Understanding Lease Payments: Power Your Knowledge
Lease payments function like a monthly rent, set formally under a contract between two parties. This agreement provides one party the legal right to use the other’s real estate, manufacturing equipment, computers, software, or other fixed assets for a predetermined period. A lease awards the lessee the limited right to use an asset without transferring ownership, in exchange for payment to the lessor.
The duration of lease payments can range from month-to-month, which is common with software-as-a-service (SaaS) models, to exceedingly long terms such as 100 years in land-lease situations.
Key Insights:
- Lease payments are regular fees—often monthly—for the right to use property, equipment, or software.
- Individuals and companies enter lease agreements for various assets like land, cars, computers, and more.
- Terms and schedules for lease payments are articulated in a legal contract.
- Lease agreements may be short-term (month-to-month) or stretch over extended periods, notably in long-term land leases.
Insights on Lease Payments
Both individuals and companies utilize lease payments. An individual might finance a car or obtain computer equipment through leasing, while companies might do the same for office spaces, machinery, or software. A lease payment considers factors like asset value, local residual values, discount rates, and the lessee’s credit score.
For companies, lease payments influence the fixed-charge coverage ratio, which is crucial for investors analyzing a company’s ability to manage fixed expenses. This ratio is an expanded version of the times interest earned ratio and generally applies to all fixed costs, including leases.
Popular Lease Types
Several common leases include:
- Operating Leases
- Financial Leases (Capital Leases)
- Sale-and-Leaseback Arrangements
- Combination Leases (blending two or more of the above)
Operating Leases
Operating leases are distinctive for financing and maintenance, combining financing charges with maintenance fees. Lessors, in this situation, regularly service the leased equipment. For instance, aircraft engines are often leased out, with maintenance inclusive—a beneficial setup given the technical expertise required.
Financial Leases
Financial leases differ as they exclude maintenance fees from payments. Innovations in this category include synthetic leases and leases tied to metrics like mileage or usage levels. A notable example is General Electric leasing locomotive parts with payments tied to mileage, ensuring lessees pay solely for their required usage.
Consumer Alerts
For consumers leasing automobiles instead of buying, be mindful of potential mileage minimums imposed by dealers to safeguard the vehicle’s resale value.
Related Terms: lessee, lessor, fixed costs, times interest earned ratio, software-as-a-service.
