Financial Management · Sources of finance and their relative costs

Leasing and Short-Term Finance Sources in ACCA FM

Updated 11 October 2026 · Fact-checked

Leasing lets you use an asset without buying it. A finance lease transfers most risks and rewards to the lessee; an operating lease does not. For lease versus buy, compare the present value of costs of each option at the after-tax cost of debt. Short-term sources include overdrafts, trade credit, factoring and invoice discounting.

Understand Leasing and Short-Term Finance Sources

A lease is a contract. The lessor owns the asset and the lessee pays rentals to use it. Leasing is a way to finance an asset without paying the full price up front.

In an operating lease, the lessor keeps most of the risks and rewards of ownership. The lease is usually short compared with the asset's life. The lessor often handles maintenance and takes the asset back at the end. It suits equipment that you need only for a while or that goes out of date quickly. Under IFRS 16, most leases appear on a lessee's statement of financial position, so the old 'off balance sheet' benefit is largely gone. Treat that point with care in an exam answer.

In a finance lease, the lessee takes most of the risks and rewards. The lease usually covers most of the asset's life. The lessee normally maintains and insures the asset and cannot cancel easily. It works like a loan secured on the asset.

Short-term finance covers needs of up to about a year. An overdraft is flexible and you pay interest only on the amount used, but the bank can demand repayment at any time. Trade credit is delaying payment to suppliers. It looks free, but it costs you the early settlement discount if you give it up. Factoring means a factor takes over your sales ledger, and often advances part of the invoice value. It can also provide credit control and, if non-recourse, bad debt protection. Invoice discounting is finance secured on invoices. You keep control of the ledger and customers are usually not told. Factoring is therefore a service plus finance; invoice discounting is finance only.

Key rules to remember

Annual cost of trade credit (forgoing a discount): [100 ÷ (100 − d)]^(365 ÷ (N − D)) − 1; d = discount % ; D = discount period in days ; N = normal payment days. This gives the compound annual cost. A simple version is d ÷ (100 − d) × 365 ÷ (N − D).
Lease versus buy decision rule: Choose the option with the lower present value of net costs; Discount at the after-tax cost of borrowing, since leasing is a substitute for debt. Include tax relief on lease payments or on capital allowances.
After-tax cost of debt: Kd (1 − T); Use this as the discount rate in lease versus buy. T = tax rate.
Factor advance: Advance = invoice value × advance %; Interest is charged on the amount advanced, and a service fee is charged on total invoice value.

How to solve Leasing and Short-Term Finance Sources questions

Use this method for any leasing or short-term finance question.

1Identify what is asked: a comparison, a calculation, or a recommendation.
2For lease versus buy, list the cash flows of each option separately by year. Buying: purchase cost, running costs, tax relief on capital allowances, any resale value. Leasing: rentals and tax relief on them.
3Check the timing of each flow, such as rentals in advance or in arrears, and the timing of tax payments.
4Choose the discount rate. Use the after-tax cost of borrowing unless the question says otherwise.
5Calculate the present value of each option and pick the lower cost.
6For short-term sources, convert each into an annual percentage cost so they can be compared, for example the cost of forgoing a discount or the cost of factor fees and interest.
7Add non-financial points: control, flexibility, risk of obsolescence, maintenance, effect on customer relationships and gearing.

Quickest way: Fast lease versus buy and trade credit cost

When to use it: Use this in Section A and Section B objective test questions where time is short and options are numeric.

For trade credit, compute the simple ratio d ÷ (100 − d), then raise (1 + that ratio) to the power of 365 ÷ (N − D) and subtract 1.
Check the period: the days gained equal N − D, not N.
For lease versus buy, compute only the differences between the options, not every cash flow.
Compare PVs of costs and choose the smaller. Do not pick the larger NPV by habit; these are costs.
Eliminate options that use the wrong rate or wrong tax timing.

Common mistakes in Leasing and Short-Term Finance Sources

Using N instead of N − D as the extra credit period when costing a discount.
Students see 'pay in 60 days' and use 60.
Fix: The extra days you gain by not paying early are N − D. For 2/10 net 60, use 50 days.
Discounting lease versus buy cash flows at the WACC.
WACC is the usual discount rate in appraisal.
Fix: The lease replaces borrowing, so use the after-tax cost of debt unless told otherwise.
Forgetting tax relief on lease payments or capital allowances.
Students focus on the pre-tax cash flows.
Fix: Add the tax saving in the correct year, allowing for any tax payment delay stated in the question.
Saying factoring and invoice discounting are the same.
Both advance cash against invoices.
Fix: Factoring includes ledger administration and credit control, and customers know. Invoice discounting is finance only and is usually confidential.
Stating that an operating lease is off balance sheet.
Older textbooks said so.
Fix: Under IFRS 16 most leases are recognised by the lessee. Mention the finance-versus-operating distinction in terms of risks, rewards and term, and note limited exemptions for short-term or low-value leases.

Worked examples

Example 1

A supplier offers a 2% discount for payment within 10 days; otherwise payment is due in 40 days. Calculate the annual compound cost of forgoing the discount, to the nearest whole percent.

Show the solution

Discount d = 2%, so you pay 98 instead of 100 if you pay early.
Cost for the period = 2 ÷ 98 = 0.020408, which is 2.0408%.
Extra credit days = 40 − 10 = 30.
Periods per year = 365 ÷ 30 = 12.1667.
Annual cost = (1.020408)^12.1667 − 1.
ln(1.020408) = 0.020203; × 12.1667 = 0.24583.
e^0.24583 = 1.2786, so cost = 0.2786, about 28%.

Answer: About 28% a year. If your borrowing costs less than this, take the discount and borrow to pay early.

Example 2

A company can buy a machine for ₹10,00,000 or lease it for 3 years at ₹3,80,000 a year, payable at the end of each year. Ignore tax. The company's cost of borrowing is 10%. Which option is cheaper, assuming buying has no resale value and no other cost differences?

Show the solution

Buying: the cost today is ₹10,00,000, so PV = ₹10,00,000.
Leasing: the PV of 3 payments of ₹3,80,000 at 10%.
3-year annuity factor at 10% = 0.9091 + 0.8264 + 0.7513 = 2.4868.
PV of lease = 3,80,000 × 2.4868 = ₹9,44,984.
Compare: ₹9,44,984 is less than ₹10,00,000.

Answer: Leasing is cheaper by about ₹55,016 in present value terms. With no resale value for the bought machine, the lease costs less on financial grounds.

Exam tips

In objective questions, read whether the discount period or the full credit period is given, and compute N − D carefully.
Lease versus buy answers are PVs of costs. State clearly that you choose the lower figure.
In written answers on factoring, split the benefits into finance, credit control and bad debt protection, and state which applies to each service.
When asked to compare short-term sources, give a cost, a flexibility point and a risk point for each. Marks are usually spread across these.
State your discount rate and its reason in one line. Examiners reward a justified rate even if the final number differs.

Practice questions from Sources of finance and their relative costs

Leasing and Short-Term Finance Sources in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Leasing and Short-Term Finance Sources: frequently asked questions

What is the difference between an operating lease and a finance lease in ACCA FM?

In an operating lease the lessor keeps most risks and rewards, and the term is short compared with the asset's life. In a finance lease the lessee bears most risks and rewards over most of the asset's life. Under IFRS 16 both are generally recognised by the lessee, with limited exemptions.

How do I decide whether to lease or buy?

Work out the present value of the net cash costs of each option, including tax effects. Discount at the after-tax cost of borrowing. Choose the option with the lower present value, then comment on non-financial factors.

What is the difference between factoring and invoice discounting?

Factoring is a service where the factor manages your sales ledger and collects from customers, often with an advance of cash. Invoice discounting is finance only. You keep control of the ledger and customers are usually unaware.

How do I calculate the cost of trade credit with an early settlement discount?

Find d ÷ (100 − d) for the discount, then annualise it over the extra days gained, which is N − D. Use compounding for the accurate annual cost. Compare the result with your cost of borrowing to decide whether to take the discount.