What are the economics/pros and cons of leasing? Leasing is becoming a preferred solution to solve this fixed asset. Such as requirements vs. purchase of the property. And while evaluating this investment, it is necessary for the owner of the capital to understand whether the leased capital will provide better returns. Let’s have a look. Between advantages and disadvantages.
What is Advantages of Leasing?
1. Balanced Cash Outflow: Leasing is the biggest advantage. Since outflows or payments related to cash leasing are spread over several years, the burden of lump sum significant cash payments is avoided. This helps a business maintain a stable cash-flow profile.
2. Quality Assets: While leasing a property, the ownership of the property still remains with the lessee whereas the lessee only pays the rental expenses. Given this agreement, it becomes laudable for a business to invest in good-quality assets that might otherwise seem ineffective or expensive.
3. Better Utilization of Capital: Given that a company can buy any Leases to invest in the asset, it releases capital to the business to meet its other capital needs or to save money for a better capital investment decision.
4. Tax Benefit: Leasing expense or lease payment is considered. Operating expenses, and hence, interest, are tax-deductible.
5. Off-Balance Sheet Loan: Although lease expenses receive the same treatment as interest expense, the lease itself is treated differently from the loan. The lease is classified as an off-balance sheet loan and does not appear on the company’s balance sheet.
6. Improved Planning: Lease expenses typically remain constant for the life of the asset or tenure of the lease, or increase in line with inflation. It helps to plan spending or cash outflows while doing a budget exercise.
7. Reduced Capital Expenditure: An ideal option for a new leased business, which means lower initial costs and lower capital expenditure requirements.
8. No-Risk of Obsolescence: For businesses working in this field, where there is a high risk of technology becoming obsolete, leasing offers great benefits. And protects businesses from the risk of investing in technology that may soon be outdated. For example, it is ideal for a technology business.
9. Termination Rights: At the end of the lease term, the lessee holds the right to purchase the property and terminate the contract on the lease, thus providing flexibility to the business.
What is Disadvantages of Leasing?
1. Lease Expense: This lease payment is treated as an expense rather than an equity payment towards the asset.
2. Limited Financial Benefit: If a lease is paid for the land, the business cannot benefit from any appreciation in the value of the land. The long-term lease agreement also carries the burden of trade, as the agreement is locked. And the expenditure is fixed for several years. In the case when the use of assets after a few years does not meet the requirement, the lease payment becomes a burden.
3. Reduced Return for Equity Holders: Given that lease, expense reduces net income without any appreciation in value, it means limited returns or lower returns for the equity shareholder. In such a case, the objective of wealth maximization for shareholders is not achieved.
4. Loans: Although leases do not appear on a company’s balance sheet, investors consider long-term leases to be loans and adjust their business valuations to include leases.
5. Limited Access to Other Loans: Given that investors treat long-term leases as loans, it may be difficult for a business to tap the capital markets and raise further debt or other forms of debt from the market.
6. Processing and Documentation: Overall, entering into a lease agreement is a complex process and requires thorough documentation and proper examination of the property being leased.
7. No Ownership: The lessee does not become the owner of the asset at the end of the lease term, although it is a good sum of payments over the years towards the property.
8. Maintenance of Assets: The lessee is responsible for this. Maintenance and proper operation of the property being leased.
9. Limited Tax Benefits: For a new start-up, tax expense is likely to be minimal. In these circumstances, there is no additional tax benefit that can be derived from leasing expenses.
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