An operating lease is a viable asset funding option for companies that don’t want to carry on the risk of selling a leased car at the end of its lease. On the other hand, finance lease transfers ownership risks without handing over the vehicle’s actual legal ownership. The two options have one thing in common. They are both a form of lease. This means the fleet management company is given authority to use the lessor’s equipment until an agreed period elapses and the business has to return the equipment.
However, despite being forms of leasing equipment, the two options have so much that sets them apart. Most of the difference between the two options can be attributed to whether the vehicle can purchase after the lease term elapses, who remains with the vehicle ownership and caters to the vehicle’s maintenance and running costs.
As the name implies, a finance lease is a financing option offered by a lessee. Simply put, the owner or lessor buys the vehicle and rents it to the lessee for a set period, after which the vehicle is returned to the lessor. The lessee carries substantially all of the rewards and risks of owning the vehicle. This puts the lessee in a position of having bought the vehicle.
The lessor only gets the rent as a fee for hiring the asset to the lessee. The vehicle’s ownership remains with the lessor, but the lessee gets authority for the asset’s exclusive use. However, the use of the asset should observe the terms of the lease. Depending on the initial agreement, a lessor may extend the lease period at the end of the lease. They can also return the asset or sell it to a third party on behalf of the lessee.
Unlike the finance lease option, an operating lease has rental charges that do not cover the entire cost of purchasing the equipment. Therefore the lessor generally expects that the vehicle will have a resale value when the lease period elapses. This resale value is known as a residual value. Depending on the asset’s expected use, a residual value is forecast at the start of the lease period.
This means that the lessor takes on a risk that the vehicle will retain the forecast residual value. The operating lease does not transfer most of the risks and ownership rewards to the lessee. Typically, an operating lease is ideal for assets with a guaranteed residual value, such as construction machinery and vehicles.