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10. Leasing

Chapter 10

LEASING

                                              by: josavere

                                                      1. DEFINITION


It is a lease with special conditions that make it a financing mechanism, through which the lessor transfers the right to use a good in exchange for the lease payment for a specified period, at the end of which the lessee has the option to buy the good-paying a certain price that is called residual value since its calculation is given by the difference between the original price paid by the lessor (plus interest and expenses) less the amounts paid by the lessee to the lessor. If the client does not exercise the option of acquiring the property, he must return it to the lessor, unless the contract is extended.

In specifically recommended cases, it is convenient to use easing because it avoids falling in cost overruns due to idle capacity and the opportunity cost of invested capital; in addition, it has a positive effect on liquidity, by allowing the company to take advantage of a good, generally very expensive, without having to pay its full cost in advance.

In addition, it has tax advantages in several aspects: first, a significant portion of the fee is treated as an expense; on the other hand, the assets and the patrimony are minor and thus, when the tax system taxes the patrimony (as it is the case with the so-called wealth tax, or presumptive income), savings are also achieved in said taxation

                                                  
                                                                      2. FEATURES:

a.To term agreed by common agreement.
b. Previously agreed won salvage value.
c.The monthly fee agreed upon by the parties.
d. The assets are owned by the leasing company.

By means of a leasing contract, a specialized company (financial institution) delivers, as a lease, acquired goods for exploitation, in exchange for a monthly fee for a specified period, whether or not a purchase option is agreed in favor of the lessor.
The company that takes an asset in Leasing, is obtaining a credit indirectly; otherwise, it would not make sense for a buyer and a seller to involve a third party that, in principle, simply makes the operation more expensive. As we will see later, leasing is an excellent mechanism in special situations despite the high cost that characterizes it.

At the Ottawa Canada convention, the following characteristics were established:

to. The user decides the specifications of the goods and selects the supplier.

b. The supplier (manufacturer or distributor) is informed that the goods are acquired by the leasing company to lease them to a user.

c. Royalties are calculated taking into account the depreciation of all or a substantial part of the good.

d. The destination of the good must not be of a personal, family, or domestic type.

Financially, it is an extension of the equivalent annual cost: the present value (cost of the property to be leased), the final value (salvage price) are known; the agreed period (term) and the interest rate and based on these, the monthly value of the leasing fees are stipulated whether they are advanced or expired.

 

3. KINDS OF LEASING

A. FINANCIAL: is characterized for an option of purchase in favor of the lease or client who chooses the good. If the leasing company accepts the operation, he/she buys the equipment, gives it in the lease to a user for one period specified the end of which it is committed to be sold by a previously defined price. In this case, the leasing company doesn't offer some guarantee and all the operating expenses and maintenance are the responsibility of the client or lease.

It cannot be canceled but by mutual agreement between the parts. The total amount of the lease is taken as a financial expense for the lease, legal proprietor of the good.

 

B. OPERATIVE OR RENTING: in this case, most of the time, the same manufacturer or distributor (supplier) acts as a lease. It is characterized because no pact of the option of purchase in favor of the client or lease and all the expenses and maintenance of the equipment are the responsibility of the landlord that serves under the OUTSOURCING figure. It can be canceled at any moment, that it transforms it into the ideal mechanism for equipment of high obsolescence.

The lease deduces the lease canons as operative costs; the landlord causes the depreciation.

 

C. BACK OR BACK LEASING: as its name indicates it, the client sells the goods to the leasing company, for a conventional value that should cover in cash and then takes it in lease. Only it can be made with productive fixed assets, computation equipment, machinery, cargo vehicles, and public transportation or on properties.

This modality is also useful in the case of care for goods. The client acquires the equipment and the leasing company cancels the expenses of import by means of a promise leasing contract. Once the equipment is nationalized, they formalize an agreement of operative leasing.

 

D. REAL STATE: when the leasing contract is made on a good productive property. It is special to develop big construction projects.  Also it is combined with the leaseback.

 

E. INTERNATIONAL: this modality eases the acquisition of machinery and equipment in the outside. The leasing company collects the canons and the tour, acting as middleman (Cross Border Leasing). In this modality it also adds the import leasing guided - back, facilitating the operation and readiness equipment that the leasing companies cannot bring directly. The contract comes under the figure of temporary import. Those tributary benefits depend on the legislation of each country, which should be consulted.

International leasing can be cross - border leasing; import leasing and export (Plan Vallejo); leasing in free zone or export leasing.

 

F. OTHERS

a. Syndicated: in the case of large operations, several companies join to assist the business. One of them leads, but they are solitary in the obligations of the contract.

b. Dry Lease y Wet Lease: special contracts for aeronautics; the first one only requires the airship and the insurance; the second, also, includes the company, the maintenance and the insurance.

c. Sub Lease: it consists on the sublease of goods given in leasing, previous acceptance of the leasing company.

d. Master Lease: when you open a credit account for certain equipment with accessories and reserves. It can also be with other additional and complementary assets of the main equipment.

e. Residence Leasing: it is guided to the financing of long term for the housing in order to facilitate mega projects.

 

 

4. OBLIGATIONS OF THE PARTS

A. COMPANY LEASING

a. To give the goods in good working conditions.

b. If it offers the purchase option, to transfer the ownership.

c. To give copy of the contract specifying clearly the main clauses.

 

B. CLIENT

a. To make appropriate use of the goods and to watch for they is conservation in good working condition.

b. If it does not offer the purchase option, to restitute the good.

c. To allow inspections of the merchandise.

d. To pay on time.

 

 

5. ADVANTAGES OF LEASING

a. It doesn't demand initial payment, because it goes on canceling as the is goods operated.

b. If the parts act diligently, it can be a mechanism of easy application. Agile and simple to process.

c. You can finance 100% of the goods object of the contract including reserves and accessories.

d. It reduces the demands of capital.

e. It eliminates, at a cost, the risk of obsolescence of the financed goods.

f. It is very flexible, because it makes comfortable to many circumstances peculiar of the users.

g. The assets don't go with adjustments for inflation for the lease. The manager that goes to a easing gives up the tributary incentive of the depreciation and the interests but he/she benefits from the lease canons, which, in the beginning, are deductible of taxes.

 

 

6. CASES WHEN LEASING IS RECOMENDABLE

a. When in reason of the technological development the probability of obsolescence is very high. It is the case of computers, where the changes are presented in a very fast pace. 
Measured A that new equipments is manufactured, the suppliers pay very expensive maintenance, which the change imposes. If the risk is too high it is more convenient to lease. In this case, rarely it is good to make use of the purchase option.

b. If the investment requires big capital expenditures. One of the biggest limitations in countries in development is the capital formation, resource that because of scarcity it doesn't make sense to immobilize it in big investments of actives that can be obtained by means of lease. It is the case of airplanes, ships, equipment of transportation, etc. What we call "great" investment of capital depends in particular on the company.

c. Some business requires equipment under good conditions of maintenance (almost new) as the trucks dispatchers. The client who can't find a product of this type at the moment that he/she wants it forgets and the sale gets lost. Hardly a person takes in only one day the sodas that he/she didn't find in the previous ones. Sale that is not made won't be replaced. In these cases, it is preferable to maintain new cars in lease that to own old ones, to avoid the inherent risks for mechanical breakdown.

d. When it is equipments for one specific job. Let us suppose that to a firm of engineers they ask him for the construction of a stadium or an airport (fact that rarely it happens), where the use of the very hard on the same thing as the execution of the job. Determined equipment should be property of a third party that it leases them for the cases that don't show.

e. In season business. To have its own equipment it would represent a very big waste and, therefore, it is better to rent them for the required time.

f. To solve serious problems of capital of work (leasing back). When a company doesn't have another resource to solve a problem of liquidity, he/she can sell their equipment or it leaves it and takes it in lease.

In the previous cases, although mathematically it would be more expensive the leasing that the purchase, it is advisable to use this option.

The financial calculation is made bringing to Net Present Value (VPN) the flows of funds of the alternatives that are presented, including different depreciation modalities it is compared with the possibility of getting a bank loan to buy the goods in cash. The tributary norm should be revised and the effect of the presumptive rent to see if he/she allows to take advantage completely of the benefit, when discounting the depreciation. Each case should be studied projecting the flow of funds carefully.

 

 

7. CALCULATION OF THE RENT RATE

Ca = [ Ia / (1 + Ia )n - 1] [Va (1 + ia) n - Vf]

(1 + ia)

Ca: Rent rate
Ia: Interest rate
n: Term
Vf: Value of purchase
Va: Present value of the good goes

Example:
The purchase of a depreciate able equipment to 5 years.
The bank receives an interest of 35% TA, that is to say, the 3,1% monthly cash.
The leasing company receives the 4,2% monthly cash.
The buyer wishes to pay the good in 3 years.
The operation of purchase is 10% of the initial value of the good.

Conventional purchase year 6 Year 1 Year 2 Year 3 Year 4 Year 5
Plan of financed Extreme financing: $1 million to Repay to the main one 333 333 334
Balance that causes interests 1000 667 334
3,1% interests to monthly 372 248 124
Plan of Linear depreciation to 5 years 200 200 200 200 200
Accelerated (40%-40%-20%) 400 400 200
Tributary deductions 
With linear depreciation
Interest Totals
372 248 124
- nondeductible Interests 61 41 20
= deductible Interests 311 207 104
+ Depreciation 200 200 200 200 200
= Total deduction 511 407 304 200 200
Economy of taxes (35%) 179 142 106 70
With accelerated depreciation deductible Interests 311 207 104
+ Depreciations 400 400 200
= Total deduction 711 607 304
Economy of taxes 249 212 106
Cash flow of the purchase 
With linear depreciation
Main Repayment of the debt
333 333 334
Payment of interests debt 372 248 124
- Economy of taxes (179) (142) (106) (70)
=cash flow 
705 402 316 (106) (70)
VPN
= 1.177
accelerated depreciation
depreciación 
page of principal
333 333 334
+ Pago de interest 372 248 124
- Economy of taxes (249) (212) (106)
= net flow of cash 705 332 246 106
VPN = 1.177
With accelerated depreciation
Repayment of the main one
638 638 638 (58.158*12)
- Economy of taxes (35%) (223) (223) (223)
+ residual Value 100
+ tributary Credit by depreciation years ss (6)
= net  cash Flow 638 415 515 (223)
VPN = 1.333

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Josavere