Most equipment leases that are put into place for Canadian based businesses are capital leases.
A capital lease is based on the commitment of the lessee to purchase the equipment at the end of the lease period for a nominal, pre-established price. The opposite to the capital lease is the operating lease where the lessee does not have an obligation to purchase at the end of the lease term. There are several variations around these two lease structures, but the underlying equipment lease would either be capital or operating by for accounting and taxation purposes.
Because the lessor doesn’t have any asset disposal risk at the end of the leasing period, the capital lease options will have lower effective costs of financing as compared to an operating lease for the same basic financing request. The smaller the projected resale value for the asset, the higher the effective cost of financing.
Capital leasing programs act very similar to an equipment loan in that they provide an amortized payment over the term of financing and at the end of the lease the borrower or lessee will own the asset. Because of this similarity, the accounting process for capital leases is comparable to what is required with an equipment loan.
Probably the biggest difference between a capital lease and an equipment loan is the amount of leverage that is available to the business owner seeking financing. In many cases, a capital lease can effectively be for 100% financing and can include installation and delivery costs as well as the cost of the asset where the lessee only has to provide one or two installment payments in advance.
From a lessor point of view, there are many leasing companies that only have capital leasing programs as they are not set up or prepared to deal with the higher amount of equipment reselling activity required with operating leases. Operating leases are also more suited to certain types of assets than others, which also factors into the capital versus operating lease decision process.
The situations where operating leases are more common is where the business owner estimates that the higher cost of financing offsets the long term maintenance costs associated with owning the equipment after the lease term. Operating leases make sense for equipment that undergo heavy use and depreciate quickly as a result, which also leads to more frequent replacement. Because the equipment can be returned at the end of the operating lease, equipment gets replaced more frequently, reducing the chances of large maintenance and repair bills.
In order to determine which equipment leasing structure makes the most sense for your equipment acquisition and your business overall, you should consider working with an equipment leasing specialist to go over all your options and help you decide the best course of action to take.
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Equipment lease financing has become the financing vehicle of choice for many business owners in several countries.
Gone are the days when traditional equipment loans were the primary lending choice. Equipment loans are provided in large numbers, but they tend to be reserved for the best lending profiles of the most patient of business owners.
There are a number of reasons for the exponential growth of equipment leasing which is expected to continue into the foreseeable future.
First, because there is such a large and diverse spectrum of equipment being sold every day, the opportunity exists for lender (or lessor) specialization by asset type, credit rating, industry, geography, and so on. Through specialization, more equipment leasing companies can exist in the market without excessive competition developing. This creates more credit availability and more choice to borrowers.
Second, more specialized leasing companies leads to more streamlined application processes. Lessors that are familiar with certain asset types and the related industries that utilize them process and generate approvals or declines faster than traditional lenders.
Third, lease companies can manage risk more effectively not only through ownership of the underlying assets being leased, but through built up relationships and investments in companies that can accurately valuate the equipment resale market and quickly liquidate inventory as required.
Fourth, equipment lease financing tends to provide some of the highest leverage of any type of business financing available today. In many cases, 100% financing is achievable for companies with decent credit and once a lessee has a strong reputation with a leasing company, higher leverage becomes easier to obtain as well.
Fifth, during a business life cycle, a business entity can go through start up, new business status, growth, distress, decline, and so on. Each of these states can result in different credit profiles that can make it more difficult to acquire financing. With lease financing, the degree of specialization that exists covers off most of these business stages in most industries, providing financing options when and where its required. Higher risk situations will carry higher costs of financing and tighter terms of repayment, but that’s going to expected. The key is knowing that regardless of the stage of development or bump in the road, there is likely going to be a source of credit to draw from for equipment financing.
Sixth, after frustration with a traditional banking process that can take too long and can be difficult to predict, business owners that turn to equipment lease financing many times do not go back to their historical banking sources for equipment loans.