Finance / Capital Lease

A capital lease is a long term, non-cancellable lease. It is more an arrangement of funds rather than a lease. In situations other than leasing, a firm needs to finance its assets either through borrowing or from his own capital. But, if a business has limited capital not sufficient to buy an asset, it will have to go either for borrowing or any other option like leasing. The basic difference between borrowing and leasing is of ownership. In borrowing, the ownership is transferred initially and in the latter, ownership is transferred at the end of the term of the lease if agreed so (the term is generally the life of the asset).

For a lessor, the financial lease is nothing but utilization of his money. In essence, he finances the asset and earns the interest on his money.

Finance / Capital LeaseHe does not have any interest in the asset as the asset is chosen by the lessee for his economic use. Assets like aircraft, railway wagons, lands, buildings, heavy machinery, diesel generating sets, ships, etc are purchased under a financial lease. Smaller assets are financed by operating lease which is different from Finance Lease. Refer Difference between Finance and Operating Lease.

Features of a Capital Lease

Ownership

In a capital lease, ownership is transferred to the lessee at the end of the lease period. It may be transferred with or without a merger or residual amount as mentioned in the agreement of finance lease.

The Term of Lease

The term of a capital lease extends over the economic life of an asset.

Monthly Lease Rentals

Monthly lease rentals or payments are the equated monthly payments which are paid by the lessee to the lessor. In the lease rental, lessor covers the investment made, interest thereon, repairs and maintenance and profit.

Asset

The lessor has nothing to do with the asset. As he is mere a financier to the asset, the asset is purchased by the choice of the lessee who is the ultimate economic user of it.

Processing Time and Fee

Unlike a loan, there is no processing fee for the lease and time for processing is also quite less compared to a loan.

Margin Money

In a loan, margin money has to be invested by the equipment buyer but in the case of the lease, the lessee does not have to pay any margin money and a full amount of the equipment can be financed here.

Collateral Security

There is no such requirement of collateral security in the case of a lease which is a must when a big loan is taken from any bank or institution.

Step Wise Process of Capital Lease Structuring

  • First of all, lessee selects the equipment or the asset.
  • Lessee only negotiates with the manufacturer about the price, features, and functionality of the assets.
  • Lessor purchases it from either the manufacturer or at times from the lessee. When the lessor purchases an asset from the lessee and leases it back to the lessee, it is a different leasing arrangement called Sale and Lease Back.
  • Post purchase, lessor leases the asset to lessee. Lessor retains ownership while lessee gets the right to use against fixed monthly rentals.
  • The capital lease provides the lessee an option to purchase at the end of the period.
  • Originally, a lease is agreed for the non-cancellable period which we call the primary lease period. During this period, the lessor/investor seeks to recover his invested money with some profits.

In summary, a capital lease is an awesome option for those businessmen who neither have their own capital nor are they eligible to take a loan. Loan taking ability is generally restricted by its requirement of collateral security which every businessman may not have.

Last updated on : January 12th, 2018
What’s your view on this? Share it in comments below.

About The Author

Sanjay Bulaki Borad
Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of training100.ru. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

Leave a Reply

Types of Mortgage Loans
  • Advance and Maturity Factoring
    Advance and Maturity Factoring
  • Debt Financing
    Sources of Debt Financing
  • Sublease
  • Triple Net Lease
    Triple Net Lease
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Recent Posts

    Find us on Facebook


    Related pages


    miller modigliani theoreminterpreting liquidity ratiosasset to debt ratio calculatorexplanation of irrcriticism of modigliani and miller theoryincremental budgeting pdflong term debt to equity ratio calculatorebit formula exampleprinciple of profit maximizationbreak even point formulasprofit margin ratio meaningdupont return on equityreceivable turnover periodhow to compute margin of safetyhorizontal mergers definitionhow to improve total asset turnoverhow to calculate internal rate of returntrade receivables turnover daysdays receivable turnoverwhat are the types of debenturesdisadvantages of arbitrage pricing theorynumber of days sales in inventory ratioglobal depository receiptoverdraft loan definitiondcf stock valuationwacc for companieswhat is meant by fictitious assetstimes interest earned calculatorcurrent cash debt coverage ratio formulaconglomerate merger definitiondebenture financingprofitability ratio analysiscapital lease journal entrysignificance of cash managementoperating profit and ebitdafinancial management numericalspvifa tablemodigliani and miller proposition 1how to write a hire purchase agreementmarket value of debt waccaccount receivable turnover in daysoperating cycle in working capital managementbank loan covenantsbills of lading typesstrategic motives for mergers and acquisitionszero based budgeting samplefinding irrcurrent account with overdraftimproving inventory turnswhat is the m&m theoryfactoring non recoursehow to calculate shareholder equityexamples of profitability ratiostobin s qdisadvantages of traditional budgetingmerchandise inventory turnoverfixed cost variable cost examplescredit vs debit in accountingexplain macro environmentcalculating receivables turnoverwacc explanationdu pont formulafixed charge coverage ratio formulainvestopedia budgetwhat does dscr stand forworking capital to sales ratio formulabond debenturearbitrage pricing theory calculatorarbitrage portfolio theoryconstant growth dividend modelimportance of npvhow to calculate the discounted cash flowaccounts payable meaning with exampleprofitabilty indexaccounts receivable with recoursesources of long term finance advantages and disadvantagesfinancial leverage meaning in hindicurrent wacc