17.13

Three Potential Pitfalls

361 views01:27 min

Leasing is a strategic way for businesses to manage assets and finances, but it comes with potential pitfalls.

One common issue is higher long-term costs.

Although leasing has lower upfront expenses, the total cost of lease payments over time sometimes exceeds the purchase price, depending on lease terms and other factors.

For example, leasing office computers for three years may cost five thousand seven hundred sixty dollars per unit, whereas purchasing them outright costs four thousand dollars.

Another drawback is the lack of equity.

Unlike ownership, leasing does not build equity in assets.

For instance, leasing high-value real estate for years does not add equity to a company’s balance sheet, potentially limiting future financial leverage.

The third pitfall involves restrictions and penalties in leasing agreements.

These restrictions often include usage limits or early termination fees.

For example, exceeding office equipment usage quotas or breaking a lease could incur significant penalties, reducing flexibility and unexpectedly increasing costs.

To avoid these issues, businesses should carefully analyze leasing terms, compare long-term costs with purchasing, and consider their financial goals before deciding.

Overview

Loading...

$$\rightleftharpoonup{xx}$$ $$\longleftharp{xx}$$, $$\longrightharp{xx}$$,

Leasing offers businesses a strategic method to access assets without significant upfront investment, making it a popular choice for managing operational and financial flexibility. However, this approach can also present challenges businesses must carefully navigate to avoid adverse outcomes.

One of the primary considerations in leasing is the potential for higher costs over the long term. While leasing can spread payments over time and reduce immediate financial burdens, the aggregate payments often exceed the cost of outright purchase. This makes leasing less cost-effective for businesses that intend to use assets for extended periods. The trade-off between short-term liquidity and long-term expense requires careful financial analysis to determine whether leasing aligns with the company’s overall cost-efficiency goals.

Leasing does not result in asset ownership, which means businesses cannot build equity through lease agreements. Equity is a critical financial component that enhances an organization’s ability to leverage assets for further investments or to secure financing. The inability to generate equity from leased assets can limit a company’s long-term financial strength and reduce its potential for asset-backed growth. This aspect of leasing may also impact balance sheet metrics, influencing perceptions of economic stability and creditworthiness.

Leasing agreements often include contractual terms defining how assets can be used and stipulations for early termination or excessive use. These restrictions can constrain a business’s flexibility to adapt to changing operational needs or market conditions. Penalties for exceeding usage limits or breaking agreements can add unexpected costs, undermining the financial predictability that leasing is intended to provide. Businesses must consider these constraints when assessing a lease's practicality and long-term implications.

Companies should conduct thorough cost-benefit analyses to effectively manage these potential drawbacks, carefully review lease terms, and align their leasing decisions with short-term operational needs and long-term financial objectives. This comprehensive approach enables businesses to maximize the strategic advantages of leasing while minimizing associated risks.

Transcript

Key Terms and Definitions

Learning Objectives

Questions that this video will help you answer

Explore More Videos

Asset Ownership

Financial Flexibility

Contractual Restrictions

Cost Benefit Analysis

Operational Needs

Long Term Expense

Equity Building

Financial Predictability