Leasing

Leasing is a contractual arrangement under which the owner of the asset (called the lessor) allows the use of the asset by the lessee in consideration for the lease rent. In other words, leasing arrangements provide an enterprise with the use of and control over assets without receiving title to them.

There is a wide variety of lease arrangements. Short-term/cancellable leases are referred to as operating leases while long-term/non-cancellable leases are known as financial leases. A sale and lease back arrangement provides for the sale of the asset by the present owner to the lessor and at the same time retaining it for use.

Leasing is a source of financing and is therefore an alternative to borrowing. The lease alternative is compared with the purchase/borrowing alternative by comparing the present value of net cash outflows after taxes. The alternative with the lower present value of cash outflows is preferred.

A firm may prefer to lease rather than buy in view of the manifold advantages it offers; it shifts the risk of technological obsolescence to the lessor; it is a convenient source of financing fixed assets particularly in situations when the lessee finds difficult to borrow money on his own; it avoids restrictive covenants of loan agreement; it frees the firm from the burden of usual equipment maintenance; it conserves borrowing capacity through “off-the balance sheet” financing and in specific situations causes lower administrative costs also. It is on the basis of a comparison of the quantitative as well as the qualitative merits and demerits that a firm should choose between the two financing alternatives: leasing and borrowing.