What is a Finance Lease?

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Finance Lease

Finance Lease – Everything You Need to Know

Many businesses require expensive assets to produce the products and services that they wish to sell. These assets are usually heavy machinery, expensive plant and vehicles. These assets are at the core of their business, without which the business simply cannot function. However, investing in big-ticket items may create cash flow problems, or it is just impossible for some companies to spend a huge sum all at once. Fortunately, there are some financial products, such as a finance lease, which enables businesses to secure the equipment they need at a low interim cost.

What is Finance Lease?

A finance lease offers a quick, flexible and affordable way to give your company the asset it requires without creating financial burden. A finance lease or capital lease or sales lease is a financial product, in which a bridging finance Liverpool company purchases and owns an asset, while giving operating control of an asset to an enterprise or business for a definite period. In this legal contract, the finance institution that buys the asset is called the lessor, and the business that rents and uses the asset is called the lessee.

When the operating control is given to the lessee, they are responsible for all the rewards and risks that may come along with the ownership of the asset. The lessee needs to show the asset as a fixed asset in their account book, and the lessee will record the payable interest of the lease as an expense. At the end of the contract, the lessee will have the option to purchase the asset for a pre-agreed amount.

A finance lease makes it easy for the business to use the asset for a lower monthly payment and spread the cost over time if they wish to purchase the asset at the end of the term.

How a Finance Lease Works?

A finance lease is a critical commercial rental agreement, which goes through the following steps:

  1. The customer or the lessee chooses the asset they need for their business.
  2. The finance company or the lessor purchases the asset.
  3. The lessor and lessee will sign a legal contract that mentions that the lessee will use the asset for the specified period and make a number of payments for the use of the asset.
  4. The lessor will recover the cost of the asset along with interest by receiving monthly payments from the lessee.
  5. At the end of the agreement, the lessee has the choice to take ownership of the asset after all payments have been cleared.

The expenses associated with bridging finance solutions will be divided into capital value and interest payments. Part of the payments will be recorded under operating cash flow, while the other part will be recorded under financing cash flow. Since the finance lease is being capitalised, the company’s assets and liabilities will increase in the balance sheet, while the working capital will remain the same.

What Makes Leasing Different from Financing?

If you need funds to buy products or improve operational efficiency of your business, but you don’t want to risk cash flow or don’t have adequate funds in hands, there are plenty of financing options available. Finance essentially means funding, which comes in the form of mortgage loans, bridging finance London and many more. Usually, a bank or private lender will give you the funds to buy assets to grow your business, and you are required to make monthly interest payments.

However, leasing is different. The leasing company doesn’t lend you money, but provide you with the assets you need to continue your business operations. The assets are not yours, but you can use it as if it was yours during the leasing agreement. When the contract ends and all the outstanding payments have been made, then you have the option to become the legal owner of the assets.

Pros and Cons of a Finance Lease

Finance lease offers several advantages and disadvantages to a company when the cost of the asset, liabilities and accounting are considered.

Pros:

  • It enables a business to use a required asset without purchasing it.
  • It makes cash flow management easier as no big upfront cost is required to purchase new assets.
  • The lessee can spread the cost over several months or years and pay a fixed monthly price, which will not rise even if the price of the asset or bank interest rates rise.
  • A very low deposit is required, which is almost equal to the first month’s lease payment.
  • Companies can claim up to 100% of the VAT on commercial vehicles and 50% of the VAT on cars.
  • The lessee holds the right to buy the asset after the lease contract ends, which could be at a bargain price.
  • Although the lessee doesn’t basically own the asset, they can still get up to 98% of sales proceeds if the leasing company sells assets to a third-party at the end of the term.

Cons:

  • The lessee cannot cancel a finance lease once the sign contract with the lessor.
  • The lessee is liable to pay all the maintenance and repairs of the asset.
  • The lessee is responsible for all the risks associated with the asset.
  • There could be usage limitations, such as a mileage cap, which causes the lessee to pay an additional amount at the end of the contract.
  • If the lessee defaults on the payment, the asset can be seized by the lessor.

Examples of Finance Lease

Finance lease has found its place in a range of industries and it is primarily used by companies looking to buy expensive equipment, but don’t want to disrupt their cash flow by paying a large sum of money for the required equipment.

Some assets that can be leased through finance lease are:

  • Land
  • Building
  • Aircraft
  • Ships
  • Vans
  • Heavy equipment
  • Industrial plants
  • Patents

The great thing about a finance lease is you have full use of the asset, but it is not recorded in your balance sheet. A finance lease is a win-win situation for a lessee as it allows them to make smaller payments for the asset and purchase the asset at the end of the term.