Conceptual Clarity
The term ‘rent’ and ‘lease’, is very common nowadays. This is the agreement between two parties where one party takes the possession of the property and the other party rents. Landlords and tenants sign the leasing agreements and rent the property. This concept of leasing is taken by the corporate houses as well. This leasing in business is indeed a good source of finance.
Public Deposits are those deposits that are raised by the organizations directly from the public. The rates are generally high compared to the bank deposits. While a con of public deposit is, it carries a high risk.
We will strengthen our knowledge in these two topics – Lease Finance and Public Deposits in the further sections.
What is Lease Financing?
A lease is a type of contractual agreement that is transacted between the lessor and a lessee. The owner who is the lessor, he grants the other party who is the lessee the right to use the asset for a specific time period, in return for a periodic payment.
In the lease contract, clearly the lease arrangement is mentioned. The asset is returned to the lessor at the end of the contractual period. Leasing is common in the acquisition of computers, electronic equipment which become out of date rapidly for the development of technology.
Merits and Limitation of Lease Financing
The Merits of Lease Financing are Mentioned as below:
Lease rents paid by the lessee are not non-taxable income.
Leasing helps in easy finance without totally diluting the ownership of the asset.
This also helps the lessee to acquire the asset with a much lower price.
Less documentation is required.
The lesser generally carries the risk of obsolescence, this allows flexibility to the lessee to change and replace the asset.
The lease agreement does not affect the debt rising chance.
The Limitations are as follows:
This results in high payout duty, if the asset is not useful and the lessee opts out for premature termination from the contract.
The financial activities of the business will be affected in case the lease is not renewed.
The lease agreement is prone to certain restrictions on the use of assets. Like, this might not allow the lessee to make modification in his own asset.
The lessee actually never becomes the owner of the asset.
What is Public Deposit?
The deposits raised by the organizations directly from the public is called public deposits. The companies work by offering higher rates of interest that are offered on these public deposits which are usually more than what is offered on the bank deposits. Any person who is willing to deposit their money in an organization does so by filling up a form of the particular organization. The organization in return issues this deposit as receipt with an acknowledgement of the debt. Public deposits take care of both the medium and short-term financial requirements of the business.
As the depositors receive more interest rate than the bank rate, the cost of deposits to the company becomes less than the cost of borrowings from the banks. The deposits are hence profitable to both the depositor as well as to the organization who is in-charge of these deposits. Companies invite public deposits for a maximum period up to three years. The accepting of these of public deposits is regulated and the rules are prescribed by the Reserve Bank of India.
Merits and Limitation of Public Deposits
The merits of public deposits are as follows:
Public deposits do not create any charge on the assets of the company, rather the assets can be used as security for raising loans.
The depositors do not have any voting rights thus, the control of the company is not diluted.
The procedure of depositing in the company is less complicated and barely contains other restrictive conditions.
The cost of public deposits is much lower than the cost of borrowings from the banks and other financial institutions.
The Limitations are:
Growing companies find it difficult to attract the public and obtain funds through the public deposit system.
It is not a reliable source of finance as the public may not respond when the company needs the money.
Collection of these deposits seem to be difficult, especially when the deposits required are quite large.
FAQs on Lease Finance and Public Deposits Explained
1. What is the fundamental concept of lease financing in business?
Lease financing is a contractual arrangement where the owner of an asset (the lessor) grants another party (the lessee) the right to use the asset for a specified period. In return, the lessee makes periodic payments, known as lease rentals. The key aspect is that the lessee gets to use the asset without owning it, making it a popular way to finance high-value equipment or property without a large initial investment.
2. Who are the lessor and the lessee in a lease agreement?
In a lease agreement, there are two main parties involved:
- The Lessor: This is the owner of the asset who gives it on lease. For example, a company that owns a fleet of cars and rents them out to businesses is the lessor.
- The Lessee: This is the party that acquires the right to use the asset by paying a lease rental. The business that rents the cars for its operations is the lessee.
3. What are public deposits as a source of company finance?
Public deposits refer to the unsecured deposits raised by a company directly from the general public. Companies invite people to deposit their savings with them for a fixed period at a prescribed rate of interest. This interest rate is typically higher than what commercial banks offer, making it an attractive option for investors. For the company, it's a way to raise medium-term finance without involving banks or financial institutions.
4. What is the main difference between a finance lease and an operating lease?
The primary difference lies in the transfer of risks and rewards associated with the asset.
- A finance lease is a long-term arrangement that transfers almost all the risks (like maintenance, insurance) and rewards of ownership to the lessee. The lease term usually covers the major part of the asset's economic life.
- An operating lease is a short-term lease where the lessor retains the risks and rewards. The lessor is responsible for the asset's maintenance, and the lease term is much shorter than the asset's useful life. This is common for assets that become obsolete quickly, like computers.
5. Why would a company choose to lease an asset instead of buying it with a loan?
A company might prefer lease financing over buying an asset for several strategic reasons:
- Conservation of Capital: It avoids a large, one-time cash outflow, freeing up funds for other core business activities.
- Risk of Obsolescence: For assets like technology or machinery that quickly become outdated, leasing allows a company to easily upgrade to newer models at the end of the lease term. The risk of the asset becoming worthless is borne by the lessor.
- Tax Benefits: Lease rental payments are treated as an operating expense and are fully tax-deductible, which can lower the company's tax liability.
- Flexibility: Lease agreements can be structured to meet the specific cash flow needs of the company.
6. What are the major limitations of raising funds through public deposits?
While useful, public deposits have significant limitations:
- Difficulty for New Companies: Only companies with a strong financial record and reputation can successfully attract deposits from the public. New or less-known companies find it very difficult.
- Regulatory Constraints: The process is strictly regulated by the Companies Act and the RBI to protect depositors' interests, involving compliance with many rules.
- Limited Funds: The total amount that can be raised through public deposits is restricted, making it unsuitable for financing large-scale projects.
- Unreliable Source: Public sentiment can change quickly, making it an uncertain source of funds, especially during economic downturns.
7. Can you provide some real-world examples of assets typically acquired through lease financing?
Certainly. Lease financing is very common across industries for various assets. Examples include:
- Aviation: Airlines often lease aircraft instead of purchasing them due to the massive cost.
- IT and Office Equipment: Startups and established companies lease computers, servers, and photocopiers to stay technologically current without heavy capital expenditure.
- Heavy Machinery: Construction and manufacturing firms lease equipment like cranes, bulldozers, and specialised factory machines.
- Commercial Vehicles: Logistics and delivery companies often lease their fleet of trucks and vans.
8. How do public deposits create a win-win situation for both the depositor and the company?
Public deposits can benefit both parties involved. For the depositor, the primary benefit is earning a higher rate of interest on their savings compared to what is offered by banks. For the company, the advantages include a lower cost of capital compared to bank loans, simpler procedures for raising funds, and no requirement to mortgage any assets as security, which preserves their borrowing capacity for other needs.
9. Under what conditions is lease financing the most suitable option for a business?
Lease financing is particularly suitable for businesses under specific circumstances. It is ideal for startups and small businesses with limited capital who need to acquire assets to begin operations. It is also highly effective for businesses in industries where technology changes rapidly, such as IT, healthcare, and R&D, as it helps them avoid the risk of technological obsolescence. Finally, it benefits companies that want to maintain a healthy debt-to-equity ratio, as lease obligations are often treated as an operational expense rather than long-term debt on the balance sheet.
