Operating Lease vs. Capital Lease: Why It Matters More Than You Think

You are planning to take on a new piece of machinery for your business.

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There are two options: Operating lease, and Capital lease. Which one should you choose?

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Turned out, in business, not all leases are created equal, especially when it comes to your balance sheet and cash flow.

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Let's break it down:

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1. Operating Lease: Like Renting a Car

• You don’t own it.
• It doesn’t show up as an asset or liability on your books (well—used to not… more on that below).
• Payments are treated like rent expense.
• Think of it as a short-term, low-commitment relationship.

💡Impact on Cash Flow & Debt:

• Easier on your financial ratios—until the new lease accounting rules (ASC 842/IFRS 16) said, “Not so fast.”
• Now, even operating leases need to be recorded as right-of-use assets and lease liabilities, which means they still show up on your balance sheet.
• But the lease obligation is usually smaller compared to capital leases, so lenders still see it as a “lighter” liability.

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2. Capital (Finance) Lease: Like a Lease-to-Own Deal

• You’re essentially buying the asset—just paying for it over time.
• The asset and the lease liability both go on your balance sheet.
• You depreciate the asset and recognize interest expense on the liability.

💡Impact on Cash Flow & Debt:

• Bigger liability = higher debt ratios.
• But you get to record the asset too, which can help balance the optics.
• It’s more of a long-term commitment—great if you plan to use the asset for its full life.

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Why This Matters for Lending

Lenders love clarity. When reviewing financial statements, they care about:

• Debt service coverage ratio (DSCR)
• Leverage ratios
• EBITDA impact
• Cash flow runway

So if your operating lease is now recognized as a liability, it could tip the scale in your debt ratios, even if your operations haven’t changed. And a capital lease? That’s an official “debt” in the eyes of the lender.

Knowing the lease classification (and how you book it) helps you avoid surprises—and gives you a better shot at getting financing or negotiating terms.

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Which One Should You Choose?

Ask yourself:

- Do you want ownership at the end?
- Is the lease term nearly the full useful life of the asset?
- Will you use this equipment daily for years to come?

If yes to most of these, you’re likely looking at a capital lease.

If you prefer flexibility and plan to upgrade frequently, an operating lease might make more sense—just remember it’s still likely to show up on your balance sheet now.

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Bottom Line

Leases may look like a simple monthly payment, but their impact on your financials can ripple through cash flow planning, bank covenants, and even business valuation.

Whether it’s a forklift or a fleet of delivery vans, how you lease matters.

And if you're unsure how your leases are being classified—or how they’re affecting your ability to raise capital—it’s worth reviewing with your CFO (or fractional CFO 👋) to avoid surprises down the road.

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At Elevate Virtual CFO, we help family business owners untangle financial decisions like these—so you can stay focused on scaling, while we keep your numbers sharp, clean, and lender-friendly.

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If you’re navigating lease decisions, expanding operations, or prepping for financing, let’s chat. We’ll help you connect the dots between finance and strategy—without the jargon.

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