Broadgate Corporate Finance Blog

Operating Lease vs. Capital Lease

Operating Lease vs. Capital Lease

If your business ever decides to lease equipment, you will face the questions of
"What is the difference between an operating and a capital lease?" and "Which option is right for me?" The differences involve several areas including accounting treatment, company credit, useful life of the equipment, and obsolesense. These differences you should consider when looking at equipment leasing options.

Operating Lease:

• You are essentially renting the equipment and will return it at the end of the lease. This can be good or bad. For example, if equipment doesn't age much in your industry you at somewhat of a disadvantage, however, if you are in an industry (let's say networking hardward), this is great because you don't get stuck with equipment that is obsolete.
• For accounting purposes, this lease is a pure expense. It's only place is on the income statement and it has no bearing on your debt-to-worth ratios or other balance sheet ratios that can effect business credit.
• In the long run, you usually pay more than if you could have obtained the equipment with a capital lease or a loan, but in the short-run (when you are cashed pinched) it can be a life saver.

Capital Lease:

• You are essentially making payments to own whatever equipment you are leasing. At the end of the term, you will usually pay a nominal amount (like $1) to obtain ownership of the equipment.
• For accounting purposes, you must capitalize the lease on the balance sheet (ergo capital lease). It will effect your long-term liabilities and assets such as bank loan would.
• Despite that it capitalizes like a typical term loan, capital leases are usually easier to obtain and consume less initial capital than a typical bank term loan.

posted by Michael Anders @ 5:33 PM