The link between leasing and return on equity: communicating to shareholders

September 23, 2016

By David Onto, Head of Intermediary Sales Australia & New Zealand

Making regular investments in assets is one of the main contributors to strong business performance. It gives a company a greater ability to compete in its markets, and helps to maintain and improve productivity.

But buying expensive assets such as plant and equipment can often put substantial strain on a company’s balance sheet. It can mean the business has to allocate too much capital to plant and equipment at the expense of investing in growth opportunities or assets. Purchasing outright an asset may also require substantial negotiation with one or more financial institutions.

An alternative to acquiring assets on balance sheet is to use a solution such as a lease or rental. This allows businesses to access state-of-the-art technology. It also helps to improve shareholder returns, and financial ratios through not tying up capital in large deprecating capex programs.

It is key however to ensure that Boards, and senior management engaged on the journey when a business decides that leasing or renting is preferred above acquiring assets. The key, is clearly explaining the many advantages offered by financing core business assets.

The benefits of operating leases

One non-ownership option is to take out an operating lease. This type of lease has specific characteristics that it is important to understand.

With an operating lease there is no requirement for a deposit and it may also be possible to finance installation and maintenance and other “soft” costs. There is also no residual liability at the end of the lease.

Perhaps the biggest benefit businesses perceive though with an operating lease is the fact they do not appear on the balance sheet. This allows the business to use the strength of the balance sheet for other purposes, for instance to make acquisitions or take advantage of other opportunities that exist for growth.

Moreover, the cost of an operating lease is fully tax deductible, giving the business the opportunity to reduce the tax the company pays.

Another advantage is that the lessee can exchange the equipment during the lease term should newer, more efficient or productive equipment be released. Also, operating leases are flexible, and at the end of the contract the business has a number of options available. It can return the asset, extend the lease or in some cases buy the asset, depending on what structure suits the company.

Operating leases are a good way of preserving cash, while at the same time giving the business access to the equipment it needs to achieve its full potential. Furthermore, we’ve seen a trend over time in our own research of firms looking to use operating leases. During the past two years of continuous research in the Alleasing Equipment Demand Index, the number of Australian businesses who said they are intending to fund their infrastructure needs via operating lease has increased – within the previous 12 months alone by 37.3%.

Advantages of finance leases

Another solution businesses can utilise is a finance lease, which has slightly different characteristics to an operating lease.

One of the most significant differences is that a finance lease appears on both the lessee and the lessor’s balance sheet as an asset and a liability.

However, like an operating lease, there is no deposit required with a finance lease, and all lease payments are fully tax deductible.

But unlike an operating lease, it’s not possible to change the equipment during the life of the lease. Plus, at the end of the contract there is an expectation the lessor will acquire the asset after making a balloon payment.

Both operating and finance leases are commonly used by companies for different reasons, depending on the asset being leased and its purpose. While there are variances between the two, both allow the business to use the strength of the balance sheet for purposes other than buying assets such as plant and equipment, retail refurbishment and fit-out and yellow goods.

It is important shareholders and management understand the rationale for leasing rather than acquiring equipment outright. This requires good communication and transparency about how companies manage their assets, so that investors in the business have confidence the company’s capital is being deployed in the best way possible.

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