The term ””finance lease” refers to a long-term arrangement in which the lessee (the owner of an asset that is leased or rented) acquires ownership of the asset. A finance lease is a commercial lease in which the lessee receives almost all of the risks and rewards of fixed asset ownership. In a finance lease, the lessee can purchase the asset for a price less than the asset’s fair market value.
Let’s look at an example to better understand finance lease. Suppose there are two people, A and B. Person A purchased a new car, and after some days, B asks him to rent the car for five years (finance lease). The following will be the terms of the finance lease: The term will be decided as the useful life span of the asset, say five years,
Then the rental amount will be decided, and all the risk/profit will belong to person B. (The damages, insurance, etc. in this instance) Person B pays the rental amount; at the end of the lease period, he can pay a balloon payment and keep the vehicle.Difference Between Finance Lease and Operating Lease
The main difference between finance lease and operating lease is that a finance lease is a long-term concept in which the ownership of the asset is transferred to the lessee (owner of an asset that is leased or rented). On the other hand, an operating lease is a short-term concept in which the ownership of the asset is not transferred and remains with the lessor (legal owner of the asset).
Understanding the distinction between financial lease and operating lease is crucial for businesses seeking to acquire assets through leasing. These two leasing options have distinct advantages and drawbacks, influencing operational and financial strategies. A finance lease entails lessees assuming near-ownership responsibilities, while an operating lease provides more flexibility and less long-term commitment. Businesses can choose the best leasing arrangement based on their specific requirements, financial goals, and risk tolerance by examining these differences.
