management of financial services unit 4

8/7/2019 Management of Financial Services Unit 4

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UNIT 4

MANAGEMENT OF FINANCIALSERVICES


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LEASING AND HIRE PURCHASEy Leasing: background: high rate of inflation, severe cost

escalation, heavy taxation and meager internal resourcesforced by many companies to look for alternative means of financing the projects. Leasing has emerged as a new sourceof financing capital assets.

y Concept: leasing is an arrangement between two parties(lesser and lessee(user)). The former arranges to buy capitalequipment for the use of the lather for an agreed period of time in return for the payment of rent. Lease rentals can beconveniently paid as per agreement over the lease period.


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DEFINITION:y Lease is a form of contract transferring the use or occupancy

of land, space, structure or equipment, in consideration of apayment, usually in the form of a rent.

----- dictionary of B&Mlease is a contract where by the owner of any asset(lesser)grants to another party(lessee) the exclusive right to use theasset usually for an agreed period of time in return for the

payment of rent----- James c.van Horne


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LEASING AS A SOURCE OF FINANCEy Leasing is an important source of finance for the lessee. Leasing

companies finance for:y Modernitization of businessy Equipment, machinery, plant etc;y Cars and other vehiclesy

Assets entitled 100% or 50% depreciation.STEPS IN LEASINGTRANSACTION:1. Lessee has to decide the asset required and select the supplier2. Entering into lease agreement with the lessera)Lease period during which the lease is irrecoverableb)Timing and amount of periodical rental paymentc) Details of any option to renew the lease or to purchase the new

asset at the end of the periodd) Details regarding payment of cost of maintenance and repairs,

taxes, insurance and other expenses.


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3 ) After the lease agreement is signed, the lesser contacts the manufacturerand requests him to supply the asset to the lessee. The lesser makespayment to the manufacturer after the asset has been delivered andaccepted by the lessee.

TYPES OF LEASE:

F INANCIAL/CAPITAL/NET/ CLOSE/ LONG-TERM LEASE: it is just like an installment loan it is a legal commitment to pay for the entirecost of the equipment plus interest over a specified period of time. Inthis, there could be a purchase option also, to buy the equipment at theend of period. The financial lease is very popular in India and also othercountries like US, UK, JAPAN, e.g.: office equipment, diesel generators,machine tools, textile machinery, containers, locomotives, etc areleased under this type.

OPERATING LEASE/ SERVICE/SHORT- TERM/ TRUE LEASE : itis a rental agreement. In this, the contractual period between lesser andlessee is less than the full expected economic life of equipment. Leasingcompany assumes risks of obsolesce. The lessor fulfills service function.Eg: computers, copy machines, vehicles etc.


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3 LEAVERAGE LEASE:this is used for financing those assetswhich require huge capital outlay( i.e. rs.50,00,000 to rs

2crores- with 10 or more years of life) 3 parties: lessor,lessee and lender. Lender provides loan to the lessor, underthe mortgage of the asset. E.g.: coal mining, pipe lines, shipsetc.

3 CROSS BOARDER LEASE: it is international leasing and isalso known as transactional leasing. It relates to a leasetransaction between 2 countries persons including exportleasing. Indian leasing industry unlikely to deal in export

border lease for aircraft etc.


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ADVANTAGES OF LEASINGy Permit alternative use of fundsy More funds for working capitaly No debt equity ratio restrictiony Faster and cheaper credity Flexibility( to suit the needs of lessee)y Protection against obsolescey Boon to small firmsy 100% financing without down payment


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DISADVANTAGES OF LEASINGy Not suitable to protect financey No tax benefitsy Loss of capital gain to lessee when the value of an asset

increasesy Cost of financing is higher than debt financingy Less liquidity of the asset in case the lessee becomes defaultery Suppliers breach of contracty

Problems between lessor and lesseeLEGAL ASPECTS OF LEASING: lessor has the duty to deliverthe asset to the lessee. Lessee has the obligation to pay thelease rentals as specified in the lease agreement.


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ACCOUNTING TREATMENTy BOOKS OF LESSOR: (sec.VI OF THE COMPANIES ACT). As an

asset in the balance sheet and income in income statement underthe heading gross heading.

y BOOKS OF LESSEE: to be shown by the way of a foot note in the balance sheet. Lease rentals to be charged to income statement.

C ONTENT OF A LEASE AGREEMENT :description of the lessor, the lessee and the equipment.amount, time and place of lease rental paymentsTime and place of equipment delivery

Responsibilities of lessor and lesseeInsuranceRepairs and maintenance


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STRUCTURE OF LEASING INDUSTRY Public sector Private sector

Leasing divisions of financial institutions e.g.:ICICI, IFCI, IRBI, NSIC

Pure leasing companies e.g.: the first leasingcompany of India ltd. The 20th century FCL,the Grover leasing ltd.

Subsidiaries of banks e.g.: SBIs SBU(SMALLBUSINESS UNITS)

Hire purchase and finance companies e.g.:sundaram finance ltd,

Other public sector organizations(manufacturing companies) e.g.: bharatelectronics ltd, ECIL ETC.

Subsidiaries of manufacturing groupvendor leasing- to burst up salesIn house leasing: to avoid IT


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Determination of lease rentalsStep I: find ou t the to tal cos t of the ass et. y

Total cos t : ass et cos t + fre ight + insur anc e + taxe s+ ins tallat ionStep II: asce rta in the cash f lows to the lessor on accoun t of own e rsh ip of the ass et

y Cash f low= am oun t of d ep reciat ion- tax advanta ge on d ep ri tax advanta ge on inv e stme nt allow anc e + salvage value.

Step III: calcu late PV of c ash f lows: c ash f lows* PV f actor. e. g.: PV f actor @10%discoun t. I yr: 0 .909; II- 0.826; III-0.75 1.

Step IV: asce rta in the m inimum req uir ed n et recov e ry th roug h lea se rental s.y MRLR= COST OF THE ASSET} TOTALPV OF CASH FLOWSStep V: calcu late pos t tax lea se rental sy PTLR: MRLR/ PV f actor of annui ty. E.g.: annui ty discoun t f actor at 10% disc .

For 5 yrs is 3 .10 5 Step VI: calcu late pre - tax lea se rentaly Pre TLR: PTLR*100 / TAXRATEy Fro m th is, the lea se rental for ea ch mon th can b e calc (exp re ss ed in te rm s of

pe r th ous and and pe r mon th). Rent pe r mon th :PRE TAXLR*100 / TOTALCOSTOF THE ASSET *1/2


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PROBLEMS OF LEASING ANDPROSPECTS

y Un healthy competitiony Tax considerationsy Lack of qualified personnely

Heavy stamp duty in some statesy Delayed payment and bad debtsProspects:1. Leasing accounts for 6% of the total capital investment in India

2. World leasing industry is growing at 10%3 . Leasing has great prospects in India: convenient and flexible

option.


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HIRE PURCHASINGy Hire purchasing is a method of selling goodsy Two parties: creditor( finance company and the hirer)y Goods are let out on hire basisy Possession of goods on the spot, but not titley Installment payment is treated as hire chargesy Ownership is transferred on the payment of last installmenty Seller can repossess the goods on buyers defaulty Hirers can terminate the agreement at any time before the

property passes.y THE HIRE PURCHASE ACT, 1972: governs the hire purchase

transactions on India.


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Hire purchase Leasing

Creditor/ hirer Ownership Owner

Consumer goods Method of financing Business assets

Can be claimed by hirer Depreciation Cant be claimed by thelessee

Interest component isdeductable

Tax benefits Rental is deductable

Hirer can enjoy Solvage value Lessor can enjoy

70-80% Extent of finance 100%

Hirer Maintenance Lessor/lessee

Hire purchase and credit saleHire purchase and installment purchase


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b ank credit for the hire purchaseb usiness:

y Procedure:y Customer and his financial positiony Purpose

y Amounty Periody Repaymenty Securityy Monitoring and control


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management of financial services unit 4

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