Sources of Business Finance

Lease Finance and Public Deposits

Have you heard about rent or lease? It is an agreement between two parties where one party rents and other takes possession for an agreed period. Landlord and tenants sign lease agreements while renting property. Companies do that all the time to raise funds. It is called as Lease Financing. It is one of the most interesting sources of finance. Let’s learn more about it.

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Lease Finance

A lease is a contractual agreement whereby one party that is the owner of an asset grants the other party the right to use the asset in return for a periodic payment. In simpler terms, leasing is renting an asset of the company for a specified period. The ‘lessor’ is the owner of the party and the ‘lessee’ is the party that uses the assets. The lessee pays a fixed periodic amount called ‘lease rental’ to the lessor for the use of the asset.

Lease contract mentions the terms and conditions involving lease arrangement.. The asset is returned to the lessor at the end of lease period. Leasing is more widespread in the acquisition of assets as computers and electronic equipment which become obsolete quicker be of rapid development in technology in the sector. It is very important while making the leasing decision to compare the cost of leasing the asset with the cost of owning the same.

Lease Finance and Public Depositssource: chrylercapital

The Lessors

  1. Specialised leasing companies: Some companies have primarily evolved in the leasing business. There are 400-odd large companies which have an organizational focus on leasing. They are known as leasing companies. These companies generate their revenue through leasing.
  2. Banks and bank-subsidiaries: RBI allowed banks to directly enter leasing in February 1994. Till then, only the bank subsidiaries were permitted to engage in leasing activities. Leasing operations of banks were regarded by the RBI as a non-banking activity.
  3. Specialised financial institutions: A number of financial institutions in India use the lease instrument along with traditional financing instruments. ICICI is one of the pioneers in Indian leasing sector.
  4. Manufacturer-lessors: A manufacturer finds the best way to sell the product on the lease when competition forces him to add value to the sales. Vendor leasing is gaining a vital scope in India. Currently, vendors of automobiles, consumer durables, etc have alliances with leasing companies to offer lease finance against their products.

The Lessees

  1. Public sector undertakings: The public sector has seen a notable rate of growth in the past. There is an increasing number of both centrally as well as state-owned institutions which have turned towards lease financing.
  2. Mid-market companies: The mid-market companies (i.e. companies with reasonably good creditworthiness but with lower public profile) have chosen lease financing as an alternative to bank/institutional financing.
  3. Consumers: Recent bad cases with corporate financing have focused the limelight towards the retail funding of consumer durables. For instance, car leasing is a dominant market in India today.
  4. Government departments and authorities: The government itself is the latest player in leasing markets. Department of Telecommunications of the central government took the lead by floating tenders for lease finance worth about Rs. 1000 crores.

Merits of Lease Finance

  • Lease rentals paid by the lessee are cut from taxable profits.
  • Leasing provides finance without diluting the ownership of the asset.
  • It enables the lessee to obtain the asset with a lower price rather than owning it.
  • Easy documentation makes it simpler to finance assets
  • The lesser carries the risk of obsolescence. This allows flexibility to the lessee to replace the asset.
  • The lease agreement does not affect the debt raising capacity of an enterprise.

Limitations of Lease Finance

  • It may result in higher payout obligation in case the equipment is not found useful and the lessee opts for premature termination of the lease agreement.
  • Financial activities of business may be affected in case the lease is not renewed.
  • There are chances that a lease arrangement might impose certain restrictions on the use of assets. For example, it may not allow the lessee to make any alteration or modification in the asset.
  • The lessee never becomes the owner of the asset. It denies him of the residual value of the asset.

Public Deposits

The deposits that are raised by organizations directly from the public are known as public deposits. Companies offer higher rates of interest offered on public deposits are usually than that offered on bank deposits. Any person who prefers depositing money in an organization does so by filling up a prescribed form. The organization in return issues a deposit receipt as an acknowledgement of the debt. Public deposits take care of both medium and short-term financial requirements of a business.

As the depositors receive higher interest rate than that offered by banks, the cost of deposits to the company is less than the cost of borrowings from banks. The deposits are profitable to both the depositor as well as to the organization. Companies generally invite public deposits for a period up to three years. The acceptance of public deposits is regulated by the Reserve Bank of India.

Merits of Public Deposits

  • Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans.
  • As the depositors do not have voting rights, the control of the company is not further diluted.
  • The procedure of depositing is easy and does barely contains restrictive conditions.
  • Cost of public deposits is lower than the cost of borrowings from banks and financial institutions.

Limitations of Public Deposits

  • Newborn companies find it difficult to obtain funds through public deposits.
  • It is an untimely source of finance as the public may not respond when the company needs money.
  • Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Solved Questions for You

Q: Under the lease agreement, the lessee gets the right to
(a) Share profits earned
(b) Participate in the by the lessor management of the organisation
(c) Use the asset for a specific time
(d) Sell the assets specified period

Answer: (c) Use the asset for a specific time

Q: Discuss the limitations of public deposits.

Answer: Newborn companies find it difficult to obtain funds through public deposits. Also, it is an untimely source of finance as the public may not respond when the company needs money. Collection of public deposits may prove difficult, particularly when the size of deposits required is large.