Lease is a contract whereby one can use the assets of the other with due permission of the owner on payment of rent without purchasing them. The owner of the asset is called ‘lessor’ and the user is called ‘lessee’. The period of use is called the ‘lease period’ after which the lessee may opt for purchase of the asset.
The owner of the assets also has the option of selling it to the user at a reduced price.
This enables the company to save the long-term funds that can be utilized for other purposes. This is known as ‘sale and lease back’ system.
Merits of Lease Financing
1. Facility to acquire asset:
It enables the lessee to acquire the asset with a lower investment.
2. Easy source:
Simple formalities make it easier to finance assets.
3. Tax deductible:
Lease rentals paid by the lessee are deductible for computing taxable profits.
4. No effect on control:
It provides finance without diluting the ownership or control of business.
5. No effect on debt raising capacity:
The lease agreement does not affect the debt raising capacity of an enterprise;
6. No risk of obsolescence:
The risk of obsolescence is borne by the lesser that allows greater flexibility to the lessee to replace the asset.
Limitations of Lease Financing
1. Restrictions on use of asset:
‘Lessor’ may impose certain restrictions on the use of assets like any alteration or modification in the asset.
2. Problem of renewal:
The normal business operations can be adversely affected in case the lease agreement is not renewed.
3. Higher payment:
It may result in higher payout obligation in case the equipment is not found useful and the lessee opts for premature termination of the lease agreement.