As a business grows, so do investment needs: new machines, vehicles, IT equipment, or production lines require financing. The two most common forms of financing for these investments are leasing and working capital financing. Both allow investment without a large one-off purchase, but their structure, costs, and effects differ significantly.
In this article, we compare leasing and working capital financing from the SME perspective. We cover the operating principles, tax treatment, balance sheet impact, and total cost of each, so you can choose the best option for your company.
What does leasing mean for a business?
Leasing is a long-term rental agreement where a finance company purchases the asset (such as a machine, vehicle, or piece of equipment) and rents it to the company for an agreed period. The company pays a monthly lease payment and gains the right to use the asset without owning it. At the end of the contract period, the company returns the asset, purchases it at the residual value, or negotiates a new agreement.
Operating lease vs finance lease
Leasing is divided into two main types: operating lease and finance lease. In an operating lease, the asset is returned to the finance company at the end of the contract, and the lessor bears the residual value risk. In a finance lease, the contract effectively covers the asset's entire economic useful life, and the company bears the residual value risk. The IFRS 16 standard significantly changed the accounting treatment of leases, but for SMEs that follow Finnish accounting legislation, the effects are smaller.
Differences between operating and finance leases:
- Operating lease: the asset is returned, the lessor bears the residual value risk, payments are recorded as rental expenses
- Finance lease: effectively equivalent to a purchase, the asset and liability are recorded on the balance sheet, the company bears the risk
- Operating leases keep the balance sheet light and financial ratios stronger
- Finance leases allow depreciation and interest deduction for tax purposes
- Operating leases suit rapidly depreciating technology; finance leases suit long-lived assets
Working capital financing for investments
Working capital financing is a broader concept that covers various forms of financing for a company's ongoing operations and investments. It can mean a bank loan, a revolving credit facility, invoice financing, or other debt financing. In the context of investments, working capital financing typically refers to a loan or credit with which the company purchases the asset and owns it from the outset.
The strength of working capital financing is its flexibility: the financing can be used freely for different needs, and the company owns the assets it acquires. Unlike leasing, an asset acquired through working capital financing appears on the company's balance sheet as an asset, which can improve the company's net worth position in the longer term.
Taxation: leasing vs purchase with working capital financing
The differences in tax treatment are a significant factor when choosing between leasing and working capital financing. Operating lease payments are fully tax-deductible business expenses, making them straightforward from a tax perspective. When an asset is purchased with working capital financing, the company makes accounting depreciation on the asset and deducts the financing interest for tax purposes. The depreciation rate depends on the type of asset: for machinery and equipment, the maximum depreciation rate is 25% of the residual value.
According to the Finnish Tax Administration, operating lease payments are fully tax-deductible business expenses. In a finance lease, depreciation and interest are recorded separately. The right choice depends on the company's overall tax situation – consult your accountant before making a decision.
Total cost comparison
Total cost is a key point of comparison. In leasing, the total cost consists of monthly payments over the entire contract period plus any buyout price or costs associated with returning the asset. For an asset purchased with working capital financing, the cost comprises the purchase price, financing interest, and any arrangement fees. Generally, leasing is more expensive in total than outright purchase with a loan, because leasing includes the finance company's margin and residual value management.
Factors affecting total cost:
- Leasing: monthly payments x contract months + possible buyout price + excess usage charges
- Working capital financing: purchase price + interest + arrangement fees – asset resale value
- Timing of tax deductions: leasing produces a steady stream of deductions, while purchase depreciation is declining-balance
- Opportunity cost of capital: capital freed up through leasing can be invested in the business
- Maintenance costs: in operating leases these may be included in the agreement; in purchase they are the company's responsibility
When to choose leasing?
Leasing is the best choice when:
- The asset depreciates quickly (IT equipment, technology) and you want to replace it regularly
- You want to keep the balance sheet light and financial ratios strong, for example for financing negotiations
- You do not want to tie up capital in a single asset but prefer to use it for running the business
- You need predictable, even monthly payments for budgeting purposes
- Maintenance and servicing are included in the lease agreement (full-service leasing)
When to choose working capital financing?
Working capital financing is the better choice when:
- The asset is long-lived and retains its value well (real estate, heavy equipment)
- You want to own the asset and benefit from its resale value
- The total cost of financing is more important than monthly cash flow
- You want to depreciate the asset for tax purposes at your own pace
- You need financing for purposes beyond a single asset
Invoice financing complements both
Regardless of whether you choose leasing or working capital financing, an investment places a burden on cash flow. Invoice financing offers a solution: by converting accounts receivable into cash, you can ensure that investment installments do not cause cash flow problems. Many SMEs use invoice financing alongside investments specifically to secure the financing of ongoing operations.
According to the Federation of Finnish Enterprises, 32% of SMEs use leasing for equipment or machinery purchases. At the same time, the use of invoice financing has grown steadily as companies have come to understand the complementary role of different financing options. The best results come when a company combines long-term investment financing with short-term cash flow management into a cohesive whole.
