Asset finance, or leasing, offers a popular way for companies to acquire essential equipment of all sorts - from vehicles to IT equipment and machinery - without having to pay the full cost up front. Assets are paid for over the life of the lease in instalments and, depending on the type of lease involved, may ultimately be owned by the company or returned to the lessor.
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The Informed Funding two-minute guide: Asset Finance
- What is Asset Finance?
Asset Finance is usually known by other names including leasing, hire purchase and contract hire. It is a way for companies to gain access to physical assets to be used in their business without having to put up the whole cost of purchasing them at the outset. The items most commonly obtained using asset finance include vehicles, plant and machinery and IT equipment.
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- How does it work?
Asset finance comes in a variety of forms including hire purchase (where the company ends up owning the item after paying all the necessary instalments); finance leases (where the company pays to use the asset for its useful life but does not own it); and operating leases (where the company pays to use the asset for a fixed period that is less than its full useful life and does not own it). Contract hire, which is often used with business vehicles, is a form of operating lease. In each case, the leasing company will purchase the asset and then charge the company a fee for the use of it. Other services such as maintenance and technical support may also be bundled into these deals.
- How long do leasing agreements usually last?
It varies according to the particular assets involved, but three to five years is typical. Operating leases can be shorter because the company may only want a piece of equipment for a specific purpose and will hand it back when it is no longer needed.
- How much does it cost?
The cost of asset finance varies depending on the credit standing of the customer and the type of agreement. Interest rates are fixed and can be as low as 3%-4% for established, low-risk companies up to 7%-9% for smaller and riskier borrowers. Sub-prime leasing rates for very small and high-risk borrowers can reach 25%-plus. Companies with little or no trading history may find it difficult to obtain asset finance through mainstream providers and may have to pay high rates if they are able to access it at all.
- What security do I need to provide?
Most asset finance requires relatively little in the way of additional security since the asset itself provides its own security so most users are not asked to provide a personal guarantee, for example. However, you may also be asked to pay a deposit when you take out the lease.
- What is sale and leaseback?
In some instances it is possible for a company to sell an asset it owns to a leasing company and at the same time take on a lease agreement giving it the use of the asset that it formerly owned. This can enable the company to release the capital value of the asset for other purposes while making regular payments in order to have continuing access to it. Depending on the value of the asset shown in the company’s balance sheet, it may also incur a capital gain or loss when it carries out the sale and leaseback transaction.
- Need to know:
- Asset finance is a well-secured form of funding and as a result tends to have relatively high rates of acceptance – almost nine out of ten applicants are successful.
- Benefits can include: no big initial outlay; regular fixed payments that can aid budgeting; access to support, maintenance and upgrades; and (except with HP) no exposure to changes in the value of the asset because you don’t own it.
- In some cases users can reduce their monthly outgoings by making a bigger “balloon payment” at the end of the lease.
- Despite the cashflow benefits, asset finance will tend to work out more expensive than a straightforward purchase because the user will end up paying both the cost of the asset itself and the cost of financing it.
The impact on the accounts will differ depending on the nature of the lease. Finance leases will be included as both an asset and a liability on the balance sheet. Operating leases will not appear on the balance sheet
The tax implications vary depending on the nature of the lease and a review of each specific situation but in general the following treatments apply:
- Hire Purchase (HP)
- HP instalments consist of a capital and interest element: the interest element of the HP payments will be a deductible expense; but the capital element will not be tax deductible
- Capital allowances should be available to the lessee from the date the asset is brought into use
- Operating lease
- Operating lease payments are fully deductible for tax
- No capital allowances will be available to the lessee
- Finance lease
- Finance leases result in both depreciation and interest being charged as an expense. Both the interest and depreciation element will be tax deductible
- No capital allowances will be available to the lessee
- Sale and leaseback
- Care needs to be taken as there may be limits to tax deductions where payments are made to the lender below a "commercial rent"
- Long funding leases
- These are finance or operating leases which last more than 5 years
- The lessee can claim capital allowances
- However, depreciation is not tax deductible
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