Among the various methods of customer credit, lease financing is one of the very important methods. In developing economies it provides a safe mode of financing, where customer gets the equipment he requires, and the financer has the safety through ownership of the equipment. Now let us discuss in detail various aspects of leasing.
Meaning: Lease is a contractual arrangement/ transaction in which a party (lessor) owning an asset/equipment provides the asset for use to another party/ transfer the right to use the equipment to the user (lessee) over a certain/for an agreed period of time for consideration in form of / in return for periodic payments / rental with or without a further payment (premium). At the end of the contract period (lease period) the asset/equipment is returned to the lessor.
It is a method of financing the cost of an asset. It is a contract in which a specific equipment required by the lessee is purchased by the lessor (financier) from a manufacturer / vendor selected by the lessee. The lessee has the possession and use of an asset on payment of the specified rental over a pre-determined time. Lease financing is, thus a device of financing/money lending. The real function of lessor is not renting of asset but lending of funds or financing or extending credit to the borrower.
Main characteristics of lease financing can be explained as following:
Parties to Contract: There are essentially two parties to the contract of leasing i.e. financer (or owner – Lessor) and user (lessee). Also, there could be lease-broker who works as an intermediary in arranging lease finance deals, in case of exposure to large funds. Apart from above three there are some times lease-financers also, who refinances to the lessor (owner).
Ownership Separated from User: The essence of a lease finance deal is that during the lease-period, the ownership of assets vests with the lessor and its use is allowed to the lessee. On the expiry of the lease tenure, the asset reverts to the lessor.
Lease Rentals: The consideration which the lessee pays to the lessor for the lease transaction is the lease rental. The lease rentals are so structure as to compensate the lessor the investment made in the asset (in the form of depreciation), the interest on the investment, repairs and so forth, borne by the lessor, and servicing chares over the lease period.
Term of lease: The term of lease is the period for which the agreement of lease remains in operations. Every lease should have a definite period otherwise it will be legally inoperative. The lease can be renewed after expiry of the term.
Classification of Lease: A lease contract can be classified on various characteristics in following categories:
Finance Lease and Operating Lease
Sales & Lease back and Direct Lease
Single investor and Leveraged lease
Domestic and International lease
Finance Lease: A Finance lease is mainly an agreement for just financing the equipment/asset, through a lease agreement. The owner /lessor transfers to lessee substantially all the risks and rewards incidental to the ownership of the assets (except for the title of the asset). In such leases, the lessor is only a financier and is usually not interested in the assets. These leases are also called “Full Payout Lease” as they enable a lessor to recover his investment in the lease and derive a profit. Finance lease are mainly done for such equipment/assets where its full useful/ economic life is normally utilized by one user – i.e. Ships, aircrafts, wagons etc.
Generally a finance lease agreement comes with an option to transfer of ownership to lessee at the end of the lease period. Normally lease period is the major part of economic life of the asset.
Operating Lease: An operating lease is one in which the lessor does not transfer all risks and rewards incidental to the ownership of the asset and the cost of the asset is not fully amortized during the primary lease period. The operating lease is normally for such assets which can be used by different users without major modification to it. The lessor provides all the services associated with the assets, and the rental includes charges for these services. The lessor is interested in ownership of asset/equipment as it can be lent to various users, during its economic life. Examples of such lease are Earth moving equipments, mobile cranes, computers, automobiles etc.
Sale and Lease Back: In this type of lease, the owner of an equipment/asset sells it to a leasing company (lessor) which leases it back to the owner (lessee).