Introduction to Leasing and Asset Finance
How does it work?
Essentially all leasing agreements work on the principle of renting an asset from a third party, usually a financial institution, for a fixed period. This type of contract is typically referred to as a lease.
Leasing plays a big part in the property market where properties are leased out to tenants. However leasing is also a popular way to finance business growth or deal with financial difficulties.
Typically the lease agreement will work as follows;
- A business requires a new asset (for example a factory needs an expensive new machine)
- The factory reaches an agreement with a lessor
- The lessor buys the new machine from its seller
- The lessor rents the machine out to the factory for a fixed term as defined in the lease agreement i.e. 2 years.
- At the end of the lease term the factory either returns the machine or renews the contract with the lessor.
Why use leasing as a form of finance?
Leasing improves cash flow for companies as expensive outgoings like purchasing equipment are offset by the lessor and the company only pays a rental fee. Although this fee will typically be more than the relative cost of purchasing the asset outright, the cost is spread over manageable rental instalments.
Unlike a loan many lease agreements are not regarded as a debt but as an expense. This is more favourable to a business entering other credit agreements where the stronger a credit position the business is in the more eligible they will be for preferential rates and higher lending.
As an asset is not owned by the business but by the lessor the residual cost of owning aging assets such as machinery are offset. This means a business can upgrade once an asset reaches obsolescence without the cost involved with selling or disposing of the aging asset. This is most effective in cases such as IT equipment leasing where technology companies want to stay up to date with their IT infrastructure without the continual cost of degrading IT kit.
Problems with leasing
As mentioned, leasing can be an expensive way to raise finance, often more than other routes including loans and always more expensive than buying an asset for cash as the lessor themselves need to make their own profit.
Lease contracts will often tie businesses into a fixed term meaning if circumstances change the business will still need to keep up lease payments.
As when leasing the business does not own the asset, when valuing a company, for example during a buy-out or merger their will be less material assets to base a valuation on.
Is leasing the right finance option for my business?
Our best advice is to consult financial specialists prior to entering any lease transactions...
About the Author:
John Mce writes for the Commercial Finance People. (http://www.commercialfinancepeople.co.uk/) Commercial Finance People is a financial recruitment consultancy, we specialise in the placement of candidates in executive and management level positions.
No. of Times this article has been viewed : 311
Date Published : Feb 15 2011
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