Lease finance and hire purchase are the options of financing the assets. These options vary from each other in many aspects viz. ownership of the asset, depreciation, rental payments, duration, tax impact, repairs and maintenance of the asset and the extent of finance.
Starting any business involves a lot of financial planning for acquisition of fixed assets like land, plant and machinery etc. Most entrepreneurs are scared of capital intensive projects due to huge financial commitments. When large capital is involved in the business, an entrepreneur wishes to spread his cost of acquisition of fixed assets over a longer period. Longer period would reduce per year commitment towards the cost of asset.
The intention is to match the commitment with the revenue generated per year so that the payments are easily manageable without any cash flow mismatch.
Lease and Hire purchase is an exact solution to that kind of financial arrangement where the cash commitment is spread over the life of the asset and on the top, lease financing does not even require any initial capital outflow also. Hence under lease, the entrepreneur can use his capital for other working capital requirements.
In simple words, Lease is a financial contract between the business customer (user) and the equipment supplier (normally owner) for using a particular asset/equipment over a period of time against the periodic payments called “Lease rentals”.
Lease generally involves two parties i.e. the lessor (owner) and the lessee (user). Under this arrangement, the lessor transfers the right to use to the lessee in return of the lease rentals agreed upon. Lease agreement can be made flexible enough to meet the financial requirements of both the parties.
Hire Purchase is a kind of instalment purchase where the businessman (hirer) agrees to pay the cost of the equipment in different instalments over a period of time. This instalment covers the principal amount and the interest cost towards the purchase of an asset for the period the asset is utilized. The hirer gets the possession of the asset as soon as the hire purchase agreement is signed. The hirer becomes the owner of the equipment after the last payment is made. The hirer has the right to terminate the agreement anytime before taking the title or the ownership of the asset.
Difference between Lease and Hire Purchase:
- Ownership of the Asset: In lease, ownership lies with the lessor. The lessee has the right to use the equipment and does not have an option to purchase. Whereas in hire purchase, the hirer has the option to purchase. The hirer becomes the owner of the asset/equipment immediately after the last installment is paid.
- Depreciation: In lease financing, the depreciation is claimed as an expense in the books of lessor. On the other hand, the depreciation claim is allowed to the hirer in case of hire purchase transaction.
- Rental Payments: The lease rentals cover the cost of using an asset. Normally, it is derived with the cost of an asset over the asset life. In case of hire purchase, installment is inclusive of the principal amount and the interest for the time period the asset is utilized.
- Duration: Generally lease agreements are done for longer duration and for bigger assets like land, property etc. Hire Purchase agreements are done mostly for shorter duration and cheaper assets like hiring a car, machinery etc.
- Tax Impact: In lease agreement, the total lease rentals are shown as expenditure by the lessee. In hire purchase, the hirer claims the depreciation of asset as an expense.
- Repairs and Maintenance: Repairs and maintenance of the asset in financial lease is the responsibility of the lessee but in operating lease, it is the responsibility of the lessor. In hire purchase, the responsibility lies with the hirer.
- Extent of Finance: Lease financing can be called the complete financing option in which no down payments are required but in case of hire purchase, the normally 20 to 25 % margin money is required to be paid upfront by the hirer. Therefore, we call it a partial finance like loans etc.
The option of lease finance or the hire purchase can be opted by the businessmen but they should be analyzed properly as to how much the option suits to the business requirement and situations.