Understanding Asset Finance
Cash flow is King in business and managing it effectively is particularly important to start-ups, which may need to meet a lot of expenses up front before they start to see a return on their investments. In the old days, overdrafts and business loans were standard ways of managing this challenge, but these days many young companies are finding that using asset finance from specialist lenders is both less hassle and more economical for them. The four main types of asset finance options are: hire/lease purchase, contract hire finance lease and operating lease. Some lenders also offer a sale and lease-back or buy-back option, but the lease-back or buy-back options tend to follow a similar pattern to the options previously mentioned.
This option is probably familiar from the consumer market, the company essentially rents the asset for the duration of the agreement and, assuming all payments are met, takes ownership of it at the end.
This is when you hire an asset in what could be called operating condition, in other words the agreement takes into account (at least some) running costs such as fuel and tax.
This is when you pay for the use of an asset over an agreed period and take responsibility for maintenance and insurance while it is in your possession. Generally, the asset is sold at the end of the agreement and the company and lender will split the proceeds in an agreed ratio (usually in the company’s favour).
This is when you simply rent the asset for the period you need it and return it at the end of the agreement.
All of these agreements are over a fixed term and generally the asset itself is all the security which is required. From a financial and tax perspective, each of these options has its own characteristics and this may sway your decision for one over the other. Your initial selection, however, should be based on the answers to four straightforward questions.
- Do you want to own the asset at the end of the agreement?
- Hire/lease purchase will offer this as standard, it may be possible with an operating lease.
- Do you want to keep the asset off your balance sheet?
- If so you need operating lease or contract hire.
- Do you want to have the option of extending the agreement (as opposed to negotiating a new one)?
- Finance lease and operating lease generally allow for this as standard. Contract hire may accommodate the request. Hire/lease purchase is very unlikely to allow for this.
- Do you want a fixed interest rate? Hire/lease purchase almost always has a variable rate, operating lease usually has a variable rate. The other options are much more likely to be available with fixed-rate deals as standard.
- Are you prepared to accept the risk of depreciation?
With hire purchase you are committing to buying the asset at the end of the agreement regardless of whether or not it’s value is still what you thought it would be. With the other forms of asset finance, you can simply hand the asset back and move on.