Lease FinancingA lease can be defined as a contractual agreement wherein one party i.e., the owner of an asset bestows the other party the right to use the asset in return for a periodic payment. It is otherwise called a process of leasing an asset for some specified period. The owner of the asset is called as the 'lessor' and the party that makes use of the asset is called as the 'lessee' (see Box A). The lessee pays a fixed periodic amount called lease rental to the lessor for the use of the asset. The terms and conditions that bound the lease arrangements are mentioned in the lease contract. During the end of the lease period, the asset is returned to the lessor. Lease finance paves way for an important means of modernisation and diversification to the organization. This type of financing is more rampant in the acquisition of such assets as computers and electronic equipment that become obsolete quicker due to the fast changing technological developments. In the process of making the leasing decision, the cost of leasing an asset should be compared with the cost of owning the same.
The important merits of lease financing are as follows:
- It aids the lessee to possess the asset with a comparatively low investment;
- The documentation process is simple and makes it easier to finance assets;
- The Lease rentals paid by the lessee can be deducted for computing taxable gains;
- This provides finance without affecting the ownership or control over the business;
- The lease agreement can never affect the debt raising capacity of an organisation;
- The lesser bears the risk of obsolescence. This enhances greater flexibility to the lessee to restore the asset.
The limitations of lease financing are listed below:
- The lease arrangement may wreak some restrictions on the use of assets. For instance, it may not entertain the lessee to perform any alteration or modification in the asset;
- When the lease agreement is failed to renew, it might lead to the disruption of the normal business operations.
- It may lead to a higher payout compulsion when the equipment is not found useful and the lessee prefers to opt for premature termination of the lease agreement; and
- The lessee will never become the owner of the asset. He/she is deprived of the residual value of the asset.