Lease finance and hire purchase are the options for financing the assets. In lease financing vs hire purchase, both the terms vary 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 to acquire fixed assets like land, plant, machinery, etc. Most entrepreneurs are afraid of capital-intensive projects due to huge financial commitments. When large capital is present in the business, an entrepreneur wishes to spread the acquisition cost of fixed assets over a more extended period. A longer period would reduce per year commitment towards the cost of an 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 asset’s life. On top, lease financing also does not require any initial capital outflow. Hence under the lease, the entrepreneur can use his capital for other working capital requirements.
In simple words, a Lease is a financial contract between the business customer (user/lessee) and the equipment supplier (normally owner/lessor) for using a particular asset/equipment over a period of time against the periodic payments called “Lease rentals.”
The 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 for the lease rentals agreed upon. A lease agreement can also be flexible to meet the financial requirements of both parties.
A lease also acts as an alternative to financing business assets. There are many options for a finance manager to choose from. He can opt for equity finance, debt finance, term loan, hire purchases, or many others. All the means of financing differ due to their different characteristics. There are some advantages and disadvantages of leasing.
A hire purchase is a kind of installment purchase where the businessman (hirer) agrees to pay the cost of the equipment in different installments over a period of time. This installment covers the principal amount and the interest cost towards purchasing an asset for the period the asset was in use. The hirer gets possession of the asset when the hire purchase agreement is signed. He becomes the owner of the equipment after he makes the last payment. The hirer has the right to terminate the contract anytime before taking the title or the ownership of the asset.
Difference between Lease Financing Vs Hire Purchase
Ownership of the Asset
In a lease, ownership lies with the lessor. The lessee has the right to use the equipment and does not have the option to purchase it. Whereas in hire purchase, the hirer has the opportunity to purchase. The hirer becomes the owner of the asset/equipment immediately after he pays the last installment.
In lease financing, the depreciation is claimed as an expense in the lessor’s books. On the other hand, the depreciation claim is allowed to the hirer in the case of the hire purchase transaction.
The lease rentals cover the cost of using an asset. Commonly, it is derived from the cost of an asset over the asset life. In the case of hire purchase, installment includes the principal amount and the interest for the time period the asset was in use.
Generally, lease agreements are for a longer duration and for more enormous assets like land, property, etc. Hire Purchase agreements are primarily for shorter duration and cheaper assets like hiring a car, machinery, etc.
In the lease agreement, the total lease rentals are shown as expenditures by the lessee. The hirer claims the asset’s depreciation as an expense in hire purchase.
Repairs and Maintenance
Repairs and maintenance of the asset in the financial lease are the lessee’s responsibility, but in an operating lease, it is the lessor’s responsibility. In hire purchase, the responsibility lies with the hirer.
The Extent of Finance
Lease financing can be called the complete financing option in which no down payments are required, but in the case of hire purchase, normally, an amount of margin money is required to be paid upfront by the hirer. Therefore, we call it partial finance like loans, etc.
People in business can opt for lease finance or the hire purchase, but they should be appropriately analyzed as to how much the options suit the business requirement and situations.
A Summary of Tabular Presentation of Differences between Lease Financing Vs Hire Purchase
|Points of Distinction||Leasing||Hire Purchase|
|Ownership||Lessor is the owner until the end of the agreement||Hirer has the option of purchasing the asset at the end of the agreement|
|Duration||Done for a longer duration||Done for a shorter duration|
|Depreciation||Lessor claims the depreciation||Hirer claims the depreciation|
|Payments||Rental payments are the cost of using the asset||Payments include the principal amount and the effective interest for the duration of the agreement.|
|Tax Impact||Lease rentals categorized as expenditures by the lessee||The only interest component is categorized as expenditure by the hirer|
|The Extent of Financing||Complete financing||Partial financing|
|Repairs and Maintenance||Responsibility of the lessee in the financial lease and of the lessor in the operating lease||Responsibility of the hirer|