Financial services are a part of the financial system. Consider an example where a finance manager plans to acquire some assets. For acquiring of assets a manager needs capital. It is not possible for a manager himself to go and raise the capital. For this some institutions provide some specialized services called financial services. These institutions provide various types of financial services like
2) Hire Purchasing
3) Venture Capital
4) Credit rating
5) Public Issue Management
6) Mutual Funds
A lease is a contractual agreement under which the owner of the asset (the Lessor) grants to another party (the Lessee) the right to use the asset for a specified period of time, in return for the payment of rentals. The contractual agreement includes the duration of the lease, the amount of lease rentals etc. At the end of the lease period the lessee may renew the lease agreement. Other wise the lessor takes back the possession of the assets.
For example: XYZ Limited entered into an agreement to provide an assets worth of Rs 150 lakhs to ABC corporation. According to agreement the ABC corporation has to pay Rs 32 per thousand per month for 5 years. In this example
XYZ Limited – Lessor
ABC Corporation – Lessee
Rs 32 per thousand per month – Lease rental
5 years — Lease period
150 lakhs – Value of the assets
Types of Lease:
Based on the lease period the leasing is classified as
(1) Operating Lease
(2) Financial Lease
The operating lease is a short term lease, the lease period being less than the useful life of the asset the lease is not fully amortized i.e. the lease rentals required to be paid by the lessee under the lease contract are not sufficient to cover fully the cost of the leased assets and rate of return required on the investments. In the operating lease the lessee or the lessor can cancel the lease agreement at a short notice.
Further, in the operating lease the lessor is responsible for maintenance of assets, insurance and taxes.
In the above example discussed, let us assume the useful life of the asset to be 12 year. One can consider it as an operating lease as the lease period is only 5 years which is less than the economic life of the assets, which is 12 years. Further the lease is not fully amortized as the lessor receives only Rs 1,92, 000 as lease rentals from lessee, by making investment of Rs 15 lakhs on the leased assets.
A financial lease is also called the capital lease. In this type of lease, the assets are fully amortized and the lease periods will be of long term, usually the economic life of an asset. Unlike the operating lease, the financial lease is non-callable. Thus, either the lessee or the lessor cannot cancel the agreement at short notice and the lessee is responsible for maintenance, insurances and taxes.
Differences between Operating Lease and Financial Lease:
1) The lease period in the case of the operating lease will be less than the useful life of an asset. Whereas, in the financial lease the lease period will be of useful life of an asset.
2) The leased assets are not fully amortized in case of operating lease, whereas, the leased assets are fully amortized in the financial lease.
3) In the operating lease the lessor is responsible for maintenance, insurance and tax. Whereas, the lessee is responsible in case of the financial lease.
4) The operating lease agreement can be terminated at short notice either by lessee or by lessor whereas the financial lease is non-callable.