When it comes to equipping your business with essential assets, have you considered all the options? For instance, even if you have sufficient start-up funds to buy your machinery outright, could those funds be put to more profitable use elsewhere in the business? Likewise, you may have your mind set on leasing. However, do you understand the differences between the various types of leases out there?
When thinking about whether to buy or lease, don’t assume that one option is always ‘better’ than the other. Much depends on what it is you’re procuring. It also depends on what it will be used for and on what else is going on with your business. All of this means what’s right for one business might not be the case for another. Here, we’ll take a closer look at the consequences of buying and leasing. We’ll also highlight which option is likely to be most appropriate in different circumstances for small business owners.
Buying assets
This is where you own the item outright. It also covers the situation where you obtain a loan or go into overdraft to finance the purchase. Although here, it’s important to factor interest repayments and any associated fees into your calculations when weighing up your options.
The possible advantages of buying
- Lower total outlay. Paying up-front, and paying less overall. This is because lease and hire purchase agreements invariably involve a higher amount payable throughout the lifetime of the asset.
- Higher value assets may be used as security against business loans.
- You are treated as the owner of the asset for tax purposes. This opens the possibility of tax breaks on certain items in the form of capital allowances.
- You can explore pre-owned buying options. If you’re a cash buyer, you may find that there are attractive bargains to be had by exploring the second-hand market, including private sales and auctions.
Drawbacks of buying
- A potential huge dent in your funds. Assuming you do not have access to an unlimited pool of cash, you’ll need to consider where your money can be most effectively put to work. If you clear your bank account to pay for equipment, does this mean that you’re left with no budget for marketing, for instance? Are you depriving yourself of a ‘rainy day’ fund to handle contingencies?
- The risk of ending up with a ‘white elephant’. Can you really be sure that the piece of machinery you’re considering buying is actually going to be put to use? What if your customer base and service offerings evolve in unexpected ways? For instance, you find that your acrylic canvases fail to sell – but your printed t-shirts are a surprising hit. Buying outright can increase the risk of being lumbered with items you don’t really need. Whereas a leasing arrangement gives you more leeway for testing the waters without a huge capital outlay.
- Upgrade cycles. One of the reasons why mobile phone contracts are so popular is because it’s relatively easy for users to upgrade to the new version each year or so. Applying the same principle, if it’s important that you keep up with the latest models, buying outright each time may prove to be a huge strain on your resources.
Buying is most likely to be appropriate when:
- You’re procuring items that are not going to become obsolete very quickly.
- You have the cash available – and you’re not leaving other parts of your business under-resourced.
- You’re sure that there’s a genuine need for the asset within your business.
- You know precisely what it is you’re buying, and you’re not going to make a costly mistake.
Leasing
A leasing arrangement allows you to use an asset without buying it outright. This is usually for a defined period of time – at the end of it, you typically have the option of extending the term, upgrading to a newer model, or simply handing the item back and walking away. With hire purchase agreements, you take ownership of the item at the end of the term.
Benefits of leasing
- Your business can get hold of the equipment and machinery it needs quickly – without facing a huge initial financial outlay.
- You can effectively spread the cost of using equipment into consistent and manageable payments.
- Leasing charges can generally be classed as expenses so you are not taxed on them.
- Leasing can be useful if you need access to certain items over the short or medium term, but you are unlikely to need it permanently. For instance, when specialist equipment is needed to complete a specific contract.
Disadvantages of leasing
- The total amount payable is higher than an outright purchase, and the assets leased generally cannot be used as security for loans.
- It’s not usually possible to hand back a leased item mid-term without financial consequences, such as early termination charges. Restrictions on sub-leasing are also the norm.
- You must read the small print to make sure you’re clear on who has responsibility for maintenance and insurance. Do you have to use a specified repairer if things go wrong? If so, who pays for this? How much is the initial deposit? The introductory monthly rate may look attractive, but what are the amounts you’ll have to pay further down the line? If there’s the option of buying the item at the end of the term, what’s the formula used for calculating its value? Does this seem fair? By no means is it the case that all leasing arrangements are the same in their terms and conditions.
Types of leasing arrangements
Here are the main categories of leasing arrangements you’re likely to come across, along with examples of where these agreements could be appropriate for your business:
Hire Purchase (HP)
- Here, you pay off the total amount stipulated under the contract and, providing that you keep up with the repayments, the asset is automatically yours to keep at the end. For tax purposes, you can apply capital allowances to the reducing balance. Also, you can offset profits against interest.
- HP can be useful where your end goal is to own the item in question. This means it can be a useful way of procuring assets such as heavy machinery that will hold their value, and will give you many years of service. It’s less attractive for high-tech items that will be obsolete (and thus have little value) by the time the term is up.
Finance lease
- This is a fixed long-term lease (usually over 3-7 years) over which time the leasing company recovers an amount equivalent to the full cost of the item plus interest. You also have the option of keeping the item at the end of the term – usually in exchange for a nominal payment.
- It’s therefore very similar to an HP agreement save for one important difference: legal ownership of the item remains with the leasing company for the duration of the agreement. This means capital allowances only apply to leases of over seven years (and occasionally over five years). Unlike with HP, where you can only offset the interest of your payments against your profits, with a finance lease you can claim tax relief on your entire monthly payment.
- The upshot is that for a small business that can’t yet make full use of capital allowances, a finance lease could be a more tax efficient alternative to an HP agreement.
Operating lease
- Here, you pay to use the item for the duration of the lease and the asset is returned automatically to the leasing company at its end. For small businesses, this can be especially useful for high maintenance items that you are not interested in owning outright. These are ones that newer models are likely to supersede.
- Usually (but not always), servicing, troubleshooting, and insurance are all handled by the hiring company.
- The rental costs can also be offset against profits when it comes to tax (capital allowances do not apply.)
Contract hire
- A contract hire agreement on a company vehicle is a common example of an operating lease. Here, you agree to take control of the car over a fixed period. The amount you pay over that period is calculated on the basis of the difference between the market value of the car at the beginning of the contract. It is also what you expect the car to be worth at the end of the contractual period.
- If vehicle ownership is likely to be one of the biggest strains on your business resources, this type of arrangement may be a useful way of splitting the cost of it into manageable chunks.
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