Funding the purchase of manufacturing equipment – what are the options?

Cash flow issues can present difficulties for businesses looking to purchase new equipment. If you are hoping to grow your business and looking for a way to finance the purchase of new assets or equipment, there are several ways to achieve this.

Asset finance presents a number of funding options, the most common being (1) equipment leasing and (2) hire purchase.

(1) Equipment leasing

This option essentially involves a leasing company leasing an asset to a business in exchange for rental payments. Equipment leasing lets you rent an asset and have all the practical benefits of ownership without the risks and without actual ownership of the asset. There are two main types of equipment leasing for businesses to consider – operating leases and finance leases.

Operating leases 

(often known as “contract hire” for vehicle leasing) are usually for a short or medium timeframe, being for a period shorter than the lifetime of the asset. Under an operating lease, a business does not take on any of the risks of ownership. The maintenance and insurance obligations remain with the leasing company. The leased asset remains off the business’ balance sheet which has tax benefits, meaning it can offset rental payments against profits. Some operating lease facilities also allow the possibility to upgrade the leased asset throughout the lifetime of the lease, if not at the end of the term.

In contrast, a finance lease is a longer-term lease which will exist for the majority of the leased asset’s lifetime. Unlike with an operating lease, the business will take on most of the risks and rewards of ownership (e.g. maintenance obligations and fluctuations in value) but as with the operating lease, the business will never actually own the asset. A business will rent the asset for a period of time and the monthly payments will add up to the cost of the asset plus interest. At the end of this initial rental period, the business can continue to lease on a new lease period, return the asset to the leasing company or sell the asset and keep a share of the income from the sale. The asset again does not show on the balance sheet of the business. VAT is spread across the monthly payments. You can offset rental charges against the profits and claim VAT.

(2) Hire purchase

This is another popular form of asset finance. It allows a business to buy assets on credit and is a better option if the asset is required for the long-term business needs. In its simplest terms, hire purchase is buying an asset but paying for it in installments. Similar to equipment leasing, the leasing company will buy the asset for the business and lease it. When the business pays the final installment they have the option to buy the asset for a nominal payment. Therefore, the key difference to equipment leasing is that with hire purchase, the business can obtain ownership of the asset at the end of the rental period. Hire purchase is the ideal way to buy an asset over time without the complication of the outright initial payment and it protects working capital. It is sometimes possible to pay low rental payments and a large balloon lump sum payment at the end of the period. The item will often appear on your balance sheet from the start of the rental term and, like a finance lease, the business will be responsible for the maintenance and insurance costs. The VAT on the asset is paid upfront and no VAT is payable on the rental payments.

Unlock Cash and Value in Existing Assets

Another asset related method of raising finance for business growth is by borrowing against your business’ existing assets. Lenders will loan funds to you taking security over your equipment. If you can’t keep up with the loan repayments, the lender can take ownership of the asset as repayment. This is an alternative way of unlocking cash in your business which would otherwise be “locked up” in assets.

In summary, asset finance is a method of lending to assist with the purchase of new equipment to help a business to grow and develop. There are many benefits of asset finance. Crucially, it is beneficial for managing cash flow and helping businesses to budget, it means businesses can obtain immediate access to equipment, and the leasing plans can be tailored to business needs and can be flexible on terms and repayment schedules.

 

Operating Lease

Finance Lease Hire Purchase
Ownership of the asset? No No Yes, at the end of the rental period
Appears on balance sheet? No No Yes
Duration Short to medium term Longer term Longer term
Responsible for maintenance and insurance? No – obligations remain with leasing company Yes

Yes

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Our Banking & Finance Group is one of the largest in Scotland,, advising clients across the entire range of mainstream finance legal work required by the Scottish market. We are regularly instructed by banks and financial institutions, borrowers and investors.

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