Operating lease

An operating lease is a type of equipment lease where your business (the lessee) rents an asset for only a fraction of the item’s useful life. Contract hire is a specialised form of operating lease. It refers exclusively to the leasing of vehicles and is therefore often called vehicle asset finance.

An operating lease is designed for businesses that want to rent an asset for the short (or medium) term. It’s the simplest form of equipment lease. Your business doesn’t take on the risks and rewards of owning the asset (i.e. maintenance costs, insurance costs and fluctuations in value) – this is in contrast to a finance lease.

Another advantage of an operating lease is that you can upgrade regularly because of the short lease terms. You might even be able to upgrade during a lease term (at no cost to your business), even with a short-term agreement.

An operating lease gives you the same tax advantages as a finance lease. The asset is seen as a rental expense – i.e. an operating cost – so it doesn’t appear on the balance sheet like it would with, for example, hire purchase. You can therefore offset payments against profit.

An operating lease may work out cheaper than a finance lease because your base rental costs are calculated using the value of the asset over the agreed lease period. The lessor would expect the asset to have a resale value at the end of the lease period, i.e. the residual value. This is because operating leases are usually taken out for assets like aircraft, vehicles and construction plant and machinery, all of which will have a residual value. Your rental payments therefore wouldn’t cover the full cost of the asset, unlike with a finance lease.

If you’re in the business of leasing vehicles in particular, you might want to look at contract hire. The difference between a finance lease and a contract hire agreement is that, at the end of the agreement, the payments you’ve made as part of your contract hire agreement will count towards the purchase of the equipment.