Finance lease vs operating lease: which is right for your business?

 In the UK, total asset finance new business reached a record £39.7 billion in 2024, growing by 3% year-on-year, driven by robust demand across sectors, even as some industries face headwinds. Understanding the distinctions between a finance lease and an operating lease is essential for making the best choice for your balance sheet, tax treatment, and operational flexibility.

What is a finance lease?

A finance lease functions much like a secured loan. You assume most of the risks and rewards of ownership, and both the leased asset and the corresponding liability appear on your balance sheet. 

Typically, the lease term covers the majority of the asset’s useful life, and at the end you have the option to acquire the asset at a nominal price. Payments blend principal and interest, which means you can capitalise depreciation and interest deductions – an attractive feature if you’re seeking to optimise your tax position.

In the UK equipment finance market, new business for plant and machinery rose by 2% in February 2025 compared with the same month last year – showing that companies are still investing in long-term assets under finance leases.

What is an operating lease?

By contrast, an operating lease resembles a rental agreement. The lessor retains ownership and bears residual-value risk, while you enjoy off-balance-sheet treatment (subject to accounting standards) and predictable operating expenses. Lease terms are typically shorter than an asset’s full economic life, making it easier to upgrade or return equipment. Many operating-lease agreements also include maintenance and service, reducing your administrative burden.

Despite these advantages, the UK’s Acquis Index reported a 14% decline in new equipment finance deals in H1 2024. This was driven largely by weaker office and retail equipment demand – even as industrial equipment finance grew by 8.2 %, highlighting how market conditions can vary significantly by sector.

Comparing the two structures

While both lease types grant access to equipment, key differences include:

• Balance-sheet impact: finance leases increase assets and liabilities – operating leases typically don't

• Flexibility vs. ownership: operating leases offer more agility for upgrades – finance leases lead to eventual ownership

Even small changes in plans can have big effects. In August 2024, new business in asset finance dropped by 7% from last year, but it was still 4% higher than it was in the first eight months of the year. This shows that businesses are changing their funding structures rather than giving up on them.

Accounting treatment and tax implications

Under IFRS 16 and ASC 842, both lease types require recognition of a right-of-use asset and lease liability. In a finance lease, these are measured at the present value of lease payments and subsequently depreciated, with interest expense recognised separately. 

Operating leases, by contrast, allow you to recognise a single straight-line lease expense, simplifying accounting but foregoing depreciation and interest deductions.

Example: real-world impact

Consider Acme Manufacturing, which opted for a finance lease to replace ageing CNC machinery. By capitalising £100,000 of lease payments over five years, Acme claimed £30,000 in depreciation and £5,000 in interest deductions in the first year, yielding a £7,000 corporate tax saving. This structure also strengthened Acme’s asset base, enabling further borrowing for growth.

Frequently asked questions

What happens at the end of a finance lease? You typically have a bargain purchase option to acquire the asset, or you can refinance or return it.

Can I switch from an operating to a finance lease mid-term? Yes, but this requires lender approval and may trigger accounting adjustments.

Which lease offers better tax benefits? Finance leases generally provide larger deductions via depreciation and interest, while operating leases simplify expenses. Consult your tax advisor to determine the best fit.

Next steps

Selecting the right lease depends on your cash flow needs, balance-sheet strategy, and growth plans. If you’d like to explore bespoke solutions – whether finance leases, operating leases, loans, or equity – browse our full range of finance options or speak directly with a specialist to explore your optimal funding mix.

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Please note that the information above is not intended to be financial advice. You should seek independent financial advice before making any decisions about your financial future.

It’s important to remember that all loans and credit agreements come with risks. These risks include non-payment and late-payment of the agreed repayment plan, which could affect your business credit score and impact your ability to find future funding. Always read the terms and conditions of every loan or credit agreement before you proceed. Contact us for support if you ever face difficulties making your repayments.

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