What is Lease Financing
What is Lease Financing has emerged as one of the most important forms of long-term finance? If a company or organization acquire the right to use an asset without purchasing it from the owner of the asset is termed as lease financing. The lease is a legal paper contract between two parties:
- Owner of the assets – Lessor
- The user of the assets – Lessee
Under this contractual agreement, the lessor grants the exclusive rights to the lessee to use the asset for a specified period in exchange of periodical payments called lease rentals.
Another word to define the fact meaning of “What is a lease financing” is a lease can be defined as a contractual agreement whereby the lessor conveys to the lessee in return for a payment or series of payments, the right to use as an asset for an agreed period of time. in essence, a lease is a divorcing agreement between the government the ownership and usage of the asset. It separates users of the asset from the owners of it.
************Remember Key Concept of What is a Lease Financing**********
“The lease deed or lease agreement should contain the following details:”
- Description of the asset being leased.
- Cost of the asset being leased.
- Starting date and ending date of the lease contract.
- Renewal options of lease contract after the end of the contract period.
- Lease rent amount, frequency of payment and payment mode.
- Options for premature termination of a contract.
Lease Contract and Types of Lease Contract
The lease financing has come out as one of the most significant sources of long-term financing. Financial lease contracts are classified into different types based on the variation in the elements of a lease. Very popularly heard leases are a financial and operating lease. Apart from these, there are also other types of leases such as sales and leaseback, leveraged lease and direct lease. They are as follows:
The operating lease also called service lease, is a type of lease in which asset is leased for a short period and the contract after giving proper notice. For Example: giving an office space on a 2-year lease cancellable on 60 days notice, lease contract for computers or office equipment or hiring a car for 2-weeks on holiday. This type of lease is prevalent particularly in those machines where technological changes are rapid.
The operating lease is preferred under the following circumstances:
- When the asset is likely to become obsolete within a short period.
- When the lease is interested in overcoming his problems temporarily.
The main features of the operating lease are as follows:
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- The leased period is substantially shorter than the expected economic life of the leased asset.
- The lessor is responsible for repairing, maintaining and insuring the asset.
- The risk of obsolescence remains with the lessor.
- This type of lease can be canceled with proper notice.
- The equipment is not fully amortized.
Financial Lease or Capital Lease
The financial lease also is known as a capital lease or fully payout lease. This is a long-term, non-cancellable contract agreement between the lessor and the lessee. The main features of the capital lease are as follows:
- The lease period is generally equal with estimated useful economic life.
- The lessee is responsible for repairing, maintaining and insuring the asset.
- The risk of obsolescence remains with a lessee.
- The equipment is fully amortized.
- The lease is not cancellable.
A direct lease is a straightforward agreement between the lessor and the lessee where acquires the use of an asset which it did not own previously. In such lease, the lease selects the required equipment and negotiates the lease price and delivery terms with the lessor. The major types of lessors are manufactures, finance companies, banks, independent leasing companies, special purpose leasing companies, etc. In such lease, the vendor generally sells the asset to the lessor and the lessor in turn lease it to the lesses.
This type of lease agreement has become popular during the last few years. It is generally used when the asset to be leased is a very costly one and the lessor is not able to provide complete finance. Lessor generally provides 40 to 50 percent of the cost of the asset at the time of purchase, while the financier, who may be a bank or a financial institution, provides the remaining amount as a loan. Thus three parties are involved in this lease contract.
Sales and Lease Back
Under a sales and leaseback lease, an owner of the asset sells it to another party and the same asset is taken on lease from that party. Thus, the lessee gets money by selling the asset and at the same time, he/she continues to use the asset by paying a fixed rental charge. Generally, the parties interested in purchasing assets under such arrangement are insurance companies, other financial institutions, institutional investors, banks and other specialized leasing companies. The lessor gets the benefit of depreciation deductions, while the lessee gets the benefit of increased funds, which she/he can use in business.
This type of lease is beneficial to both parties. The lessee gets back the price of the asset by selling it-and so his liquidity increases. The lessor gets the benefit of tax advantages from depreciation charges. Such an arrangement is particularly useful to the firm facing a shortage of liquidity.