Glossary of Finance & Lease Terms
Accelerated Payments – A payment schedule where payments decrease over the term (i.e., 50% in year one, 30% in year two, 20% in year three). This method may eliminate a down payment requirement. It will also reduce the amount of interest charged because the loan is repaid at a faster rate.
Advance Payments – A technique used in leasing to reduce the monthly payments. The effect is similar to a down payment in a finance transaction.
Amortization – The process by which a debt is reduced over a set time period. In a loan, it is the portion of the monthly payment which is not interest and is used to pay back the principal amount of the loan.
Assets – The combination of tangible and intangible properties owned, which include but are not limited to cash, credit, tools, buildings, inventories, goodwill, patents and franchises.
- Current Assets Assets such as cash, inventories and receivables which are subject to constant change. Same as Liquid Assets.
- Fixed Assets Those permanent assets which are intended for continued use or possession; common classifications being land, buildings, equipment and patents. Most Caterpillar product is placed in this category.
Assignment – Refers to the written transfer of a security interest in equipment on a finance contract to a third party, i.e., a dealer assigning his rights and interest in a conditional sale contract to a credit institution.
Balloon Payment – A financial installment at the maturity of a finance contract which is greater than the regular installment.
Base Rate – The periodic cost (usually monthly) to lease or rent a unit of equipment. Taxes may or may not be included.
Book Value – The portion of the original value of an asset which is still undepreciated, that is, the amount which has not been written off and remains on the company’s books.
Capital Working – The dollar value of current assets less current liabilities.
Capital Lease – (also called Finance Lease or Non-Tax Lease) – A term from the FASB Accounting Rules for leasing. For accounting purposes (books) a finance or tax lease is defined as either a capital lease or an operating lease. A capital lease must be shown in the asset and liability sections of a balance sheet. An operating lease is not hence the term off balance sheet financing. However, operating lease obligations of 12 months or longer are shown in the footnotes to the balance sheet. The following four tests are used to determine whether a lease agreement is a capital or operating lease for accounting purposes: (if the lease meets any of these criteria, it is a capital lease, otherwise it is an operating lease).
- The lease transfers ownership to the lessee at the end of the lease term.
- The lease contains a bargain purchase option. For accounting purposes this means a price sufficiently lower than the expected Fair Market Value so that at the inception of the lease, the exercise of the option is reasonably assured.
- The lease term is equal to 75% or more of the estimated economic life of the leased property (economic life in the hands of one or more users with normal repair, maintenance and overhaul).
- The present value of minimum rentals, plus any guaranteed residual value, is equal to 90% or more of the fair value of the property (fair value = cash price the discount rate used to present value the rentals is the lessee’s incremental borrowing rate, which is his cost to borrow a similar sum for a similar term).
Collateral – Real or personal property pledged to secure a loan. Generally the equipment which is financed or leased.
Credit Line – A dollar limit of funds pre-approved to loan to an individual or company.
Credit Rating – A composite evaluation of a person’s or corporation’s financial strength and trustworthiness.
Current Ratio – The ratio of current assets to current liabilities. The ratio is very important to business owners and short-term creditors because liquidation of current assets is a source of funds for current liabilities. An acceptable minimum ratio is 2:1, which considers that current assets sometimes shrink in value whereas current liabilities do not.
Default – Refers to the inability of a customer to meet the terms of a finance or leasing obligation. May result in repossession of the equipment.
Depreciation – Normally, charges against earnings to write off the cost of an asset over its estimated useful life. It is a bookkeeping entry and does not represent any cash outlay nor are any funds earmarked for the purpose. Also, the method by which the values of an asset is reduced over time. There are several methods of depreciation, the most common are: straight line, double-declining balance, sum of the years digits.
Equity – Ownership interest in an asset or a company. A down payment or trade-in will give the customer up-front equity in his financed equipment.
Estimated Residual Value of Leased Property – The estimated fair value of the property at the end of the lease term.
Fair Market Value – Fair market value is the price a willing buyer will pay and a willing seller will accept for the equipment on an as is/where is basis.
Fair Market Value Purchase Option – An option to purchase property at the end of the lease term at its fair market value.
Fixed Price Purchase Option – An option to purchase at a predetermined fixed price as shown in the contract.
Floating Interest Payments – Tied to the Prime Rate of interest or other benchmarks such as Treasury Bills or Notes, floating interest payments are the result of an agreement wherein interest charged goes up or down in proportion to changes in the prime rate. For instance, prime plus two would indicate a rate of interest two percentage points above the prime rate.
Full Payout Lease – A lease arrangement where the customer agrees to pay the full purchase price, plus interest, on an installment basis over a given term and exercise the $1 purchase option at the end of the contract.
Indemnity Agreement – An agreement whereby the lessee protects the lessor from liability as a result of ownership of the leased equipment.
Indemnity Clause – Although lease documentation contains various indemnities, indemnity clause usually refers to the tax indemnity clause whereby the lessee indemnifies the lessor from loss of tax benefits.
Initial Direct Costs – Direct costs incurred by a lessor in negotiating and consummating a lease, such as commissions and legal fees.
Installment Sale – Sale of equipment with purchase price payable in installments. Title passes at the inception of the contract.
Interest – The charge for the use of another’s money. (Make sure you are comparing apples to apples.)
Lease – An agreement in which one party (the lessee) gets use of the property of another (the lessor) in exchange for a fee (usually money). Title to the property remains with the lessor during the agreement. Term is normally three to seven years. There is no legal difference between the terms rent or lease.
Lease Rate – The equivalent simple annual interest rate implicit in minimum lease rentals or the lease factor.
Lease Term – The fixed, non-cancelable length of time for the lease. Includes, for accounting (FASB 13) purposes, all periods covered by fixed-rate renewal options which for economic reasons appear (at the inception of the lease) likely to be exercised, and for tax purposes, all periods covered by bargain renewal options.
Lease With Purchase Option – A contact whereby the lessor grants to the lessee the privilege of purchasing the leased equipment at a specific time(s) during or following the term of the lease.
- Finance lease purchase option: is an option at less than fair market value and is construed as a sale.
- Tax lease (also called a true lease) purchase option: is an option at fair market value or a fixed price generally construed as a fair retail price at the termination of the lease. Not considered a sale.
Lessee – The user of the equipment being leased.
Lessor – The owner of equipment which is being leased to a lessee (user).
Loan Balance – Outstanding amount of loan on equipment financed at any give time during the term of a loan.
Net Assets – Total assets less total liabilities.
Net Working Capital – The excess of current assets over current liabilities.
Present Value – Literally, the value today (at present) of an amount of money to be paid in the future. Present value depends on the interest rate assumed to discount the future values.
Prime Rate of Interest – The simple interest rate charged by banks to the most credit worthy companies on a short-term commercial basis.
Principal – The actual amount financed or the unpaid balance, excluding interest, on a finance contract.
Purchase Option – An option for the lessee to purchase leased property at the end of the lease term. In order to protect the tax characteristics of a tax lease, the purchase option cannot be at a price less than fair market value at the time of the purchase. The option on a finance lease (non-tax) must be a bargain option.
Rent – The money paid to lease another’s property. There is no legal difference between rent and lease.
Rental Agreement – An agreement to pay for use of another’s equipment. Similar to a lease, except with rentals, maintenance is usually performed by the lessor and the cost of the maintenance is included in the payment.
Residual or Residual Value – The value of equipment at the conclusion of the lease term. Also may be used to refer to that portion of the delivered value of equipment not paid for during the term of the agreement.
Residual Risk – Risk taken by the lessor or lessee who loses equity or profit if the value of the equipment at the end of the lease term is less than estimated.
Return On Investment – The yield. The interest rate earned by the financing source. Measured by the rate at which excess cash flows permit recovery of investment.
Right of First Refusal – If a lease contains a right of first refusal, the lessor retains the right to continue ownership of the equipment at the end of the lease term. Lessor is not obligated to sell the equipment; but, if the lessor offers the equipment for sale at a stated price, the lessee then has the right to purchase the equipment or refuse the offer.
Salvage Value – The minimum value for a depreciable asset. After sufficient depreciation is taken such that cost less accumulated depreciation equals salvage value, no more depreciation may be taken. Not the same as residual value.
Seasonal Payments – A payment to coincide with a user’s source of income due. (i.e. sale of crops, livestock, lumber etc.)
Security Agreement – A term from the Uniform Commercial Code. No matter what you call the contract, the U.C.C. considers it a security agreement and it is enforced under this body of law (except in Louisiana). A lease is not a security law (except in Louisiana). A lease is not a security agreement under the U.C.C. A lease may or may not be determined to be a security agreement based on it’s terms. Since no universal definition exists on a state-to-state basis as to exactly what constitutes a lease a precautionary filing is customarily made on a lease. To perfect a security agreement, the seller must file notice of his security interest (form) in public records. Timeliness is the keynote. The Security Agreement is an agreement which creates or provides for a security interest, whereby the seller is to retain financial ownership in the equipment. In the event the customer defaults under the terms and conditions of the contract, the seller may initiate legal action to repossess the equipment. Conditional Sale Contracts, and leases with options to purchase for a nominal sum are examples of security agreements.
Security Interest – The right of the lender to recover the property leased or financed in case the borrower defaults or goes bankrupt. The property cannot be seized and sold to settle the borrower’s debts, but must be returned to the lender. This security interest must be stated in the loan documents and perfected by filing a UCC-1 financing statement.
Selling Price – The price at which equipment is purchased, which may or may not include a discount, a trade-in allowance, freight and taxes, but excluded any interest or finance charges.
Skip Payment Agreement – A financing arrangement where payment timing is set to approximate expected cash flows. Generally used with seasonal businesses.
Tax Lease (Also called Operating Lease or True Lease) – A lease which meets the guidelines of the Internal Revenue service for a lease.
Term – The fixed, non-cancelable period of time for the contract.
Termination Schedule – Leases sometimes contain provisions permitting a lessee to terminate the lease during the lease term in the event the leased equipment becomes obsolete and/or surplus to its needs. Liability of the lessee in such a case is set forth in a termination schedule which values the equipment at various times during the lease term. If the equipment is sold at a price lower than set forth in the schedule, the lessee pays the difference. If the resale is at a higher price, the excess amount belongs to the lessor.
True Lease (Also called Operating Lease or Tax Lease) – A contract whereby the lessor grants to the lessee the right to use the lessor’s property for a stated period of time. At the end of the lease period, the property is returned to the lessor. See Capital Lease for comparative explanation.
Yield – The rate of return on an investment earned by the lender in a lease or finance transaction, which is measured by the rate at which the excess cash flows permit recovery of investment. (see also Return of Investment).
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