The Market of Selling Paper is Huge!
The Market for Leasing Assets
In my role as a Category Manager of Fleet for my organization I've had the opportunity to learn why giant organizations like mine chose to lease and pay more by doing so...
Why Lease and Pay Interest?
Leasing is a way big companies can free up their balance sheet from how much it actually costs to operate their business. For example, if a company requires 100 million in assets to service it's customers, most likely it wouldn't have had that much in cash and would have required debt or a loan from a bank.
The work around so that the capital expenditures required to operate don't impact your balance sheet and to avoid hitting your debt covenants, is to have an operating lease.
Operating Lease
Due to this work around and large companies wanting to use debt to acquire companies/competition, there is a huge market for essentially selling paper to banks! Operating leases basically mean that the amount you pay versus the fair market value at the time the capital is financed, do not exceed 90% than it is considered an operational expense as opposed to an asset on the balance sheet.
So the actual payment to the equipment is treated just like an electricity bill as far as debtors are concerned when approved debt or any increase.
Types of Operating Lease
There are many different ways companies can prove the 90% test when selling leases to potential customers and sometimes the accounting terms are used interchangeably to conceal margins, etc.
Trac-Lease + Split-Trac Lease
Trac-Lease is a lease in which the lessee owns all the risk and sets an amount they will commit to owing the lender based upon the initial capital required. So if a truck cost 100k the trac amount could be 20% and at the end of the lease term you would owe 20K. At the end of the term the lessee would have a choice to sell the asset, retain or scrap it.
No matter the choice, the 20% to the lender would be owed. Most times, companies would sell the asset and either profit or loss based on the use of the asset, because more use depreciates the asset. Companies then try to manage life cycles of assets well in order to break-even upon the sale at the end of term.
Split-trac is exactly like a trac, except there are additional clauses that ensure the lessee is honoring certain commitments similar to warranty procedures assets typically require otherwise. In this model the risk is split between the lender and lessee.
Split tracs to 20% or any % put the back 5% of the residual risk on the lender. So another easy example is if a truck is 100k, you owe 20k at the end, you sell it for $1,000, you pay $15,000, and the lender pays $4,000.
Fair Market Value
A fair market value lease is one that the lender bears all the risk but there are much more strict clauses and the use of the asset is determined upfront with penalties for over usage built into the contract language.
Lenders will use this model if they have a good channel to sell assets better than competition, which banks who fund them money prefer.
In another post, I'll write the strategy on how Fair Market Value Leases can make companies a ton of money!
Sources
Believe it or not I have no sources from this post but from my own head! This is what I do people! ;)
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You're right. I have always wondered when customers order goods from China, which are cheaper by only 10% in our country. When the quantity is large it is understandable.In the interest of truth, US import policy and the imposition of tariffs on most goods help the economy grow, but on the other hand it "alienates" countries.
I could make an entire series about China trade policy. A commodity simply means price wins, e.g. why would you pay more for something like wood, metal, etc. With Commodities, quality is not really factored. Some countries will dump there raw materials to exploit capitalism and weaken the infrastructure only to later increase those materials because at that point the investment and R&D would outweigh the slow premium that get's added over time. Then rinse and repeat. China is good at this!