5 min read5 December 2019
In this guide, we dissect equipment financing and leasing by providing examples, highlighting tax considerations and explaining the options.5 December 2019
Whether your business wants to put out a new product line, fit out some premises, or better manage seasonal demands, equipment financing can help you do so. With a vast number of options available, this guide will take you through the basics of equipment leasing and financing, cover some key differences and highlight the pros and cons.
Equipment financing is a kind of business finance that helps companies purchase equipment and machinery. In most cases the funds are secured against the equipment itself. In general, equipment financing falls into two categories:
Capital Lease Capital leases tend to be long-term agreements that are non-cancellable. They're usually used to lease equipment that a business needs for long-term use and it's often possible to purchase the equipment at the end of the lease period.
Operating Lease Operating leases are in most cases opposite. They're short-term and can be cancelled before the end of the lease period. Businesses use operating leases when they intend to use equipment in the short-term or plan on replacing the equipment after the lease ends.
Equipment finance involves your business taking out a kind of business loan, which is used to acquire assets or equipment. The business then makes repayments over a period of time, during which it has possession and use of the assets. This style of finance allows businesses to manage cashflow by spreading out the costs of expensive equipment, which it may eventually own once the funds are repaid.
Here are some kinds of things that small businesses commonly finance:
Let’s look at a more detailed equipment finance example.
Bear Kitchen is a game restaurant that's become known for its wide range of wild meats. The restaurant is expanding its menu to include items from further afield, so it needs more on-site refrigerators. Because Bear Kitchen’s cashflow is often affected by seasonal trends, the owners choose to finance the refrigerators over two years. This helps Bear Kitchen grow its business and reputation, while managing the repayments over a preferred time-span.
The walk-in fridges cost £10,000 and the equipment finance provider agrees to a 24 month repayment schedule. The interest rate for the funds is 12.1% fixed, which results in 24 monthly repayments of £468.30 over the two year period. The total repayable amount will be £11,238.
Typically, businesses can finance equipment for as little as a year and for longer periods up to seven years.
The length of financing will depend heavily on what kind of equipment is being funded, how much it will lose its value, and for how long a finance company is willing to agree in your contract.
By now, you’re probably thinking of an important question: should the business buy equipment or lease it instead? Again, this will depend heavily on the nature of your business and the equipment it needs. But there are important points to keep in mind.
If you operate in an industry where technology and equipment change rapidly, leasing may be a better way to keep up with the latest tools. More importantly, it helps your business reduce upfront costs, while allowing it to invest the cash it would have used to purchase equipment into other areas of the business, such as recruitment, marketing, training or product development.
Of course, every business is different. There is an almost endless array of equipment your business might need. Here are some common types:
Heavy equipment finance companies have long had a role in helping residential and commercial builders across the country. Given the specialist machinery needed to complete large developments and key infrastructure projects, it’s no wonder that many construction firms opt to use construction equipment financing for bulldozers, excavators, drills and cranes.
Similarly, woodworking requires specialist equipment. Whether your business makes designer wood furniture or roofs, floors, or sheds – the right machinery is needed. Some typical kinds of leases may cover wood lathes, bench grinders, or sanding machines. The benefit of leasing this kind of equipment – as opposed to buying outright – is that businesses can better manage seasonal changes in demand, keep inventory up to date, and manage cashflow.
Of course, woodworkers cannot make cabinets, furniture, or other wood-based products without the raw materials to do so. Logging businesses play a critical role and they too need specialist equipment to do so. That can include feller bunchers, delimbers, or stump grinders.
Equipment leasing is a kind of rental agreement that allows your business to use equipment in exchange for payments. It can be a useful option, if you prefer to avoid making a large outright purchase, while still getting to use key equipment to keep your business competitive.
There are a range of different equipment options, but here are the three common kinds: contract hire, hire purchase and finance lease.
Contract hire can be a useful option for businesses that need access to specialist equipment for a limited time, such as a one-off project. For example, a painting company may only need a motorised crane to reach the windows on the higher floors of an apartment block and not for the rest of its typical ground floor projects. A key benefit for businesses is that this kind of hire may be recorded as a business expense.
As the name suggests, hire purchase allows your business to use the equipment while making payments toward its eventual purchase. Under this arrangement, a business will eventually own the equipment it’s currently hiring.
With finance leases, the lender makes the equipment purchase for your business and then it make repayments to the lender, who retains ownership of the equipment while your business uses it. Again, this can be useful for businesses who want to avoid making a large purchase.
There are several benefits to leasing equipment instead of purchasing it outright:
And what about the drawbacks? There are a number that you should be aware of:
In one sense, rental agreements are leases under a different name. Rental agreements are often for a shorter period of time, such as a year or less.
You don’t own the asset, so no. The upside of this is that it doesn’t appear on your books. The downside is that you don’t acquire an asset that can be used as collateral for seeking additional finance down the track.
It depends. Under capital allowance rules, you may be able to deduct some of the costs of long-term leases from your taxable profits each year. Again, you will need to talk to your accountant about this, as eligibility can be limited.
Luke O’Neil founded Genuine Communications is 2018 – a marketing and advertising business dedicated to providing high quality research-driven content. Based in Sydney, Luke has written on an array of topics in finance, tech and legal sectors.
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