Leasing is like hire purchase except that no deposit is required. It is a way of acquiring vehicles, plant or equipment without an initial outlay. The leasing institution (lessor) buys the equipment and leases it to you (lessee) in return for regular lease payments. The equipment is the security for the lease. At the end of the lease period, you may return the equipment to the lessor or purchase it for a previously stipulated residual price. The lease payments are tax deductible where the equipment is used to produce business income. Leases are generally available from finance companies and occasionally through banks.
There are two main types of lease- the operating
lease and finance lease.
Under an operating lease, (or contract rental)
the lessee pays a monthly rental for the use of the asset and then
returns it to the lessor on completion of the lease period.
The lessee has no responsibility for the value of the asset other than to
return it in “fair wear and tear” with kilometres travelled or hours used
not exceeding parameters agreed at the outset of the lease contract.
Operating leases are suitable typically for substantial organizations
with strong cash flows where use of an asset to generate income, rather than
ownership, is the key business criteria.
With a finance lease, the asset is leased for
an agreed period after which ownership normally transfers to the customer on a
payment of a lump sum or “residual value”
Sometimes referred to as lease to own, a finance lease requires the
lessee to carry the risks and rewards of ownership, including the financial risk
that market value may not equaql the residual value
the end of the lease term.
| Suitable
for the use of secondary assets i.e. not essential to producing core
products/ services |
| Generally
require a strong balance sheet (few organizations have all their assets
leased) |
| Can
significantly reduce paperwork and the need to manage own assets) |
| Removes
residual risk i.e. the low returns on resale. |
| Lease
payments are fully deductible if used for business purpose |
| As
an off Balance Sheet item, operating leases do not affect debt-to-equity
ratios. |
| Does
not build up equity in the business. |
| Can
be more costly, particularly if the lessor believes the asset will be
difficult to dispose of at the end of the lease period. |
| As
a fixed term contract, leases have significant penalties for early
termination. |
| Should
not be seen as a means of finance when insufficient deposit is available |
| The
asset is owned with all rights of ownership and liabilities. |
| Helps
increase equity in the business. |
| Normally
easier than lease to achieve finance approval for a new business with little
borrowing track record. |
| Tax
benefit comes through deductibility of interest paid on borrowings to
procure the asset (claimed in year incurred) and depreciation (cost of asset
claimed over a number of years). |
| Inflation
benefits those who own against those who lease. |
| Greater
flexibility- as the owner of
the asset it is normally theirs to sell or trade if desired. |
| Purchaser
carries all the residual (resale) risk. |
| Leaves
the entire management of the assets to the purchaser. |
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