Running a business involves numerous financial decisions, including how to acquire equipment, vehicles and machinery in a cost-effective manner.
The hefty upfront costs associated with purchasing these items can often pose a challenge. Fortunately, there are financial solutions like asset finance and leasing that not only ease the burden on your cashflow but can also open doors to growth opportunities. What is asset finance? It is a financial tool that enables businesses to acquire essential assets through methods like leasing or hire purchase. Understanding business finance is an important aspect in helping businesses navigate these financial decisions with confidence.
In this blog, we’ll explore the ins and outs of both asset finance and leasing, shedding light on how they work and the various options available.
Understanding asset finance and leasing
Asset finance allows businesses to use equipment without depleting their cash reserves or making significant capital expenditure. The mechanics are straightforward: a business uses its existing assets as collateral for a new loan, a process known as asset based financing.
This arrangement allows for manageable payments in instalments over time, sparing you from the financial strain of making a lump sum payment. A business loan can also be secured using assets as collateral, providing financial support for managing cash flow, addressing unexpected expenses, and acquiring new assets.
Depending on the specific asset finance option chosen, you may either own the item outright after completing payments or return it to the provider, offering a level of flexibility that resonates with many business owners.
Types of asset finance, operating lease, and leasing
Asset finance comes in different flavours, but three main options dominate the landscape:
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Hire purchase: This option enables you to pay for an asset in instalments, with ownership transferring to you upon completing payments. However, be prepared for the responsibility of maintaining the asset. Asset based lending can also be used to free up cash by selling a hard asset to a finance company and then leasing it back.
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Finance leasing: In this scenario, a leasing firm purchases the asset on your behalf and rents it to you. After the lease term, you can extend the rental, return the equipment, or even sell it on behalf of the leasing firm. A finance company can provide funding for assets and may also take responsibility for maintaining them.
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Contract hire: Tailored specifically for vehicles, this option involves making regular payments to a provider who procures and maintains the vehicles for you. Once the lease period ends, the provider assumes responsibility for the vehicles.
Is leasing an option?
Asset leasing involves acquiring the temporary use of machinery, equipment or vehicles rather than outright ownership. Leasing can positively impact a business’s cash flow and financial stability by providing flexibility in managing expenses. The two primary lease types, operating leases and finance leases, differ in their accounting treatment.
In an operating lease, the lessee (the party leasing the asset) avoids assuming ownership risks and rewards, essentially entering into a rental agreement. Lease payments are treated as operating expenses, and the leased asset is typically excluded from the lessee’s balance sheet.
On the other hand, a finance lease sees the lessee taking on ownership risks and rewards, often using the lease for asset acquisition financing.
Here, the leased asset is recognised on the lessee’s balance sheet as both an asset and a liability. Depreciation and interest on the lease liability impact the income statement.
IFRS 16 and its impact on the balance sheet
The accounting landscape shifted with the introduction of international financial reporting standard 16 (IFRS 16) in January 2019. Under IFRS 16, operating leases must now be recognised on the balance sheet, aligning them with finance leases for a more accurate financial representation. This change impacts the terms and duration of a finance agreement, as lessees must now account for these leases on their balance sheets throughout the lease term.
IFRS 16 marks a revolutionary change in lease accounting, implementing the ‘right-of-use’ model. If a company controls or has the right to use a leased asset, it must be recognised on the balance sheet, eliminating the previous practice of keeping significant financial liabilities off-balance sheet.
This standardisation aims to bring transparency to companies’ lease assets and liabilities.
As companies navigate these changes, staying updated on accounting standards and consult the latest guidance for accurate and current information is important.
The shift toward the ‘right-of-use’ model reflects a comprehensive effort to provide a standardised and transparent approach to reporting leased assets, fostering financial clarity in the business world.
Choosing an Asset Finance Lender
Choosing the right asset finance lender can help businesses acquire assets without putting a strain on their cash flow. With numerous lenders offering asset finance solutions, it’s essential to research and compare different options to find the best fit for your business needs. Here are some factors to consider when selecting an asset finance lender:
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Reputation: Look for lenders with a solid reputation in the market. Check their ratings with the Financial Conduct Authority (FCA) and other regulatory bodies to ensure they are trustworthy and reliable.
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Experience: Consider lenders with experience in financing the type of asset you need. An experienced lender will have a better understanding of your specific requirements and can offer tailored solutions.
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Flexibility: Choose a lender that offers flexible repayment terms and options, such as variable interest rates or balloon payments. This flexibility can help you manage your cash flow more effectively.
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Customer Service: Evaluate the lender’s customer service, including their responsiveness, communication, and support throughout the application and repayment process. Good customer service can make a significant difference in your overall experience.
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Fees and Charges: Compare the fees and charges of different lenders, including interest rates, arrangement fees, and early repayment charges. Understanding the total cost of borrowing will help you make an informed decision.
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Asset Expertise: Consider lenders with expertise in financing the specific asset you need. They will have a better understanding of its value and depreciation, which can be beneficial in structuring your finance agreement.
By carefully evaluating these factors, you can choose an asset finance lender that meets your business needs and provides a competitive and flexible financing solution.
Looking Ahead: Pros and Cons of Asset-Based Finance and Asset-Based Lending
Asset-based finance and asset-based lending are popular financing options for businesses looking to acquire assets or release cash from existing assets. While these options offer several benefits, they also have some drawbacks. Here are the pros and cons of asset-based finance and asset-based lending:
Pros:
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Improved Cash Flow: Asset-based finance and asset-based lending can help businesses improve their cash flow by releasing cash from existing assets or acquiring new assets without a large upfront payment. This can be particularly beneficial for managing day-to-day expenses and funding growth initiatives.
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Increased Flexibility: These financing options offer flexible repayment terms and options, such as variable interest rates or balloon payments. This flexibility can help businesses manage their cash flow more effectively and adapt to changing financial circumstances.
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Access to New Assets: Asset-based finance and asset-based lending can provide businesses with access to new assets, such as equipment, vehicles, or property. Acquiring these assets can help businesses expand their operations and increase productivity.
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Tax Benefits: These financing options can offer tax benefits, such as depreciation and interest deductions. These benefits can help businesses reduce their tax liability and improve their overall financial health.
Cons:
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Risk of Asset Depreciation: Asset-based finance and asset-based lending involve the risk of asset depreciation. If the value of the asset decreases significantly, it can impact the business’s cash flow and financial stability.
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Interest Rates and Fees: These financing options often involve interest rates and fees, which can increase the cost of borrowing. It’s important to carefully consider these costs and how they will impact your cash flow.
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Repayment Terms: Asset-based finance and asset-based lending often involve strict repayment terms. Managing these terms can be challenging, especially during periods of financial uncertainty or economic downturns.
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Collateral Risk: These financing options often require collateral, which can put the business’s assets at risk if they are unable to repay the loan. It’s key to assess the potential risks and ensure you have a solid repayment plan in place.
By carefully evaluating the pros and cons of asset-based finance and asset-based lending, businesses can make informed decisions about their financing options and choose the best solution for their needs.
Looking ahead: Pros and cons of asset-based finance and asset based lending
While asset finance is a cost-effective solution for many businesses, it’s crucial to weigh the pros and cons before making a decision. Asset refinance can unlock the cash value of an asset to fund business expansion.
In an upcoming blog, we’ll provide a comprehensive guide to navigating asset-based finance, delving deeper into its advantages and potential pitfalls. Asset finance is often a cheaper alternative to other forms of business financing.
These benefits can help businesses reduce their tax liability and improve their overall financial health.
At Cottons, we specialise in partnering with SMEs and startups to achieve their growth goals. If you’re considering asset finance and leasing or have questions about the best financing route for your business, reach out to us. A finance provider plays a vital role in owning and maintaining the asset in various financing arrangements.
We’re here to help you make informed decisions for a prosperous future.
