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Sale and Leaseback

See Also:
Lessor vs Lessee
Lease Agreements
Capital Lease Agreement
Operating Lease
Working Capital

Sale and Leaseback Definition

The sale and leaseback definition is a transaction in which a company sells its property to another company and then leases that property. The company that sells the asset becomes the lessee, and the company that purchases the asset becomes the lessor. In this type of transaction, the lessor is typically an insurance company, a finance company, a leasing company, a limited partnership, or an institutional investor.

The property sale is done with the understanding that the seller will immediately leaseback the property from the buyer. The details of the lease agreement are arranged for a specific period of time and a set payment rate. Depending on the type of lease arrangement, whether it’s an operating lease or a capital lease, the lessee may or may not record the leased property on its balance sheet.

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Sale-and-Leaseback Justification

Why would a company sell an asset and then lease it? The company may want to free up cash tied up in the property. Also, the company may arrange for a capital lease, in which case it can keep the asset and the liability off of its balance sheet. Finally, since the sale-and-leaseback arrangement is a type of loan, the company may want to enter into this type of deal if the lease payments are lower than the interest payments it would have had to pay if it had borrowed money to finance the purchase of the asset.

Sale-and-Leaseback Advantages

The primary advantage of the sale and leaseback arrangement is that the company selling and then leasing the asset is essentially releasing the cash tied up in that asset prior to selling it. It also continues to benefit from the usage of the asset. If the lease is a capital lease, the company can keep the value of the property off of its balance sheet. Depending on the terms, the arrangement may be cheaper than financing the purchase of the property with a bank loan.

Sale and Leaseback Example

Let’s look at a sale and leaseback example. Imagine a company owns an asset but is having difficulty freeing up cash for current liabilities and short-term debt payments. The company has poor credit, and a bank loan would be very expensive.

The company could instead choose to sell one of its long-term assets to an insurance company. Immediately, they should arrange to lease that asset back for a specific period of time. If the insurance agrees to lease the asset for a rate less than the interest rate the bank wanted to charge the company for a loan, then the sale-and-leaseback arrangement with the insurance company would be the superior alternative.

This way the company is relieved of its cash shortage. It uses the proceeds from the sale to payoff short-term debts and liabilities in order to continue operations. It is also able to continue to benefit from the utilization of its asset. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

sale and leaseback, Sale and Leaseback Example, Sale and Leaseback Definition

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sale and leaseback, Sale and Leaseback Example, Sale and Leaseback Definition

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Removal Costs

See Also:
Average Cost
Agency Costs
Fixed Costs
Variable Cost
Loan Term

Removal Costs Definition

Removal costs, defined as the costs of removing any physical material from the original location it was placed in, is an often forgotten cost. Despite this, it can have a huge effect on the finances of a company. Major manufacturing plants, businesses with fragile equipment, and multi-national corporations can see removal costs average higher than the entire yearly budget of some small businesses. Though seemingly unimportant, this plays an important role in the irregular fixed or variable costs of many companies.

Removal Cost Explanation

Removal cost, explained in varying importance and detail, remains part of the cost structure of many companies. There are 3 major factors of removal cost: labor, lease on equipment used for the removal job, and spoilage or damage to the material in transit. Removal costs can be a major line item or a minute cost depending on the type of business.

The hadron collider, due to the massive and technical nature of equipment, must make a removal cost estimate and finish work by comparing this to the actual cost of the removal job. On the other hand, the local cosmetics boutique probably never thinks about the removal cost for mannequin and inventory. Still, each of these businesses experience removal costs. In a similar manner, oil companies see removal costs for their platforms in a different light. These businesses may even see these matters as important enough to enact a removal cost management system of it’s own.

Removal costs become more complicated in different environments. In a sterile and empty warehouse, removal costs would be at their minimum. In the very same warehouse, removal costs could skyrocket simply from filling the plant with inventory which then must be worked around. Under water, in mountainous regions, and other unique terrain removal costs play an important role. One day businesses could even deal with removal costs of items in space.

Removal Cost Example

For example, Kyle owns a large distribution warehouse for oilfield equipment. His warehouse has been running for quite a while and works on a tight operations schedule. Kyle, the founder and CEO of the plant, has faith in his decision making abilities.

Kyle has found a property which will serve as a more efficient warehouse. The facility is well maintained, closer to major transportation routes, and being sold at a discounted price. Kyle decides to make the switch and prepares his employees to move.

In this project, Kyle must move inventory, inventory storage and accounting equipment, offices, and more. He sees this as a minor setback to his operations which will pay off in the end.

Kyle and his team work diligently and are nearly completed with their move. Now, the only items left are the inventory storage racks. Kyle is just about to begin when his company CFO rushes out of the office to speak with him.

Surprising News

His CFO shares surprising news: moving these racks is a poor financial decision. Kyle, skeptical of this, wants to see the proof.

Liam, the CFO, shows his work. The removal cost of the inventory storage system will cost approximately $12,000 for a plant of this size. To put things in perspective, the racks have already become fully depreciated. Liam knows that the plant, even though it is being sold, will still need storage when the new tenant moves in.

Liam, through his contacts, was able to find an inventory storage system for $14,000. Though this is more expensive than the removal cost, the item will be shipped for free. On the other hand, Liam also knows the real estate market for warehouses. A new purchaser of the property will need an inventory storage system just as Kyle did. This, along with other benefits of this property, will be of persuasive value in selling the property. His calculation, based on expertise, places this negotiating power to increase total property value by $20,000. It seems many warehouse owners have the same concerns and hassle as Kyle when they decide to move.

Conclusion

Kyle remains skeptical until Liam completes his explanation. In a persuasive manner, Liam lays out the details of the plan. On the downside, Kyle’s plant could loose $2,000. On the upside, however, Kyle’s plant can make $20,000. Kyle decides to run with the plan that Liam has carefully formulated. Kyle is pleased with Liam’s work and will treat him to an expensive steak dinner for catching the mistake before it happened.

removal costs

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Lease Term

See Also:
Capital Lease Agreement
Lease Agreements
Operating Lease
Sale-and-Leaseback
Why Is Intellectual Property Risk Everybody’s Problem?

Lease Term Definition

Defined as the period of time in which a contracted lease is in place, lease term establishes the time period to both the lessee and lessor. Lease terms generally come on 3 forms: fixed, periodic, and indefinite. Additionally, a lease can cover either material or non-material property. An example of this would be a real estate lease as compared to a software lease.

Lease Term Explanation

Lease term, explained to many as the period of time where they have usage rights to a piece of property, is a deeper concept than this. It forms part of the lease term sheet, the document which spells out the entire lease agreement. Lease term, also known as lease tenure, lease period, and more, is merely a part of this agreement. Still, it serves as the basis and arguably most crucial aspect to any lease.

Lease term can last for a specific period of time (fixed), can be extended at the will of both parties (periodic), or can last for an undetermined period of time (indefinite). Additionally, leases can exist as either capital or operating leases. Here, these leases would be casually referred to as “lease-to-own” or “rental”. These two leases often create a lease term which is differed by the needs of both parties. Capital leases, often, are not at will, periodic, or indefinite. Operating leases, on the other hand, can be more lax on time expectations while more specific to the rights of the tenant. Naturally, the soon-to-be property owner will begin negotiations with more clearly defined rights than the soon-to-leave renter. The flexibility of leases negates mathematical calculations on a lease term calculator. Negotiating leases is as much an art as a science.

Lease Term Example

Tex, an entrepreneur from Texas, has been quite successful as a “land man”. With a keen eye, a good team, and a little luck he has gained the mineral rights to several properties which are oil rich. Finding and tapping the natural resources that the land offers has created a mutually lucrative environment for both Tex and the property owners he leases from.

As a part of his business, Tex works with all kinds of leases. Based on his research, the work of his team of geologists, his legal counsel, and his sense of adventure, Tex decides which lease term options to take part in. Tex is now working with two property owners.

First Property Owner

One, Louie, has a property with a small well. This well, close to the surface of the land, can be easily accessed by the equipment Tex uses. Tex has encouraged Louie to get his land appraised so that the two men can make an agreement which benefits both parties. It is now time to negotiate the lease to the mineral rights of the land. At the table, Tex expresses that he is interested in an indefinite operating lease on Louie’s land. Tex thinks the well will be tapped within a couple years but wants to hedge his bet by keeping rights until the job is finished.

The two men agree and begin to decide on the terms of the lease. They decide on fixed payments, rights of use on Louie’s property, and that the lease will be at will. To ensure that he maintains use for as long as he needs, Tex includes a commission plan which gives Louie a percentage of the income made from the oil in this commercial lease term sheet. As Tex puts it, “you can catch a cow better with sweet feed than with sour grapes”.

Second Property Owner

Next, Tex begins talks with another property owner known as Okie. The two men meet at the table after each has performed the proper due diligence on the property. The findings indicate that there is little limit to the oil that can be gained from this property, though it is deep into the earth. Being a man with many projects, Tex opts for a capital lease rather than buying the property outright. This allows him to eventually own the property while gaining profits from it now.

Okie sees this as a fair trade and the two men begin the specifics of the agreement. They discuss duration until ownership is transferred, the amount of regular payments, and more. It is decided that Tex will start a balloon payment schedule, where he makes minimum lease payments until the end of the lease where he pays much of the property off in a large, final payment. He will sweeten the deal by paying slightly more to Okie for his property than he normally would. The two men agree and complete the lease term agreement.

Tex is satisfied with the two deals he made. He knows that each serves a certain place in his company. Tex also knows that he has given a fair deal to Louie and Okie. To Tex, everything has gone according to plan. He begins the cycle anew by reviewing an equipment lease term sheet that has been placed on his desk.

Lease Term

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Fixed Charge Coverage Ratio Analysis

See Also:
Fixed Charge Coverage Ratio Definition
Operating Income (EBIT)
Debt Service Coverage Ratio
Fixed Costs
Times Interest Earned Ratio
Free Cash Flow
Financial Ratios

Fixed Charge Coverage Ratio Analysis Formula

See the fixed charge coverage ratio analysis formula below:

Times Interest Earned Ratio = (EBIT + fixed charge) ÷ (total interest + fixed charge)

Fixed Charge Coverage Ratio Calculations

Fixed charge coverage ratio calculations can be simple or difficult depending on the complexity of the associated financial information. For example, a company has $ 16,000 in EBIT, $ 1,000 in interest payments and $2,000 in lease payments.

Fixed charge coverage ratio = (16,000 + 2,000) / (1,000 +2,000) = 8

This means that a company has earned eight times its fixed charges.


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Fixed Charge Coverage Ratio Example

For example, Ron owns a small business which provides artisan-quality roofing services to upscale homes. Ron has carved a unique niche for his company over time. He is proud of his achievements and satisfied customer base.

Recently, the recession has caused Ron to see less jobs for Spanish tile roofing. With this serving as the bread-and-butter of Ron’s company, he wants to be prepared for additional dips in his revenues due to less sales.

Ron, essentially, wants to perform fixed charge coverage ratio analysis to assure that his company can survive the recession.

Ron speaks to his controller and performs the following equation. Ron’s company has $ 16,000 in EBIT, $ 1,000 in interest payments and $2,000 in lease payment. So…

Fixed charge coverage ratio = (16,000 + 2,000) / (1,000 +2,000) = 8

After speaking with his controller, Ron is confident that his company can survive an extended recession. He needs to check he has not violated his fixed charge coverage ratio covenant (bank requirement) for his bank loan.

Ron’s company controller looks at the agreement. Ron, after a little work, realizes that his company has not violated a covenant. Despite the fact that Ron’s company has an acceptable fixed charge coverage ratio, EBITDA will remain the same for his covenants with the bank to stay unbroken. Ron respects the value of keeping up-to-date with financial statements, as well as bank agreements, thanks to the hand of his company accountant.

fixed charge coverage ratio analysis

Resources

For statistical information about industry financial ratios, please click the following website: www.bizstats.comand www.valueline.com.

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FASB Lease Accounting Changes

See Also:
Capital Lease Agreement
Lease Agreements

FASB Lease Accounting Changes

A change in accounting rules implemented by The Financial Accounting Standards Board (FASB) has led to FASB lease accounting changes. Furthermore, the proposed lease accounting changes will bring a large amount of debt onto the balance sheets of companies that have large operating lease commitments. Going forward, the lease commitment will be recognized as a liability. In addition, the offsetting asset will be a right-to-use for the material being leased.

FASB Lease Accounting Rules

An example of an operating lease would be where a company rents office space. Under the new FASB lease accounting changes, the future lease payment obligations will be on the balance sheet as a liability. The offsetting asset will be an equivalent “right-to-use” entry.

At the end of the contract, the capital lease has an option to purchase the leased asset. In accordance with the new FASB lease accounting rule, the capitalized lease is already required to be carried on a company’s balance sheet as a debt to lease holder and an asset entry for the item being leased. This ruling in effect makes all leases capital leases.

Effective date

The effect of the FASB proposal on lease accounting could be enormous on industries that have large exposure to operating leases, such as real estate companies, etc. Also, a possible effect of the FASB lease accounting proposal would be where companies have to recognize leases on their balance sheet. That changes some loan covenants for debt ratios, etc. The changes became effective after the FASB decision in March 2011.

FASB lease accounting changes

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