Businesses can use asset finance to obtain the equipment they need to grow and provides an alternative to paying the asset’s full cost upfront (rather helpful if the asset is a ship!). Below, we set out the different ways a business can finance an asset focusing particularly on leasing and operating leases and hire purchase.
What is Leasing?
Leasing allows the lessee (the business) to access and use new equipment through renting from the lessor (the leasing company) for a contracted period. In this scenario, the lessor owns the asset, and the lessee pays rent to the lessor for using the asset. There are two main types of leasing – a finance lease and an operating lease.
What is a Finance Lease?
The lessor under a finance lease buys the asset from the manufacturer and leases it to the lessee. The lessee pays the lessor rent which is equivalent to:
- The full value of the asset under the terms of the lease; and
- An amount equal to a return on capital to the lessor (the interest).
Matters to Consider With Finance Leases
Title passes from the manufacturer to the lessor and remains with the lessor for the term of the lease. At the end of the term, the lessee may:
- Have the right to purchase the equipment for a nominal amount;
- Continue to lease the asset; or
- Assist in the sale of the asset to a third party.
In most cases, it is the lessee and not the lessor who assumes most of the risk while operating the asset. For example, the lessee is typically responsible for insurance and maintenance of the asset. A finance lease is recorded on the lessee’s balance sheet which means that the asset is recorded as an asset or liability in the lessee’s business.
What is an Operating Lease?
Under an operating lease, the asset is usually leased for a limited time, and when the lease ends, the lessee returns the asset to the lessor. The lessor will then, hopefully, lease the asset to another business. The lessee pays the lessor rent, which is calculated on a portion of the asset’s value.
Matters to Consider with Operating Leases
Title passes from the manufacturer to the lessor and remains with the lessor for the term of the lease. At the end of the term, the lessee usually returns the asset to the lessor. It is not expected that title will pass to the lessee at the end of the lease term. The lessor hopes that by leasing the asset to many different companies, it will recoup more than the cost of the asset in rent.
The lessor bears more responsibility for the maintenance of the asset during the life of the lease. Entering into an operating lease provides the lessee with the ability to update its equipment/assets regularly without having to endure the expense of buying them outright. The lessee can return the asset to the lessor without being involved in the sale, or disposal of the asset. The lessee’s balance sheet doesn’t record the assets under an operating lease as an asset or liability, rather it’s recorded on the lessor’s books.
Advantages of Leasing
As the ownership of the asset remains with the lessor, repossessing the asset is usually easier. Another advantage of leasing is that there are no limits on borrowing as leasing is not a loan (notwithstanding limits contained in the lessee’s constitution or any other documents to which it is a party).
Disadvantages of Leasing
There are also disadvantages of leasing. Some of these disadvantages include costs, lack of ownership on the part of the lessee and risk of maintenance. Using leasing to finance your business’ equipment can free up the cash it might otherwise have used to buy assets. Businesses may also decide to lease their equipment rather than buy it outright because they can negotiate better financial terms than if they were to arrange traditional loan financing for their equipment.
What is Hire Purchase?
Another type of asset finance is by hire purchase where a business buys equipment and makes instalment payments over time. In this case, the buyer is leasing the assets but will eventually own the asset after paying the full amount of the hire purchase contract along with a nominal purchase price. Hire purchases are more common when a company is dealing with customers rather than in the business to business market. Hire purchase agreements may be used for buying cars and computer equipment, for example.
Matters to Consider with Hire Purchase
The lessor retains title to the asset, which only passes at the end of the hire period if the lessee opts to exercise its purchase option. It is not possible for the lessee to modify or change the asset into another product. This is important for the lessor who can then quickly identify and repossess the asset if the lessee defaults.
Advantages of Hire Purchase
Financing your assets through hire purchase can be advantageous given the certainty of repayments and the ability to negotiate the term of the hire purchase. If the lessee decides not to buy the asset at the end of the term, they can simply return the asset to the lessor.
Disadvantages of Hire Purchase
Hire purchase can be expensive and will typically require the payment of a deposit.
There are many options in which you could acquire the equipment you need for your business. Using asset finance, rather than a traditional loan can offer a good alternative for businesses, particularly if they were struggling to find a suitable loan. Some options you might consider include leasing your equipment through a finance lease, an operating lease or using a hire purchase agreement. When deciding the best way to finance your business’ needs, you should look at many factors including the nature of your business, the nature of the equipment you want to finance as well as its economic life. If you have any questions, get in touch with our banking and finance lawyers on 1300 544 755.