Finance leases are a popular product option that can provide significant advantages to businesses. Whether you’re looking to acquire new equipment, vehicles, or other assets, finance leases offer a practical and accessible way to achieve your goals. But how does a finance lease work? And how do you know whether it’s the right commercial financing solution for your business?
In this complete guide to finance leases, we’ll walk you through the definition of finance leases, benefits, drawbacks, and the different types of finance leases available.
How do finance leases work?
At its core, a finance lease is an agreement that allows a business to use an asset for an extended period, typically the asset’s economic life, without bearing the full cost of ownership.
When a business decides to pursue a finance lease, they choose an asset they wish to acquire, which can include anything from machinery to vehicles. In this finance lease example, the business identifies a lessor, such as Metro, to provide the financing. The lessor purchases the asset and leases it to the business for an agreed-upon term.
During the lease term, the business makes regular payments, covering both the asset’s depreciation and the financing cost. At the end of the lease term, the business often has the option to purchase the asset at its residual value or continue leasing a new asset.
Benefits of finance leases
Finance leases offer a range of advantages for businesses, making them an attractive option for acquiring assets. Here are some key finance lease benefits:
- Improve Cash Flow: Finance leases require a lower initial cash outlay compared to an outright purchase, which frees up capital for other business needs.
- Access Latest Equipment: Businesses can more easily acquire the latest and most advanced equipment in their industry without large upfront investments.
- Tax Benefits: In many cases, finance lease payments are tax-deductible, which can provide potential tax advantages for businesses.
Flexible Terms: Finance lease terms can be tailored to match the asset’s expected economic life, ensuring flexibility and suitability for the business.
Finance lease process
Understanding the process of obtaining a finance lease is the first step for businesses considering this financing option. Here’s a step-by-step guide to how finance leases work:
Step 1: Choose an asset
Select the asset you need for your business operations. Assets can be anything from tertiary assets to more substantial investments such as light commercial vehicles, agricultural equipment or yellow goods. It’s crucial to evaluate your business requirements carefully and choose an asset that will enhance your operations and productivity.
Consider the following when selecting your asset:
- Relevance: Ensure that the chosen asset aligns with your business’s goals and needs. It should contribute to improved efficiency and profitability.
Lifecycle: Assess the expected economic life of the asset to determine the most suitable lease term.
Step 2: Find a lessor
Choosing the right lessor is a critical decision in the finance lease process. Look for a lessor with a proven track record in finance leasing and a reputation for reliability and transparency. Metro, for example, is a trusted name in the industry, offering tailored solutions to meet your unique business needs.
When researching and selecting a lessor, consider:
- Reputation: Investigate the lessor’s history, reviews, and customer testimonials to gauge their credibility and trustworthiness.
- Experience: Ensure that the lessor has experience in financing assets similar to the one you’re seeking.
Flexibility: Opt for a lessor who can tailor lease agreements to accommodate your specific business requirements.
Step 3: Negotiate a lease agreement
Once you’ve chosen your asset and selected a reputable lessor, it’s time to negotiate the lease agreement. This is a crucial step where you determine the terms and conditions that will govern your finance lease. Key points to address during negotiations include:
- Lease Period: Agree on the lease’s duration, considering the asset’s expected economic life, your business needs, and budget.
- Payment Schedule: Define the payment structure, including frequency (e.g., monthly or quarterly) and the amount of each instalment. Ensure it aligns with your cash flow.
- Additional Conditions: Discuss any specific conditions or requirements, such as maintenance responsibilities, insurance, or options for asset upgrades.
- Residual Value: Clarify the asset’s residual value at the end of the lease term, which is the amount you may need to pay to acquire the asset if you choose to do so.
Documentation: Review and finalise all necessary documentation, including the lease agreement and any associated paperwork.
Step 4: Make lease payments
Once the lease agreement is in place and all details are settled, it’s time to begin making regular lease payments. These payments typically cover both the depreciation of the asset and the financing cost. Making consistent and on-time payments is essential to ensure the smooth operation of your business.
Step 5: What happens at the end of the lease?
At the end of the lease term, you will have several options to consider:
- Purchase the Asset: You may choose to buy the asset at its residual value, taking full ownership of it.
Continue Leasing: Alternatively, you can opt to continue leasing the same asset if it still suits your business needs, or negotiate a new lease agreement for a different asset.
Accounting and tax implications of finance leases in Australia
Understanding the accounting and tax treatment of finance leases is essential as it can impact your business’s financial statements and tax deductions.
- On-Balance Sheet: Finance leases often require the asset to be recognized on the lessee’s balance sheet. This can affect financial ratios and financial statement presentation.
- Tax Deductions: Lease payments are typically tax-deductible expenses, reducing the lessee’s taxable income and potentially lowering their tax liability.
Is a finance lease not right for you?
While the various types of finance leases offer many advantages, they may not be the best fit for every business, so it’s important to consider any potential finance lease drawbacks. If finance leasing doesn’t align with your needs or circumstances, there are alternative financial products to consider, such as Commercial Loan or Chattel Mortgage (CM), which Metro also offers.
Unlike a Finance Lease, a Commercial Loan gives you ownership right away and you then pay off the loan from the income the asset generates in your business. A Chattel Mortgage, meanwhile, is a financing option that allows you to take ownership of the asset immediately while financing the purchase through a mortgage arrangement.
Where do I start?
If you’re interested in exploring finance leases or other financing options, Metro is here to guide you. Our team of experts can help you assess your business’s specific needs and find the financing solution that best suits your requirements. Contact us today to get started.
