Asset finance is a versatile form of funding that enables businesses to acquire essential equipment, machinery, or vehicles without the need for a large upfront payment. This financing method allows companies to spread the cost of an asset over time, easing cash flow pressures and supporting growth. By using asset finance, businesses can access everything from office technology to heavy machinery, without the financial burden of purchasing outright.
This guide will explain the key types of asset finance, their benefits, and considerations for businesses seeking to use this funding option.
Types of Asset Finance
Asset finance encompasses several methods for acquiring or using equipment. Each type offers different advantages, depending on the asset and business needs. The primary types of asset finance include:
1. Finance Lease
In a finance lease, a leasing company purchases the asset on behalf of the business, which then rents it for a set period. The lessee (the business) makes regular payments covering both the asset’s value and interest.
At the end of the lease, businesses can choose to continue renting, return the asset, or sell it on the leasing company’s behalf. However, the business is responsible for maintenance and insurance throughout the lease term.
2. Operating Lease
An operating lease is similar to a finance lease but generally has a shorter term and allows for easier asset upgrades. In this arrangement, the leasing company often handles maintenance, reducing the business’s responsibilities. This option works well for businesses needing frequent updates to technology or equipment.
3. Hire Purchase
Hire purchase is a popular option for businesses looking to own the asset at the end of the financing term. The business makes instalment payments until the total cost of the asset is covered. While the asset appears on the balance sheet from the start of the agreement, full ownership is only transferred after all payments are made. This method provides a clear path to asset ownership but typically requires the business to maintain the equipment.
4. Contract Hire
Often used for leasing vehicles, contract hire allows businesses to rent an asset for a predetermined period. The leasing provider handles maintenance and servicing, which simplifies the management of large fleets. Contract hire is ideal for businesses that want the convenience of fixed monthly payments without long-term asset ownership.
5. Hire Purchase with Balloon Payment
This is a variation of hire purchase where businesses pay lower monthly instalments but face a larger final payment, known as a “balloon payment.” While it reduces short-term financial pressure, it may result in higher overall costs. This method is suited to businesses looking for manageable monthly costs but prepared for a larger payment at the end of the term.
Benefits of Asset Finance
Asset finance offers numerous benefits to businesses, particularly in managing cash flow and expanding operations. The key advantages include:
1. Lower Upfront Costs
Unlike outright purchases, asset finance requires little or no initial payment. This enables businesses to start using the equipment without needing to save for a large lump sum, freeing up capital for other investments.
2. Spread Payments
By spreading payments over the asset’s useful life, asset finance helps maintain a steady cash flow, making it easier to manage day-to-day business expenses. This approach also ensures that the asset is generating revenue while payments are made.
3. Preservation of Working Capital
Instead of tying up large amounts of capital in asset purchases, businesses can retain liquidity for other operational needs or opportunities. This can be particularly beneficial for SMEs or startups that need to keep their cash reserves intact.
4. No Additional Collateral
In most asset finance agreements, the asset being financed serves as the collateral. This means businesses do not need to pledge other assets to secure financing, reducing risk for newer or asset-light businesses.
5. Potential Tax Benefits
In some cases, payments for leased or financed assets can be offset against profits, offering potential tax savings. However, businesses should consult with tax professionals to fully understand the tax implications.
Considerations and Risks
While asset finance offers numerous benefits, there are a few important considerations for businesses before entering into an agreement:
1. Ownership
In most asset finance arrangements, the business does not own the asset until the final payment is made. This can limit the flexibility of asset use, such as in the case of vehicle leases where mileage restrictions may apply.
2. Maintenance Responsibilities
Depending on the type of asset finance, businesses may be responsible for maintenance and insurance. This can add additional costs, particularly with finance leases and hire purchase agreements.
3. Long-Term Commitment
Asset finance agreements often involve multi-year commitments, meaning businesses must be confident in their ability to make repayments over the term. Defaulting on payments could result in the loss of the asset and negatively impact the company’s credit rating.
4. Damage Liabilities
Any damage to the asset during the term of the lease may incur penalties or repair costs. Therefore, businesses must ensure they are able to maintain and protect the asset properly.
Asset Finance vs. Asset Refinancing
It’s important to distinguish asset finance from asset refinancing. While asset finance helps businesses acquire new assets, asset refinancing allows businesses to unlock cash from existing assets by using them as collateral for a loan. This option can be useful for businesses looking to improve cash flow without purchasing new equipment.
Is Asset Finance Right for Your Business?
Asset finance can be a valuable tool for businesses that need to acquire essential equipment but wish to spread the cost over time. It can be particularly beneficial for SMEs, startups, and businesses in capital-intensive industries, such as manufacturing or logistics. However, businesses should carefully assess their financial health and future cash flow to ensure they can meet repayment obligations.