Question

In your firm, what benefits does leasing offer, compared to the purchase of an asset? Provide examples.

Answer 1

Benefit of leasing compared to asset purchase:

Avoids heavy investment and borrowing at start: For the asset purchase entire purchase amount need to be paid upfront. Purchase cost can be funded through internal accrual or debt funding. In both the way, firm incurs a heavy cash outflow at start of the period.

Whereas under leasing arrangement, there is no large cash outflow at inception. Lease rental to be paid on monthly basis, so cash outflow is spread across the period.

Asset light balances sheet: In case of asset purchase, asset is classified as fixed asset on balance sheet. Accordingly, liability or bank loan comes on liability side of balance sheet. Increase in asset impacts the operational efficiency ratios such as asset turnover ratio. Whereas, under leasing asset does not reflect on balance sheet. Similarly, for leasing bank credit is not required and firm can utilise bank facilities for business expansion purposes.

Avoiding obsolescence: Due to change in technology, machines and equipment evolves over the period. In case of leasing, firms can easily lease the machines with new technology and stay competitive. However, in case of asset purchase, replacing the machines and equipment needs heavy investments.

Additional Cost: Usually leasing company provides maintenance support such as for repairing the machine or running the machine. However, in case of asset purchase firm need to develop these capabilities inhouse, which requires additional expenses.

Exapmle : Firm can purchase a machine for $ 10,000 or can lease at annual  lease expense of $ 2000. At the end of lease period, leasing firm will take back the machine.

Here, if firm A decides to purchase the machines then upfornt need to pay $ 10,000.

Answer 2