01. What is Operating lease?
Operating lease is a contract wherein the owner, called the Lessor, permits the user, called the Lessee, to use an asset for a particular period without any transfer of ownership rights.
Rapid technology development in the present era, has increased the risk of obsolescence in some industries. The manufacturers have to change their equipment to ensure high productivity or to improve the quality of the product.
It doesn’t make sense to make a large cash outlay for an asset that will only be used for a short period of time.
With a lease, lessee can avoid a hefty up-front charge and can make payments as you generate cash flow with your new asset.
Users lacking staff or expertise of handling specialised equipment can get support from the lessor.
A lease allows lessee to deduct the payments as operating expenses during the period in which they are paid. If the lessee purchases the asset, interest as well as depreciation may be deducted. In most cases, lease tax benefits turn out to be higher.
With the lease, an asset can be bought at today’s price and the payments can be made from tomorrow’s earnings, which provides inflation hedge.
Generally, an asset purchased increases the debt and reduces the available cash. In contrast, leases are not recorded as debt and are treated as an operating expense.
Lease payments are accounted as operating expenses, as a result the company’s profits to fixed assets ratio improves. This in turn permits greater bank borrowing capacity, in some cases.
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