How much is cash worth to your business? We’re going to take an educated guess and say that having cash in your business is essential. Without a healthy cash flow, businesses slow down, struggle to function, and will eventually shut down completely. Why, then, do so many businesses insist on using their precious cash to buy new assets or fund growth when they do not need to?
In this article we take a closer look at the cash vs leasing debate, the pros and cons of both options, and the potential savings your business could make with smarter financial choices.
We know, it’s not exactly an original topic for an asset finance broker, and as we emerge from lockdown and work towards something more like business as usual, we could all do with a little inspiration. So what better way to lift our spirits than with some of those uplifting (albeit cheesy) sayings usually plastered across the walls of downstairs toilets, on cushions, and, of course, the always popular novelty mug?
Money DOES make the world go round
Of course, the best things in life are free. You can’t buy love. All you need is love, and all the other platitudes out there. But when it comes to running a business, there’s no getting away from it, money does make the world go round.
In order to operate and grow, businesses need to acquire assets. Those assets might be computers, office furniture, plant, machinery, vehicles, software, or other types of equipment that enable the business to function.
The big question is what is the best way to acquire those assets. The two main options are:
- Buying assets outright, or
- Leasing assets.
Buying an asset outright with cash
If it is important that the business owns the asset(s) and you have the capital available, buying an asset outright can be a sensible decision, particularly if the assets are going to retain or appreciate in value. Having said that, buying assets with cash carries both advantages and disadvantages which businesses should be aware of.
|Advantages of buying assets with cash||Disadvantages of buying assets with cash|
|You will own the asset fully.||You have to pay the full cost of the asset upfront which can cause a dent in its cashflow.|
|You can claim capital allowances on the asset.||Your choice of assets may be influenced by restricted cash flow, i.e., you may buy what you can afford, not what you need.|
|You avoid entering a financial agreement that may be difficult to terminate.||You may have to take out a loan or overdraft to fund the purchase, and in some cases early repayment of the loan could be demanded at short notice.|
|The asset will usually cost less overall as there are no interest rates to pay.||You will be responsible for the maintenance, repair or replacement of the assets.|
|The value of the asset may depreciate over time meaning it will be worth less than what you paid for it.|
|You will not be able to take advantage of the tax benefits of deducting the leasing costs from taxable income.|
Leasing enables you to use assets for a fixed period of time in return for regular fixed payments. In some cases leasing enables businesses to acquire assets that they would not be able to afford if they had to pay in full upfront, but that is not the only reason why businesses choose to lease assets.
|Advantages of leasing assets||Disadvantages of leasing assets|
|You don’t have to pay for the full cost of the asset and so can retain cash in the business.||A deposit or some payments in advance may be necessary.|
|You may be able to access a higher quality of asset than you could if buying outright.||As leasing agreements will include interest, you may end up paying more for the asset than you have had you bought it outright.|
|The regular payments are easy to budget for, and as rates are fixed, there will be no surprise costs to cover.||You will not own the asset, although some agreements will give you the option to purchase at the end for a fee.|
|Spreading the cost over time enables you to match the costs in line with your income/return on investment.||You will be committing to making the payments for the term of the lease.|
|In many cases the costs of the assets are fully tax deductible, and sometimes capital allowances can also be claimed on the assets.||You will need to ensure that you fully understand the terms of lease, including any end of lease obligations or payments.|
|In the case of operating leases, you are not responsible for the maintenance of the assets.|
|The leasing company carries the risk of the assets breaking down or malfunctioning.|
|It is sometimes possible to upgrade the assets during the lease by making a small change to the regular payment rather than having to pay a large lump sum.|
The main point to take away here is that there is no right or wrong way to fund your business’ operation and growth, but businesses should not dismiss the option of leasing assets before they have weighed all their options, and certainly not before they have done the maths.
Don’t go broke trying to look rich
In reality, there are many situations when leasing is a smarter financial decision than buying assets with cash, as this example illustrates.
|Paying in cash||Leasing option (monthly payments £1,998.50)|
|Project cost||£100,000||Total repayable over 5 years = £119,910.00|
|Tax saving (based on 19% corporation tax, assuming that Annual Investment Allowance has been used elsewhere)||£11,955.94||£22,782.90|
|Cost after tax saving||£88,044.06||£97,127.10|
|Net Present Value (NPV)*||£90,522.47||£79,617.34|
*What does Net Present Value mean? 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.
There is a misconception that the only businesses that would choose to lease are those that cannot afford to pay in cash. Some businesses might even avoid leasing as they do not want to give off the impression that they are low on cash. A possible consequence of this, unfortunately, is that businesses part with their cash unnecessarily, causing themselves cashflow problems that prevent them from being able to invest in growth and often missing out on tax savings.
Essentially, they go broke trying to look rich.
This point of view is made even more ironic when you consider that many of the world’s most successful, cash-rich businesses opt to lease assets and use leasing regularly in their financial strategy.
Lease, Laugh, Love
Almost all businesses reach a point when they need to spend money on new assets in order to grow. Assets that 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.
Many businesses have a negative perception of leasing, or any form of debt. In the UK we regularly hear phrases like saddled with, crippled by or even strangled by debt, and we strive to own our own home and become ‘debt free’ by retirement. But if you are a business owner, this negative perception of debt and leasing assets could be holding you back. 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.
Take a moment to think about what you could do if you leased more of your business’ assets rather than parting with your cash. Would you…
- Invest in research and development?
- Launch a new product?
- Boost your marketing strategy?
- Buy more stock?
- Hire or promote essential staff?
- Protect your business against unforeseen circumstances (like a pandemic-induced lockdown) with an emergency fund?
Leasing can be a powerful funding tool for businesses of any size, and when their debt-to-equity ratio hits the right spot, they can accelerate their growth without taking on too much risk. You could get the assets your business needs to succeed now, spread the cost via regular affordable payments, keep hold of your cash to further growth (or maintain liquidity), and potentially unlock big tax savings.