Asset finance is a boon to small and medium enterprises as it saves them precious working capital and helps them to improve their cash flow by letting them lease/hire expensive business critical assets rather than buying them outright.
In general asset finance is available through two routes - hire purchase and leasing. Under a hire purchase arrangement, the ownership gets transferred to the customer at the end of the hiring period while in a leasing arrangement the customer must return the equipment back to the leasing company.
In both the options, the customers must pay an agreed monthly or quarterly rental for the length of hiring/leasing period. In this article we will talk about leasing and its various aspects.
This non-transferring of the ownership is the fundamental characteristic of the lease arrangement. During the period of lease, the customer pays monthly or quarterly (or whatever is agreed) to the leasing company. This rental payout is deductible from income in some cases (except for a finance lease).
There are various types of leasing:
Finance Leasing
This comes closest to the hire purchase option of asset financing with one major difference - the ownership of the asset doesn’t get transferred to the business customer at any point of leasing period.
In this arrangement the customer pays the full cost of the equipment, plus the charges in the form of lease rentals over the period of the lease. The customer also gets to bear risks and enjoy benefits usually associated with the ownership without actually owning the asset - he must bear the maintenance and insurance cost of the asset and will have to treat the asset as a capital asset in the balance sheet.
At the end of the lease term, usually the asset in question is re-leased to the customer at much reduced payments or is sold second-hand to an unrelated third party.
Operating Leasing
While the term for a finance lease is long, an operating leasing is usually resorted to if the need of equipment is for a shorter period. Here the full cost of the equipment is not recovered and at the end of the lease term, usually the equipment is leased to some other customer or is sold second-hand.
This type of lease is fairly common for cars and construction equipment for whom there is a mature and ready second-hand market. The usual period is of two to three years or longer, but always short of the working life of the asset. The leased asset would not go in the balance sheet as part of capital assets. Rather the lease expenses will be treated as deductible expenses in the income statement.
Contract Hire
This is a variation of an operating lease and is mostly used for vehicles. With this option the customer gets the chance to use the new asset without bearing the risks associated with ownership. Here leasing companies agree to bear some part of the management and maintenance expenses. You need to work out full details with the leasing company.
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