High Risk Financial Services: Equipment Leasing
Corporate financial professionals love the predictability of equipment leasing. By leasing, the cost of the equipment can be can spread over a fixed period with set lease payments. By exchanging the relatively unpredictable cash flow of equipment ownership for unchanging lease costs, cash flow forecasting can be more reliable and more easily formulated.
Lessees can also avoid the risks of equipment obsolescence—a particularly acute risk in information technology.
But enterprise financial services departments are making a dangerous mistake if they consider equipment leasing a low-risk source of financing. Equipment leasing can be a high risk financial service and when lease agreements are not structured properly, it’s common for lessees to pay 20-50 percent more than if they had purchased the equipment.
One of the principal ways in which lessors make money is end-of-lease revenue. Equipment leasing companies—whether captive or independent—focus on creating leases that provide profit for them when the lease expires.
Corporate financial managers at firms entering into various forms of financing including equipment leases need to appreciate the critical importance of reviewing various terms and conditions such as end-of-lease terms to ensure that the terms don’t favor the lessor.
The terms defining “fair market value” should be carefully reviewed to ensure that the contract language won’t leave the lessee paying much more than expected at end of lease.
In addition to end-of-lease terms, to keep an equipment lease from becoming a high risk financial service, all aspects of lease agreements need to be thoroughly analyzed to identify potential risks.
For example, the potential cost of interim rent is often under-appreciated. Interim rent is paid for equipment from the time it’s delivered until the lease begins. If not contractually limited and monitored, interim rent can add material costs to a lease.
Equipment leasing documents are typically prepared by lessors and presented as “standard”. But the “standardization” belies the fact that lease agreements are highly specialized contracts that deserve much more than the cursory attention of financial services managers in an enterprise.
In many cases, enterprises make the decision to contract with experts in equipment leasing to assist with review of lease terms, evaluation of lessors and perform lease-versus-buy analyses, as well as analysis of past lease performance to determine true leasing costs to ensure a lease program’s performance can be accurately measured to drive continuous improvement.