Almost all businesses reach a point when they need to spend money on new assets such as equipment or machinery in order to grow. These assets deliver a more efficient and effective operation lead to increased revenue and profits. Those profits can then be put towards further investment, leading to yet higher revenue and profits.
However, if the assets are only ever funded by taking capital from the business, cashflow and growth are likely to be impacted. This is why many businesses choose to lease assets rather than buy them, but is it always the right decision?
Advantages and disadvantages of leasing business assets
Leasing assets can be a powerful way to fuel growth and improve a business’ financial agility. By leasing the assets that your business needs in order to grow, you can spread the cost over time via fixed regular payments and keep cash in the bank. At the very least, this gives you financial breathing space, a healthy cashflow and more flexibility, so you can put your mind – and the cash you’ve saved – to the task of building your business’ future.
There are two main forms of asset finance:
- Leasing – renting it over a period in return for fixed rental payments. At the end of the lease the assets can be returned or you can continue to lease on an ongoing basis for a fee.
- Hire purchase arrangements – an initial deposit is paid towards the cost of the asset and the balance is then paid in instalments over a period of time. At the end of the hire purchase period, you would make a final payment and gain ownership of the asset.
Many businesses choose to lease equipment that has high maintenance costs, can quickly become outdated, or is only used occasionally.
Advantages of leasing assets
- Businesses don’t have to pay the full cost of the asset up front enabling them to keep more capital in the bank for other areas or unforeseen circumstances.
- Businesses can access a higher standard of equipment, which might otherwise have been too expensive to buy outright.
- Paying for the asset over time via fixed regular payments makes it easy to budget in the future and match repayments to income.
- Interest rates are fixed enabling predictable costs and making it easier to forecast cash flow.
- Businesses can usually deduct the full cost of lease rentals from taxable income.
- Businesses avoid having to worry about overdrafts or loans used to pay for the assets in cash being withdrawn at short notice, forcing early repayment.
- In the case of an operating lease or contract hire, businesses often do not have to worry about maintenance.
- The leasing company carries the risks if the equipment breaks down
- If the assets need to be upgraded or replaced businesses can simply make a small adjustment to their regular payment rather than invest a lump sum upfront.
Disadvantages of leasing assets
- Businesses can’t claim capital allowances on the leased assets if the lease period is for less than five years (and in some cases less than seven years)
- In some cases a deposit or advance payments might be required.
- The interest applied can make the assets more expensive in the long-term than they would have been when bought outright.
- A business might find themselves locked into agreements that can be difficult to terminate should their financial circumstances change.
- Leasing agreements can be more complex to manage than buying outright and may add to a business’ administration.
- Companies usually need to be VAT-registered to take out a leasing agreement.
- The business will not own the asset, although they may have an option to buy it at the end of the agreement.
Advantages and disadvantages of buying business assets
Advantages of buying assets
- The business will fully own the asset (unless it is used as security for a loan)
- Capital allowances can be claimed on the assets.
- Businesses are not tied into agreements that might be difficult to terminate.
- The assets are often cheaper when bought outright as businesses avoid paying interest.
Disadvantages of buying assets
- Paying for the asset outright means parting with a chunk of capital that can impact your cash flow.
- If it is necessary to use an overdraft or loan to fund the purchase there is a chance they could be withdrawn at short notice and, in some cases, early repayment of loans can be demanded.
- Smaller businesses might not get the same price as bigger businesses.
- There is a risk that a business could buy assets that are not right for their needs with no option to upgrade or replace as there often is when leasing.
- The business is responsible for maintenance, repairs, and replacement of the assets.
- Businesses cannot take advantage of the tax benefits of deducting the cost of rental from taxable income.
- The value of the asset may depreciate over time and be worth less than the business originally paid for it.
Understanding depreciation of assets
Over time the value of physical assets like machinery, equipment, or vehicles will decrease as they become worn and/or obsolete thanks to newer versions being released. This is called depreciation and is used in business accounting to write off the value of assets that you have bought. Depreciation means the cost of the asset is spread out over the years of its use, so it is written off against the profits of several years rather than just the year of purchase. It is not allowable for tax, but you may be able to claim the cost of some assets against taxable income as capital allowances.
To work out depreciation you need to know:
- the date you started using the asset
- the asset’s estimated useful life
- the asset’s initial cost
- any possible value it may have at the end of its use – eg to be reused or reconditioned, or as scrap
- any costs that may be related to disposal.
What are the tax implications of buying vs leasing assets?
There are tax implications and potential benefits to consider with both leasing arrangement and buying assets outright. To understand and compare the tax reliefs available to you it is worth contacting a finance professional such as your accountant, but a commercial finance broker or should also be able to explain your options to you.
Any commercial finance broker or leasing company that you use should be a reputable company that is regulated by the Financial Conduct Authority (FCA).
What does Net Present Value mean?
When considering leasing assets you are likely to come across the term Net Present Value (NPV). In its simplest terms, NPV is the value of money today, compared to the value of the same amount, at a future point in time. When inflation is high, net present value becomes a more important consideration. As we are comparing you paying out cash today against finance that will require making fixed payments over a period of time in the future, we need to ensure that we are comparing like for like – £1 in the future is worth less than £1 today. This is why we need to apply a discount to the future rentals and tax savings to bring them into today’s value of money.
Before signing any finance agreement…
It is important that you seek professional and impartial advice before proceeding with any loan agreement, finance lease or hire purchase. You should also ensure that:
- Your contract corresponds with any verbal or written quotations
- The period for which you need the asset is covered by the length of the leasing agreement
- You are aware of any financial penalties that may be incurred if you wish to end the agreement early
- The equipment you are leasing is new
- You have read the contract carefully before signing it – checking the total cost, the period of hire and notice periods
- You understand all the contract terms and conditions, and charges.
Interested in leasing assets for your business?
We can help businesses to by obtaining the best funding options and facilities, quickly and efficiently, whilst ensuring your short-term goals and long-term ambitions are considered in your financial strategy.
If you are interested in leasing assets for your business, get in touch with us today. We will assess your business’ individual circumstances and work with you to decide which, if any, finance solution would be the right choice.
Complete the form below to send us an enquiry.