Paying cash for the equipment that your business needs isn’t always an option. Whether it’s a desk or a boat, asset finance can be your best choice.
Many businesses struggle to finance the equipment needed for day-to-day operations. This is especially true for businesses in the early stages of development. They tend to be more financially stressed than more mature businesses, so finding money to put into the business might not be possible without external help.
Even if you might be able to pay upfront for an asset, this might hurt your cash flow and affect your growth prospects.
This is where asset finance comes into play. It’s a pretty straightforward form of payment plan where you make regular payments instead of paying in full upfront. In return, you get to either use an asset for a certain amount of time and return it, or gain ownership over it after making the last payment.
If you’ve never looked into asset finance, there are a few things to consider when determining the best option for your business. Each financing option may come with a different payment structure and its own set of benefits and drawbacks. Getting the right deal is essential for financing the equipment you need without affecting the operation of your business.
Before we get into the things that you need to know about asset purchase, let’s take a look at the types of assets that qualify for this form of financing.
Types of Assets
- Each asset is a resource that needs to ensure future economic benefits.
- From the perspective of ownership, you should be able to turn the assets into cash or cash equivalent.
- Every asset has an economic value and the owner can exchange or sell them.
You can classify these assets in three different ways. The first one separates the assets according to their physical existence as follows.You can classify these assets in three different ways. The first one separates the assets according to their physical existence as follows.
- Tangible – Physical, material assets that can serve various purposes and can be easily evaluated. These include buildings, machinery, vehicles, and so on. If the lifespan of a tangible asset is higher than one year, it’s common practice to depreciate them in your books and business tax return.
- Intangible – As implied by the name, these have no physical substance and can be quite hard to evaluate because of this. They include goodwill, copyrights, patents, etc. They can be crucial to an innovative company’s success, but their impact is often hard to measure.
Another classification criterion is convertibility based on whether they can be easily turned to cash.
- Fixed – Commonly referred to as PPE (Plant, Property, Equipment) assets, these are essential to a company’s vitality. They’re long-term assets that are operational or utilisable for years before you need to replace them. As such, they can’t be easily converted into cash. Some examples include buildings, machinery, and patents.
- Current – Readily convertible to cash or cash equivalents. These include fixed deposits, stocks, inventory, etc. When a business needs some quick cash, liquidating these assets is among the first options.
Lastly, we can classify assets based on their usage.
- Operating – Necessary for everyday operations and outputs, these assets serve the purpose of generating revenue. Examples include production equipment, inventory, accounts receivable, licenses, and patents.
- Non-Operating – Not required for generating revenue but needed for long-term results. These include vacant land, marketable securities, and short-term investments.
Of course, it’s possible to use more than one classification to describe an asset. For example, machinery is a tangible, fixed, operating asset. You can use asset financing to purchase almost all of the above resources. Let’s take a look at the most common financing models and the way they work.
Asset Finance: Commercial vs. Consumer
There are a few differences between commercial and consumer asset finance that you need to take into account before taking out a loan:
- Level of protection – In general, consumer loans have the highest level of protection, while commercial borrowers like businesses expose themselves to more risk.
- Ease of access – Consumer loans are easy to come by and research. The process of getting a loan is quite straightforward. Commercial loans, on the other hand, often require expert assistance such as the engagement of a broker to make the loan available
- Interest rate disclosure – Consumer loan documentation must include the interest rate and Annualised Percentage Rate (APR). This isn’t the case with commercial loans, which is why it might be harder to compare the available options.
Now that you understand some of the main differences between these loan types, let’s take a look at some of the most common asset finance options.
- Finance Lease
Under a finance lease, a bank buys an asset and leases it to you. The bank’s balance sheet includes the value of the asset, and the repayment goes into your profit/loss statement. You pay the full value of the asset with interest to your lessor over an agreed-upon timespan. As a lessee, you get to write off the rentals, but the asset remains under the lessor’s ownership.
You can either return or buy the asset after the lease expires. The contract should specify the buyout at the end of the lease. In addition, you can deduct the leasing fees from your taxes if the amount doesn’t exceed ATO’s Depreciation Limit.
The biggest benefit of a finance lease is that you get to use an asset right away. This makes it perfect for situations where you need to replace your fixed assets as soon as possible but can’t afford the replacement. In addition, there are no changes to the monthly payments so you’ll be able to plan ahead.
- Operating Lease
You can use an operating lease to finance almost any asset. It’s the most appropriate option if you don’t need an asset for your business’ entire working life. You make a monthly payment to the lessor for using the equipment, after which they take it back.
The major advantage of an operating lease is that the lessor assumes the responsibility of maintaining the asset. Since you don’t own the asset after the lease period, it doesn’t show up in your balance sheet.
- Hire Purchase
The way that a hire purchase works is quite simple. The lessor buys an asset on your behalf and lets you use it for a monthly payment. At the end of the lease period, you have an option to return the asset or buy it and take full ownership for a nominal sum.
Hire purchase used to be one of the most popular asset finance options. However, their GST treatment changed back in 2012. After that, this became a much less attractive option, so many lenders don’t even offer it anymore.
Still, it does come with a few benefits. First of all, you don’t have to make any deposit. This protects your cash flow and may speed any application. There’s also no need to provide any form of security as the asset serves this purpose.
- Chattel Mortgage
With a chattel mortgage, your movable property serves as security for the loan. Unlike a conventional mortgage that uses real property for security, the seller can treat the equipment as a guarantee for the loan. The mortgage is on the balance sheet with a loan recorded in liabilities. In case of a default, the seller retrieves and sells the equipment to cover the losses.
Chattel mortgages come with a few benefits that make them quite attractive. First of all, you can claim tax deductions if the amount doesn’t exceed ATO’s Depreciation Limit, as well as depreciation and interest. Also, GST is only applicable to the asset’s purchase price rather than the balloon payment at the end. This means that you can claim GST on your asset immediately, as long as you account for your expenses on a cash basis. In addition, 100% finance is available to approved customers.
- Consumer (NCCP) Loan
In essence, this is a consumer version of a chattel mortgage. You borrow money to purchase an asset that you own in your personal name. The asset acts as a security in the event of a default.
After the last payment, the asset remains under your ownership. Should you default on a payment, the lender can take the asset away and sell it to cover their losses.
- Novated Lease
A novated lease requires a three-way agreement between financier, employer, and employee. The financier has ownership of the asset, while the employer and employee agree to share the responsibility for it. The employer leases an asset on behalf of their employee, and all the repayments go through him.
The employee pays monthly repayments through a combination of their pre and post-tax salary. This means they get to reduce their taxable income. At the same time, the lessor takes care of all administration needs, meaning there are no costs to the employer.
This is a very common way of purchasing company cars where the employee is also allowed to use the car for their personal needs. If the employee leaves the company before the lease expires, they have the option to buy the car directly from the lender.
Choosing the Right Asset Finance Option
As you can see, there are various options for financing the assets needed to grow your business. There are a few things to consider before you make the final decision.
Think about the timespan of asset use, your cash flow, and the expected benefits from buying the asset. Unless you’re confident that you can use it for revenue growth, financing the asset can be quite cumbersome.
If you need help choosing the best option, it’s best to consult your financial professional. There are various features to asset finance options that you might not be aware of. They can make a world of difference to the final deal.
To find the right form of asset finance for your business, you can start by taking this quiz.