Types of Equipment Leases: Definition, And Explanation of 3 Types

Overview:

Capital Expenditures are important for the growth and expansion of the company. They require considerable planning, and resources that need to be utilized.

Organizations need to ensure that they are able to finance this particular capital expenditure with relative ease.

Given that companies do not always have sufficient resources to finance these operations internally, they need to arrange for this equipment using an alternate strategy.

The best course of action in this regard is mainly leasing equipment for the company.

Definition of Equipment Lease

An equipment lease can be defined as a contract that is signed between two parties (the owner of the asset, and the user of the asset), to give the right to the user to utilize the asset for a specific time period, against a fixed amount as a return to the owner of the asset.

Equipment leases allow companies to procure their respective assets without worrying about arranging an upfront payment to finance the respective equipment cost.

In typical lease contracts, there are two parties involved: the user of the asset and the owner of the asset.

In exchange for using the asset, the owner gets a certain return, which is basically his incentive to invest in the particular capital asset, on behalf of the company.

There are two main equipment leases: Operating Leases and Capital Leases. Other subcategories of equipment leases include Lease Back Agreement and Trac Lease.

Types of Equipment Lease

1) Operating Lease

Operating Lease is perhaps the most popular category of equipment lease. It allows the user of the asset to utilize it for a time period shorter than the asset’s life.

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These leases are relatively short-term and mostly expire within a window of 12 months. For an equipment lease, examples of Operating Lease might include transportation vehicles, cold stores, and machinery for order fulfillment.

Under the contract signed under an operating lease, the owner gives the right to the asset user to use the asset for the agreed-upon.

During this timeline, the ownership of the asset tends to remain with the owner of the asset.

In this regard, it is also important to highlight the fact that the asset’s legal ownership stays with the asset’s owner. The ownership is not transferred, regardless of the user having physical possession of the asset.

The user can cancel equipment extended for usage under Operating Lease Agreement at any given time.

2) Capital Lease

Capital Leases, unlike Operating Leases, are relatively long-term in nature. They are mainly used for equipment that is high-value and is used for a considerable time frame.

In the case of a Capital Lease, the ownership of the asset is also transferred to the user of the asset.

After the end of the lease period, the lessee (user of the asset) also has the option to buy the asset.

Therefore, a lease in this regard is considered a loan that is extended to the lessee, against the equipment purchased.

Examples of equipment that usually involves capital leases include heavy machinery, ship, and plant purchase. It is also represented as a loan (Long Term Liability in the Financial Statements of the agreement.

3) Lease Back Agreement

A lease Back agreement constitutes the use of an asset leasing back the asset from the buyer of the asset.

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Therefore, in this type of lease, it can be seen that the seller of the asset becomes the lessee, whereas the buyer of the asset becomes the lessor.

Companies mostly do this when they need cash to finance their expenses, and they need to use the equipment too.

Therefore, it is considered a highly useful resource when a company has an asset that can be sold, in exchange for cash.

The contingency in this regard is simply the fact that there is a need to ensure that companies have assets that can be presented for sale.

In the same manner, they should also have a buyer who is interested in agreeing.

Conclusion

Hence, it can be seen that equipment leases can be regarded as an extremely viable resource that can help companies to carry out capital expenditures without having to worry too much about financing.

Even though cumulatively it often costs higher as compared to a lump-sum purchase of the given asset, it saves the organization from an otherwise scenario of a liquidity crunch.