When it comes to financing equipment or property, businesses have multiple options to choose from. Two popular choices are finance leases and instalment sale agreements. While these two choices are similar in some aspects, there are also significant differences between the two.
What is a Finance Lease?
A finance lease, also known as a capital lease, is a type of lease agreement that allows a business to lease a piece of equipment, vehicle or property for an extended period. The lease contract stipulates that at the end of the lease term, the business has the option to purchase the asset for a predetermined amount, typically referred to as the residual value.
During the lease term, the business is responsible for making monthly payments to the leasing company, which includes both the interest and principal payments. The business also assumes risks and benefits similar to ownership, including maintenance and insurance costs, and the ability to claim any tax benefits related to depreciation.
What is an Instalment Sale Agreement?
An instalment sale agreement, also known as a hire purchase agreement, is a type of financing agreement whereby the business purchases the asset and makes repayments to the financing company over a set period. Unlike a finance lease, ownership of the asset is transferred to the business immediately upon signing the contract.
During the repayment period, the business is responsible for making monthly payments to the financing company, which includes both interest and principal payments. The business will own the asset outright once the final repayment has been made.
Key Differences between Finance Lease and Instalment Sale Agreement
Ownership: The key difference between a finance lease and an instalment sale agreement is ownership. In a finance lease, the leasing company retains ownership of the asset, while in an instalment sale agreement, the business becomes the owner of the asset.
Monthly Payments: In a finance lease, monthly payments include both interest and principal repayments. In an instalment sale agreement, monthly repayments include interest payments only, with the principal being paid off at the end of the repayment period.
Depreciation: In a finance lease, the leasing company typically claims tax benefits related to depreciation, while in an instalment sale agreement, the business is responsible for claiming any depreciation-related tax benefits.
Residual Value: In a finance lease, the business has the option to purchase the asset at the end of the lease term for a predetermined residual value. In an instalment sale agreement, the business owns the asset outright at the end of the repayment period.
Both finance leases and instalment sale agreements are viable options for financing equipment and property for businesses. However, there are significant differences between the two in terms of ownership, monthly payments, and tax benefits.
Before deciding on which option to choose, businesses should consider their financial situation, cash flow, and future needs. It’s important to seek professional advice from a financial advisor to ensure that the option chosen aligns with the business goals and objectives.