Advantages and Disadvantages of Leasing

After reading this article you will learn about the Advantages and Disadvantages of Leasing:- 1. Advantages of Leasing to the Lessee 2. Disadvantages of Leasing for the Lessee 3. Advantages of Leasing to the Lessor 4. Disadvantages for the Lessor.

Advantages of Leasing to the Lessee:

(i) Avoidance of Initial Cash Outlay:

Leasing enables a firm to acquire the use of an asset without making capital investment in buying the asset. The lessee may avail 100% finance from lease financing and avoid even initial investment in margin money as required under loan financing. However, some leasing companies demand that first lease rent should be paid in advance.

(ii) Minimum Delay:

Usually, leasing companies take much lessor time in processing the lease proposal as compared to the lengthy procedure involved in the term-loan financing. Thus, a firm can avoid delay in the use of an asset by taking it on lease.

(iii) Easy Source of Finance:

Leasing provides one of the easiest sources of intermediate and long- term financing. It does not require any mortgage of the assets because the ownership of asset leased remains with the lessor and is not transferred to the lessee.

Moreover, various restrictive provisions imposed in term loan financing are avoided. The initial cost of raising finance through leasing is also much lesser than that of raising long-term loans.

(iv) Shifting the Risk of Obsolescence:

In the present era of rapid changing technologies, a firm has to bear the risk of obsolescence if it purchases the asset. The firm (lessee) can easily shift this risk upon the lessor by acquiring the use of the asset on lease rather than buying the same.

(v) Enhanced Liquidity:

Sale and leaseback arrangement enables a firm to improve its liquidity position by realising cash from the sale of fixed assets and retaining the economic use of the same. Thus, the lessee can salvage its working capital crisis through lease financing.

(vi) Conserving Borrowing Capacity:

Leasing is a form of financing that does not reduce or affect the borrowing capacity of the lessee firm. It is considered to be a hidden form of debt which does not appear as a liability in the balance sheet of the lessee. Thus, it does not affect the debt equity ratio of the firm acquiring use of an asset through leasing.

(vii) Tax Planning and Differential Tax Advantage:

As lease rentals are considered as a revenue expense while determining taxable profits, it is advantageous for-the lessee in minimising tax liabilities. Moreover, the lessor who is usually in the higher tax bracket passes on the benefit of depreciation advantage to the lessee in the form of reduced lease payments.

The lessee can also arrange to adjust lease rentals in such a way that it reduces his tax liability and thus helps him in tax planning.

(viii) Higher Return on Capital Employed:

Since the lessee acquires only the right to use the asset without owning it, such asset does not appear on the asset side of the balance sheet. This implies higher earnings against capital employed and higher rate of return on capital employed.

(ix) Convenience and Flexibility:

Operating or service leases are usually cancelable enabling the lessee firm to terminate the lease if it does not require the use of the asset, any more. Hence, it is very convenient and flexible mode of financing fixed assets.

(x) Lesser Administrative and Maintenance Costs:

Under a ‘ gross lease’ arrangement, the lease can avail the specialised services of the lessor for maintenance of the asset leased. Even in case of operating lease agreement there could be a provision of maintaining the asset by the lessor.

Although, the lessor charges for such maintenance and service costs by way of higher rentals, the lessee’s overall administrative and service costs are reduced because of specialised services of the lessor.

Disadvantages of Leasing for the Lessee:

(i) Higher Cost:

The lease rentals include a margin for the lessor as also the cost of risk of obsolescence; it is, thus, regarded as a form of financing at higher cost.

Advantages and Disadvantages of Leasing to the Lessee:

Advantages:

a. Avoidance of Initial Cash Outlay.

b. Minimum Delay

c. Easy Source of Finance

d. Shifting the Risk of Obsolescence

e. Enhanced Liquidity

f. Conserving Borrowing Capacity

g. Tax Planning and Advantage

h. Higher Return on Capital Employed

i. Convenience and Flexibility

j. Lesser Administrative Cost

Disadvantages:

a. Higher Cost

b. Loss of Moratorium Period

c. Risk of Being Deprived of the Use of Asset

d. No Alteration or Change in Asset

e. Loss of Ownership Incentives

f. Penalties on Termination of Lease

g. Loss of Salvage Value of the Asset.

(ii) Loss of Moratorium Period:

The lease rentals do not take care of the gestation period. It usually takes a long time before the asset generates funds to pay it back. The term loan provides certain moratorium period in repayments for that reason. But no such moratorium is permitted under lease arrangements.

(iii) Risk of Being Deprived of the Use of Asset:

The lessee may be deprived of the use of the asset due to the deterioration in the financial position of the lessor or winding up of the leasing company.

(iv) No Alteration or Change in Asset:

As the lessee is not the owner of the asset, he cannot make any substantial changes in the asset. Contrary to it, in case of outright purchase the buyer can modify or alter the asset to increase its utility.

(v) Loss of Ownership Incentives:

There are certain advantages of owning the assets, such as depreciation and investment allowance, In case of lease; the lessee is not entitled to such benefits.

(vi) Penalties on Termination of Lease:

The lessee is usually required to pay certain penalties if he terminates the lease before the expiry of the lease period.

(vii) Loss of Salvage Value of the Asset:

An asset generally has certain salvage value at the expiry of the useful life. As the lessee does not become the owner of the asset, he cannot realise the salvage value at the expiry of the lease rather he has to return the asset to the lessor.

Advantages of Leasing to the Lessor:

(i) Higher Profits:

The lessor acting prudently can make high profits from leasing of the asset. The profits will take care of his cost of capital as well as the risk involved.

(ii) Tax Benefits:

The lessor being the owner of the asset can claim various tax benefits such as depreciation, investment allowance, etc. In fact, leasing has been successfully employed by the leasing companies to reduce their tax liabilities.

(iii) Quick Returns:

The lessor gets quick returns in the form of lease rentals as compared to investment in other projects which have a longer gestation period.

(iv) Increased Sales:

Lease financing through third parties has helped manufacturers to increase their sales. The lessors are also in a position to demand certain concessions from the manufacturers.

Disadvantages for the Lessor:

(i) High Risk of Obsolescence:

The lessor has to bear the risk of obsolescence especially in the present era of rapid technology developments.

(ii) Competitive Market:

As a number of leasing companies have emerged in recent years in India, the lessor has to face a tough competition from Indian as well as foreign companies. Due to this competition, the lessor may not be able to obtain sufficient lease rentals to recover the cost of the asset and his expected profit on investment as well as taking the risk.

(iii) Price-Level Changes:

In spite of the increase in prices of assets due to inflation, the lessor gets only fixed rentals based on previous costs.

(iv) Management of Cash Flows:

The success of a leasing business depends to a large extent upon efficient use of cash flows which are very difficult to manage because of unexpected market fluctuations.

(v) Increased Cost due to Loss of User Benefits:

The lessor is not entitled to certain benefits available to buyers who are actual users of the assets such as concession in sales tax, duties, etc. This increases the cost of the asset and compels the lessor to charge higher lease rentals.

(vi) Long-term Investment:

It usually takes a long time to recover the cost of the lessor in the capital outlays through lease rentals. Thus, lease rentals received may not represent actual realised profits because of inherent risks involved. Payment of dividends out of present earnings may ultimately result into payment out of capital.

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