Fixed-term (and usually non-cancelable) lease that is similar to a loan agreement for purchase of a capital asset on installments. The lessor's services are limited to financing the asset, the lessee pays all other costs including insurance, maintenance, and taxes. Finance leases are regarded as essentially-equivalent to a sale by the lessor, and a purchase by the lessee (even though the title remains with the lessor). Therefore, leased assets must be capitalized and shown in the lessee's balance sheet as a fixed asset with a corresponding non-current liability (lease payable).
The lessee acquires all the economic benefits (such as depreciation) and risks (such as the possibility of the loss of the leased asset) of ownership but can claim only the interest-portion (not the entire amount) of the lease payment as an expense. To be considered a finance lease, a lease must meet one or more of these main criteria:
- Title of the asset passes automatically from the lessor to the lessee at end of the lease term
- Lease contains a bargain purchase option under which the lessee may acquire the leased-asset at less than its fair market value at the end of lease term
- Lease term is for a period longer than the 75 percent of the estimated economic life of the asset
- The present value of the lease payments is greater than 90 percent of the fair market value of the asset at the beginning of the lease term.
A finance lease is a 'full payment lease' because the lease payments pay back (amortize) the full cost (including financing costs, overheads, and profit margin) of the leased asset to the lessor, with little or no dependence on the residual (or salvage) value of the asset.
Finance leases are reported by the lessee as if the assets being leased were acquired and the monthly rental payments as if they were payments of principal and interest on a debt obligation. Specifically, the lessee capitalizes the lease by recognizing an asset and a liability at the lower of the present value of the minimum lease payments or the value of the assets under lease. As the monthly rental payments are made, the corresponding liability decreases. At the same time, the leased asset is depreciated in a manner that is consistent with other owned assets having the same use and economic life
Often with a shorter time frame than financial leasing (always significantly shorter than the working life of the asset), operating leasing is more like a regular rental. The lessor expects to be able to either sell the asset in the second-hand market or to lease it again and will therefore not need to recover the total asset value through lease payments. There may be an option to extend the leasing period at the end (this negotiation can only take place at the end of the initial rental period).
Sustains a Competitive Edge
Businesses change almost daily. New competitors, new market forces, new financial strains, and new organizational structures all add up to a need for flexibility. When selecting new technology, one often wonders if it will be replaced by a faster, more powerful alternative next year, or even next month. Leasing can help avoid the risk of ownership because you only pay for the use of the equipment. When your lease expires, you can then buy the equipment, trade it in for the latest technology, or simply walk away (depending on the type of lease chosen). With leasing, you can put a technological "safety net" in place, so your companies' competitive edge is never dulled by the process of moving up to faster, larger, or different equipment.
Leasing can overcome budget limitations
Do you have a capital expenditure budget that has no room for the purchase of new equipment, but an operating budget that has plenty of room for low monthly lease payments. For as little as the first and last monthly payments, you can start using your equipment.
Perfect Solution for Expanding Businesses
You deserve access to the latest equipment and technology. Leasing protects you from being locked into owning equipment that may not meet your future needs. You will have the flexibility to upgrade to the newest releases, features and functionality as they become available. Leasing is often the financing solution of choice for businesses that hesitate to buy equipment because they fear it will become obsolete before they can fully depreciate it.
Leasing offers a wide range of options and flexibility that purchasing equipment or standard loans do not. Leases are easily customized to meet a customer's specific financial goals. From no cash up front, or grace periods, to Fair Market buyouts, or EGP 1 buyouts, leasing offers the customer the most flexibility with the widest range of options. Lease terms for capital equipment range from 12 months to 84 months and can be devised to keep up front costs low, or give the lowest monthly payments, or make the end of lease buyout as low as possible.
The preservation of cash flow compared to conventional financing is the most attractive benefit of leasing. It doesn't require the cash outlay for a large asset purchase and can be used to overcome budget limitations. Existing cash position and lines of credit remain free and liquid for other working capital needs that have higher ROE and/or ROA metrics
Hedges Against Inflation
In an operating Lease, payments are made for the usse of the asset. You do not pay for ownership on equipment that consistently depreciates. Furthermore, your cash savings can yield a return that fights inflationary pressures.
Unlike typical financing methods, leasing provides 100% financing for asset acquistion. Most costs incurred in acquiring an asset can be financed by the lease. These costs include delivery charges, interest charges on advance payments, sales or use taxes, installation and training costs. Such costs are not usually financed under alternative methods of asset financing.
Arrange Faster And More Affordable 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.
Lease arrangements helps to protect the lessee against the risk of obsolescence in respect of the assets which become obsolete at a faster pace.
Sale and Leaseback
A sale and lease back transaction is a deal in which a company sells legally owned equipment to a leasing company and leases it back for a period acceptable to both parties. A sale and lease back enables businesses of all sizes - from small-to-medium enterprises to large corporations - to free up capital through the sale of assets at the written down or market value.
There are two key reasons for companies to consider a sale and leaseback transaction;
- Liberate Capital
Depending on the quality of the asset being sold, freeing up equity at good rates presents opportunities for companies to redeploy this capital into core business activities with higher rates of return, or to reduce higher cost of borrowings.
- An alternative to conventional financing
Companies can investigate the potential for sale and leaseback transactions as an alternative to borrowing from more traditional sources. The feasibility of this will depend on where the investment yields currently sit in relation to the weighted cost of capital (internal) and external sources of finance.