of the specified period, you can buy the equipment at a price lower than the actual market value. 

These two scenarios illustrate two different leasing options – Operating lease and Capital or Finance lease. 

Which one is right for you? Read on to find out.

Operating lease

When you sign a rent agreement/contract to lease an asset, you agree to pay lease rentals for the lease tenure. Generally, the lease period is lesser than the utilisable period of the asset. It is also known as a Service lease.

Wet vs Dry Operating lease

There are two different kinds of operating leases. In a wet lease, the lessor provides essential operating services such as personnel, insurance and maintenance services along with leasing. In contrast, only the equipment is leased out in cases of a dry lease. 

Tata Capital offers equipment on lease in sectors like healthcare, medical technology, vehicles, etc. Avail of the best offers that will enable you to scale your business without burdening stressed capital reserves.

Additional Read – How can health care centres scale their businesses through Equipment leasing?

Advantages of Operating Lease

In this sort of arrangement, tax deductions are allowed on rent payments. The lessor bears maintenance and repair costs. Though there is no asset ownership, the lessee can upgrade or replace the asset to the latest model if so desired on the expiry of the lease.

Leasing equipment is prudent since companies won’t get stuck with outdated equipment. More importantly, the cash flow remains unstressed and smooth. 

However, you must keep in mind that the leased asset does not add to the company's equity. Since its ownership reverts to the lessor at the end of the term, it remains off the balance sheet.

Capital or Financing Lease

When a lease is taken based on a long-term loan agreement/contract, you have an opportunity to buy the asset at the end of the specified time at a mutually agreed fair price. Lessors cannot generally cancel such leases, and the asset cannot be sub-leased to third parties. The risks, maintenance and insurance are to be handled by the lessee.

operating lease vs financial lease

Types of Capital lease

Direct Lease

As the name suggests, the manufacturer of the asset or leasing firms lease the asset directly to the lessee.

Sale and Lease Back 

In this arrangement, an asset is sold by a firm A to a lessor B. Lessor B, in turn, leases the asset back to firm A that had sold the said asset. Insurance companies and finance companies commonly utilise this type of lease. The lessee, firm A, earns money from the sale while continuing to use the asset sold.

Leverage Lease

Tata Capital offers this popular option to its customers, wherein the lessor borrows money from a lending partner to buy the asset. Then the lessor leases the said asset to a lessee who pays the lease rental. The lessor repays the loan to the lending partner.

Heavy equipment integral to businesses such as industrial ovens, machines for agricultural use etc., often requires considerable capital investment. Companies can invest in such equipment without worrying about limited capital to fund it upfront with a leverage lease.

Lending institutions like Tata Capital support entrepreneurs, especially in the post-Covid slump, through equipment financing in line with this type of lease.

Additional Read – 5 things to consider before leasing a car

Advantages of Financing Lease

The Financing Lease is advantageous as the lessee becomes the asset owner at a bargain price. Lessors can claim depreciation of the asset and reduce taxable income. Businesses can also improve tax savings as lease rentals and interest paid is accounted as an expenditure. 

However, it is essential to remember that since it is a loan agreement against the asset, if there are glitches in paying interest, a credit score is affected negatively. In a worst-case scenario, non-payment could lead to repossession of the asset. There is also the risk of the leased asset becoming obsolete due to technological leaps, resulting in the lessee getting stuck with an outdated asset. 

Making informed choices

A lease could give a new lease of life to your business, but you have to make an informed choice regarding the type of lease. Experts at Tata Capital corporate will help you arrive at a prudent decision, considering your requirement and convenience. Reach out to us to know more. 

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