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How does leasing work ?

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How does leasing work?

Leasing is a financial arrangement in which an asset is rented for a fixed period, with the option for the lessee to purchase it at the end of the contract. 

This mechanism enables companies to use equipment, vehicles or goods without having to make a substantial initial investment. 

The contract specifies the rents, the duration and the conditions under which the lessee can exercise his purchase option. 

This system is particularly appreciated for its flexibility and ability to adapt to changing business needs.

Background and context

The concept of leasing, although based on long-established economic practices, came into its own in the business world after the Second World War. 

This financing system found particularly significant application in sectors requiring the use of expensive equipment. 

For example, lease financing was widely adopted for the acquisition of transport equipment, such as trucks and tractors, as well as forestry equipment, such as skidders and chainsaws. 

Initially adopted by American companies to optimize their capital management, leasing has gradually spread internationally. 

Today, leasing is an integral part of financial and operational planning for companies of all sizes. In addition, it enables them to remain competitive without increasing their indebtedness. 

This development has also led to the adaptation of legal and regulatory frameworks, ensuring greater protection for stakeholders and the adoption of stricter standards of financial transparency.

The parties involved in a leasing agreement

The lessor

The lessor is the party who owns the asset and makes it available to the lessee in the form of a lease. Typically, this may be a financial institution, a leasing company or an equipment vendor seeking to finance the use of equipment without immediately transferring ownership. 

The financier's role is to determine the terms of the leasing contract, including duration, rental amounts and purchase options. It also assumes the risk of the lessee's non-performance during the lease period.

The lessee

This is the company or individual who obtains the right to use the leased asset in exchange for periodic payments over a fixed term. 

At the end of the leasing contract, the lessee often has the option of purchasing the asset at an agreed residual price, renewing the lease or returning the asset to the lender. 

The customer benefits from the use of the equipment without the need for significant initial capital. This advantage enables them to conserve their financial resources for other operational or strategic investments.

Third parties (banks, suppliers)

Third parties, notably banks and suppliers, support leasing arrangements. 

On the one hand, banks finance the purchase of goods, which the lessor then offers for lease. 

They can also act as guarantors for these transactions. On the other hand, suppliers supply the leased goods and often offer maintenance services or warranties for the equipment. 

Finally, collaboration between these parties facilitates the process and reinforces the financial security of the leasing operation. This approach ensures long-term stability and success.

How leasing works

Leasing implementation process

Leasing begins with the identification of the lessee's equipment requirements. 

Next, the lessee selects the desired asset and searches for a lessor who can supply this asset in the form of a lease. 

The two parties then negotiate the terms of the contract, including the lease term, periodic payments, and the option to purchase at the end of the lease. 

Once the contract has been formalized and signed, the asset is delivered and can be used following the agreed terms, subject to regular payments.

A typical leasing operation

Let's take the example of a company wishing to acquire a new fleet of vehicles without tying up its capital. 

The company turns into a leasing company specializing in vehicle financing. After selecting the vehicle models required, the company negotiates a three-year leasing contract. 

The terms include fixed monthly rentals and a residual value purchase option at the end of the contract. 

During the term of the lease, the company benefits from the use of the vehicles for its operations, while retaining its investment capacity for other projects. 

At the end of the contract, the company can choose to purchase the vehicles at a predetermined price, renew the contract or return the vehicles to the lessor. 

This scenario illustrates how leasing enables companies to maintain financial flexibility while meeting their equipment needs.

Benefits of leasing

For the lessee

One of the main advantages of leasing for the lessee is the conservation of financial resources. 

By opting for leasing, companies avoid the often high initial capital outlay associated with equipment purchases. For example, in the forestry sector, the acquisition of a new skidder could cost around CAD 365,000 if purchased outright. 

By choosing a leasing contract, a company can instead spread this amount over manageable monthly payments. 

What's more, leasing contracts often provide flexible terms that can adapt to a company's changing needs. 

This includes the possibility of upgrading or replacing equipment before the end of the lease term. 

Another advantage is that lease payments are generally considered as deductible operating expenses, which can lead to tax benefits.

For the lessor

For the owner, leasing represents a stable and predictable source of income. By establishing contracts, it ensures a flow of payments over an extended period, which facilitates financial planning. 

What's more, by retaining ownership of the equipment, you benefit from asset depreciation for tax purposes. 

By enabling leasing, leasing allows the lessor to develop long-term relationships with users. And this relationship can lead to contract renewals. 

It also opens the door to other financing opportunities with the same customers. 

These developments help to increase customer loyalty and expand business volume.

Disadvantages of leasing

Lessee risks

One of the risks associated with leasing for the lessee concerns total long-term costs. Often, cumulative payments can exceed the initial purchase cost of the asset. 

What's more, the lessee is generally responsible for maintaining the leased equipment, which can lead to additional, unforeseen expenses. 

In addition, at the end of the contract, the lessee may have the option of purchasing the equipment at a residual price. 

This price does not necessarily reflect the current market value, which may limit the lessee's financial flexibility.

Risks for the lessor

For the lender, the main risks of leasing include payment default by the lessee. If the lessor runs into financial difficulties and cannot meet the terms of the contract, this can affect the lessor's profitability. 

Similarly, there is a risk associated with the residual value of the equipment. If the market value of the equipment falls faster than expected, the financier may incur a loss when the asset is repossessed at the end of the contract. 

Finally, the process of recovering and reselling the equipment can be costly and complex, affecting the lessor's liquidity and financial results.

Parties' rights and obligations

Lessor's obligations

The owner must supply an asset that conforms to the specifications set out in the leasing contract. 

In addition, the lessor must inform the lessee of all conditions and restrictions relating to the use of the equipment. 

He must also provide the necessary legal documents attesting to ownership and authorizing legal use of the equipment.

Lessee's obligations

The lessee undertakes to make the agreed payments regularly throughout the term of the contract. He must use the equipment in accordance with the established conditions, without causing any damage other than normal wear and tear. 

The user is also required to take out adequate insurance to protect the asset against potential damage or loss. At the end of the contract, the beneficiary must either return the equipment in good condition, purchase the good according to the predefined conditions, or renew the contract if this option is available.

Lessor's rights

The owner has the right to receive payments on time and in the amounts agreed in the contract. In the event of non-payment, the lessor has the right to repossess the equipment. 

In addition, the supplier may inspect the equipment at reasonable intervals to ensure that it is maintained in good condition and used in accordance with the terms of the contract.

Lessee's rights

The user has the right to use the equipment exclusively for the purposes specified in the contract. He also has the right to have the equipment in good working order throughout the loan period. 

Finally, if the customer decides to purchase the equipment, he has the right to acquire it at a predefined price as specified in the contract.

Terms and conditions of sale for finance leases

There are several cases in which a leasing contract can be terminated before its normal expiry date. Here are some of the most common scenarios:

‍Violation of the contract: If one of the parties fails to comply with the terms of the contract, such as non-payment of rent or non-compliance with the conditions of use of the equipment, this can lead to early termination of the lease.

‍Mutual agreement: Both parties, the lessor and the lessee, can agree to terminate the lease early by mutual consent. This can occur for a variety of reasons, such as the replacement of equipment with newer technology or changes in the lessee's operational needs.

‍Insolvency: If the lessee becomes insolvent or enters bankruptcy, the lessor may choose to terminate the lease to repossess the equipment and secure its residual value.

‍Purchase option term: Some leasing contracts include a purchase option that the lessee can exercise before the end of the term. If the lessee decides to purchase the equipment, the lease is terminated once the purchase is finalized.

‍Damage or loss: If the leased equipment is damaged or lost and cannot be satisfactorily replaced or repaired, this may also lead to the end of the lease.

‍Assignment of contract: In some cases, the leasing contract may allow the loan to be assigned to another party.

This possibility can be envisaged when a company wishes to transfer its rights and obligations to another entity without interrupting the continuity of service or use of the equipment.

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