Leasing

Leasing is an agreement between two persons where by one person arranges to buy some
fixed assets for the use of another person who inturn agrees to make periodic payment in the
form of rent for the use of the asset.
According to James C. Van Horne "Lease is a contract whereby the owner of an asset grants to
another party the exclusive right to use the asset usually for an agreed period of time in return
for the payment of rent."
Types of Leasing
1.Financial Lease (Full payout lease)
A financial lease is one which transfers substantially all the risks and rewards incidental 10
ownership to the lessee. Under the lease title to the property may or may not be transferred to
the lessee. A financial lease is also known as Capital lease, Long-term lease, Net lease, Close
lease, etc.
Features of a financial lease
i. Selection: The lessee selects the equipment according to his requirements, from the
manufacturer or distributor.
ii. Negotiation: The lessee negotiate and settles with the manufacturer distributor, the price, the
delivery schedule, maintenance, payment and so on.
iii. Purchase by lessor: The lessor purchases the equipment either from the manufacturer
distributor.
iv. Ownership retained by lessor: The lessor retains the ownership while lessee is allowed to use
the equipment.
v. Option to purchase in future: A finance lease provide a right or option to the lessee, to
purchase the equipment at a future date.
vi. Period of lease: The period lease is usually spread over the expected economic life of the
asset.
vii. Right to use the asset: The lessee is entitle to exclusive and peaceful use of the equipment
during the entire lease period, provided he pays the rentals and complies with the terms of the
lease.
2.Operating lease (Service lease)
An operating lease is one which does not transfer substantially oll the risks and rewards
incidental to ownership to the lessee. An operating lease is also known as Service lease,
Short-term lease or True lease.
Features of Operating Lease
i. Shorter period: Operating lease is generally for a term shorter than the economic life of the
asset.
ii. Not fully amortised: The cost of the assets are not fully amortised as the lease periods are
shorter than the expected life of the assets.
iii. Several leases for same assets: The lesser gives the right use the same property to several
parties to recover the cost of investment.
iv. Residual value: The residual value of the property has more importance than that of financial
lease.
v. Loss of obsolescence: In operating leasing the lessor has to bear the risk of obsolescence, as
lessee is free to cancel the lease at any time.
vi. Maintenance: Usually, operating lease generally includes maintenance clause requiring the
lessor to maintain the leased assets and provide services such as insurance, fuel etc
3.Leverage Lease
A leveraged lease is a lease agreement that is financed through the lessor with help from a
third-party financial institution. In a leveraged lease, an aset is rented with borrowed funds. A
leverage lease is used for financing those assets which require very huge capital outlay The
outlay for purchase cost of the asset is generally crores of rupees, having economic life of 10
years or more.
4.Sale and Lease Back
It is a type of leasing in which a firm which has an asset sell it to the leasing company and gets
it back on lease. The asset is generally sold at its market value. The firm receives the sale price
in cash and gets the right to use the asset during the lease period.
5.Cross Border Lease
Cross-border lease is international leasing which relates to a lease transaction between a lessor
and lessee domiciled in different countries It is also known as transactional leasing.
6.Domestic Leasing
Domestic lease relates to a transaction between a lessor and lessee domiciled in the same
country
7.Wet Lease and Dry Lease
A wet lease is one where the lessor is responsible for full control and maintenance of leased
asset. A dry lease involves the payment of insurance and maintenance costs by the lessee
8.Vendor Leasing
A vendor leasing is one where the retail vendors tieup with the lease finance companies which
give financing option to the customers of the vendors to purchase a product. This type of lease
is popular in auto finance.
9.Direct Leasing
Direct leasing is a financing arrangement by which the lessor buys the property and rents it
directly to the lessee
10.Single Investor Leasing
Under single investment leasing all the money required to purchase the equipment comes from
the same source.
Services/Functions of Lessor
1.Provision of credit facility: One of the most important functions of a lessor is granting credit
facility to enable the lessee to acquire the use of the asset, by permitting the lessee to avoid
paying the full purchase price of the asset.
2.Absorbing obsolescence and risks: In the case of non cancellable operating lease, the lessor
provides the advantage of 30 days time for cancellation of the lease by the lessee.
3.Comprehensive package: The lessor usually undertakes to provide a package of services
such as general maintenance, accounting etc to the lessee. This way the lessor saves the
lessee from having to deal with each peace meal payment.
Advantages to Lessee
1.Efficient use of funds: Leasing arrangements allow the lessee to use the asset without owning
it. This enables the lessee to make efficient use of available financial resources.
2.Permit Alternative use of Funds: A leasing arrangement provides a firm with the use and
control over asset without incurring huge capital expenditure.
3.Faster and Cheaper Credit: Leasing is found to be less expensive as compared to buying the
asset. Leasing permits the firms to acquire new equipment without going through formal scrutiny
procedure.
4.Flexibility: Leasing arrangements may be tailored to the lessee's needs more easily than
ordinary financing.
5.Enhanced borrowing capacity: Leasing may increase long-term ability to acquire funds. The
lessee can utilise more funds for working capital needs.
6.Boon to Small Firms: The firms which are either small or have uncertain records of earning are
able to obtain the use of asset through lease financing.
7.Protection against Obsolescence: A firm can avoid risk of obsolescence by entering into
operating lease agreement.
8.Cent Percent Financing: Lease financing enables a firm to acquire the use of an asset without
having to make a down payment.
9.Off Balance Sheet Financing: The biggest advantage claimed by lease financing is that the
asset acquired and the corresponding liability need not be shown in the balance sheet.
10.Better liquidity: 'Sale and Lease back' arrangements provide the advantage of better liquidity.
11.No Restrictive Covenants: The restrictive covenants such as debt-equity ratio, declaration of
dividend etc., which are usually imposed under debenture or loan agreement are absolutely
absent in a lease agreement.
Advantages to Lessor
1.Stable business: Leasing mechanism provides for a continuous and stable manufacturing
business for the lessor.
2.Wider distribution: Leasing allows for capturing a wider distribution network by the lessor
because the lessees do not have to allocate funds for heavy capital investments
3.Sale of supplies: Depending on the nature of the leasing arrangement, the lessor has to
ensure the supply of spare parts and components required for the maintenance of the asset
leased.
4.Second-hand market: The asset which are reverted by the lessee to the lessor can be leased
again or sold in the open market.
5.Tax benefits: There is relative tax benefit for the receipt of lease rentals. For instance, sales
tax payable on lease rentals is lower than the direct tax payable on revenue receipts on the sale
of the asset.
6.Absorbing obsolescence risks: In the case of a non-cancelable financial lease, the risk of
obsolescence arising from the usage of the asset has to be borne by the lessee.
7.Fillip to capital market: Leasing companies are financial intermediaries They facilitate the flow
of savings into real investments by reducing the terms on which finance is provided.
8.Easy finance: The demand for capital equipment has increased due to the easy and
convenient availability of finance.
Disadvantages/Limitations of Leasing
1.Not a suitable mode of finance: Lease is not a suitable mode of project finance. This is
because rentals are repayable soon after entering into lease agreement while in new projects
cash generations may start only after a long gestation period.
2.Non availability of certain tax benefits: Certain tax benefits/incentives such as subsidy may not
be available on leased equipment.
3.Loses the advantage of a potential capital gain: The value of real assets such as land and
building may increase during lease period.
4.High cost of financing: The cost of financing is generally higher than that of debt financing.
5.Heavy penalty: A manufacturer who wants to discontinue a particular line of business will not
be in a position to terminate the contract except by paying heavy penalties.
6.Loss to the lessor: If the lessee is not able to pay rentals regularly, the lessor would suffer a
loss particularly when the asset is a sophisticated one and less liquid.
7.Lessee is not entitled to any protection: In case of lease agreement, it is lessor who has
purchased the asset from the supplier and not the lessee.
8.Unnecessary complications: In the absence of exclusive laws dealing with the lease
transaction, several problems crop up between lessor and lessee resulting in unnecessary
complications and avoidable tension
9.Costly option: Leasing is costlier as compared to with straight borrowing if the lessor is only a
financial intermediary and not a manufacturer.
10.Double sales tax: Depending on prevailing sales tax laws in various states, there are
possibilities of the lease rental revenues attracting sales tax twice at the time of the sale and
when the asset is leased out.
11.Unfavourable gearing: Leasing creates fixed obligations. This results in an increase in the
capital gearing of the company and adversely affect to the borrowing capacity of the company.
12.No working capital: Leasing provides a mechanism only for long-term capital requirements. It
fails to provide access to much needed working capital finance.