Managing the cash flow of a business is definitely one of the most important tasks of being a business owner. Prudent business owners regularly look at updating vital business equipment to take advantage of efficiencies that are created by newer technology. Choosing the right type of asset finance to fund this equipment can help save you time and money to invest in growing your business.
It is important to ensure that the terms of asset finance is arranged so that the cash flow generated by the asset is matched to the loan repayment obligations.
When considering asset finance options, look to ask yourself:
- What capital do I need to grow my business?
- Is my cash flow subject to peaks & troughs?
- How long will I need the equipment and how long before I will need to upgrade it?
- Is technology rapidly changing in my industry?
- Do I want to ‘own’ or ‘return’ the asset?
Plant and equipment assets can generate cash flow for a business over long periods. Ideally, any asset finance should be repaid by the time the asset is retired, or at least from the residual proceeds from the sale of the asset at that time. Ideally, you should endeavour to cover the repayments on the debt over a shorter period than the estimated life of the item because rapid improvements in technology can result in perfectly working items of plant no longer being viable and thus having little or no value.
Costs vary dependent the asset finance chosen, but it is not always the form of finance that appears to be the least costly that is ultimately the best choice for your business. Generally, the following types of financing are available:
Equipment Loans have become the most common and popular form of Asset Finance. The finance provider lends you the funds to buy the asset, and then takes a mortgage over the equipment. Payments are made over a term, generally between two to five years, depending on the equipment’s expected effective life. The rate of interest is set at the start of the loan and regular P & I payments made. The payments are generally monthly but, in some seasonal businesses such as agriculture the timing of payments can be matched with the times when the business generates its cash flows, i.e. Annual repayments in February after Harvest income has been received.
Some banks offer an Equipment Loan facility, where a business will be given a pre-determined limit, which allows them to continually update and purchase new equipment without going through an approval process provided the limit is not reached.
A Hire Purchase is where the financier pays for the asset and the client hires the asset from the financier for a fixed monthly repayment over the term. The client may use the asset but is not the owner of the asset and the title to the asset only passes once the goods have been paid for.
Operating Lease: A fixed-term rental agreement where you rent the asset from the financier, who owns it. This type of facility is useful for rapidly depreciating items like IT equipment because there is more flexibility to update and you can hand the equipment back at the end of the lease.
Finance Lease: A fixed-term rental agreement where you rent the asset from the financier, who owns it. At the end of the term of the lease, the business acquires the plant for an amount agreed at the commencement of the lease (usually called the lease residual). It is important to ensure that the final payment is not likely to exceed the estimated value of the item at that time.
The most suitable source of funding for you will depend on your business, the asset you are buying and your circumstances at that time. Therefore, it is a good idea to seek advice from your accountant before taking out any form of financing.