Finance lease

A finance lease is a type of equipment lease where your business (the lessee or hirer) rents an asset for an agreed period of time from a leasing company (the lessor or owner). The leasing company effectively buys the asset for you and rents it back to you for an agreed period. Finance leases are also known as capital leases.

A finance lease is a type of asset finance. Your business (the lessee) takes on most of the risks and rewards of ownership of an asset (i.e. maintenance costs, insurance costs and fluctuations in value) but you never actually own the asset. A finance lease therefore looks a lot like hire purchase, but it’s treated differently for accounting and finance purposes. This is the main reason you might pick one over the other. Put simply, with hire purchase the asset shows up on your balance sheet whereas with a finances lease the asset is treated as an operating cost.

A finance lease consists of a primary rental period, where you pay monthly payments until you’ve paid for the full cost of the asset plus interest (hence the term capital lease).

At the end of the primary lease period, the asset will most likely be near the end of its useful life. You can then choose one of three options:

• continue to use the asset during a secondary lease period (often with much cheaper payments and for an indefinite period)
• sell the asset to a third party, acting on behalf of the lessor (and take a majority of the sale proceeds)
• return the asset to the lessor.

You might also consider an operating lease (including contract hire) or hire purchase.