Leasing Definition and Steps, Advantages, Disadvantages

Leasing is a kind of financial service which allows a firm to use and control the asset without acquiring it. Leasing helps small firms to acquire assets of higher value. It is the form of renting of assets.

The maximum period of lease according to law is for 99 years. Previously land or real resate, mines and quarries were taken on lease. But now a day’s plant and equipment, modem civil aircraft and ships are taken.

A lease is a contract under which one party, the lessor (owner of the asset), gives another party (the lessee) the exclusive right to use the asset usually for a specified time in return for the payment of rent.

Leasing is the process by which a firm can obtain the use of certain fixed assets for which it must make a series of contractual, periodic, tax-deductible payments. A lease is a contract that enables a lessee to secure the use of the tangible property for a specified period by making payments to the owner.

Major Features of Lease

• The Contract: There are essentially two parties to a contract of lease financing, namely the owner and the user.
• Assets: The assets, property to be leased are the subject matter lease financing contract.
• Lease Period: The basic lease period during which the lease is non-cancelable.
• Rental Payments: The lessee pays to the lessor for the lease transaction is the lease rental.
• Maintain: Provision for the payment of the costs of maintenance and repair, taxes, insurance, and other expenses appertaining to the asset leased.
• Term of Lease: The term of the lease is the period for which the agreement of lease remains in operation.
• Ownership: During the lease period, ownership of the assets is being kept with the lessor, and its use is allowed to the lessee.
• Terminating: At the end of the period, the contract may be terminated.
• Renew or Purchase: An option to renew the lease or to purchase the assets at the end of the basic period.
• Default: The lessee may be liable for all future payments at once, receiving title to the asset in exchange.

Steps

1. Lessee identifies the equipment and the supplier or lessor of the asset
2. Lessee enters into agreement with lessor
3. Lessor delivers the asset to the lessee

Advantages Of Leasing

Acquisition of long-term assets requires huge cash outlay which is sometimes quite beyond the financial capacity of the actual user. In such a situation, the user can lease such capital assets. Leasing serves as a long-term funding that can be used for acquisition of capital assets. The advantages of leasing are as follows:

• Trading On Tax Shield

In case of a non-tax paying lessee, the cost of financing an asset is much higher as compared to a tax-paying lessee. However, when tax-paying owns the assets, he generally passes a part of the tax benefit to the lessee by means of lower rental charge. As a result of this favor, the real cost of the asset to the lessee, work out to be lower than that what it would have been if he were the owner of the assets.

• Absence Of Restrictive Convenience

The financial institution while lending money usually attach several restrictions on the borrowers as regards management, debt-equity norms declaration of dividends etc. Such restrictions are absent in the case of lease financing.

• Boon For Small Firm

Acquisition of assets through a leasing arrangement is particularly beneficial to small firms which cannot afford to raise their capacity on account of scarcity of financial resources.

• Leasing Protects against Obsolescence

Lease arrangements helps to protect the lessee against the risk of obsolescence in respect of the assets which become obsolete at a faster pace.

• Leasing Increases Lessee’s Capacity to Borrow

Leasing arrangements enable the lessee to use more of its own funds for working capital purposes instead of using low yielding fixed assets. The debt-equity ratio of lease does not alter because of assets acquired under lease arrangements. As such lease arrangements can resort to further borrowings in case the need arises.

• Leasing Arrange Faster and Cheaper Credit

Leasing companies are generally more accommodating than banks and other financial institutes in respect of terms of financing. As such, it has generally been found that acquisition of assets under leasing arrangement is cheaper and faster as compared to acquisition of assets through other sources of financing.

• Leasing Permits Alternative Uses

A leasing arrangement provides a firm with the use and control over the assets without incurring huge capital expenditure and requiring to make only periodical rental payments. Thus, leasing saves funds for alternative uses.

Disadvantages Of Leasing

• Deprived of The Asset IN Case of Default

In case the lessee makes a default in rental payment, the lessor is entitled to take over the asset and the lessee has no right to prevent him from doing so.

• Deprived on Ownership

In a leasing arrangement, the lessee does not get the ownership of the asset. it gives only the right to use. As such, the lessee, cannot pledge the asset for securing loan from financial institutions.