Question

Many firms are using leasing techniques to improve performance. Leasing offers opportunities to unlock funds tied up in assets and also offers the potential to generate additional cash flows through efficient tax management. The technique of sale-leaseback was used for real estate, but the technique can also be used for other productive assets. Potential benefits of using this technique is described in an article entitled, "US-Sales-Leasebacks_UnlockingValue," (see U.S. sale/leasebacks: Unlocking Value - CBRE United States www.cbre.us/AssetLibrary/US_Sale-Leasebacks_UnlockingValue_FINAL.pdf) by. After reviewing this article, answer the following questions:

a)Leasing transactions—particularly sales-leasebacks—are often labeled as balance sheet mining transactions. What does that mean?
b)What is the potential advantage of having a lease categorized as an operating lease instead of a capital lease?
c)What are the risks associated with these types of leases?

Answer 1

Sales-leasebacks free up capital by selling assets and leasing them back, potentially aiding financial performance. Operating leases provide off-balance-sheet financing, improving financial ratios. However, there are risks such as market variability and changes in accounting standards.

Step-by-step explanation:

Leasing transactions, especially sales-leasebacks, are often referred to as balance sheet mining transactions because they involve the sale of an asset with the intention of leasing it back. This strategic move is used by firms to free up capital tied in assets while still retaining the use of those assets. The freed-up capital has the potential to improve liquidity and can be used for other investments or to reduce debt, ultimately leading to the optimization of a firm's financial performance.

The main advantage of having a lease categorized as an operating lease instead of a capital lease lies in the off-balance-sheet financing. An operating lease does not require the asset or corresponding lease liability to be recorded on the company's balance sheet. This categorization can lead to improved financial ratios and might have positive implications for the perceived financial health of a company.

However, there are risks associated with these leases, which stem from the possibility of inflated asset values, interest rate and market changes affecting lease terms, and the obligation to continue paying lease payments without owning the asset. Moreover, with changes in accounting standards, the distinction between operating and capital leases may become less significant over time, impacting the financial strategies companies have relied upon.