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As with any heavy asset, equipment based industry, shipping containers require a great amount of capital investment to be effective and profitable to owners and investors. Given that a direct cash purchase of shipping containers can tie up a large amount of capital, typically starting at $10 million dollars, many shipping lines and container leasing companies will finance their fleets through operating leases or finance leases to leverage their equity and maximize cash flow. Finance leases are also referred to as capital leases. For the extent of this article we will refer to them as finance leases, but the two terms are interchangeable. |
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Operating leases and finance leases are both financial tools that allow the organization utilizing the asset, in our case the shipping containers, to get the greatest benefit at the lowest cost. The biggest difference between the two is ownership at the end of the term. At the conclusion of an operating lease the ownership is returned to the lessor, while at the conclusion of a finance lease the lessee has the option to purchase the shipping containers from the lessor at a price that is determined when the lease agreement is signed.
At the start of a finance lease negation process, the lessor and lessee must agree on the final purchase price of the shipping containers. The two commonly accepted ways to value containers are either book value, or fair market value. Book value is depreciated value and may have no real world relevance. Accountants typically use straight line depreciation of X% annually, and at the end of a five year lease is the book value. Fair market value can be more difficult to agree on, as inventory and supply can change in five years, which would impact the replacement cost of the containers. ContainerAuction.com can provide current trends in pricing and offer guidance on the fair market value of shipping containers.
While ownership is arguable the largest difference between the two, there are several other differences that make both options appealing to both the lessor and lessee.
Tax management is a topic that everyone holding both domestic and international assets is aware of, and the owners of shipping containers are no different. Having a large number of assets on the books of a company may make it seem stronger financially; however it could also increase the tax burden.
Under the terms of a finance lease, the owner of the shipping container is the lessee, and the lessee is recorded as the legal owner of the shipping container. With this ownership, they are able to record depreciation and interest expenses related to the containers.
Under an operating lease, the lessee is not recorded as the legal owner of the shipping container, and is only renting the unit. Therefore, the monthly or quarterly lease payment is recorded as a rental expense.
Every company manages their balance sheet in different ways. Different tax jurisdictions, capital requirements, and short and long terms goals of the company are taken into consideration by the corporate management team.
Finance leases are recorded as both an asset (leased/financed asset), and due to the lease payments a liability, and are required to show up on the balance sheet. This reflects back to tax management and while it does increase the net value of the company, it could also increase the taxable income of the asset through ownership.
Operating leases provide no risk, or opportunity, of ownership and have no impact on the balance sheet and value of the company. In fact, operating leases do not appear on the balance sheet, only the profit and loss statement. The benefit of an operating lease is to reduce taxable income by showing the lease payment as a rental payment.
Aside from the payments and financial management, there are daily operating costs that are associated with shipping containers, primarily the cost of maintenance and up keep, as well as the cost of insurance.
With regards to a finance lease, since the end ownership of the shipping container resides with the lessee, the lessee is responsible for all maintenance and insurance costs.
Operating leases are only slightly different, the lessee remains responsible for the maintenance costs; however the lessor is responsible for all insurance and other costs.
Shipping containers can be financed several different ways and the modelling can be negotiated and determined various ways depending on the needs of the lessee. The needs of the lessee must be taken into consideration during the process, and the lessor must be comfortable with the risk profile of their lessees. While this article has only touched on the surface of shipping container finance, the management team of ContainerAuction.com has been involved in various finance and consulting projects for clients around the world. If you have any questions please feel free to contact us.