LEASING

Project Finance
Defined by the International Project Finance Association (IPFA) as the following:

The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project.

In other words, project financing is a loan structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary security or collateral. Project finance is especially attractive to the private sector because they can fund major projects off balance sheet.

Sources of Finance
Internal sources of finance

Personal savings Retained profits Working capital Sale of fixed assets Ownership capital Ordinary shares Preference shares Non-ownership capital Debentures Bank overdraft Loan Hire-purchase Lease Grant Venture capital Factoring Invoice discounting

External sources of finance

Choosing an appropriate source of finance

The factors that need to be considered when choosing an appropriate source of finance are:
The amount of money needed The urgency of funds

The cost of the source of finance

The risk involved The duration of finance The gearing ratio of the business The control of the business

Lease Financing
Lease financing denotes procurement of assets through lease.

lease is a contract between the owner of an asset (the lessor) and

its user (the lessee) for the right to use the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).
The important feature of a lease contract is separation of the

ownership of the asset from its usage.

Lease financing is based on the observation made by Donald B.

Grant: Why own a cow when the milk is so cheap? All you really need is milk and not the cow.

Importance 0f Lease Financing

Leasing industry plays an important role in the economic development of

a country by providing money incentives to lessee.

The lessee does not have to pay the cost of asset at the time of signing the

contract of leases.
Leasing contracts are more flexible so lessees can structure the leasing

contracts according to their needs for finance.

The lessee can also pass on the risk of obsolescence to the lessor by

acquiring those appliances, which have high technological obsolescence.

Today, most of us are familiar with leases of houses, apartments, offices,

etc.

Types Of Lease Agreements

Lease agreements are basically of two types. They are

Financial lease and Operating lease. The other variations in lease agreements are Sale and lease back Leveraged leasing and Direct leasing.

Financial Lease
Long-term, non-cancellable lease contracts are known as

financial leases. The essential point of financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost. Under this lease the lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising there from are transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the lessor. Financial lease is also known as capital lease. In India, financial leases are very popular with high-cost and high technology equipment.

Operating Lease
An operating lease stands in contrast to the financial lease

in almost all aspects. This ease agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset at the end of the lease period. Normally the lease is for a short period and even otherwise is revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found suitable for operating lease because the rate of obsolescence is very high in this kind of assets.

Sale And Lease Back

It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the buyer), who in turn leases back the same asset to the owner in consideration of lease rentals.
However, under this arrangement, the assets are not physically

exchanged but it all happens in records only.

This is nothing but a paper transaction. Sale and lease back

transaction is suitable for those assets, which are not subjected depreciation but appreciation, say land.
The advantage of this method is that the lessee can satisfy himself

completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement.

Leveraged Leasing
Under leveraged leasing arrangement, a third party is involved

beside lessor and lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third party i.e., lender. The lender is paid off from the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with the asset.
LESSOR LESSEE

LENDER

Direct Leasing

Under direct leasing, a firm acquires the right to use an

asset from the manufacturer directly. The ownership of the asset leased out remains with the manufacturer

Essentials of Lease Financing

Parties to the contract

Lessor (the owner ) Lessee (the user) Lease broker (who acts as an intermediary in arranging lease deals.) Lease financier (who refinances the lessor)

Asset The asset, property or equipment to be leased is the subject matter of a contract of lease financing. Ownership separated from

user

The essence of a lease financing contract is that during the lease-tenure, ownership of the asset vests with the lessor and its use is allowed to the lessee. On the expiry of the lease tenure, the asset reverts to the lessor.

Lease Rentals
The consideration which the lessee pays to the lessor for the lease

transaction is the lease rental.

The lease rentals are so structured as to compensate the lessor for

the investment made in the asset (in the form of depreciation), the interest on the investment, repairs/insurance if any borne by the lessor, and servicing charges over the lease period.

Structuring of Lease Rentals

The lease rentals are structured to suit the lessors and the lessees.

From the lessee's angle, the structure of the lease rental should

synchronies with his operational cash flow pattern.

The dimensions of the synchronization between the lease rental

and the pattern of cash flows of the lessee are periodicity of rentals, lease rentals in advance/arrear, profile of rentals and so on.
The lease rentals should ensure a given/ expected return to the

lessor.

Advantages of Leasing to the Lessee

To the Lessee Lease financing has following advantages to the lessee:
Financing of Capital Goods Lease financing enables the lessee to have finance for huge investments in land, building, plant, machinery, heavy equipments, and so on, upto 100 per cent, without requiring any immediate down payment. Thus,

the lessee is able to commence his business virtually without making any initial investment

Additional Source of Finance Leasing facilitates the acquisition of equipment, plant and machinery,]without the necessary capital outlay, and, thus, has a competitive advantage of mobilising the scarce in financial resources of the

business enterprise. It enhances the working capital position and makes available] the internal accruals for business operations.

Less Costly Leasing as a method of financing is less costly than other alternatives available.

Ownership Preserved Leasing provides finance without diluting the ownership or control of the promoters. As against it other modes of long-term finance, viz. equity or debentures, normally dilute the ownership of the promoters.

 Advantages of Leasing to the Lessor

To the Lessor A lessor has the following advantages:
Full Security The lessor's interest is fully secured since he is always the

owner of the leased asset can take repossession of the asset if the lessee defaults. rate of return is more than w" the lessor pays on his borrowings. Also, the rate of return is more than in case of lending finance direct.

High Profitability The leasing business is highly profitable since the

Trading on Equity Lessors usually carry out their operations with

greater financial leverage. That is, they have a very low equity capital and use a substantial amount of borrowed funds and deposits. Thus, the ultimate return on equity is very high. potential. Lease financing enables the lessees to acquire equipment and machinery even during a period of depression, since they do not have to invest any capital. Leasing, thus, maintains the economic growth even during a recession.

High Growth Potential The leasing industry has a high growth

Limitations of Leasing

Restrictions on Use of Equipment Limitations of Finance Lease Loss of Residual Value Consequences of Default Understatement of Lessee's Asset Double Sales Tax

Hire Purchase

Hire purchase is a type of installment credit under which the hire

purchaser, called the hirer, agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of principal as well as interest, with an option to purchase.
Under this transaction, the hire purchaser acquires the property

(goods) immediately on signing the hire purchase agreement but the ownership or title of the same is transferred only when the last installment is paid.

Hire Purchase (Cont)

The hire purchase system is regulated by the Hire Purchase Act 1972. This Act defines a hire purchase as an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which:
The owner delivers possession of goods thereof to a person on

condition that such person pays the agreed amount in periodic installments. The property in the goods is to pass to such person on the payment of the last of such installments, and Such person has a right to terminate the agreement at any time before the property so passes

Diff. Between Lease Financing & Hire Purchase

A lease transaction is a commercial arrangement, whereby an equipment owner or manufacturer conveys to the equipment user the right to use the equipment in return for a rental. No option is provided to the lessee (user) to purchase the goods. Lease rentals paid by the lessee are entirely revenue expenditure of the lessee. Lease rentals comprise of 2 elements

Hire purchase is a type of installment credit under which the hire purchaser

finance charge capital recovery.

agrees to take the goods on hire at a stated rental, which is inclusive of the repayment of principal as well as interest, with an option to purchase. Option is provided to the hirer (user). Only interest element included in the HP installments is revenue expenditure by nature. HP installments comprise of 3 elements normal trading profit finance charge recovery of cost of goods/assets

ByPriyanka Chauhan