Advantages and Disadvantages of Lease!
Leasing out the assets and properties is an age-old practice which is gaining momentum in recent years. According to ‘Marwan Mohammad Abu Orabi’ (2014) (Published in Global Journal of Management and Business Research: C Finance), a lease is an agreement between the lessor (owner of the asset) and the lessee (user of the asset) where the property is given for use for a fixed term in return for periodic payments known as lease rentals or lease payments. Leasing is gaining popularity to resolve the fixed asset requirement issues faced during the purchase of the asset. It is necessary to understand advantages and disadvantages of lease before deciding on leasing out the property or asset.
Both the user and the owner of the asset i.e. the lessee and the lessor have some leasing advantages and disadvantages which are listed below. Let’s have a look at them.
Advantages of Leasing to the Lessee (User of Asset)
There are various advantages of leasing for the lessee which are listed below:
01. No Need of Initial Investment
- Lease is usually taken or provided on those assets or properties which require a huge financial investment.
- It provides 100% financing without any need of immediate down payment.
- In this way, the lessee faces no obstacles in starting the business without any initial investment though some leasing companies insist to pay in advance the first lease rent.
02. Suitable and Easy Source of Finance
- In leasing, the initial cost of raising finance is quite less compared to long-term loans.
- There is no need to mortgage any assets because during the lease period, the ownership is in the hands of the lessor.
- It allows the firms or lessee to use an asset or property without doing strict and rigid formalities. So, it is cheaper as well as faster than other options.
- An asset on lease may cost less than the other financing alternatives available.
03. Free from Restrictive Terms and Conditions
- Lessee feels free from various restrictive terms and conditions like representation on board, conversion of debt to equity, payments of dividends etc.
- This prevents the invasion of the financial freedom of the lessee.
- Hence, lease finance is preferred over institutional finance.
04. Less Delay
- Generally, time taken to process the lease proposal is lesser than the term-loan financing This helps the firm/lessee to possess the right to use the asset or the property with no or less delay.
05. Balanced Flow of Capital
- The cash flow of the lessee can be balanced by proper framing of lease rental.
- The lease rentals are usually paid from the funds which are generated by the use of the asset or property.
- The lessee’s capacity of paying the rentals is kept in mind while deciding the lease period.
- Institutional finance repayment is generally burdensome during initial years if the asset does not generate enough income for paying of rentals.
06. Faster and Simple Documentation Procedure
- Lease arrangement involves simple and quick documentation process and is free from the hassles of long and tiresome procedures of institutional financing.
07. Flexibility and Convenience
- If the lessee/firm does not require the use of asset till the end of lease period, the lease can be terminated in the middle in case of operating or service lease.
Hence it can be said as a convenient and flexible mode of financing.
08. Less Maintenance Costs
- In case of gross lease arrangement, the specialized services provided by the lessor can be used for the maintenance of the asset leased.
- Also, in case of an operating lease, there can be a provision of asset maintenance which is provided by the lessor.
09. Higher Capital Return
- In case of lease, the asset does not appear on balance sheet on the asset side as the lessee has only the right to use the asset and not own it.
- This indicates a higher rate of return on the capital employed resulting in higher earnings per share.
10. Tax Advantages
- It is quite beneficial for the lessee in reducing the tax liabilities as the lease rentals are regarded as revenue expense.
- The lease rentals can be adjusted by the lessee so that it helps in planning the taxes and reducing the tax liabilities.
- It is a good source of finance for profit generating companies having more tax liabilities and less capital.
11. No Risk of Disuse of Asset/Property
- The risk of disuse of the asset or property is on the shoulders of the lessor as he is the owner of the asset.
- The lessee can replace the asset anytime with the latest and updated technology.
12. Potential for Growth
- There is a high potential for growth in leasing industry.
- The lessee can acquire property or equipment for the business even during recession when he is pressed for funds.
- This can maintain growth pace during the recession period.
Disadvantages of Leasing to the Lessee (User of Asset)
Leasing is not always in favor of lessee. There is also disadvantages of leasing, to its credit, and those are listed below:
01. Risk Involved in Deprived Use of Asset
- In case of deterioration in the financial position of the lessor or winding up of leasing company, the use of asset may be deprived to the lessee.
02. Loss of Ownership Incentives
- There are various benefits of leasing which are prevalent while owning an asset such as investment, incentives and depreciation allowance. The lessee is not entitled to such benefits in leasing.
03. No Permission to Renovate
- The lessee cannot make any considerable changes in the asset or property as he is not the owner of the asset or property.
04. Loss in the Salvage Value of Asset
- Salvage value is the estimated amount of an asset’s worth at the expiry of its useful life.
- The lessee cannot realize the salvage value of the asset at expiry of the lease period as he is not the owner of the asset rather the asset is returned to the lessor.
05. Loss of Warning Period
- In contrast, if the asset or property is purchased, the buyer can alter it to increase its utility, or for modernization or for any other reasons such as to incorporate his personal choice of decor.
- It generally takes a long time for an asset to generate funds to pay back from it.
- The term loan provides a specific moratorium period in repayments of the loan amount. But in case of lease arrangements, no such moratorium period is permitted.
06. Penalty on Lease Termination
- If the lessee terminates the lease before its time period, certain penalties may be incurred upon by the lessor.
07. Higher Cost
- For the lessee, the lease rentals include a margin as the cost of risk of disuse of the property. which is why it is regarded as a form of financing at a higher cost.
Advantages of Leasing to the Lessor (Owner of Asset)
The lessor who gives the property on lease also has various advantages of leasing as stated below:
01. Quick & Higher Profits
- The lessor receives lease rentals from the lessee which help in making high profits.
- The profits made through leasing of asset takes care of the cost of capital as well as the risks involved with it.
- The rate of return is quick and more than what the lessor pays on his borrowings for acquiring such assets.
02. Trading on Equity
- For lessors, it is possible to trade on equity.
- Lessors can earn a high return on equity with ample borrowings and low equity capital.
- If the lessee fails to pay the lease rentals, the lessor can repossess the leased asset, property or equipment, the lessor interest is secured here.
04. Tax Benefits
- Lessor being the owner of the asset can claim various tax related benefits such as depreciation, incentives on investment, etc.
- Depreciation is deducted from the income. Less is the income, less is the tax laid on it.
- If lessor falls under the bracket of high tax, he can lease out assets or property with high rate of depreciation and reduce his tax liability.
05. Increased Sales
- When manufacturers increase their sales with the help of lease financing through third parties, the lessor can also demand certain benefits from the manufacturers.
Disadvantages of Leasing to the Lessor (Owner of Asset)
Various disadvantages of leasing to the lessor associated with leasing of the property or asset are as follows:
01. No Benefits of Price Rise
- The lease rentals are generally fixed throughout the lease period so if there is any increase in the prices of the assets due to inflation, there is no benefit to the lessor.
02. Increased Cost Due to User Benefit’s Loss
- The benefits which are available to the users of asset such as concession in GST/ VAT, duties, etc. are not available to
- This in turn increases the cost of the asset or property which leads to higher lease rentals imposed by the lessor.
03. Market Competition
- All across the world there has been an increase in the number of leasing companies in recent years. Due to this increased competition, the lessor may have to lease out the property at lower lease rentals and not earn the expected profits from the investments made on the property or asset.
04. Long-Term Investment
- The capital outlays earned through lease rentals usually takes a long time to recover the cost of the lessor.
- As inherent risks are also involved in lease rentals, it may not represent the actual realized profits.
05. Cash-Flow Management
- Due to unexpected market fluctuations, it is quite difficult to manage the efficient use of cash flows which to a large extent decides the success of the leasing businesses.
06. High Risk of Obsolescence
- In the present times of rapid changing technology, there is risk of obsolescence (state of being unused) of technical equipment which also lies on the shoulders of the lessor.
The article deals with the advantages and disadvantages of lease to both the lessee and the lessor. We hope that it has provided you the broad ideas on leasing. If you would like to add some points to it or you want to share your views on the above article, please do share it with us in the comment box given below.