This is another important source of external finance. A lease is a contract in which the lessor (owner of asset) allows the lease to use the asset in consideration of a rental payment made periodically. This rental is called lease premium. Usually a lease involves 2 parties – the lease and the lessor; but under certain circumstances a third party may be involved (we shall discuss this later).
Type of Leases Include:
1. Operating lease
2. Finance lease
3. Maintenance lease
5. Sale and lease back
An operating lease is one in which the contract can be cancelled by either of the parties upon due notice to the other. This implies that there is no definite duration for the contract.
A financial lease on the hand is a firm and building contract between the lease and the lessor for a specified period and cannot be cancelled or amended unless all the parties agree. Unless otherwise agreed, the lessor is not expected to maintain or service the assets under a financial lease. The financial lease may provide for the continued possession of the asset by a renewal provision/or by an option to purchase provision.
A maintenance lease is one in which the lessor is expected to maintain and service the assets during the period of the lease. This occurs mostly in the lease computers, photo copiers and other technical equipments where special (rare) skills are needed for maintenance. A maintenance lease is usually of short duration and of the operating type. Because of the extra services provided, the lease premium is often higher than the ordinary.
A leverage lease, also called a third party lease is a type of lease that involves a third party.(i.e. in addition to the lessee and lessor). Under this type of lease the lessor borrows money from the lender to acquire the asset which is then leased to the lessee.
Sale and lease back occurs where a firm sells part of its fixed assets to a buyer who agrees to lease back the asset to the firm. The ownership of the assets stays with the new buyer while the firm retains possession and use of the assets. This is a means of raising long term finance.
ADVANTAGES OF LEASING
1. The lease premium is fixed and payable at regular intervals. The lessee is therefore happy that his financial commitments can easily be ascertained.
2. There is no need for any initial capital outlay since the lease agreement usually covers the total finance for the acquisition of the asset.
3. The timing of the rental payments (lease premia) can be very flexible. For instance the due date for each payment can be made to synchronize with the high liquidity points of the business besides, the rentals can be arranged that the amount increases as the project becomes more established.
4. The secondary period of the lease (which is usually the last two years of the working life of assets) attracts only nominal rental.
5. Though the lease cannot claim any capital allowances on the leased assets, the rentals are allowable expenses for corporation tax purposes.
6. Legal costs and documentations are quite minimal while interest element of the cost is only about 150% of overdrafts rate.
7. Leasing does not affect the gearing ratio of the firm and therefore may not affect the availability of other credit facilities or borrowings. However, this conclusion should be taken with caution.