Understanding Leasing: Types, Contracts, and Operations
Leasing: Significa lease, or arriendo. It’s a contract between a lessor and a lessee whereby the lessor, completing its agreement with the lessee, in his own name, acquires certain assets, movable or immovable, that will be leased for an agreed total price, distributed in installments, fixed or variable, over a period of time, after which, for a fixed residual value, the asset is capable of being acquired by the lessee, be returned, or be leased back.
In a leasing operation, the following parties typically appear:
- The party that needs to utilize certain equipment, normally a fixed financial institution.
- The party that provides funding for the equipment.
- The manufacturer or supplier of the equipment.
3 Phases of Leasing:
- The client commissions the lessor to acquire specific equipment from a supplier on their behalf.
- The right to use the asset in question is transferred for a fixed period agreed upon by both parties.
- The customer has the option to purchase the asset at the end of the usage period.
Stipulations in a Leasing Contract:
- Asset Description: A detailed description of the property to be leased.
- Contract Duration: The agreed-upon time between the parties, which can cover the entire economic life of the asset or a portion thereof.
- Effective Interest Rate: The interest rate applicable to the transaction.
- Payment Installments: Payments can be constant, increase, or decrease over the contract’s duration.
- Taxes and Insurance: Liabilities for taxes, brokerage fees, and insurance maintenance, which may be payable by the lessor, the lessee, or both.
- Early Cancellation: The contract may be cancelable by either party, non-cancelable, or cancelable with a penalty payment.
- Non-Payment Implications: Various obligations and privileges established in case of default.
- Lessee Options at Contract End: Return the asset, buy the leased asset at its residual value, or renew the contract for a further period.
- Residual Value: The price set for the asset if the purchase option is exercised.
Operating Lease
An operating lease is a contract whereby a person, usually a manufacturer or supplier, cedes to another the use of some asset against lease payments, which cover both financing and maintenance costs, including repairs. There may be a purchase option, though not as common as in a financial lease. Another distinctive characteristic is that the contract is made on standard assets. One of the main characteristics of this approach is that the duration of the contract is basically fixed in the short term, mitigating the risk of obsolescence of these goods.
Financial Lease
A financial lease is a contract whereby a leasing company, following customer specifications, provides equipment against lease payments that exceed the purchase price, divided over a period of time, which often coincides with the fiscal and economic life of the equipment, during which the contract is irrevocable. The risk is borne by the tenant, who, upon completion of that period, can return the equipment, extend the contract, or purchase it. Maintenance and repair costs are typically borne by the user or lessee. Contract durations are long-term fixed due to the high cost of acquiring such goods.
Direct Leasing
Direct leasing is conducted through negotiation between the prospective tenant and the leasing company. The company, according to the tenant’s instructions, buys the material for subsequent leasing to the tenant. This focuses especially on computers or specialist industrial machinery.
Indirect Leasing
This type is promoted by the manufacturers themselves or distributors. The user, once the equipment and supplier are selected, goes to the leasing company to finance it, and the leasing company places the order with the supplier who provides the equipment.
Lease of Movable and Immovable Assets
There are two types: movable assets, such as industrial equipment, cars, and consumer durables, which are financed through leasing; and immovable assets, such as property purchased and constructed by a leasing company for industrial or commercial use, with the purpose of hiring a user with a unilateral undertaking to sell.