Leasing – Meaning, Types, Benefits and Limitations

Leasing is understood to be a financial instrument that permits an individual or the lessee to enjoy the utility of a physical asset without possessing it or without assuming ownership of the asset. Leasing can also be defined as an arrangement between two main parties namely: the lessor or the leasing company and the person or the lessee. The customer or the lessee can rent the asset from the company for a particular period of time. The rent for leasing are always predetermined and are due after a particular fixed intervals of time and the lessee assumes the ownership of the property for the entire lease period. There is no purchase option at the expiry of the lease period. Leasing applies to equipment’s that are expensive and bulky or large. Leasing has advantage of tax exemption since the individual avoids the per annum leasing charges; also there is the advantage of avoiding the making of down payments.

A company with huge capital outlay will use their profits to lease assets by simultaneously defraying charges from depreciation as profits. Business organizations consider the use of leasing as the best instrument to apply for capital equipment during the financial period of the investment. There is always an operational capital that is accrued from leasing especially when the companies supply the equipment instead of financing the equipment, this kind of capital accrued is called financial leasing. Leasing can be an instrumental source of finance and can be used to modernize business operations.

Types of Lease

There are five types of leasing namely: financial leasing, operating lease, leverage lease, the sale and lease back and cross border lease.

1. Financial lease: This is a type of lease which cannot be revoked or canceled. The lessee enjoys the use of the asset for a long period of time; the lessee maintains, insures and can avail it for after sale services and warranty. In this type, the lessee bears responsibility over obsolescence for the entire period of lease. Financial lease has the option of purchase after the predetermined period. Nominal charges are charged to the lessee so as to finance legal and other costs.
2. Operating lease: The contract period between the parties’ covers a period of less than economic life of the equipment; the contract is short term in nature. The operating lease contract can be terminated via a notice as stipulated in the agreement terms. Obsolescence risks, maintenance costs and other expenses lie in the hands of the company or lessor.
3. Leverage lease: This only applies to assets of massive capital and involves three parties; the lesser, lessor and the lender or other stakeholders.
4. Sale and lease back: This is an arrangement where a company can sell an asset to a company the can lease it out. The lessee can get the equipment at a market value. The lease back arrangements are at a net basis.
5. Cross border leasing: This is also called transactional leasing and it is a leasing transaction between parties based on different countries.

Why Leasing is Better than Buying?

Renting is a good offer because it does not require an immediate significant investment of money. Instead, the tenant signs a contract in which he undertakes to pay a certain fixed fee for each specified period. Renting avoids a lot of paperwork and liability for the building or equipment that went wrong. Leasing allows redirecting existing capital into business development instead of buying a building or equipment.

The lease allows timely and much cheaper modernization. When a large amount of equipment is bought with capital, it has to work until it pays off, and thus if the production volumes are not too large, it can take a long time. In the case of a lease, the equipment does not need to be thrown away, and capital is not invested in it. It will be enough to exchange it in order to rent new units. Thus, the lease optimizes the enterprise and will not allow it to become obsolete.

Benefits of Leasing

1. Leasing can help save capital which can be used for other productive purposes. A purchase would involve upfront payment of a large amount which would be a drain on an organization’s resources.
2. If the leased product is related to technology, the problem of technology obsolescence can be avoided by leasing different equipment in place of the existing one. The only problem to take note of is that it should be incorporated into the lease agreement.
3. Tax deductions are allowed on the leased item and hence companies can claim the same and get the benefit of additional resources.
4. If the cost of debt is high in a particular market leasing would be the preferred alternative.
5. It is equivalent to getting 100% finance for the product without its attending costs.
6. Leasing is more advantageous if the use for the product is short or medium term.
7. The organization can test the viability of a new product or location. If not found feasible, it can be abandoned without heavy losses.

Limitations of Leasing

It is worthwhile to mention a few disadvantages also.

1. The lessee has no ownership or stake in the item leased. Any appreciation in value (e.g. property) will benefit the lessor only.
2. Increase in rent periodically may prove to be costly in the long run.
3. Flexibility in suing the leased item may be curtailed.
4. The clauses in the lease agreement may be more beneficial to the lessor than the lessee.