Characteristics of Financial Lease and How It Works

Characteristics of Financial Lease and How It Works

Financial lease is a financing activity done through providing capital goods to support the continuity of the business production throughout a certain period. If a company require capital goods such as machineries, motorized vehicles, or office equipment, financial lease company can fund such capital goods.

In financial lease, there is a contract between two parties. Other than that, financial lease is also a safe business which is regulated through the directive by the Indonesian Ministry of Finance No. 1169/KMK.01/1991.

How financial lease works

Financial lease assists newly formed companies or those with a middle-lower financial situation. The financial lease process involves several parties: the financial lease company as a lessor, the client as a lessee, the seller who provides the capital goods as a supplier, and an insurance company as a party who bear all the risk of financial lease.

Every financial lease company will provide different type of contracts, but in general it contains identity or information of a client, type of capital goods required, amount or value of the leased good, term of payment, ownership requirements, and the penalty. After an agreement is reached, the financial lease company will contact the supplier and the insurance company to start the process as soon as possible.

 Cost incurred by the client in a financial lease process includes administrative fee which is usually calculated yearly, interest rate of the leased capital goods, and the insurance premium as the one who bear the risks. These fees and costs are written in the contract; thus, the client have a control to agree or disagree.

Difference between financial lease and consumer financing

Contrary to the common belief, financial lease and consumer financing are not the same. Both provides a financing service, but there is a fundamental difference between the two in the type of client.

Financial lease targets companies or organizations as their client. Financial lease helps companies to acquire capital goods for their business operational, meanwhile consumer financing helps individual clients to finance their necessity goods.

Types of financial lease

There are several types of financial lease to be chosen, depends on conditions and needs of each client. Following are the types:

  1. Financial lease

Financial lease company (lessor) is the legal owner of the capital goods used by the client. The client exercises a full control of the goods and own a right over risks and profits generated by the capital goods. Furthermore, the client also has an option to buy the capital goods according to the agreed upon residual price.

  1. Operating lease

Different with financial lease, the company (lessor) have an obligation toward operational cost, maintenance, and tax of the capital goods. Other than that, the capital goods belong to the lessor, not the client. At the end of the leasing period, the client does not have an option to purchase the capital goods.

  1. Sales type lease

This activity is typically done by a financial lease company which is also a producer or a supplier of capital goods. Thus, profits earned consist of the sales and interest during the lease period.

  1. Leverage lease

If usually financial lease only involves lessor, lessee, supplier, and insurance, in the leverage lease activity there is an additional party: a credit provider. This party pays for a major part of the transaction for the capital goods. For example, lessor only have to pay 40% of the total value of the capital goods, and the rest is covered by the credit provider.

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