EVALUATION ON LEASING AND ITS IMPACT ON THE PROFITABILITY POSITION: A STUDY WITH SPECIAL REFERENCE TO JET AIRWAYS

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1 Special Issue for International Conference on Business Research, Dept of Commerce, Faculty of Science and Humanities SRM Institute of Science & Technology, Kattankulathur, Tamilnadu. EVALUATION ON LEASING AND ITS IMPACT ON THE PROFITABILITY POSITION: A STUDY WITH SPECIAL REFERENCE TO JET AIRWAYS 1 ANAND SHANKAR RAJA M 1 Assistant Professor, Denary of Commerce and Management CHRIST (Deemed to be University), Bengaluru, Karnataka Abstract The economic value of using leases can be perceived over purchasing the asset. The main benefit of leasing is seen in the proposition that it provides the entity with enhanced cash flows and increased tax benefits. This statement is widely regarded as the essence of leasing. The firm can protect itself from debt burden by usage of leases. Large capital-intensive firms and small firms can reap the benefits of the financial service and preserve cash flows. While this may be true in certain cases, in many other cases, the usage of lease has negatively affected the financial performance metrics as seen in many previous studies conducted outside India. Finance leases require the lessee to make a payment over its lease term over the economic life of the asset equal to its fair value. This is seen as a drawback. Thus, this study is conducted with reference to Jet Airways to test the proposition of improved economic benefit to the lessee. A correlation analysis was conducted between lease index and the financial performance metrics namely profitability, liquidity and solvency. The study revealed that there is an overall negative impact owing to the usage of leases in the capital structure. Hence, firms have to not merely employ lease owing to the proposition of increased tax and cash flow benefits, rather they have to employ efficient capital budgeting decisions to understand if it results in net positive cash flows. If not, then other alternative mechanisms of financing must be identified. Keywords: Leasing, Financial impact, profitability, capital structure, cash flows AN OVERVIEW ON LEASING INDUSTRY IN INDIA Leasing in India is not a recent concept. The First Leasing Company of India provided the first financial service of leasing. This followed the growth of many companies subsequent to 1973, and the leasing industry only saw a rise ever since. The credit crunch is not an unheard concept. In the light of restricted credit policies of industrial banks and other commercial financial institutions, lease financing is emerging, from the producing end and the consuming end. The delays that are associated with acquisition of heavy capital funding have led the way to expansion of lease financing. The role of leasing has grown manifolds by allocating scarce finances into capital markets. Though leasing has ranked lower in comparison to other financial services, the importance it holds to the companies that avails such services is what the researcher is willing to study. The widespread use of leasing in India depicts that the business community has accepted this mode of financing. Thus, leasing is a modest yet effective way of infusing assets into a business.study by Marwan Mohammad Abu Orabi, studied the Impact of Leasing Decisions on the Financial Performance of Industrial Companies, This study focused on the effect of leasing on the financial performance of the companies listed on the Amman Stock Exchange in Jordan The study listed lease as an independent variable measurable in three ways- leasing index, fixed asset turnover and total assets turnover. The dependent variables studied were grouped as liquidity (current ratio, quick ratio, net working capital turnover) and profitability (net operating profit, net profit, Dividend per share, Earnings per share) and risk indicators (Degree of financial advantage and operating advantage, standard deviation of sales). Study by Winfred Wanjiru Munene, reveals that the Effect of Leasing on Financial Performance of Companies Listed at the Nairobi Securities Exchange. The indicators like liquidity, size of the firm, financial lease, operating leases etc. were taken as independent variables while financial performance (Return on Assets) was taken as dependent variables. The Return on Assets was one major financial performance indicator that was studied using multiple regressions. The study overall revealed that the financial performance was not affected by the usage of lease financing at all levels of significance. The researcher recommends that the usage of lease should be looked into, as there is not value add in the financial performance of the company. Study by Bello Umar, Impact of Leasing on liquidity of Nigerian Oil and Gas Companies. The study was aimed at finding out the incidence of employing leases on the liquidity of oil and gas companies listed on the Nigerian Stock Exchange before the period of January The study revealed that liquidity remains unaffected by use of lease in the capital assets. There was evidence of insignificant relationship between lease financing and liquidity at all levels of significance. Study by Ms. Mandeep Kaur and Dr. Pooja aimed at analyzing effect of leasing on the financial statements of a company with special examination of the impact on performance or profitability. The study stated that the operating leases have positive effects on short-term current ratio as compared to financial leases. However, the Gross Profit margin remained the same in both cases. PROBLEM STATEMENT Leasing is a component of capital structure of a large number of companies. The significance also extends to the fact that without the usage of leased assets, many projects would not have been undertaken. When many academicians, authors, corporations and other stakeholders sing praise of the utility of a non-capital intensive financing technique, the focus of this paper is to quantitatively prove whether such claims are substantially valid. Thus, the idealistic view of employment of leasing reducing capital costs and resulting in increase in profitability has been put to test in this paper. The problem of whether leasing provides significant benefits to the operating efficiency which yields better profits are subject to tests. The argument in favor of leases augmenting cash flows, enhancing tax benefit and increasing in net profits is subject to study. Together, the solvency position is also evaluated in this study. Studies similar to these have been extensively conducted in growing economies like Africa and Jordan, whereas little research has been done in India. Therefore, International Journal of Research in Engineering, IT and Social Sciences Page 19

2 the researcher is keen on conducting a similar test on the companies that operate in India. OBJECTIVE OF THE STUDY To evaluate whether leases have a relationship with the financial performance metrics of the company that use finance leases. To assess whether the usage of lease has a positive or a negative impact on the financial performance metrics. To evaluate whether the usage of lease is beneficial to the company. SIGNIFICANCE OF THE STUDY The conclusions reached by the conduct of this research will hold of great significance to various stakeholders both who employ leasing and the investors who are willing to understand the benefit of an important capital structure decision. The study can also be a guide to better policy formulation with respect to the leasing industry. RESEARCH MOTIVATION Leasing has been an invention that has enabled efficient utilization of resources. The advent of leasing has promised the lessee value add without the debt burden. Therefore, the implications of leasing are far-fetched. Where most textbooks and scholarly material sing praise of the financial service, previous studies in other nations have proved that employment of leases is subjective to each business entity. Not only is the benefit attributable to the particular entity, the cost-benefit analysis is allocated asset wise also. In the light of this, the research was conducted to put the postulate into test. The outcome would validate whether the cost of leasing an asset is actually beneficial over purchasing it. Companies perform capital budgeting decisions; the study of leasing having an impact on the profitability could be an additional test for asset allocation. The optimum utilization of resources leads to reduced wastage and maximum productivity; hence, lease is one way to capacitate optimum utilization. The outcome of the study would validate claims for the above-mentioned statement. SAMPLING FRAME The aim of the study is to identify the impact of using leases on the financial performance of the company. The study is limited to the study of financial leases only. The aircraft industry uses leases in highly large volumes. As having ownership of the big bird is an exorbitant affair, many airlines prefer to lease their assets. Hence, leasing is highly prevalent in the air travel industry. The samples are chosen only from the airline industry. (PSA, 2010). Of the airlines, the study will be conducted only on Jet Airways. The airlines have consistently been using leasing for more than 5 financial years. Other carriers either limit the usage of leases or do not use financial leases, which is the significant area of study in this paper. The company leases three types of assets: 1. Leasehold land 2. Aircraft (Narrow Body) 3. Aircraft (Wide Body) The company in daily operations significantly uses the assets mentioned above. Jet Airways regularly leases their assets. As on January, the carrier announced the lease of 8 aircrafts. Similarly, it also lends out its aircrafts on lease. Hence, the study would be limited to the detailed investigation of the financial performance of the carrier. SOURCES OF DATA The data is collected from secondary sources. Annual reports of the companies are referred to for the leased assets percentage. The financial metrics are collected from the software Prowess. All other information is derived from secondary sources only. TOOLS USED IN THE STUDY The statistical tools used in the study are correlation analysis and Students t test. Correlation analysis is used to study the linear relationship between two variables. Thus, this tool is used to establish a correlation between financial metrics and lease index. HYPOTHESIS DEVELOPMENT The hypotheses that were formulated for the purpose of this study are as follows: H a: There is relationship between leasing and profitability. Ho: There no is relationship between leasing and profitability. H a: There is a relationship between leasing and liquidity. H o: There is no relationship between leasing and liquidity. H a : There is a relationship between lease and return on assets. H o : There is no relationship between lease and return on assets H a: There is a relationship between leasing and debt equity H o: There is no relationship between leasing and debt equity Table No. 1.1: Research Data International Journal of Research in Engineering, IT and Social Sciences Page 20

3 Objective 1: To evaluate whether leases have a relationship with the financial performance metrics of the company that use finance leases. The relationship between the variables was established using t tests. Based on the previous studied, the following hypotheses was formed and tested. H 0: There is no relationship between leasing and profitability. H 1: There is relationship between leasing and profitability Lease Index Profit After Tax t df Table No 1.2: One Sample Test Result for PAT Sig. (2-tailed) Mean Difference 95% Confidence Interval of the Difference Lower Upper The null hypothesis is accepted. It can be said that there is no significant relationship between leasing and profitability. H 0: There is no relationship between leasing and liquidity. Ha 2: There is a relationship between leasing and liquidity. Table No 1.3: One Sample Test Result for Current Ratio t df 95% Confidence Interval Sig. (2- Mean of the Difference tailed) Difference Lower Upper Lease Index Current Ratio Hence, the null hypothesis is rejected and the alternative hypothesis is accepted. Therefore, it can be said that there is a significant relationship between leasing and liquidity. H 0: There is no relationship between lease and return on assets. Ha 3 : There is a relationship between lease and return on assets. Table No 1.4: One Sample Test Result for Return on Assets 95% Confidence Interval of Sig. (2- Mean t df the Difference tailed) Difference Lower Upper Return on Asset The null hypothesis is rejected and the alternative hypothesis is accepted. Hence, there is a relationship between leasing and return on assets. H 0 : There is no relationship between leasing and debt equity Debt/ Equity t Table No 1.5: One Sample Test Result for Debt Equity Ratio df Sig. (2-tailed) Ha 4 : There is a relationship between leasing and debt equity Mean Difference 95% Confidence Interval of the Difference Lower Upper International Journal of Research in Engineering, IT and Social Sciences Page 21

4 The null hypothesis is accepted concluding that there is no relationship between leasing and debt/equity Based on the above inferences, a correlation analysis was done to establish the strength of the relationship between the variables. Objective 2: To assess whether the usage of lease has a positive or a negative impact on the financial performance metrics. Table No 1.6: Tabulated Data for Lease Index and PBDITA and Correlation results Year Lease Index PBDITA as % of total income Column Thus, there is a positive yet moderate correlation between lease index and Operating profits. Operating profits here is calculated by dividing Profits before interest, depreciation, taxes and amortization by the total income. Table No 1.7: Tabulated Data for Lease Index and PAT and Correlation results Year Lease Index PAT as % of total income Column Thus, there is a negative and moderate correlation between leasing and profits after tax. Thus, as the amount of leased assets increases, the profits after tax (profits available to equity shareholders) increase. Table No 1.8: Tabulated Data for Lease Index and Current Ratio and Correlation results Column 1 Column 2 Column International Journal of Research in Engineering, IT and Social Sciences Page 22

5 Table No 1.9: Tabulated Data for Lease Index and Quick Ratio and Correlation results Year Lease Index Quick Ratio Column Leasing has a strong negative correlation with current ratio and with the quick As the lease index reduces, the liquidity has risen. (As seen in the trend of current ratio and quick ratio). Thus, a strong opposite relationship exists between the variables. Table No 2.0: Tabulated Data for Lease Index and Return on Assets and Correlation results Total income / total Year Lease Index assets Column There exists a strong negative correlation between Lease index and Return on Assets. As the amount of leases decrease, the return on asset is improving as seen in the trend. Thus, leases negatively affect the return on assets. Table No 2.1: Tabulated Data for Lease Index and Debt Equity Ratio and Correlation results Year Lease Index Debt/ Equity Column There exists a negative yet mild correlation between lease index and debt/equity As lease increases, debt/equity ratio reduces. This signifies that the usage of lease reduces debt burden but not to a significant level. Thus, leases and debt component are negatively correlated; however, their inverse relationship is not strong. International Journal of Research in Engineering, IT and Social Sciences Page 23

6 FINDINGS The study was aimed at finding the relationship between leasing and the financial performance metrics of the firms that use financial leases. The proposition that was put to test was whether the usage of lease was a substitute to the purchase of an asset and whether it has benefits over and above such purchase. The target company for the study chosen was Jet Airways. Its financial ratios and lease details were collected and analyzed over a period of 7 years from 2011 to The study used t test and correlation analysis to achieve desired results. THE STUDY REVEALS THREE SIGNIFICANT RESULTS: Relationship between leases and profitability- The usage of lease is mildly positively correlated to the operating profits. Whereas there is negative correlation to the net profits. This can indicate the drop in net profits due to high indirect expenses. The indirect expenses also include the lease rentals with respect to finance leases. Relationship between lease and liquidity- The usage of lease is strongly negatively correlated to the liquidity. The cash flows are curbed. The result derived is contradictory to the general proposition that leasing improves liquidity. Relationship between lease and return on asset- The strong negative correlation that exists between the variables signify that leasing has adversely affected return on assets. This result agrees to the previous test between leasing and net profits that revealed that the increase in leases tends to reduce profits. The profits decline, thus reducing the return on assets. Relationship between lease and solvency- The negative correlation established between leasing and debt equity has signified that usage of lease will reduce the debt component. The findings of the study have suggested that leases have a negative impact on the financial performance of the company. The usage of lease has only helped improve the operating profits. Other than this variable, every other liquidity and solvency measure considered for this study has been negatively impacted by the usage of leases. The findings of this study are similar to the findings of the studies done previously in other parts of the world. The previous studies reveal that large listed companies are adversely impacted by the usage of lease. In case of this study also, the same results apply. Thus, firms have to recalculate the usage of financial lease as there is no significant value adds in the capital structure. In such a scenario, purchase of lease should be considered, as there is no benefit derived from the usage of lease financing. CONCLUSION The study reveals that there is no beneficial relationship between the usage of lease and the financial performance of the company studied. This may be only with reference to the air transport industry, as the study involved usage of data from financials of Jet Airways. However, findings of the study may act as a guide to the decisions to the other industries also. The study concludes that leasing does not have a positive and significant relationship with the financial performance. Firms should be careful while employing lease into their capital structure. The study recommends that there is no substantial increase in value adds owing to use of the financial service. There is positive ROA owing to lower levels of leasing, thus firms should reconsider alternative methods of acquisition. Secondly, higher usage of lease has curbed the liquidity of the firms. The company must not merely consider the reduced interest costs owing to lesser borrowings for the purpose of purchasing the asset, it must also see how the increased lease rentals affect the free cash flows in the firm. Liquidity is an important measure of an entity being able to meet its obligations immediately. In such a situation, where leases do not help augment liquidity, such a financial decision needs to be re-considered. Capital budgeting for assets has to be re-assessed. Thirdly, the study recommends that the debt equity ratio is inversely related to the usage of leases. The employment of lease has helped reduce the burden on debt obligations; however, it has no strong correlation with the variable. The firms have to analyze the benefits of leasing over purchase. In leasing, the total amount of the minimum lease payments is usually equal to the fair value of the leased asset. In such a scenario, many claim that this is depriving the opportunity of the firm to have owned it all together. Thus, the study recommends the computation of benefits that the financial lease would have over ownership of the asset. Lease expense and amortization rate has to be considered before commencing a lease. For large corporations, leasing may not provide the actual value add that it intends to provide. Thus, the benefit of leasing can be more often seen in small firms as proved by the previous literatures. LIMITATIONS OF THE STUDY The data utilized for the purpose of the study is secondary data published in the annual reports and other websites along with the software Prowess. Thus, the validity of the study is limited to the extent of the data published in the above-mentioned sources. The study is limited only to the extent of finance/capital leases. Operating leases are not considered for the purpose of the study. Thus, the results of the study are limited to the usage of financial lease in the capital structure. The operating lease has to be studied separately. The study focuses on one particular sector only. The study results are limited only to this particular industry. The airline industry is chosen as the prime area of study owing to extensive and prominent usage of leasing. The usage of leases has been limited to a few companies and to a smaller extent. The growth of leasing is consistent, yet not a significant financial service. The introduction of IFRS 16- Leases will completely change the representation of leases in the financial statements. Thus, the study is valid for periods of study before January 2019, the effective date of implementation of the proposed lease standard. FUTURE SCOPE OF THE STUDY The International Accounting Standards Board has proposed the new accounting standard for accounting for Leases- IFRS 16. The implementation of this would result in changes in the Key Performance Indicators. The International Journal of Research in Engineering, IT and Social Sciences Page 24

7 implementation is proposed as on the date of January Thus, the study of similar nature can be performed in the periods post usage of the newly proposed standard. India is on its way to complete convergence of IFRS in the near future. Thus, the implications of the leased standard is said to be greatly significant. The implementation of Ind AS or Indian Accounting Standards has not yet necessitated the lessee in recognizing an operating lease on the balance sheet; however, the implementation of IFRS would likely bring a change in Ind AS 17. Studies can also be done in various other sectors also. The usage of leases in still growing in India, hence the study can be extended to other specified industries. The result of this would mean a better understanding of the acceptance of the service, which would help lessor companies improve their offerings in terms of type of lease and other related services. Leasing activities are growing extensively in terms of type of asset being leased. For example, prime office space leasing has picked up momentum across eight key Indian cities. The occupiers attempt to insulate themselves from the real estate price escalations. Various sectors are expected to reap benefits of leasing - including pharmaceuticals, ecommerce, engineering etc. Although the fear of IT sector disruptions being a threat to the process of outsource, yet there is a bright future for India in leasing. Thus, future research can be conducted to evaluate the growth of lease in office spaces and real estate in large, medium and small-scale firms. BIBLIOGRAPHY 1. B.Brahmaiah, A. P. (1992). Leasing Industry in India: Problems and Prospects. Journal of Management. 2. Bawnih, M. S.-S. (2008). Determinants of financial leasing development in Jordan. Studies in Business and Economic Journal. 3. Bello Umar, A.-M. A. (January 2016 ). IMPACT OF LEASE FINANCING ON LIQUIDITY OF NIGERIAN OIL AND GAS COMPANIES. International Journal of Economics, Commerce and Management. 4. Crane, D. L. (n.d.). Measuring Financial Performance: A Critical Key to Managing Risk. 5. Demper, S. (15 October 2012). Accountingqualityof Leases Acomparisoninvalue relevanceofthelease accountingmodels. 6. Kajirwa, I. H. (2016). Effects of Operating Lease Finance on Financial Performance of Parastatal Sugar Manufacturing Firms in Kenya. Research Journal of Finance and Accounting. 7. Levis, M. A. (1998).The determinants of the leasing decision of small and large companies. European Financial Management. 8. Marian Siminica, D. C. (2012). The Correlation between the Return on Assets and the Measures of Financial Balance for Romanian Companies. INTERNATIONAL JOURNAL OF MATHEMATICAL MODELS AND METHODS IN APPLIED SCIENCES. 9. Ms. Mandeep Kaur, D. P. (2016). EFFECT OF LEASE STRUCTURE ON FINANCIAL STATEMENTS AND PERFORMANCE OF THE COMPANY. International Journal of Application or Innovation in Engineering & Management. 10. Munene, W. W. (October, 2014 ).THE EFFECT OF LEASE FINANCING ON THE FINANCIAL PERFORMANCE OF COMPANIES LISTED AT THE NAIROBI SECURITIES EXCHANGE. 11. Nevitt. (n.d.). 12. Olatunji Eniola Sule, S. I. (February 2014). Equipment Leasing as a Source of Finance For Small and Medium Scale Entrepreneurs In Nigeria. International Journal of Management Excellence. 13. Orabi, M. M. (2014 ). The Impact of Leasing Decisions on the Financial Performance of Industrial Companies. Global Journal of Management and Business Research: C Finance. 14. PSA. (2010, February ). Aircraft leasing in India - a look at the DGCA s policy prescription. 15. PwC. (n.d.). IFRS 16: The lease standard is changing. Are you ready? 16. Services, I. M. (August-2011). Leasing in India- Poised for. 17. Singh, S. (July 2017). Ratio Analysis in Manufacturing Sector-A Study. International Journal of Innovative Research in Engineering & Management. 18. Zhang, N. (November 17, 2011). Leasing, Uncertainty, and Financial Constraint. The University of British Columbia. International Journal of Research in Engineering, IT and Social Sciences Page 25