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All You Wanted to Know About Leasing but Were Afraid to Ask

By Fernando de Obeso | Mon, 10/05/2020 - 13:30

Leasing has a number of positive attributes that make it an attractive option, including benefits for your return on equity, therefore leading to greater profits. Here is everything you wanted to know about leasing but were afraid to ask.

What is Leasing? 

In general terms, the lease is a contract or agreement by which there is a relationship between two parties (companies), by which they oblige each other for a determined period of time to cede or use a good, leaving the party that takes advantage or uses the good to pay a determined price. In other words, it is a lease contract for a defined period of time.
More specifically, and in financial terms, pure leasing or operational leasing is an agreement whereby the lessor (owner of the facility) transfers the right to use the asset to the lessee in exchange for the payment of the lease for a specified period of time, at the end of which the lessee has three options: to purchase the leased asset through the payment of the purchase option; to return the asset; or to renew the asset. In other words, pure leasing is financing structured as a lease agreement, at the end of which the lessee has an option to buy.

How is it different from a regular loan?

Leasing differs in three main points with respect to a regular loan: 
The Ownership of the Good. The property or asset that is leased belongs to the lessor of the equipment, that is, it belongs to the person who offers it for rent. Although the lessee enjoys the good of the equipment, the lessee does not have final possession of it until he or she exercises the option of purchase, that is, does not purchase it from the lessor. A clear way to see this is that the individual renting a car "enjoys" the use of the car when renting a car, even though it is not his property as it belongs to the company that rented it.

The deductibility of the cost of the lease and the financial costs. The payment becomes 100 percent deductible from income tax since rent is an expense, that is, a payment for a service or enjoyment of a good. This implies that this bill or receipt is paid as part of the normal expenses of the company, just like when the rent is paid for a house or business premises, and thus reduces the profit on which the tax is collected. In short, you can save 30 percent on each payment, depending on your income tax rate.

Its flexibility. The lease is very flexible and can be adjusted to the lessee's requirements. The first is the down payment, rents left on deposit or in escrow, similar to when you rent a house where rents are requested in escrow so that the owner can collect possible damage to the equipment or property. Leases have three main components. The second part is the monthly rent itself and by moving the down payment or rents left in the deposit and the residual value, this component can be adjusted. Finally, the third component is the residual value or option to buy, i.e. the amount paid by the tenant at the end of the term so that his property becomes the property he was renting. 

How can leasing help me earn more money?

Few companies, especially in the health sector, look at how financing products like leasing can make them more money and improve their Return on Equity (ROE). The ROE is one of the most used variables for knowing how "good" a business is. Often, doctors know that their clinic is profitable because it leaves them money, allows them to have a good lifestyle, etc. However, although it may not be clear initially, leasing can make my clinic a better business. 

How does this happen?

Firms have assets such as bank money, inventories, and equipment. The company holds these assets either because the partners have contributed them (Capital) or because this asset is owed. So, it is a liability, which is why the accountants' famous rule is that total Assets equal Liabilities plus Capital, i.e. what you have (Assets) you put in (Capital) or you owe it (Liabilities). This is why the more profit the clinic has with less cash invested by the partners (capital), the better the ROE and the better the company.

To illustrate how leasing improves ROE, let's say a clinic needs to buy an ultrasound worth MX$1 million to perform the 100 exams per month that its patients require. In this case, it buys the ultrasound and as an example this generates a profit – assuming there are no other expenses – of MX$50,000 per month (100 studies at MX$500 each). In other words, MX$1 million was invested in the ultrasound and MX$50,000 of profit was generated BEFORE taxes. Assuming that there are no other costs or expenses, in this example, I would have to pay MX$15,000 in taxes (30 percent per MX$50,000 of profit), which means that my profit would be MX$35,000. My ROE is only 3.5 percent, the MX$35,000 profit over the one million from the cost of the ultrasound.

Taking the same example, but now instead of buying the ultrasound I lease it so I don't invest any of my money (Capital) and the ultrasound lease is MX$10,000 a month. In this example, I end up with a MX$40,000 profit after paying the ultrasound rent; however, I pay less tax, since I only pay MX$12,000 in taxes against MX$15,000 in the previous example because as I mentioned, the ultrasound rent is deductible. However, the greatest benefit is seen in the profit that the money I invested in my business is generating (ROE), since I obtained an after-tax profit of MX$28,000, but without investing a single peso, which means that my ROE is infinitely higher in this example because I did the business with other people's money. This means that the million pesos I was planning to use for the ultrasound is now available to invest in other businesses or to buy other goods to make MORE MONEY. 

In this simple example, you can see the advantages of leasing and how you can get to the point of why people say, "making money with other people's money is the best business."

Do you want to make more money with other people's money? I’m at your service fdeobeso@saludfacil.org.

Photo by:   Fernando Obeso

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