Why the Operating Lease is More Attractive to Businesses Today

In recent years, the popularity of operating leases has surged among businesses worldwide. Once considered a less favorable option compared to capital leases or outright purchases, operating leases are now seen as a strategic tool that offers flexibility, preserves capital, and enhances financial management. This shift in perception is not limited to one region; it’s a global trend driven by changes in accounting standards, economic conditions, and business strategies. In this article, we’ll explore why operating leases have become more attractive to businesses and how this trend is playing out on a global scale.

The Financial Flexibility of Operating Leases

One of the primary reasons businesses are increasingly opting for an operating lease is the financial flexibility they offer. Unlike capital leases or purchases, which tie up capital in assets, operating leases allow businesses to use assets without the burden of ownership. This flexibility is particularly appealing in industries where technology or equipment quickly becomes outdated, as it enables companies to upgrade without significant financial penalties.

Benefits of Operating Leases

1. Preservation of Capital: Operating leases allow businesses to conserve capital, which can then be allocated to other critical areas such as research and development, marketing, or expansion. This is especially important for small to medium-sized enterprises (SMEs) that may not have the financial resources to purchase expensive equipment outright.

2. Off-Balance-Sheet Financing: Traditionally, operating leases were kept off the balance sheet, meaning that the lease obligations didn’t appear as liabilities. This helped businesses maintain a healthier-looking balance sheet, which could be beneficial when seeking financing or attracting investors. However, recent changes in accounting standards, such as the introduction of IFRS 16 and ASC 842, have required companies to report most leases on the balance sheet. Despite this change, the appeal of operating leases remains strong because they still offer flexibility in financial planning and reporting.

3. Cost Predictability: Operating leases typically involve fixed monthly payments, which helps businesses predict and manage their costs more effectively. This predictability is crucial for cash flow management, allowing companies to budget with greater accuracy and avoid unexpected financial strain.

4. Tax Benefits: In many jurisdictions, lease payments on operating leases are fully tax-deductible as a business expense. This can result in significant tax savings, making operating leases an attractive option from a tax planning perspective.

Deloitte reports that 60% of CFOs in multinational corporations now favor operating leases over capital leases due to the flexibility and financial benefits they provide.

Global Trends in Operating Lease Adoption

The increasing attractiveness of operating leases is not confined to any single region; it is a global phenomenon. Businesses across the world are recognizing the strategic advantages of operating leases, particularly in response to changes in the global economic landscape and evolving accounting standards.

Regional Adoption and Trends

1. North America: In the United States and Canada, operating leases have become increasingly popular, especially in sectors such as technology, healthcare, and transportation. The adoption of ASC 842, which requires companies to recognize most leases on the balance sheet, initially caused some concern. However, businesses have adapted by integrating operating leases into their overall financial strategy, leveraging the flexibility and tax benefits they offer.

2. Europe: European companies have also embraced operating leases, particularly in the wake of IFRS 16. The standard’s requirement to report leases on the balance sheet has led businesses to reassess their lease portfolios. Many have found that operating leases provide the flexibility needed to manage assets efficiently in a rapidly changing market.

3. Asia-Pacific: In the Asia-Pacific region, operating leases are increasingly seen as a way to support growth in emerging markets. Businesses in these markets often face volatile economic conditions, making the flexibility of operating leases particularly valuable. Additionally, the ability to upgrade technology and equipment without significant upfront costs is crucial for staying competitive in fast-growing industries.

4. Latin America: In Latin America, where economic instability can be a concern, operating leases are favored for their ability to reduce financial risk. Companies in this region appreciate the ability to access the latest equipment and technology without committing large amounts of capital, which can be better utilized elsewhere.

Regional Trends in Operating Lease Adoption

RegionKey Industries Using Operating LeasesImpact of Accounting StandardsKey Benefits of Operating LeasesNorth AmericaTechnology, Healthcare, TransportationASC 842 - Requires leases on balance sheetFinancial flexibility, tax benefits, cost predictabilityEuropeManufacturing, Retail, FinanceIFRS 16 - Requires leases on balance sheetAsset management efficiency, tax benefitsAsia-PacificTechnology, Manufacturing, ServicesIFRS 16 & Local StandardsGrowth support, asset upgrading flexibilityLatin AmericaConstruction, Energy, TransportationVaries by countryRisk reduction, access to latest technology

PwC highlights that the adoption of IFRS 16 and ASC 842 has led to a 40% increase in businesses reviewing and optimizing their lease portfolios, demonstrating the global impact of these standards on lease management.

The Strategic Advantages of Operating Leases

Beyond the financial and accounting benefits, operating leases offer strategic advantages that make them an attractive option for businesses looking to stay agile and competitive in a fast-paced global market.

Strategic Flexibility and Agility

1. Upgrading and Replacing Assets: One of the most significant advantages of operating leases is the ability to upgrade or replace assets regularly. This is particularly important in industries where technology evolves rapidly, such as IT and telecommunications. By leasing rather than owning, companies can avoid obsolescence and ensure they always have access to the latest equipment.

2. Risk Management: Operating leases allow businesses to manage risk more effectively. In uncertain economic environments, committing to long-term ownership of assets can be risky. Operating leases provide the flexibility to scale operations up or down as needed, without the burden of owning assets that may lose value or become redundant.

3. Focus on Core Competencies: Operating leases enable businesses to focus on their core competencies rather than managing assets. For example, a company in the logistics industry can lease its fleet rather than owning and maintaining it, allowing management to focus on optimizing supply chain operations rather than dealing with vehicle depreciation and maintenance.

4. Enhanced Cash Flow: By spreading the cost of assets over the lease term, operating leases improve cash flow management. This enhanced cash flow can be redirected into strategic investments such as product development, market expansion, or digital transformation, further driving business growth.

McKinsey & Company reports that companies utilizing operating leases effectively are 30% more likely to achieve their strategic growth objectives compared to those relying solely on asset ownership.

Conclusion

The increasing attractiveness of operating leases to businesses globally is a reflection of the flexibility, financial benefits, and strategic advantages they offer. As accounting standards evolve and economic conditions remain uncertain, more companies are recognizing the value of operating leases as a tool for managing assets, preserving capital, and maintaining agility in a competitive market. Whether in North America, Europe, Asia-Pacific, or Latin America, the trend towards operating leases is clear and likely to continue as businesses seek smarter, more efficient ways to manage their resources and achieve their objectives.