Q&A with ABF on asset finance
A vast and often bewildering array of funding choices are available to SMEs. In this feature Alternative Business Funding helps explain one option: asset finance.
Help! I need to buy a new piece of equipment but I don’t have the working capital to pay for it – what are my options?
Don’t worry, there are a number of finance options available to you as a small business if you need to invest quickly. In your case, it sounds as if asset finance might be what you’re looking for. You’ll be able to get the equipment you need and make regular fixed payments against the overall cost: you won’t need to tie up a huge amount of cash and you can pay for it over a term that reflects how long you’re going to be using it.
Sounds great, so what is asset finance?
Asset finance allows you to borrow against the value of the equipment you need. It’s basically a form of financing that allows SMEs to get their hands on an expensive asset quickly while paying back the debt in small manageable instalments plus interest. It means you can get start using otherwise expensive machinery or equipment without having to make a large, possibly prohibitive payment. Good examples include machinery, vehicles and some kinds of technology.
There are a few types that we can talk about in more detail shortly but let’s look at some of the pros and cons of asset finance.
Let’s start with the good news. What are the advantages of asset finance?
There are several although some depend on the kind of arrangement you choose. However, in general terms:
• Asset finance is great news for your cash flow, really at any time, but especially if you are just starting out; the main benefit is being able to get hold of a van, or racking for your warehouse, as examples, when you haven’t got free cash to cover the whole cost
• The interest rates on monthly instalments are fixed, so you know exactly how much you need to pay back, meaning no nasty surprises
• Depending on the style of arrangement, facility costs and/or ownership can be claimed as a business expense that will reduce your tax bill
Are there any downsides?
• If you can’t make the payments, then naturally you’ll lose the asset – but if you consider a secured bank loan where the security is probably your home, it helps put things in perspective
• When you include interest rates over the lifetime of the arrangement you’ll end up paying more than the value of the asset
You mentioned there were a few different kinds of asset finance?
One of the most common asset finance models is hire purchase.
Hire purchase? I’ve heard of that.
Absolutely, it’s an established and very popular method of funding for small businesses. Put simply it’s a way for an SME to buy an asset in small instalments while making use of it immediately. Plus, with hire purchase, once you have completed your repayments you own the asset outright. For tax purposes you are the owner of the asset and you can normally claim capital allowances.
The downside of hire purchase is that you’ll typically need to pay a deposit. This is normally between 10 and 20 per cent of the value.
However, keep in mind depreciation – in other words the reduction in value of an asset over time. Some items age better than others, and on the plus side, the SME will get the benefit of depreciation on the asset for tax purposes.
Leasing is another popular asset finance model.
And how does leasing differ from hire purchase?
With leasing you don’t automatically own the asset outright. When the set and agreed leasing period comes to an end, you may have an option to buy e.g. the machinery. Alternatively, you could start a new lease arrangement with different, perhaps updated machinery.
With leasing, if your equipment, asset or machinery breaks down or is replaced by a newer model, then the leasing company may fix or update it. Plus, the leasing company may offer some kind of support for the asset e.g. servicing.
One word of caution: make sure you read the terms and conditions of the lease carefully. Some agreements carry early termination fees.
You mentioned a couple of kinds of leasing?
Yes, operating lease and finance lease. Let’s start with a finance lease and use a fork lift truck as an example.
Think of finance lease as a kind of loan. It’s an arrangement where a business pays to use an asset for the maximum extent of its economic lifetime. With a finance lease, the risks and rewards associated with the fork lift belong to the leasing organisation. The lessee is considered the owner of the fork lift and it appears on the balance sheet. Whilst you will usually benefit from depreciation for tax purposes, you won’t be eligible for capital allowances.
And an operating lease?
With an operating lease, the company leasing the fork lift – i.e. you – does so for a term that is less than its economic life. Think of an operating lease as renting the fork lift. All the risks and rewards associated with asset ownership remain with the lessor, not you, and at the end of the lease, you will no longer be able to use it. Repayments are treated as operational expenses and the fork lift doesn’t appear on the company’s balance sheet.
Got it. Anything else?
Yes, because the asset is effectively security, lenders ask for personal guarantees less frequently.
It’s also worth mentioning that some assets serve the business over a long period of time, so it makes sense to pay for them over a period. Many large, well established businesses with good cash balances still fund purchases in this way, thus keeping their cash back.