Operating Lease

Presented by-Pratitee Kamal

Presented for- Professor Cecille O Rosada
MADS 6601-Financial Administration
Date: April 23, 2022
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Operating Lease

An operating lease is a type of contractual agreement where

the owner of an asset or equipment ( officially termed as Lessor )
allows the user (officially termed as Lessee) to use an asset for a particular
duration without transferring any rights in ownership at the end of the lease
term.
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Example: Let’s Consider

The market price of each

machine is $ 5,000,000,
They can decide to lease
A firm Needs at least 2 such
the press machine for $
which operates in 5,000 a month.
machines for its two
manufacturing auto production plants.
parts trying to expand Hence the effective
its business, require expense would be $
The management does
10,000 per month for the
more press machines. not want to invest
firm ( taking both
significant capital until
machines into account).
they are sure of the
demand.
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How Oerating Leases Work

Assets Accounting Ownership

Typically, all types of Recorded as off-balance Retained by the lessor during
assets and equipment sheet items and after the lease term.
can be rented as an Allows firms to keep debt Term is less than 75% of the
operating lease. to equity ratio low and in asset’s estimated economic life.
Ex: aircraft, machinery, permissible limits Present value of lease payments
land or real estate, or is less than 90% of the asset's
some business- fair market value.
specific equipment/s
Cannot contain a bargain
purchase option.
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Advantages

▸ Equipment Required for Short Duration Leasing the equipment at a

fraction of the amount and use the remaining amount to generate more profitable opportunities

▸ Equipment might become Obsolete/Outdated Firms can

safeguard themselves by paying a small amount from any such disruption

▸ Tight Cash Flow A firm going through the times of distress can opt for operating lease
without putting capital at risk

▸ Tax Benefits The lease expenses can be deducted from the operating expenses during
the payment period
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Disadvantages

▸ Finance Cost Put the firm at an interest rate risk, might question the management strategy

▸ Reduced return for equity holders In the leasing contract, the firm does
not own the equipment. Had it been owned, it would have been an asset, but in operating lease terms, it is
realized as a liability on the financial statements
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Conclusion

Operating lease provides benefits to business, especially emerging firms. It

provides a mechanism through which they can continue their business
operations through the services of the equipment or machinery without
actually owning the underlying asset.
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References

https://www.wallstreetmojo.com/operating-lease/
https://www.investopedia.com/terms/o/operatinglease.asp
https://corporatefinanceinstitute.com/resources/knowledge/accounting/op
erating-lease/
Thank You