Equipment Leases involve two parties getting into an agreement in order to give rights to the lessee to use an asset, owned by the lessor, in exchange of fixed payments extended to the lessor.
The lease payment is considered as the equivalent of the monthly rent, as mutually decided upon in the lease contract.
The contract in this regard specifies the duration of the lease contract, the payment cycles, as well as other terms and conditions that might be relevant to the cause.
The calculation of lease payment in this regard is considered to be a factor of a number of things, including an asset’s value, locally set residual values, discount rates, as well as the credit score based on which the markup decided.
Lease Payments are also associated with other monthly rental payments that are extended to the owner of the asset in exchange of using the particular asset.
Types of Lease Payment Structures
Lease Payments are mostly structured in order to facilitate companies to adjust in accordance to the cash flow of the lessee, in order to make the lease payments within a convenient threshold for the company.
Therefore, they can be structures as per the mutual consensus of both parties. There are a number of recommended models for structuring lease payments, which are as follows:
- Equated Annual Lease Payments: Equalized lease payment is charged across all years in the lease agreement.
- Stepped Lease Payments: In this structure, lease payments increases every subsequent year with a given percentage. Therefore, this accounts for inflation.
- Ballooned Lease Payments: In this payment structure, payments are equalized in the initial years of the lease agreements, and then the latter years constitute of significant and heavy payments.
- Deferred Lease Payments: Using the deferred payment structure, the lease payments begin after a certain agreed upon period. Before this period, the lessee is not supposed to pay lease payments.
Advantages of Lease Payments
Regardless of the fact that lease payments are often associated with an additional expense for the company, it can be seen that it results in the company benefitting from these payments on the following grounds:
- Maintaining Liquidity: Firstly, it can be seen that lease payments help maintain liquidity for the company, because it helps them to conserve their resources, and use them elsewhere. They can use the assets while still continuing to use the asset, which helps them to keep their liquidity intact.
- Opportunity Cost of Capital: There is an inherent opportunity cost associated with capital expenditures. The company might have to use their retained earnings, or go for external sources of finance in order to procure the respected equipment. There is an opportunity cost involved with all these decisions, either in form of compromised business opportunities, or business equity being adversely impacted as a result of this.
- Technological Risk Mitigation: Given the fact that technological advancements are fast paced, it can be seen that capital expenditures are likely to occur at regular intervals, as opposed to long term investments. In this regard, it is often a good idea for companies to lease their equipment, and save themselves from the hassle of technological obsolesce.
Tax-Related Advantages of Lease Payments
In addition to internal strategic alignment that is facilitated as a result of lease payments, it can be seen that there are also a couple of other tax related advantages related to lease payments, to the lessor, as well as the lessee.
To the lessor, it can be seen that he is facilitated because of depreciation. In the case where the lessor is in a higher tax bracket, assets are extended to the buyer with increased depreciation rates.
This also reduces the tax liability of the company in a significant manner. This can be considered as considerable tax savings, and subsequent advantage transferred in the form of increased profits, or added advantage to the lessee.
From a lessee’s perspective, lease payments can facilitate significant tax advantages for the company. The lease payments can be adjusted in order to get a lower taxable amount as profit.
Therefore, it can be seen that lease payments can be defined as the payments that are extended to the lessors in return of the asset being used by the lessee. It can be structured in a variety of ways.
The structure is mainly contingent on the personal preference of the parties involved, after factoring in elements including time duration of the lease, the value of the asset, as well as the credit score of the lessee.