Lease financing is increasingly becoming a popular way of acquiring assets. It is a cost-effective financing option for any firm that wants to acquire the use of assets at a lower cost. This method of financing has several advantages and disadvantages.
Advantages:
To the lessor, lease financing has the following advantages:
- Has an assured regular income – the lessor gets lease rentals for the entire period of the lease, which is assured and regular income.
- Preservation of Ownership: the lessor retains ownership of the asset, especially for a finance lease which involves the transfer of risk and rewards without the transfer of ownership to the lessee.
- Tax Benefits: The tax benefit associated with the depreciation of the leased asset remains with the lessor.
- High Profitability: The rate of return from a lease is higher than interest payable on financing the asset; hence leasing is a highly profitable business.
- Potential for Growth: the lessor has a high potential for growth due to the rising demand for leasing as a cost efficient method of financing.
- Full Recovery of Investment: through a finance lease, the lessor can recover all investments on the leased asset through lease rental.
To the Lessee, the following benefits of a lease can be identified:
- Use of capital goods: The lessee gets the chance to use an asset and pay small regular rentals.
- Tax Benefits: the lessee also enjoys a tax advantage because lease rentals are often deducted as business expenses.
- Cheap: Leasing is a cheaper or less expensive source of financing; cheaper than other sources of financing.
- Technical Assistance: for an operating lease, the lessee can get technical assistance from the lessor in respect to the leased asset.
- Inflation Friendly: The lessee pays fixed amounts of lease rentals even if inflation rises.
- Ownership: the lessee may purchase the leased asset at the end of the lease period and take full ownership of the asset.
Disadvantages of Lease Financing
Disadvantages to the Lessor:
- Less profits in case of inflation – the lessor gets constant amounts even when inflation rises
- Double Taxation: sales tax on the leased asset may occur twice – at the time of purchase and the time of leasing.
- Chance of Damage: the asset may be damaged while it is still being used by the lessee during the lease period.
Disadvantages to the Lessee:
- Compulsory payments: the lessee is required to make regular payments of lease rentals even when the asset is not in use.
- Ownership: the lessee does not usually take ownership of the asset at the end of lease agreement unless they purchase it.
- Costly: leasing can be costly to the lessee because it involves the payment of lease rentals and other expenses incidental to the ownership of the asset.
