Leasing

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Leasing is the purchase of a specific asset, which is paid for by the lease provider on the company’s behalf. In exchange, the company pays a fixed rate, which includes interest and principal, to the leasing company. It may also be charged for personal property taxes on the asset purchased. The lease may be defined as an operating lease, under the terms of which the lessor carries the asset on its books and records a depreciation expense, while the lessee records the lease payments as an expense on its books. This type of lease typically does not cover the full life of the asset, nor does the buyer have a small-dollar buyout option at the end of the lease. The reverse situation arises for a capital lease, where the lessee records it as an asset and is entitled to record all related depreciation as an expense. In this later case, the lease payments are split into their interest and principal portions, and recorded on the lessee’s books as such.

The cost of a lease can be reduced by clumping together the purchases of multiple items under one lease, which greatly reduces the paperwork cost of the lender. If there are multiple leases currently in existence, they can be paid off and re-leased through a larger single lease, thereby obtaining a slightly lower financing cost.

The leasing option is most useful for those companies that only want to establish collateral agreements for specific assets, thereby leaving their remaining assets available as a borrowing base for other loans. Leases can be arranged for all but the most financially shaky companies, since lenders can always use the underlying assets as collateral, and rarely impose any other financing restrictions. Furthermore, future operating lease payments are not listed on the balance sheet as a liability; instead future lease obligations are listed in a footnote.

However, unscrupulous lenders can hide or obscure the interest rate charged on leases, so that less financially knowledgeable companies will pay exorbitant rates. Also, a company is obligated to make all payments through the end of a lease term, even if it no longer needs the equipment being leased.