Leasing, as a financial instrument, was able to affirm itself in manydeveloped countries as one of the most effective and accessible mechanisms forfinancing the expansion and development of the means of production, asset financenecessary for the development and for the application of new technologies inbusiness. Leasing is a modern way of financing through which the customer enjoys agood, the payment being spread over the period of the lease, and the installmentspaid being deductible according to the type of leasing contract. Compared withother forms of financing, leasing has the advantage of eliminating red tape requiredfor the granting of credits and the financial guarantees only with the asset that is thesubject of the lease

Adrian SIMON

Directory of Open Access Journals

Scientific Bulletin – Economic Sciences, Vol. 9 (15) - Finance -    65 ECONOMIC ASPECTS OF FINANCIAL LEASING IN BUSINESS INVESTMENTS Senior lecturer Ph.D Adrian ŞIMON Universitatea „Petru Maior” Tîrgu-Mureş adr_simon@yahoo.com Abstract:  Leasing,  as  a  financial  instrument,  was  able  to  affirm  itself  in  many developed  countries  as  one of  the  most  effective  and  accessible  mechanisms  for financing the expansion and development of the means of production, asset finance necessary  for  the  development  and  for  the  application  of  new  technologies  in business. Leasing is a modern way of financing through which the customer enjoys a good, the payment being spread over the period of the lease, and the installments paid being deductible according to the type of leasing contract. Compared with other forms of financing, leasing has the advantage of eliminating red tape required for the granting of credits and the financial guarantees only with the asset that is the subject of the lease. Keywords: 4. Jel Classification: O16, G23, G32 1.  CONCEPT,  ECONOMIC  CONTENT  AND  CHARACTERISTICS  OF LEASING OPERATIONS Changes occurring in the global economy, the requirements of scientific and technical progress on the replacement of fixed assets and the need for more efficient use of financial resources imply the use of new methods of renewing the technical-material base. Out of these considerations  leasing,  in  recent  decades,  has  become  a  non-traditional  and  effective investment tool.  Operations  similar  to  "leasing"  were  known  in  ancient  Babylon  2000  years  BC.  Including  leasing  practice  in  economic  relations  took  place  in  the  year  1877,  when  telephone company "Bell" decided not to sell the telephone appliances made by them, but to lease them. Leasing appeared first in the United States, gradual penetrating in other countries, particularly in Europe. There are several different definitions accepted of the term “leasing”. From the point of view of financial specialists leasing is an original financing technique, medium-term or long term, practiced by a financial company, having as legal support a contract of lease of goods. A broader definition of the concept of leasing could be the following: a trade and financing method  by  location  by  financial  institutions  specializing  in  these  operations,  by  financial institutions or directly by manufacturers, to companies that carry out particular operations, or do not have sufficient borrowed or own funds to buy them. On the other hand, leasing is a rental  technique  -  carried  out  by  specialized  financial  companies  -  of  equipment  to beneficiaries who do not have borrowed or own funds to purchase them from manufacturers.  The harmonization of the legal framework for international leasing was accomplished on the 28th May 1988, by the adoption of the Convention on international financial leasing by Adrian SIMON   66 the Commission of the International Institute for Uniformity of Private Law (UNIDROIT), at Ottawa, to which 59 countries participated and signed. In  Europe,  the  representative  of  the  leasing  industry  is  the  European  Federation  of National Associations of Leasing Companies - Leaseurope, founded in 1973. Although  Leaseurope  was  founded  with  the  intent  to  be  a  forum  in  which  to  discuss  the  specific problems  of  this  new  form  of  financing,  it  has  become  an  institution  for  promoting  the interests  of  its  members  in  negotiations  with  the  European  Union  Commission,  the International Council for Accounting Standards etc.  Basically, one can say that leasing operations involve a method of financing, lending and development of the technical-material base of enterprises with limited possibilities to attract sources of financing and a method of long term investment in assets of funds available or borrowed. 2.  PARTICULARITIES OF THE DECISION MAKING PROCESS WITHIN THE ANALYSIS  OF  INVESTMENT  PROJECTS  FINANCED  THROUGH FINANCIAL LEASING Investment decisions are intended to identify and select the most profitable projects for the investment of money on the long term. We believe that the following factors contribute when  considering  an  investment  decisions  with  a  greater  responsibility:        -    Making  investments  puts  a  hold  on  important  financial  funds  on  the  long-term,       therefore, the company is waiving its internal flexibility and becomes more   vulnerable;  -  Investment  decisions  involve  the  expansion  of  operations  based  on  increased         future  cash  flows,  so  that  the  investment  decision  implies  the  identification  and          proper planning of revenues expected during the life cycle of the investment project;         -  Investment decisions define the business’s strategies. The investment process is an important component of strategic management. In our opinion, the analysis of investment projects financed through leasing should be based on the following steps:  •  Defining the investment project; •  Identification of the financial flows related to the investment project;  •  Project selection based on the updated net value (UNV) or the internal rate of return (IRR); •  Project implementation.  1.  Defining  the  investment  project:  At  this  stage,  the  company  identifies  a  set  of independent projects, which would come out of the overall strategy of the company. The investment projects which completed each other are combined to create independent projects. Anything company, in the search for investment projects, starts with the specific advantages which it has and is trying to capitalize. Typically, investment projects can be built according to the following alternatives:  -  Investment  projects  of  specialization  and  deepening  of  the  profile  of  activity, developing products and new technologies; -  Diversification investment projects (investment portfolio), respectively the buying of social capital of other companies. 2. Identification of the financial flows related to the investment project: It is the most important phase of the investment process. The decision regarding the implementation of the investment project is influenced decisively by the size of the financial flows. The risk of the investment project also depends on the ability of managers to estimate correctly the size of the Scientific Bulletin – Economic Sciences, Vol. 9 (15) - Finance -    67 cash flows. We believe that there are three financial flows that characterize the investment process, namely: a.  The cost of the investment - a net negative financial flow, consisting of the expenses that  the company makes to put together the expected business: purchasing and installing the  equipment,  initial  value  of  necessary  intangible  assets  (patents,  licenses)  and  the original value of the current assets. CI = VFA + VIA + VCA + O.C. – VLFA, where:  CI- the cost of the investment,  VFA - the value of fixed assets invested, VIA - the value of intangible assets invested,  VCA – the initial value of current assets,  O.C. – other investment costs,  VLFA - the liquidation value of fixed assets replaced. Typically, the liquidation value of the fixed assets is determined by the following relationship:         Selling price - (selling price - stock value) * tax rate on income b.  Financial  flows  during  the  life  of  the  investment  project  -  Profit  is  not  a  good  indicator  of  the  outcome  of  the  economic  activity,  because  it  may  vary depending on what methods are applied for the assessment of costs. Thus, the evaluation of the operational results of the investment is made based on the cash flow. There are two main components of cash flow: - net profit - as a result of operational activities;  - depreciation and amortization - the recovery of the amount invested in fixed assets and                intangible assets. PF = NP + D+ AIA + I ± ∆ WC - OF, where: PF - the annual positive flows generated by the investment, NP - the net profit, D - the annual depreciation of fixed assets,  AIA - the annual amortization of intangible assets,  I – interest on loans and leasing used to finance the investment, ∆ WC – the changes in the working capital, OF - other financial flows (the cannibalization effect of income). c.  Financial  flows  related  to  the  liquidation  of  the  investment  -  In  the  event  of liquidation of the investment there are two financial flows:  - The liquidation value of assets over the long term. Liquidation value of fixed       assets is determined by the following relationship:                Selling  price  -  (selling  price  -  balance  amount)  the  rate  of  income  tax    - Amount of revolving fund, as the ceasing of activity will also mean the recovery                 of the amounts invested in stocks and claims.    LF= VLFA + WC, where:     LF- liquidation flow,  VLFA - the liquidation of fixed assets, WC- working capital when the investment is liquidated. 3. Project selection based on the updated net value (UNV) or the internal rate of return (IRR): In this phase, the manager must compare positive flows with the negative ones, in order  to  decide  whether  to  implement  the  project.  Using  the  well-known  criteria  of  the updated  net  value  (UNV)  and  the  internal  rate  of  return  (IRR),  he  will  decide  on  the effectiveness of the analyzed project. An important step is to determine the rate of update. The Adrian SIMON   68 rate of update, used in the estimation of the efficiency of the investment projects, should reflect more variables:  - Expectations for return of capital providers;  - Opportunity cost of capital; - Inflation level; - Risk of project, etc. If the UNV is positive, the investment will be implemented. UNV shows by how much the value of the company will increase if the project will be implemented. By determining the  IRR the company  can  establish the economic profitability of the project. As a rule of thumb, the project is implemented if the IRR is greater than the weighted average cost of capital corresponding to the project. Typically, a project that is acceptable under the criteria of the UNV, will automatically also be accepted under the criteria of IRR, therefore, in some cases it is sufficient to calculate only the first indicator indicator. 4.  Project  implementation:  The  decision  of  implementing  the  project  depends,  in addition to the UNV and the IRR, on the investment budget allocated by the business for the investment project.  Usually, the company may waive some investment projects keeping their financial capabilities in mind, simply because there are other projects that have a greater UNV or IRR. Investment decisions are intended to identify and select the most profitable projects for the investment of money on the long term. We believe that the following factors contribute when considering an investment decisions with a greater responsibility:  -     Making investments puts a hold on important financial funds on the long-term,         therefore,  the  company  is  waiving  its  internal  flexibility  and  becomes  more vulnerable;  -  Investment decisions involve the expansion of operations based on increased   future cash flows, so that the investment decision implies the identification and   proper planning of revenues expected during the life cycle of the investment project;         -  Investment decisions define the business’s strategies. The investment process is an important component of strategic management. 3.  THE ADVANTAGES OF LEASING IN FINANCING INVESTMENTS The causes for the rapid growth of the funded lease are found in those advantages which this  financing  method  offers,  compared  to  the  purchasing  of  assets  with  cash  or  with contracted loans. The analysis of the qualities of the leasing operations, in comparison with traditional  forms  of  financing  investments,  proved  that  financial  leasing  is  a  much  more attractive method in the investment activity.  The indicator according to which one compares leasing and credit is the total expenditure for each source of funding. The basic principles of choice between two sources of funding refer  to:  the  amount  of  lease  payments  and  the  amount  of  payments  for  credit  are incomparable; we can not compare the credit interest rate with the commission established by the  leasing  company  for  its  services;  we  must  take  into  account  all  of  the  expenses  for maintenance for every possible funding source; we must take into account the tax benefits for leasing and for credit; the analysis of cash flows should be consistent with the term of full depreciation of the asset, without limitation to the maturity terms of the sources of funding; all cash flows are discounted to the same period.  Using in a significant extent leasing in the business investment activity offers additional benefits over other methods of financing the assets:   -  Increased financing availability of the company;  Scientific Bulletin – Economic Sciences, Vol. 9 (15) - Finance -    69 -  Through leasing one can ensures rapid recovery of assets in case of insolvency of  the company which is the lessee;  -  Leasing allows splitting the risk between the lessor and the lessee;  -  Flexibility;  -  A number of tax benefits through cost-benefit accounting. One  of  the  main  benefits  of  funding  by  leasing  concerns,  firstly,  the  right  of  the Contracting Parties of the lease to use the depreciation of the leased object with the coefficient of acceleration up to 2. This leads to the reduction of payments related to income tax during the first years after purchasing the asset as well as reducing the payments for property tax. Leases may also be considered a form of privatization, which has advantages both for the state  –  temporarily  preserving  the  ownership  of  the  economic  agent  concerned,  with  the possibility of being definitively privatized after the customer has proven management skills - and for the actual customers, with the possibility to drawn into this action capable managers, who, having no capital, couldn’t engage in such business. Other advantages of leasing include: ￿ ￿ ￿ ￿ the possibility of larger investments by companies which do not have own financial resources, but have real possibilities of development;  ￿ ￿ ￿ ￿ the cost of capital assets is spread over the useful operating life;  ￿ ￿ ￿ ￿ avoiding capital restraints; ￿ ￿ ￿ ￿ allows  precise  quantification  of  the  costs  of  leasing  over  the  entire  duration  of  the contract;  ￿ ￿ ￿ ￿ helps avoid bureaucracy, the leasing company taking over all operations related to the purchasing of the asset.  4.  ESTIMATING RISK FACTORS FOR INVESTMENT PROJECTS THROUGH LEASING Leasing  is  the  solution  that  allows  overcoming  the  difficulties  arising  from  an inappropriate  economic  environment  -  expensive  and  limited  funding,  bureaucracy  of  the banking system, and also allows businesses to obtain the right to use, with minimal initial financial efforts, machinery, equipment, technological equipment, that will generate increased productivity, profitability and increased profits.  The quality of the investment project is determined, in a large part, by calculating the risk factors of the project. For an investment project with the financing by leasing risk factors are associated with the long-term character of the financing. All participants (direct and indirect1) in the investment project are subject to risk. For  any  investment  project  on  the  long  term,  one  of  the  main  factors  which  determine the dynamics of the indicators of the project is inflation2. If the project is oriented towards  leasing  of  imported  equipment,  a  risk  factor  is,  of  course, the currency exchange rate. Another risk factor, to be taken into account in the evaluation of investment projects financed through leasing refers to the need for credit (medium-term and long-term), to avoid disruptions in the funding flows. In this context, it is necessary to quantify the credit risk, called the risk of insolvency risk. This risk expresses the likelihood of actual receipt of the given credit and the afferent interest in due time. Non-compliance is a prime credit risk to which leasing companies need to develop protective measures. An additional risk is related to the refusal of the leasing beneficiary to pay until the equipment is properly manufactured,                                                  1 Lessor and Lessee 2 By inflation we refer to a general increase in price levels. Adrian SIMON   70 maintained and repaired. Through a permanent supervision of the risk level one can manage credit risk on the basis of two fundamental principles: dividing risks and limiting risks. Other categories of risk that appear in leasing operations are: project risks, risks that relate directly to the asset took through leasing, portfolio risk, risk related to interest rate, tax risk, legislative risk etc.  CONCLUSION In conclusion, we can state that leasing companies should establish their own systems of risk assessment and control, so as to avoid their occurrence or, when risks do appear, to have good methods and techniques of risk management. The use of financial leasing as an effective investment in fixed funds of the enterprises, depend not only on the existence of laws, but also on the accuracy of leasing operations, effective risk management and a favorable investment climate. The liberalization of the economies of Central and Eastern Europe states, amplified by their wish to integrate into the world economy, provided an upward dynamic for the leasing market,  attracting  substantial  foreign  investments  in  this  sector.  In  recent  years,  the contribution  of  leasing  transactions  indicates  an  increase  in  the  percentage  of  total investments in fixed capital in these countries. Factors  stimulating  the  development  of  leasing  constitute  fiscal  advantages  in comparison  with  bank  lending  (accelerated  depreciation,  including  the  award  of  lease payments  to  production  costs  etc..),  how  accessible  the  financing  of  fixed  assets  is,  and moderate risks for sellers of automobiles and machinery manufactured by local producers.  REFERENCES 1.  Alexe, Adrian Liviu. Reglementări privind operaţiunile de leasing, Bucureşti: Centrul de Informare şi Documentare Economică, 2006 - 59 p. – (Biblioteca Economică) 2.  Dedu,  Vasile,  Ganea,  Tudor  Alexandru.  The  fiscal  treatment  of  leasing  in Romania:Banking and Finance , 2001,V. Nr. 5,p. P. 11-13. 3.  Peterson, George E. Land leasing and land sale as an infrastructure-financing option. November 2006 / George E. Peterson. – Washington : \The \\World Bank, 2006.-25 p. – (Policy Research Working Paper ; 4043). 4.  Şimon,  Adrian.  Bursa  şi  piaţa  bursieră/  La  bolsa  y  el  mercado  bursàtil.  –  Editura Universităţii “Petru Maior” Tîrgu-Mureş, 2007 5.  Tulvinschi,  Mihaela.  Aspects  regarding  financial  leasing  between  residents:  Public Finance and Accounting, 2006, Nr. 3, P. 11-15  

Economic aspects of financial leasing in business investments

Abstract

Similar works

Full text

Available Versions

Directory of Open Access Journals