Operating leases vs. finance leases: upcoming trends for fleet management companies

Vehicles are an essential part of most businesses and one of the newer trends in the automotive sector, is that business are now turning more and more to leasing vehicles rather than owning them. They tend to choose operating leases over finance leases as a way of lowering their costs and stabilising cashflow.

So, what about you? Is your business ready to support customer needs for operating leases and efficiently manage your fleet?

Operating leases or finance leases?

Our experience comes from automotive finance and equipment finance companies, as we deliver end-to-end lease management software packages. For many years we heard our customers saying that we do mostly finance leases and have few operating leases. Typically, those operating leases were high value contracts with key customers. Now we see an increasing demand for operating lease products.

From the contractual perspective, essentially there are two groups of asset finance products:

• Lease-type products (financial leases, operating leases)
• Loan-type products (hire purchase, chattel mortgage and others)

However, from a business process and software perspective, finance leases are similar to loan-type products, while operating leases are quite different and require specific software features.

The understanding of the definitions operating lease and finance lease may differ, depending on whom you ask. Sales people will say that a lease with a guaranteed residual value would be finance lease, and a lease with an unguaranteed residual would be operating lease. Finance lease customers most likely pay in full and keep the asset after the lease term (as residual value is often less than market value), while operating lease customers most probably return the asset and get a new one. However, an accountant would say that finance vs. operating lease is an accounting  classification, assessed by the lessor, and each lease is assessed on a contract-by-contract basis. These two views (sales view and accounting view) are often in line, because the marketing definition of the financial product usually implies the accounting classification.

Flexibility is the key

There used to be two main reasons why customers would choose an operating lease over a finance lease:

• Opex vs. capex (business preference not to have the lease on their balance sheet)
• Flexibility

Now, with a new reporting standard in place (IFRS 16) the first reason has gone. There is no lease classification on the lessee side. Essentially, all the long term leases (12+ months) are capitalized on the balance sheet. With the introduction of IFRS 16, there was a widely accepted prediction that operating leases will now be less attractive: perhaps in other lease categories, but not in automotive.

The second reason—flexibility—is apparent more than ever. With emerging trends of “car-as-a-service,” or “mobility-as-a-service,” in the near future we probably will have products which are non-lease at all, so the software will have to support many differing and changing agreements. And for business customers it will be opex again, just like any other service with no long term commitment. We will probably stop using the word “lessee” in the near future, and the word “driver” will become more appropriate.

Leasing software to support new asset finance trends

Will it be flexible operating lease products or car-as-a-service in the future? In any case, the leasing company will have a fleet to manage, so there will be an increased demand for fleet management features in lease management systems.

With SOFT4Leasing’s fleet management solution you can easily master customer contracts according to preferred conditions.

It also gives you high flexibility in the service package, pricing and fees management. It can differentiate according to car category or model, or customer category (business use or consumer use), and can be specific to promotional programs.

To support agreements with third-party service providers, the system can track commissions earned, defined as a percentage of the service amount. It also has a generic framework to interface with third-party service providers to receive incoming documents for actual services, allocate the service to customer contracts and particular assets, perform budget control, produce G/L postings for actual costs, accounts payable and amounts to be billed to the customer.

The system supports a variety of service budget scenarios and can be integrated with general ledger accounts for service provision, actual costs, fixed portion billed to the customer and actual cost re-charged to the customer.

At Soft4, we are working hard to keep up with the market, as we see a clear shift from finance leases towards operating and full-service leases today, as a step towards evolving new flexible and all-inclusive automotive products.

Regardless of the waiting time for car-as-a-service to surface in the future, the demand for fleet management functions is here today. Is your current software flexible enough to launch new leasing products?