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Leasing vis-a-vis bank loan
Syed Ishtiaque Reza
4/29/2004
Leasing is seen by the business community as an alternative source of finance. This can be an important asset to any growing business. If conserving working capital and lines of credit are important to a business, leasing is considered for acquiring new equipment, software, furniture and raising capital.
Leasing offers full financing for not only the equipment but also for entire project amount including soft costs, wall and floor coverings, site preparation, installation and delivery, etc. Leasing thereby allows one to direct cash toward other business expenses and investments. An improved cash position helps an ongoing capacity to obtain additional credit.
Leasing can provide an extended line of credit for future purchases, such as, copiers, computers, phones, printing equipment and much more. Leasing has tax advantages which can make leasing less expensive. Leasing costs are deductible expenses that immediately reduce taxable income.
Our businessmen usually run to banks and credit organisations for loans. A loan requires the end-user to make a down payment. The loan obtained, thus, finances the remaining amount. But a lease generally requires no down payment and finances only the value of the equipment expected to be depleted during the lease term. The lessee usually has an option to buy the equipment for its remaining value at lease end.
A loan usually requires the borrower to pledge other assets for collateral. The leased equipment itself is usually all that is needed to secure a lease transaction. The end-user bears all the risk of equipment devaluation. The end user transfers all risk of obsolescence to the lessors as there is no obligations to own equipment at the end of the lease.
End-users may claim tax deduction for a portion of the loan payment as interest and for depreciation which is tied to depreciation schedules.
When leases are structured as true leases, the end-user may claim the entire lease payment as a tax deduction. The equipment write-off is tied to the lease term, which can be shorter than depreciation schedules, resulting in larger tax deductions each year.
Financial Accounting Standards require owned equipment to appear as an asset with a corresponding liability on the balance sheet. Leased assets are expensed when the lease is an operating lease. Such assets do not appear on the balance sheet, which can improve financial ratios.
Leases also take into account that the equipment is worth something at the end of the lease term. This is called its residual. Residuals are built into the lease pricing, usually making the lease payments lower than a loan. To compare lease products, it is better to compare monthly payments than to try to compare loan interest rates with lease rates. On a cost-of-capital basis, leasing is often the most cost effective option.
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