Your business needs new plant, a computer system, or a delivery van, and you don’t want to dip into your capital reserves or bank balance to buy it!
How do you acquire this new asset? How do you finance it?
By leasing!
Leasing is a convenient way to go, but beware; the sales person selling you the equipment, and offering you the lease option, will probably earn an extra bonus: - a commission on the finance package as well as the normal commission on the sale of the equipment. So, buyer beware!
For business customers, there are two significant benefits from leasing:
- Conserving your own capital and obtaining extra funds from a lessor financier, and
- The immediate tax deductions for the lease payments.
So leasing can be a practical and convenient way to go, but it is not always the best option.
The basic test in assessing the relative merits of leasing versus other forms of finance is: will the equipment to be leased produce a net increase in cash, or a net gain in profit, to the business, over and above the tax deduction for the rental costs? If it cannot, or does not, think again as there are other alternatives to leasing that may be more advantageous.
These alternatives include entering into commercial hire purchase, or simply negotiating a business loan with your bank. Each of these options has different commercial outcomes for the business and different tax benefits. Provided below is a short comparison of the three options and their respective advantages and disadvantages.
- Leasing:
The business receives a tax deduction for the lease rental payments, but the finance company providing the lease finance retains ownership of the plant and claims the tax depreciation.
At the end of the lease period, the business has the opportunity to buy the plant at its agreed residual value.
- Commercial hire purchase:
The financing company retains ownership of the plant until the hirer pays all payments of principal and interest.
The interest is tax deductible to the financier, and because the financier is implied to be the owner of the plant, it receives a tax deduction for depreciation.
Businesses can maximise their financing and taxation arrangements by scaling down their repayments in early years and a catch up, or balloon payment, at the end.
As the finance company retains ownership of the plant (which will suffer some technological devaluation) the interest rate under such arrangements tend to build-in this risk, and involve higher interest costs.
- Bank loans:
Simply, the interest is tax deductible and the business receives a deduction for depreciation.
Each of the above options needs to be analysed to determine the net cost to the borrower.
Here are 5 questions to decide when, and how, to finance the purchase of an asset:
- Will the acquisition of the financed plant improve your net cash flow and profit? If not, why are you contemplating this acquisition?
- Will your cash flow comfortably meet the full ongoing costs of the selected financing package?
- Have you really shopped around for competitive quotes for each of leasing, commercial hire purchase and/or bank loan?
- Have you analysed the tax and depreciation impact of each option?
- Have you determined the total cost of each option?
Selecting and committing to the purchase of a major asset is a big decision for any business: choosing the correct financing package can either enrich or denigrate this decision.
Good luck, or I should say good management, as you decide to lease or not to lease!