What does a Lease (Leasing) mean? A Lease is a contract between the owner of the asset and beneficiary. This article explains the content of Leasing – Meaning, Definition, Types, Advantages, and Disadvantages; Owner of the asset calls lessor and the beneficiary calls lessee. The lessee has the right to possess and to use the asset on payment of the specified rentals over a predetermined period. Also, Learn Investment Banks with their Principle and Functions.
The Concepts of Leasing explains as their topic of Meaning, Definition, Types, Advantages, and Disadvantages.
Here are we can discuss the topic; Meaning of Leasing, Definition of Leasing, Types of Leasing, Advantages of Leasing, and Disadvantages of Leasing. A “Lease” is defined as a contract between a lessor and a lessee for the hire of a specific asset for a specific period on payment of specified rentals.
The maximum period of the lease according to the law is for 99 years. Previously land or real estate, mines and quarries were taken on the lease. But now a day’s plant and equipment, modem civil aircraft and ships are taken.
Definition of Leasing:
Lessor: The party who is the owner of the equipment permitting the use of the same by the other party on payment of a periodical amount.
Lessee: The party who acquires the right to use the equipment for which he pays periodically.
Lease Rentals: This refers to the consideration received by the lessor in respect of a transaction and includes:
- Interest in the lessor’s investment.
- Charges have borne by the lessor. Such as repairs, maintenance, insurance, etc.
- Depreciation, and.
- Servicing charges.
At present there are many leasing companies such as 1st Leasing Company, 20th Century Leasing Company which are doing quite a lot of business through leasing, It has become an important financial service and a lucrative avenue of making sizable profits by leasing companies.
Steps involved in Leasing:
A contract of the lease provides a person an opportunity to use an asset that belongs to another person.
The following steps involving in a leasing transaction:
- The lessee identifies the need for the equipment and selects the supplier.
- The lessee approaches a leasing company or Lessor to lease the equipment needed.
- They have to furnish the following information: 1) Name and address of the lessee. 2) Details about his business. 3) Name and address of the guarantor, if any. 4) Description of the equipment. 5) Name and address of the supplier and the quoted price. 6) Place of installation, and. 7) Duration of the lease.
- The Lessor examines the proposal after receiving the particulars from the lessee and evaluates the credit-worthiness and rent-paying capacity of the lessee.
- The Lessor and Lessee entered into the lease agreement. It contains the terms and conditions of the lease such as lease period, rental payments, details regarding renewal of lease period, cost of repair and maintenance, insurance and any other expenses, etc., and.
- After the lease agreement signs, the Lessor requests the manufacturer to supply the asset to the lessee.
Types of Leasing:
After their definition the content is the following different types of leasing are discussed below:
Financial Lease:
This type of lease which is for a long period provides for the use of the asset during the primary lease period which devotes almost the entire life of the asset. The lessor assumes the role of a financier and hence services of repairs, maintenance, etc., are not provided by him.
The legal title retains by the lessor who has no option to terminate the lease agreement. The principal and interest of the lessor are recouped by him during the desired payback period in the form of lease rentals.
The finance lease also calls a capital lease is a loan in disguise. The lessor thus is typically a financial institution and does not render specialized service in connection with the asset. A financial lease is an alternative to borrowing money and buying the equipment.
The features of the financial lease are:
- The machinery selects from the supplier by lessee based on his requirement.
- The lessee negotiates the terms of the purchase i.e., price, delivery, installation, warranties, maintenance, and payments.
- The payment for purchases make by Lessor and he is the legal owner of the machinery.
- The risk of obsolescence and responsibility for maintenance are to be borne by Lessee, and.
- Lessee has to pay rent regularly.
Operating Lease:
It is where the asset not wholly amortizes during the non-cancellable period if any, of the lease and where the lessor does not rely on is profit on the rentals in the non-cancellable period.
In this type of lease, the lessor who bears the cost of insurance, machinery, maintenance, repair costs, etc. is unable to realize the full cost of equipment and other incidental charges during the initial period of the lease. The lessee uses the asset for a specified time.
The lessor bears the risk of obsolescence and incidental risks. Either party to the lease may termite the lease after giving due notice of the same since the asset may lease out to other willing leases.
Operating lease is a rental agreement and its features are as follows:
- The period of the operating lease is generally shorter than the economic life of the leased asset, and.
- The “lessor” bears the risk of obsolescence and responsibility for the maintenance of the asset.
Sale and Lease-Back:
To raise funds a company may sell an asset that belongs to the lessor with whom the ownership vests from thereon. Subsequently, the lessor leases the same asset to the company (the lessee) who uses it.
The asset thus remains with the lessee with the change in title to the lessor thus enabling the company to procure the much-needed finance. It is an agreement between the owner of the asset and the leasing company.
First, the firm (owner) sells the asset to the Leasing Company and leases it back simultaneously. The ownership of the asset transfers to the leasing company, the company, in turn, leases it to the seller and the seller becomes a lessee.
Sales Aid Lease:
Under this arrangement, the lessor agrees with the manufacturer to market his product through his leasing operations, in return for which the manufacturer agrees to pay him a commission.
Specialized Service Lease:
In this type of agreement, the lessor provides specialized personal services in addition to providing its users.
Small Ticket and Big Ticket Leases:
The lease of assets in smaller value generally calls as small-ticket leases and larger value assets are called big-ticket leases.
Cross Border Lease:
Lease across the national frontiers calls cross broker leasing. The recent development in economic liberalization, the cross border leasing is gaining greater importance in areas like aviation, shipping and other costly assets which base likely to become absolute due to technological changes. The lease agreement makes between the persons of the two countries. Lessor and lessee are domiciled in different countries, the lease says to be the cross-border lease.
Advantages of Leasing:
After their definition and types the content is the following Merits or Advantages of leasing below are:
- The most important merit of leasing is flexibility. The leasing company modifies the arrangements to suit the requirements of the lease.
- In the leasing deal, less documentation involves, when compared to term loans from financial institutions.
- It is an alternative source to obtain the loan and other facilities from financial institutions. That is the reason why banking companies and financial institutions are now entering into leasing business as this method of finance is more acceptable to manufacturing units.
- The full amount (100%) financing for the cost of equipment may make available by a leasing company. Whereas banks and other financial institutions may not provide for the same.
Balanced Cash Outflow:
The biggest advantage of leasing is that cash outflow or payments related to leasing are spread out over several years, hence saving the burden of one-time significant cash payment. This helps a business to maintain a steady cash-flow profile.
Quality Assets:
While leasing an asset, the ownership of the asset still lies with the lessor whereas the lessee just pays the rental expense. Given this agreement, it becomes plausible for a business to invest in good quality assets which might look unaffordable or expensive otherwise.
Better usage of Capital:
Given that a company chooses to lease over investing in an asset by purchasing, it releases capital for the business to fund its other capital needs or to save money for a better capital investment decision.
Disadvantages of Leasing:
In the base of their advantages is the following Demerits or disadvantages of leasing below are:
- In leasing the cost of interest is very high.
- The asset reverts to the owner on the termination of the lease period and the lesser lose his claim on the residual value.
- Leasing is not useful in setting up new projects as the rentals become payable soon after the acquisition of assets.
- The lessor generally leases out assets that are purchased by him with the help of bank credit. In the event of a default made by the lessor in making the payment to the bank, the asset would seize by the bank much to the disadvantage of the lessee.
Limited Financial Benefits:
If paying lease payments towards land, the business cannot benefit from any appreciation in the value of the land. The long-term lease agreement also remains a burden on the business as the agreement locks and the expenses for several years are fixed. In a case when the use of assets does not serve the requirement after some years, lease payments become a burden.
Reduced return for Equity Holders:
Given that lease expenses reduce the net income without any appreciation in value, it means limited returns or reduced returns for an equity shareholder. In such a case, the objective of wealth maximization for shareholders not achieves.
Limited TAX Benefits:
For a new start-up, the tax expense is likely to be minimal. In these circumstances, there no adds tax advantage that can derive from leasing expenses.
References: From online content collection with the site of #efinancemanagement and #yourarticlelibrary.
