Financing equipment
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Hiring or leasing equipment is one way of making your working capital go further. Instead of paying out up front, you can spread your payments over a set period, and benefit from the use of the equipment in the meantime.
Of course you have to pay for this benefit, but with the right deal it will serve you well. With the wrong deal, you could end up paying well over the odds or getting involved in a dispute. So think through what you want to achieve, and check the small print on the deals you are offered, before you sign anything.
This briefing looks at the advantages of equipment finance (or asset finance, as it is often called), and suggests some ways to make sure it meets your requirements. It covers:
- Deciding whether equipment finance is right for your business.
- Different forms of finance arrangement.
- What to look out for.
- Where to get help.
1 Is equipment finance for you?
Below are the main benefits that equipment finance can offer.
1.1 You can save cash.
- You can spread the payments over several years. Three to five years is normal, but it could be longer for heavy plant and machinery with a long working life.
Financing should not last longer than the expected economic life of the equipment.
- You can tailor the timing of the payments to suit your expected cashflow.
For example, you may be able to arrange an initial payment holiday (the overall payments may change slightly).
- You can keep the overall payments lower by going for an operating lease rather than a purchasing arrangement (see 2.2).
The finance company takes the equipment back at the end of the period to sell it.
- You may be able to get extra cash by selling and then leasing back assets you already own.
1.2 You can control your outgoings.
- You will normally be offered a fixed-rate deal.
You will know what your payments are going to be, right from the start (though changes in tax rates or allowances might affect your payments under a lease).
- Provided you honour the terms and conditions, the finance will be secure for the term of the agreement.
1.3 You need offer no extra security.
- The equipment itself is normally the only security on a finance agreement.
- If you borrow from your bank to buy the equipment instead, you would normally have to provide extra security (if the bank doesn't already hold sufficient security).
Finance arrangements must normally be shown on your balance sheet. This increases your gearing (the ratio of borrowings to equity), so it may affect your ability to borrow.
The main exception is operating leases (see 2 ).
1.4 You can easily replace the equipment at the end of the agreement.
- With some financing arrangements you never own the asset, just have use of it while the agreement lasts.
- If the equipment is likely to be worn out or outdated by the end of the agreement, this arrangement could suit you.
- You may be able to replace the asset before the end of the financing term, although there will be a cost.
1.5 If appropriate, you can arrange a service contract at the same time as the finance deal.
This could be a good option if the equipment needs continuous servicing support (eg a server unit). If service is included, it must be shown on the agreement. If it is not shown, do not sign.
- Take care before signing any service-inclusive deal.
There could be too much scope for confusion about the charges.
- You should be able to get a deal with payments directly related to use, and all service and maintenance elements (except accidental damage) included.
- Check whether - and to what extent - consumables are included.
- If you pay charges based on metered use, take readings before and after the engineer calls, and insist that test use is credited back to you.
Questions to ask
- Are you buying (or leasing) new equipment? How do you know it is new? Is it writen down anywhere? Does the serial number match up?
- What is the list price? What would the makers charge if you bought it direct?
- What is the delivery charge?
- What are the maintenance and servicing charges? Does the deal depend on your purchase of a certain amount of consumables? If so, what quantity?
- How many instalments do you have to pay throughout?
- How much are the instalments, and what do they cover?
- Are there any usage charges (eg excess mileage charges on cars)? When do they kick in?
- Are spare parts guaranteed for the life of the lease?
- What happens at the end of the term? Do you have to give notice to end the deal? Can you extend it if you want to?
- What happens if you cannot maintain your payments?
- What happens if the equipment does not work, or works inadequately?
2 Types of contract
If equipment finance might make sense in your circumstances, you need to decide on the type of contract.
2.1 If you want to own the asset at the end of the agreement, go for a hire purchase (sometimes called a lease purchase) arrangement.
- A purchase arrangement makes sense when the asset would be worth more to you than the finance company could make by selling it secondhand.
For example, PCs lose value fast, because new models with improved technology are introduced.
But if you do not need machines with greater abilities, it might pay you to keep your existing PCs going.
- Negotiate the payment arrangements you want. You might want payments spread evenly over the term of the agreement.
Or you might want lower regular payments, but a bigger final payment (a 'balloon' payment). This will only be available on equipment with reliable second hand value.
- You could hedge your bets by going for lower payments, and making a decision on selling or keeping the equipment nearer the end of the contract.
But you will have to meet the 'balloon' payment in full, whether or not you decide to sell, and whatever the equipment is worth by then.
- The asset remains the property of the finance company until the final payment is made.
You are responsible for insurance and maintenance, and must not let the equipment out of your possession.
2.2 If you do not want to own the asset at the end of the period, go for a lease instead.
- With a finance lease, the asset is sold to a third party at the end of the agreement, and you receive most of the proceeds as an agreed rebate.
Alternatively, you may be able to extend the agreement for another term, at a much lower cost.
For example, the quarterly payment on the first agreement might become the annual payment on the second.
- With an operating lease, you make lower payments in total but do not normally share in the proceeds when the equipment is eventually sold.
Many finance companies offer operating leases only on assets which are easy to sell (eg cars).
Provided that an operating lease fulfils the requirements of the 90 per cent rule, it may not need to be shown on your balance sheet, though the rules are changing.
- As with hire purchasing, you are responsible for maintenance and insurance.
3 The tax position
The tax position depends partly on whether the deal will eventually give you ownership of the equipment, and partly on your own tax position.
3.1 If you are going for a purchase agreement:
- You can claim capital allowances.
- You can offset the interest element of the payment against your taxable profits.
- If you are VAT registered, you can generally reclaim the VAT on the capital cost of the asset.
3.2 If you are going for a lease agreement:
- You cannot claim capital allowances.
- You can offset the rental payments against your taxable profits.
- You can reclaim the VAT on rentals (if you are VAT registered).
Special rules apply to cars.
The 90 per cent rule
Anything that you are purchasing (eg through hire purchase) must be entered on your balance sheet (see 1.3).
If you are leasing or contract-hiring an asset, and the finance company or dealer holds a significant residual value at the end of the contract, the liability need not be shown on your balance sheet. The 90 per cent rule is normally used.
If the present value of the minimum rental payments to be made amounts to 90 per cent or less of the cost of the equipment, the liability need not be shown on your balance sheet.
- The present value means the discounted cash value - get your accountant or the finance company to do the sums if the dealer cannot.
- Any charges for servicing or maintenance must be stripped out first.
A lease is unlikely to qualify for off-balance-sheet treatment if:
- You benefit from any rebate at the end of the agreement when the equipment is sold.
- You can roll over the contract without paying an economic rent.
4 Where to get help
Equipment finance is a difficult area. You need advice, particularly if you are dealing with an unknown company or if you are considering a large purchase. Good advice in this area can be hard to find.
4.1 Ask the Finance and Leasing Association for an up-to-date list of members and a copy of their code of practice (020 7836 6511).
4.2 Ask your accountants if they have a leasing expert or, if not, who they can recommend.
4.3 Try to find a specialist consultant on equipment finance.
