Lesson 1, Topic 1
In Progress

5.3. The option of leasing as a method of reducing start-up capital is considered for own venture.

ryanrori January 7, 2021

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Read the following on leasing from the website:

http://www.sba.gov/test/wbc/docs/finance/lease_basics.html

The Basics of Leasing SHOULD YOU LEASE OR BUY EQUIPMENT? Small businesses have difficulty raising capital — that’s no secret. This difficulty (among other reasons) has caused many to look at leasing as an alternative financing arrangement for acquiring assets. All types of equipment leasing – from motor vehicles to computers, from manufacturing machinery to office furniture – have become more and more attractive. This lesson describes various aspects of the lease vs. buy decision. It lists advantages and disadvantages of leasing and provides a format for comparing the costs of each option. WHAT IS A LEASE? A lease is a long term agreement to rent equipment, land, buildings, or any other asset. In return for most – but not all – of the benefits of ownership, the user (lessee) makes periodic payments to the owner of the asset (lessor). The lease payment covers the original cost of the equipment or other asset and provides the lessor a profit. TYPES OF LEASES There are three major kinds of leases: the financial lease, the operating lease, and the sale and leaseback. Financial leases are the most common by far. A financial lease is usually written for a term not to exceed the economic life of the equipment. You will find that a financial lease usually provides that: Periodic payments be made, Ownership of the equipment reverts to the lessor at the end of the lease term, The lease is non-cancellable and the lessee has a legal obligation to continue payments to the end of the term, and The lessee agrees to maintain the equipment. The operating lease, or “maintenance lease,” can usually be cancelled under conditions spelled out in the lease agreement. Maintenance of the asset is usually the responsibility of the owner (lessor). Computer equipment is often leased under this kind of lease. The sale and leaseback is similar to the financial lease. The owner of an asset sells it to another party and simultaneously leases it back to use it for a specified term. This arrangement lets you free the money tied up in an asset for use elsewhere. You’ll find that buildings are often leased this way. You may also hear leases described as net leases or gross leases. Under a net lease the lessee is responsible for expenses such as those for maintenance, taxes, and insurance. The lessor pays these expenses under a gross lease. Financial leases are usually net leases. Finally, you might run across the term full payout lease. Under a full payout lease the lessor recovers the original cost of the asset during the term of the lease. KINDS OF LESSORS   As the use of leasing has increased as a method for businesses to acquire equipment and other assets, the number of companies in the leasing business has increased dramatically. Leasing is now a billion dollar industry. Commercial banks, insurance companies and finance companies do most of the leasing. Many of these organisations have formed subsidiaries primarily concerned with equipment leasing. These subsidiaries are usually capable of making lease arrangements for almost anything. In addition to financial organisations, there are companies that specialise in leasing. Some are engaged in general leasing, while others specialise in particular equipment, such as trucks or computers, for example. Equipment manufacturers are also occasionally in the leasing business. Of course, they usually lease only the equipment they manufacture. ADVANTAGES OF LEASING   The obvious advantage to leasing is acquiring the use of an asset without making a large initial cash outlay. Compared to a loan arrangement to purchase the same equipment,   lease usually: Requires no down payment, while a loan often requires 25 percent down; Requires no restriction on a company’s financial operations, while loans often do; Spreads payments over a longer period (which means they’ll be lower) than loans permit; and Provides protection against the risk of equipment obsolescence since the lessee can get rid of the equipment at the end of the lease. There may also be tax benefits in leasing. Lease payments are deductible as operating expenses if the arrangement is a true lease . Ownership, however, usually has greater tax advantages through the investment tax credit and depreciation. Naturally, you need to have enough income and resulting tax liability to take advantage of those two benefits. Leasing has the further advantage that the leasing firm has acquired considerable knowledge about the kinds of equipment it leases. Thus, it can provide expert technical advice based on experience with the leased equipment. Finally, there is one further advantage of leasing that you probably hope won’t ever be of use to you. In the event of bankruptcy, claims of the lessor to the assets of a firm are more restricted than those of general creditors. DISADVANTAGES OF LEASING In the first place, leasing usually costs more because you lose certain tax advantages that go with ownership of an asset. Leasing may not, however, cost more if you couldn’t take advantage of those benefits because you don’t have enough tax liability for them to come into play. Obviously, you also lose the economic value of the asset at the end of the lease term, since you don’t own the asset. Lessees have been known to grossly underestimate the salvage value of an asset. If they had known this value from the outset, they might have decided to buy instead of lease. Further, you must never forget that a lease is a long term legal obligation. You usually can’t cancel a lease agreement. So, if you were to end an operation that used leased equipment, you might find you’d still have to pay as much as if you had used the equipment for the full term of the lease.  ACCOUNTING TREATMENT OF LEASES Historically, financial leases were “off the balance sheet” financing. That is, lease obligations were often not recorded directly on the balance sheet, but listed in footnotes, instead. Not explicitly accounting for leases frequently resulted in a failure to state operational assets and liabilities fairly. LOOK BEFORE YOU LEASE A lease agreement is a legal document. It carries long term obligations. You must be thoroughly informed of just what you’re committing yourself to. Find out the lessor’s financial condition and reputation. Be reasonably sure that the lease arrangements are the best you can get, that the equipment is what you need and the term is what you want. Remember, once the agreement is struck, it’s just about impossible to change it. The lease document will spell out the precise provisions of the agreement. Agreements may differ, but the major items will include: The specific nature of the financing agreement Payment amount Term of agreement Disposition of the asset at the end of the term Schedule of the value of the equipment for insurance and settlement purposes in case of damage or destruction Who gets the investment tax credit Who is responsible for maintenance and taxes Renewal options Cancellation penalties, and Special provisions.