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Advantages and disadvantages of Leasing or Lease finance over purchase of asset.

Updated on September 17, 2013

One of the most important form of long term finance nowadays is Lease financing. In lease financing a company can rent a asset or acquire right to use an asset without buying it from the actual owner. It is a written agreement or deed between two entities or firms, one who owns the assets and the other one which wants to use the asset for rent. There are lots of advantages and disadvantages of lease finance, some of the important points are discussed here.

It has become progressively more usual nowadays to lease purchase equipment, assets and vehicles. There are some mutual benefits for both lessee and lessor. On Lessee point of you leasing will be beneficial in many forms like avoiding bad investments, quickest and easiest method of financing, avoiding huge investments at one time etc.

Lease finance not only limited to industrial equipment and assets. We can lease a car or two wheeler and any other domestic equipment. There are lots of financing companies and agencies which provides such options for the needy.

Source

If you or your organization is seriously thinking of leasing an asset, I suggest you to read Negotiate the Best Lease for Your Business written by finance gurus Janet Portman Attorney and Fred S. Steingold Attorney. This great book provides complete insight on determining the real cost of renting and negotiation techniques to get the most out of your agreement.

The owner of asset or equipment, who wants to rent his asset is termed as ‘Lessor’. The user of the assets who pays for it on regular intervals is termed as ‘Lessee’. Till the tenure stated in the agreement between them, the Lessee can economically use the asset but the ownership of the asset remains with Lessor.

As per the lease contract or agreement a predetermined fixed payment is done periodical by the lessee for using the asset, which is called as ‘Lease rent’. After the lease period the possession of the asset reverts back to the Lessor. The Lessee should maintain the asset in good working condition under the contract period, he should not sell, mortgage, alter or modify the asset under the contract period. Car leasing has been drastically increasing in recent years, in which owner of the car leases it to another person under the contract.

There are two types of lease financing viz. Operating lease contract and Financial lease contract. Under Operating lease contract Lessor selects and buys the equipments or automobiles and leases it to the lessee, Lessor bears the insurance, maintenance and repair cost of the equipments or automobiles. Whereas in case of Financial lease contract Lessor just acts as financier, lessee can select and buy the equipments or automobiles based his requirements with the financial help from Lessor, Lessee bears the cost of insurance, repair and maintenance cost of the equipments or automobiles under contract period.

The lease deed or lease agreement is the document which bonds the legal relationship between lessee and Lessor, the agreement should contain following details,

  1. Description of the asset being leased
  2. Cost of the asset being leased
  3. Starting date and ending date of the lease contract
  4. Renewal options of lease contract after the end of contract period
  5. Lease rent amount, frequency of payment and payment mode.
  6. Options for premature termination of contract.
  7. Terms of use of the asset.

Advantages of Lease finance over purchase of asset.

  • Huge capital investment on asset can be eliminated buy lease purchasing of assets.
  • Risk of depreciation and obsolescence doesn’t affect to the lessee.
  • Leasing is quickest and easiest method of financing of capital
  • The periodic lease rents paid by the lessee are tax deductible expenditure.
  • Leasing increase the borrowing power of the company as its debt equity ratio will be unaffected by lease purchase.
  • Bad investments can be avoided by lease purchasing.
  • Lessee can lease purchase and pay for asset only for the time he needs it.
  • Lease financing is not affected by inflation. Even if the costs go up over some years, you still pay the same lease rent as agreement.
  • In case of car lease finance or auto lease finance, one can enjoy using latest or high cost cars without buying it for a desired period of time.

Disadvantages of lease financing:

Lease financing is a favored means of financing long term capital. However it is having following disadvantages.

  • Lessee has an obligation to continue making lease rent payments even if he is not economically using the asset because of decline in his business.
  • Even though lessee is not the owner, he is still responsible for repair and maintaining the asset as specified by the contract.

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    • shabarigirish profile imageAUTHOR

      shabarigirish 

      7 years ago

      Thanks for your comments Anna Smith.

    • anna.smith profile image

      anna.smith 

      7 years ago from Germany

      Great Hub.

    • shabarigirish profile imageAUTHOR

      shabarigirish 

      8 years ago

      Hi Magdy, in point 4 under the heading ‘Advantages of Lease finance over purchase of asset’ I have mentioned your point, but it was not explained elaborately, Thanks for clearly explaining it with a reference and assisting the readers. The lessee can get a tax advantage on leased asset; it is really an important point to be considered. Thanks again.

    • profile image

      Magdy 

      8 years ago

      Nice article, I would like to add another one more key advantage, that leasing allows the lessee, in effect, to depreciate land, which is prohibited if the land were purchased. Because the lessee who leases land is permitted to deduct the total lease payment as an expense for tax purposes, the effect is the same as if the firm had purchased the land and then depreciated it.(Corporate finance 2nd ed for Smart.Megginson.Gitman, Page 638)

    • shabarigirish profile imageAUTHOR

      shabarigirish 

      8 years ago

      Thanks for your comments Neil.

    • Neil Ashworth profile image

      George Poe 

      8 years ago from United Kingdom

      Great article.

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