Does an Operating Lease Make Sense For My Business?

By Mike Elton

An operating lease is a financing agreement where the term of the lease is shorter than the actual useful life of the equipment. For example, an airplane with an economic life of 25 years may be leased to an airline for five years on an operating lease. In business, operating leases are most commonly used to allow the business the use of equipment on a relatively short-term basis.

The determination of whether a lease is a finance (also called capital) lease or an operating lease is defined in the United States by Statement of Financial Accounting Standards No. 13 (FAS 13).

Operating leases can be more expensive than standard financing or leasing, since the lessor leases the equipment to the business for a fixed monthly amount, and also assumes the residual value risk of the equipment. One example of this in the consumer market is car leases. The consumer gets use of the vehicle for a specific time period, but at the end of the lease, must either return the vehicle to the dealer or assume a new lease.

Deciding whether a lease makes sense for your business depends on your firm's circumstances at the time you're making the decision. A few questions to ask yourself include how much you want to spend, how healthy is your cash flow, how long do you need the equipment, your history in caring for equipment, and what impact the lease will have on your taxes. Your accountant can help you determine if an operating lease has a financial benefit to your company.

An operating lease is most beneficial to companies when:

1. Equipment will not be used long-term. It doesn't make sense to make a large cash outlay for equipment that will only be used for a short period of time.
2. Your equipment will become outdated quickly. If technological advances in your industry tend to make your equipment obsolete every few years, a short term lease can help you stay up to date.
3. Cash flow is tight. With a lease, you avoid a hefty up-front charge, and you can make payments as you generate cash flow with your new equipment.
4. You want to protect your balance sheet. An equipment purchase is recorded in your balance sheet, which increase your debt and reduces your available cash. In contrast, most leases are not recorded as debt, and are treated as an operating expense.

You want the tax benefits of leasing. A lease may allow you to deduct your payments as operating expenses during the period in which you pay them. If you purchase equipment, you may be able to deduct the interest, as well as the cost of the depreciation. Consult your tax advisor for which situation is most advantageous for your business.

An operating lease may not be for everyone, however. Some things to keep in mind are:

1. You are tied into payments for the length of the lease. A lease is a commitment to making the payments for the length of the contract.
2. You won't build up equity.Buying something outright will give you equity. Just make sure that older equipment will still provide value for your business.
3. With leasing, you may pay more over the long term. Lease payments include taxes, insurance and risk premiums, since the lessor is assuming the risk for the purchase.

Mike Elton is the Vice President of Sales for Advantage Leasing Corporation. Advantage Leasing is an equipment leasing company in Milwaukee, Wisconsin lending to business customers throughout the United States with financing needs valued between $5,000 and $200,000.

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