Advantages and Disadvantages of Lease Financing

Lease Financing is a medium and long-term financing arrangement. Under lease finance, the owner of the asset grants another entity the right to use that asset in return for monthly payments. The lessor is the asset owner, while the lessee is the user. Lease rental is the monthly payment paid by the lessee to a lessor. The terms & conditions of the lease must be outlined in a contract between a lessor and the lessee.

The lessee is granted the right to utilize the asset, but the lessor retains ownership. After the lease contract, the assets are returned to the lessor, or the lessee can purchase the asset or extend the lease arrangement.

In this article, we'll examine the advantages & disadvantages of lease financing.

Advantages of Lease Financing

To Lessor: From the viewpoint of the lessor, the following advantages of lease financing:

• Tax Benefits

As the asset's owner, the lessor can get several tax benefits, including depreciation and investment incentives. Income is reduced by depreciation. The tax imposed on income decreases as it increases. To lower his tax obligation, a lessor subject to a high tax bracket can rent out assets or real estate with a high depreciation rate.

• Security

The lessor may take back the leased asset, property, or equipment if the lessee cannot pay the lease rentals; in this way, the lessor's interest is safeguarded.

• Guaranteed Regular Income

Lessors earn lease rents by leasing assets for the life of the lease, providing a fixed and regular source of revenue.

• Growth Opportunities

There is a ton of opportunity for growth in this. The demand for leasing is continually rising because it is the most economical method of financing. Economic development is possible even while the economy is in a slump. Leasing hence offers a far greater potential for expansion than other business types.

• High Profit

Leasing is very profitable since the rate of return (ROI) on lease rents is substantially more than the interest payable on the asset's financing.

• Preservation of Ownership

In lease financing, the lessor holds ownership of the asset while passing all risks and benefits associated with the owner to the lessee.

To Lessee: From the viewpoint of the lessee, the following advantages of lease financing:

• Tax Benefits

The lessee can also obtain a tax benefit by deducting the MLPs, or lease rents, as expenses.

• Liquidity

Without investing in the asset, the lessee can make money using it. He can use his money for working capital requirements.

• Hidden Liability

Liabilities related to leases are not included on the business's balance sheet. Loans obtained to purchase assets, however, are recorded as liabilities. Leasing thereby aids the lessee in presenting a higher debt-to-equity ratio.

• Time-Saving

After applying for a loan, the asset is instantly usable without waiting for approval, sanction, etc. You can match lease rentals to the lessee's cash flow.

• Zero chance of Obsolescence

The lessor is liable for the asset's Obsolescence due to technical developments.

• Flexibility

A lease's conditions are more adaptable. The lessee can change the rental time based on his needs and concerns.

• Convenience

The simplest way to finance fixed assets is by leasing. There is no need for a mortgage or hypothecation. A long-term loan from a financial institution is not subject to restrictions. Leasing involves many fewer formalities than borrowing money from financial institutions.

• Favorable to Inflation

Leasing is inflation-friendly because the lessee must pay a fixed rent annually, irrespective of how much the asset's price fluctuates.

• Ownership

The lessor allows the lessee to buy the assets for a modest cost once the main period has ended.

• Less Delay

In general, processing a lease proposal takes less time than term-loan funding. Lease Financing enables the business/lessee to get the right to utilize the asset or property quickly.

Disadvantages

To Lessor: From the viewpoint of the lessor, the following disadvantages of lease financing:

• Unprofitable in the situation of Inflation

Even if the asset's cost rises, the lessor's fixed annual lease rental amount cannot be increased.

• Double Taxation

Sales tax could be levied twice: Once when the asset is purchased and a second time when it is leased.

• Ownership

The lessor allows the lessee to acquire the assets after the primary period has passed by paying relatively little money.

• Market Competition

There are now more leasing firms than ever before. The lessor may have to rent out the property at a reduced rental rate due to the increased competition, which might prevent them from realizing the anticipated returns on their investments in the asset or property.

• Greater Probability of Asset Damage

Since ownership is not changed, the lessee utilizes the asset irresponsibly, increasing the likelihood that it won't be usable once the primary lease time has ended.

• High risk of Obsolescence

Due to the current condition of rapidly evolving technology, the lessor is also concerned about the danger of technical equipment becoming obsolete (state of being unusable).

To Lessee: From the viewpoint of the lessee, the following disadvantages of lease financing:

• Contract restrictions

The lessee may not be allowed to change or modify the asset in any way under a lease agreement.

• Compulsion

Finance leases are non-cancelable; the lessee must pay the lease payments even if a business does not intend to utilize the asset.

• Ownership

At the expiration of the lease arrangement, the lessee cannot own the asset unless he chooses to buy it.

• No Renovation Permission

No extensive modifications can be made to the Asset or Property by the lessee because the lessee doesn't own the Asset or Property.

• Loss of Asset Salvage Value

The salvage value of an asset is the projected amount of its worth at the end of its usable life. The lessee cannot collect the salvage value of the asset when the lease time expires since he does not have ownership of the asset, which is returned to the lessor.

• No Warning Period

Contrarily, if the asset/property is acquired, the buyer can change it to boost usability, modernize it, or for any other purpose, including incorporating his personal décor preference. An asset often takes a long time to produce enough money to repay the loan. The term loan stipulates a defined moratorium time in debt repayments. However, in lease agreements, no such period is permitted.

• Higher cost

The lease rentals for the lessee include margins as the expense of risk of property disuse. It accounts for the perception that it is a more expensive kind of borrowing.

• Understatement of Assets

Since the lessee does not own the asset, it cannot be listed on the balance sheet, which understates the lessee's asset.

• Regular rents

The lessee has to pay regular lease rent to the lessor.

The Conclusion

The pros and cons of leasing to both the lessor and lessee are discussed in this article. For individuals unable to get money through debt financing, lease finance is the ideal choice. People with excess assets can lease such assets to others who need them. Leasing thus becomes advantageous for both the lessor as well as the lessee.