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

Leasing equipment or vehicles lets you spread the cost of essential assets, so you can keep cash in the business for growth or unexpected expenses. And right now, the way UK businesses are using leases is changing fast.

In the 12 months to August 2025, UK businesses invested nearly £40 billion in asset finance – covering everything from vans and machinery to IT equipment. During this time, operating leases grew by 4%, while finance leases declined by 12%, suggesting that while economic uncertainty still lingers, more companies are choosing flexibility over long-term commitments.

There’s another big change on the horizon. From January 2026, new accounting rules (FRS 102) will mean most operating leases appear on your balance sheet for the first time. That could affect how lenders, investors, and even customers see your business. So if you’re considering a lease, it’s worth thinking ahead.

What’s the difference between a finance lease vs. operating lease?

When you’re weighing up a finance lease and an operating lease, the differences come down to ownership, cost, and flexibility.

Finance leases can work well if you want to use an asset for most of its life and benefit from tax relief. You’ll pay more each month, but you can usually claim capital allowances and interest deductions. And at the end of the term, you might have the option to buy the asset for a nominal fee.

Operating leases are more like renting. You’ll pay less each month, and you can hand the asset back or upgrade when the lease ends. That makes them suitable if you need to keep your options open – like when technology moves fast or your business is still finding its feet.

How does each type of lease work in practice?

Finance lease

Let’s imagine you need a £50,000 machine for your manufacturing business. With a finance lease, you’d typically pay a small upfront fee, then fixed monthly payments over 3-5 years. At the end, you could extend the lease, upgrade to a newer model, or buy the machine for a small fee (often just £1).

Tax relief is the major benefit here. Because the lease appears on your balance sheet, you can claim capital allowances on the asset’s value, plus deduct the interest portion of your payments. That can add up to serious savings, especially if your business is profitable.

But there’s a trade-off. You’ll usually pay more each month than with an operating lease. And because you’re responsible for maintenance, you’ll need to budget for repairs and insurance too.

Operating lease

Now let’s imagine you’re a tech startup and need laptops and servers. An operating lease lets you use the equipment for a set term (e.g. two or three years) then hand it back or upgrade to the latest model. Your monthly payments will be lower than a finance lease, and you won’t have to worry about selling old kit or dealing with depreciation.

This is why operating leases are so popular for assets that date quickly, like IT equipment or vehicles. You get the latest tech without the hassle of ownership. And because the lender handles any maintenance, you can focus on running your business.

The downside is that you’ll never own the asset, and if you go over vehicle mileage limits or return equipment in poor condition, you could face extra charges.

Accounting and 2026 tax changes

Right now, operating leases don’t appear on your balance sheet. Instead, they’re treated as a simple expense. But that’s about to change. From January 2026, new UK accounting rules (FRS 102) will require most operating leases to be capitalised. This means you’ll need to recognise a ‘right-of-use’ asset and a lease liability on your balance sheet.

How could this impact your business?

• Your balance sheet will show higher assets and liabilities, which could affect financial ratios like debt-to-equity (which lenders and investors use to assess your business).

• If you have financial covenants, like loan agreements tied to your balance sheet, this change could trigger a breach if you’re not prepared.

• Finance leases already appear on your balance sheet, so if you’re using one, you won’t see a change.

Tax treatment is another key difference. With a finance lease, you can claim capital allowances and interest deductions. With an operating lease, your payments are fully tax-deductible as a business expense, but you can’t claim capital allowances.

Learn how to decide between leasing and financing business assets.

Which lease is right for you?

Choosing between a finance lease and an operating lease depends on your business goals, cash flow, and how long you’ll need the asset.

Consider a finance lease if you:

• Want to use the asset for most of its useful life (e.g. machinery, long-term vehicles)

• Can benefit from tax relief through capital allowances and interest deductions

• Prefer the option to own the asset eventually, even if you don’t need it right away

• Have steady cash flow and can handle higher monthly payments

Consider an operating lease if you:

• Need the asset for a shorter period or plan to upgrade regularly (e.g. IT equipment, company cars)

• Want to keep monthly costs low and preserve cash for other priorities

• Don’t want the hassle of maintenance, repairs, or selling the asset later

• Operate in a sector where equipment becomes outdated quickly

Hidden costs to watch out for

No matter which lease you choose, always check the fine print. Look out for:

• Early termination fees if you want to end the lease early

• Excess mileage or wear-and-tear charges (especially for vehicles)

• Maintenance responsibilities as some leases include it but others don’t

• VAT treatment – with finance leases, VAT is usually spread across payments, but with operating leases, it’s often charged upfront on the total rental value

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FAQs

What happens at the end of a finance lease?

At the end of a finance lease, you’ll usually have three options:

• Extend the lease on a rolling basis

• Upgrade to a newer model

• Return the asset

Some agreements let you buy the asset for a nominal fee, but this isn’t automatic.

Can I switch from an operating lease to a finance lease mid-term?

Possibly, but it’s not straightforward. You’ll need your lender’s approval, and there may be fees or accounting adjustments. It’s usually best to pick the right type of lease from the start.

Which lease offers better tax benefits?

Finance leases generally provide more tax relief, as you can claim capital allowances and interest deductions. Operating leases are simpler – your payments are fully deductible as a business expense. Always check with your accountant to see which works best for your situation.

How will the 2026 accounting changes affect my operating lease?

From January 2026, most operating leases will need to be capitalised on your balance sheet. That means you’ll recognise both an asset (the right to use the equipment) and a liability (the lease obligation). This could impact your financial ratios and how lenders view your business.

Are there any hidden costs with leasing?

Potentially. Look out for early termination fees, excess mileage charges (for vehicles), and costs for damage or wear and tear. Some leases also require a deposit or security, so always read the terms carefully.

Can I lease used or second-hand equipment?

Often, yes. Many lenders offer leasing for used assets, but the terms and rates may be different than those for new equipment. The asset will need to meet the lender’s condition and age criteria.

What happens if I default on a lease payment?

If you miss payments, the lender could repossess the asset or charge late fees. Defaulting can also harm your credit score, making it harder to secure funding in the future. If you’re worried about your finances, speak with your lender immediately. They may be able to provide support such as payment holidays.

Is leasing available for startups or freelancers?

Yes, but you may need to provide a personal guarantee or a larger deposit. Some lenders offer startup-friendly terms, so it’s worth shopping around or using a broker like Funding Options to find the most suitable deal for your circumstances.

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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