Leasing is a form of rental system. So, the main functions of leasing companies is to lease out equipments as rent to industrial companies. The rental covers the accelerated depreciation of machines, interest on initial capital value and service charges. That is in leasing business or arrangement, the user of a capital equipment (ie, an investor) does not buy the product himself but only buys the use of it against payment on a monthly rental fee to a leasing company which owns the product. There are two types of leasing arrangements, namely, operating leasing and finance leasing.

In operating leasing, the purchaser of the capital equipment offers his product for lease. IBM is the famous example for this kind of leasing. IBM leases its computers users along with its technical services and also if necessary continuous replacement by updated equipment. Operating leasing is, therefore, direct and there is no middleman.

In finance leasing-also known as capital leasing-there are three parties involved, viz, the producer of the capital equipment, the buyer of the capital equipment (who is the investor) and a leasing company.

The leasing agreement involves renal payment including amorlisation, interest and a leasing contract fee. This is a financial arrangement and there are no technical obligations of the lessor towards the lessee.

Benefits of the Leasing

leasing has become an important alternative to equity financing. Leasing is superior to buying capital equipment through borrowed funds, for the lessee has a higher borrowing capacity which he can use for other purposes. Compared to bank borrowing, leasing process cent percent finance and there by helps the lessee to put his funds to other uses such as development and marketing and maintenance as in the case of aircraft, shipping, Xerox machines etc. it is more convenient to the lessee to lease and pass on those risks to the lesser which can provide these special services.

Advantages to the lesser

  1. Lease is an additional financial product involving ownership and risk taking for a reward in terms of rentals.
  2. Lease improves profitability due to attached tax benefits to the lesser.
  3. It is a marketing strategy for capital intensive goods like plant and machinery and provides a competitive edge for sale of the product by the manufacturer.
  4. Lease arrangement is a simple document and less messy than the formalities to be observed for bank borrowing.
  5. As a financing technique it is more rewarding and attractive to lesser.
  6. It is flexible and can be opened and closed quickly.

Advantages to lessee

  1. Leasing provides 100% finance for the cost of equipment while in the case of bank borrowing or installment sale, it is subject to initial payment or margin requirement from the lessee.
  2. Leasing preserves and improves the cash position and liquidity of the company.
  3. It is flexible and can be adjusted to the cash flow forcast.
  4. If neither change the equity ownership nor dilutes the equity, nor adversely affects the debt equity ratio of the company.
  5. It achieves gearing and provides a hedge against inflation and helps the tax planning.
  6. It is off balance sheet method of financing, straight forward, simple and efficient.