How Leasing Works, With Practical Examples

Leasing has been an asset use and funding option available to companies for many years. Lessors, such as Quadrent, have developed sophisticated offerings enabling companies to effectively transfer asset ownership risk, diversify their funding sources, optimise asset use, and realise a range of other operational, strategic and financial benefits. With the right leasing provider, asset use and a company’s financial objectives can be more closely aligned than what’s available through traditional funding channels.

Quadrent, in collaboration with SAR Accounting Advisory, recently hosted a webinar outlining how companies can master leasing strategies to boost cash flow and proactively manage a potential economic downturn. View the webinar recording here, and click here to read the summary. Keep reading below to learn more about leasing and its practical benefits.

What is leasing?

Leasing is fundamentally about transferring the ownership risk of an asset. The most popular form of leasing is for property. Businesses generally lease property because they can’t afford the CAPEX investment required to buy the property. For example, if your company were to purchase every building it operates out of, there wouldn’t be enough space on your balance sheet for all the other necessary liabilities and accounts that go into running and maintaining the buildings.

For equipment leasing, such as car fleets, non-essential machinery and equipment, and IT devices, businesses can still avoid an upfront CAPEX spend while also transferring ownership risk to the lessor. These risks include obsolescence and maintenance. For example, a lease on a car allows the business to use the vehicle while the costs of maintenance and obsolescence remain with the lessor. In short, if you include these costs when evaluating whether to you should own the car yourselves, it becomes easier to see the value in choosing a lessor who addresses these risks (i.e. ownership costs) instead.

What assets can and can’t be leased?

While many assets can be leased, there are some scenarios where it doesn’t work. Any equipment that is specialised or key to a business’s performance or output generally isn’t suitable for leasing. For example, specialised equipment that makes a product essential to your business’s output is something where your business should control as much of the process and equipment as possible.

Assets that are most suitable for leasing are commoditised equipment, such as laptops, mobile devices, cars, and property, to a certain extent. This is because lessors have the expertise to derive the most value out of these assets at the end of their useful life within the business.

How does leasing work?

A finance lease allows the lessee to take ownership of the asset at the end of the lease term. The cost of the asset plus interest to finance the purchase is spread evenly across the life of the lease term. An operating lease, in contrast, is more complex but can deliver more value to the business. The regular lease payments are still spread evenly across the lease term, but the lessor takes a residual position in the asset.

In short, the residual value the lessor can derive from the asset after the lease term, is passed to the lessee upfront as a discount, reducing the cost of the lease payments.

Should you lease or should you own?

Deciding whether to lease or own will depend on a range of factors. First, it’s important that any comparisons are done on a like-for-like basis and the total cost of ownership (TCO) is considered, not just the price to acquire the asset. As part of your analysis, you should include the end-to-end cost of the asset lifecycle. These costs include procurement, financing, sustainability and environmental impact, and the human capital and IT requirements to manage and maintain the assets.

Accounting considerations for leasing

While the advent of IFRS 16 has made leasing considerations more complex, the accounting standard was designed to put leasing and buying on a level playing field from a CAPEX perspective. However, the key advantage of leasing is that it gives you greater flexibility in capital allocation and utilisation.

By having leasing on the balance sheet under IFRS 16, the accounting outcome is the same for buying and leasing assets. However, quite often, businesses don’t use a weighted average cost of capital (WACC) to assess their CAPEX purchasing decisions. This results in CAPEX models looking more favourable, but as mentioned above, the TCO should include everything associated with the use of the assets.

Asset disposal considerations for leasing

Another key factor that’s often forgotten is the end-of-life costs. For example, when a business no longer has a use for a fleet of laptops, these items can’t just be disposed of without considering the environmental impacts. With the rising expectations around sustainability and environmental, social and corporate governance (ESG), companies need to factor in the costs of disposing of assets safely to reduce environmental impact and address data security risks. These should be factored into your buying costs early on. By using a leasing provider, these are incorporated into the overall cost of the lease.

Unlock cash flow and optimise your asset use with Quadrent

Leasing offers a flexible, strategic alternative to traditional funding methods, aligning asset use with a company’s financial goals while transferring the risks inherent in asset ownership. By leveraging sophisticated leasing products, your business can optimise its cash flow, reduce the TCO of assets, and ensure machinery and equipment are always up to date. With the right leasing provider, your company can access tailored leasing solutions, that support the business’s operational and strategic objectives.

Quadrent's asset financing and leasing solutions can help you unlock cash flow and transfer the risk of asset ownership. Click here to contact our team for more information.