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This article outlines both the real benefits of asset finance as well as the many additional considerations that must be made in order to make an informed financial decision about acquiring assets.
Most businesses need to use a variety of assets in order to provide a service or manufacture a product for their customers.
Assets range from equipment assets like computer systems, photocopiers, office furniture, restaurant equipment, plant, machinery to vehicle assets like commercial vehicles, company cars, forklift trucks and buses.
Paying for assets outright with cash can place a strain on the working capital position of a business. It can also reduce the future opportunities a business has to raise funds for growth.
Asset Financing is about the alternative financial methods that can be used to acquire or rent business assets without using up valuable working capital.
Also worth noting is that some businesses acquire assets without being fully aware of the impact the financing method they choose has on their cash-flow, tax and VAT liability, credit status, bank exposure (especially during times of lean trading) and available funds for growth.
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Asset Finance Options
There are three main ways to finance an asset:
There are both advantages and disadvantages of each option:
PURCHASE OUTRIGHT:
Advantages of purchase
Disadvantages of purchase
LEASING:
Advantages of leasing
Disadvantages of leasing:
As well as a variety of ways of acquiring an asset there are several different types of asset finance. There are many similarities as well as distinct differences and your ultimate choice must take into consideration your very specific criteria.
Asset Finance Types:
Operating Lease
The asset belongs to the lessor who effectively rents the asset to you the lessee over an agreed period (usually one to five years). Since the lessor will either sell the asset in the second hand market or lease it again at the end of the agreed term the lease payments can be kept low because the full asset value does not need to be recovered by the lessor during the first term. At the end of the leasing period the asset is either returned to the lessor or a further leasing agreement may be negotiated (only at the end of the initial term).
Contract Hire
Is another form of operating lease (often used with vehicles) which includes many potential service features like maintenance, replacement during repair, management, etc. again the lessor owns the asset.
The rental calculation is based on a residual value of the asset over a predetermined period and so includes a fee to cover for depreciation over the hire period.
Finance Lease
Again the asset is owned by the lessor only this time the leasing payments are calculated to include the full cost of owning the asset. Alternatively a balloon payment may be included to keep repayments low. When the asset is sold at the end of the term the lessee will share a percentage of the disposal price with the leasing company. There may be an option to extend the rental period at the end of the term for a “peppercorn” rent.
Contract/Hire Purchase
Contract purchase is the commercial equivalent of hire purchase. The asset is owned by the “hiring” company until the final payment is made at the end of the term.
Lease Purchase
Lease purchase is technically impossible since lease means rental not purchase. Lease purchase is essentially a hire purchase contract with a single larger payment at the end of the term. Once the final payment is made then legal title to ownership is transferred to the purchaser.
Leasing versus Purchase (Further comparisons and considerations)
As mentioned earlier there are key differences between leasing and purchasing assets.
Below are a selection of the additional considerations:
Tax
Leasing (Operating, Contract Hire and Finance) contract repayments are 100% fully tax allowable unlike outright purchase options where only the capital allowances can be claimed against tax.
If the purchase was made via a Lease/Contract Purchase or with a bank loan then the interest charges can also be reclaimed against tax.
Cash-flow
Leasing preserves the working capital of a business and is also tax efficient. It enables businesses to use their working capital to invest for growth or in assets that have the potential to appreciate. Outright purchase options use up available funds and are not as tax efficient. Lease/Contract Purchase options also preserve working capital but are not as tax efficient compared to Operating and Finance Leasing options.
Credit and debt status
Operating Lease and Contract Hire options preserve the credit status of a business as these lease payments are normally classified as an expense and not debt -operating leases and Contract Hire arrangements are regarded as “off balance sheet”. This therefore preserves the flexibility to utilise any further debt facility (from the bank/specialist lender) for other more growth focused requirements.
Balance sheet
If an asset is purchased (outright or with Lease purchase) or acquired using a Finance Lease then it will show on the balance sheet since it is ultimately owned by you. However Operating Leases and Contract Hire options keep assets acquired in this way off the balance sheet thereby further protecting your credit status.
VAT
With all the purchase options VAT is payable up front whereas with Operating and Finance Leases VAT is payable over the term of the lease thereby further protecting cash-flow.
Exposure to obsolete technology
Leasing options which enable the lessee to hand back the asset at the end of the agreed term help the lessee to benefit straight away from improvements in new technology associated with the particular asset. However if the asset has been purchased outright there is the challenge of finding a buyer for the older asset before a new purchase can be made.
Frequently asked questions:
Q. Why should I lease assets when I could buy them outright?
A. It allows your business capital to be used for projects which will hopefully help your business grow and make increased profits. Leasing lets you pay for your assets as they are being used by your business over time. There are also tax benefits which enable 100% of lease repayments to be written off against profits.
Q. Wouldn't a bank loan or overdraft be better than leasing?
A. A bank loan is a viable option but several issues must be considered
If interest rates rise a bank loan may become more expensive
Bank loans reduce your available credit facilities thereby affecting future borrowing opportunities.
From a tax perspective only the interest payable on the bank loan and the capital allowances are tax deductable
With an overdraft or loan there is always a small possibility that the bank may decide to withdraw the facility during more difficult times of trading or that rates could rise in line with banking policy.
Q. What if I need to add onto or upgrade my assets in the future?
A. With a Lease rental agreement, you can add onto it or upgrade it anytime you need to in the future. This allows you to continue to meet your future needs and remain in control of your budgets.
Q. What happens at the end of a lease contract?
A. In most cases you will be offered the option to purchase the equipment at the end for a nominal fee upon expiry of the lease.
How Diverse Finance can help: