An Overview of Asset Financing
It has become challenging for businesses to explore appropriate and budget-friendly finance options while focusing on growth. In contemporary times the companies that fund businesses that require funding have experienced a surge in the demand for asset finance to invest in machinery, equipment, and vehicles.
Moreover, by 2015 companies used asset finance, mainly leasing and hire purchase agreements, to fund 32% of UK investments. Detailed insight of these finance options will help in understanding the choices that businesses and entrepreneurs have to grow their business when purchasing assets that are otherwise out of their reach because of limited funds.
What Does Asset Finance Mean?
Asset finance is an investment that businesses acquire to attain high-value equipment or assets that are supposedly essential for the growth of the business in the respective market. It is a practice of borrowing funds or loans by using a company’s investments or balance sheet assets as a security. In asset finance, instead of outright buying the equipment the company needs, you agree with the financing organizations where you hire the required equipment on a lease between 1-5 years.
There are other options in the market; however, asset finance is far more flexible in comparison to others. Various assets can be submitted as assurance along with machinery, inventory, even buildings are considered as a high-value asset, and the amount loaned usually depends on the value that particular assured assets hold.
Why Do Businesses Need It?
Most of the time, entrepreneurs and small businesses stop growing beyond a certain point, even though the potential is there. Sometimes it is the lack of opportunities that become the key hurdle, but most of the time, it’s the lack of funds required to purchase the equipment that can help it grow. Asset finance is both that opportunity and support that can be used by any organization in need of that financial assistance that can help with that additional push.
Furthermore, the long term plans to return the funds, ease out any pressure in buying the much-needed equipment. Finance companies pay for any physical asset that a particular business requires, but the consumer will only pay a pre-agreed monthly sum to the company. Moreover, the asset may come under the ownership of the business. It depends on what sort of asset finance the business owner is seeking.
Some asset finances may be leased for several years. However, some finance companies also rent the money spreading over the lifespan of the asset. So it might be challenging to understand what type of asset finance will suit your business?
Types of Asset Finance
Primarily three types of asset finance can be availed for the businesses, Hire Purchase, Finance Lease, an Operating Lease. However, there are few other specialized types of asset finance, in this guide, we will cover all the options available to help you understand the number of opportunities available. Each method comes with its pros and cons, but overall it follows the same fundamental concept of asset finance.
It is the purest form of asset finance that allows a business to attain an asset by spreading the total cost over a more extended period. This sort of investment gives the client the chance to own high-end equipment without jeopardizing their regular cash flow. With this type of finance, the client undertakes to lease an asset for the business through a finance company. Sometimes all it takes are a few steps to improve the quality of your cash flow management.
In turn, the finance providing company acquires the asset and claims the ownership until the agreed leasing period finishes. The purchase means the finance provider takes full responsibility for the insurance and the maintenance of the asset. The client pays the provider regularly for the usage of the asset. The client takes over the ownership at the end of the leasing period.
Hire purchase allows the receiver to minimize any adverse impact on the cash flow by customizing the payment plan. The finance companies depending on their organizational policy may also offer clients a minimum rental payment on a monthly or quarterly basis. In turn, it settles on the balloon payment. The balloon payment is a large sum of money paid as a final instalment of the lease while considering the asset value at the end of the leasing span.
Additionally, If we look through the perspective of the accounts, hire purchase allows the client to list the asset in the balance sheet during the lease period. The business can record the total cost of the asset along with the rental payment as the liability.
Finance lease is homogeneous to hire purchase in terms of characteristics but differs as far as accounting and taxation are concerned. Also known as a capital lease, its commercial application allows the lessee to acquire ownership of the leased materials at the end of the leasing period. The lessor financing company allows the client to utilize the asset during that period in favour of monthly instalments. The client has the option to acquire ownership through balloon payment or opt for the purchase price.
Finance lease is beneficial for the lessee in terms of tax, and this is why businesses are more motivated to secure it. The leasing period may run for the full working life of the asset or at least for a significant portion of it. However, the lessee holds the responsibility of risks and rewards of the possession.
Tip: Explore other Tax Efficient Investments for your business.
It allows the lessee to put the asset in the balance sheet the same as the hire purchase. However, the finance provider is the one with the tax-ownership of the asset and, therefore, can claim the capital allowances. The capital lease always intends to sell the asset after the end of the leasing period, even if the asset is not in the state of further usage.
It has somewhat the same characteristics of finance leasing as it allows the lessee to rent the equipment or machinery against fixed monthly instalments over the leasing period. But the end of the leasing period comes with more options for the lessee. The client can take over the ownership by buying the asset on the agreed sum, extend the lease, return it to the lessor or upgrade the equipment with the new version.
Businesses with such need of equipment find it hard to maintain and buy the costly asset as, within no time, the material comes with new upgrades and changes that completely downplays the rented asset. That is why small businesses seek the equipment lease to avoid high-cost involved in the ownership and maintenance of the equipment.
Responsibilities of servicing and maintenance are determined through agreement, and the client is not solely accountable. Furthermore, it’s an excellent option for businesses that need up to date equipment to the latest models in the short term.
It is quite similar to equipment leasing that businesses choose when the company needs specific equipment. But it has no intention to use it for an extended period. Moreover, the transaction is not inclined towards acquiring any ownership of the machine. This type of leasing is often affordable as the rental cost depends on the short term of the leasing time.
The lessee only has to pay the pre-calculated value of the equipment over the agreed time. It also benefits the lessee in terms of direct identification of payable fees to revenues generated through the same leased assets.
Consequently, the ownership of the asset remains with the provider, but unlike the already discussed leases, in this type, the lessee cannot list the asset in the balance sheet. In terms of taxation, the operating lease takes almost the same pattern as a finance lease. The provider rents the asset to the client. Moreover, the provider claims the tax from the profits of the lessee.
Asset refinancing inhabits under the umbrella term of asset finance. However, it strongly identifies as a form of the lease based on the pre-owned assets of the client. It deals with the sale of a previously owned asset of the client to the provider who, in turn, lends a lump sum to acquire the asset. Furthermore, the lessee accords to lease the sold asset back and agrees to pay back the lump sum and the rental fees in regular instalments.
It lets asset-rich businesses in need of capital to instantly generate a hefty amount from the current resources without surrendering the authority to use the assets. It is especially suitable for vulnerable businesses who might have encountered any profit deprivation and decline in revenue generation. Such situations call for massive money infusion while avoiding giving up the currently available resources, and that is when refinancing fills up the void.
The other option for the lessee is to put the current assets as security against the funds. As the refinancing does not consider previous financial records, hence it is more convenient and easy to acquire in comparison to other forms of finances.
Video: Asset Finance
Watch the video to learn about how does asset finance work?
Contract hire or vehicle asset finance
It is progressively similar to operating lease. However, as the term predicts, it solely deals with the leasing of vehicles. A business dealing with cars and wishing to grow its assets will seek for a lessor who can supply the demand. The lessor will provide the required resources along with the maintenance
Furthermore, it also offers complete disposal of the asset on the completion of the leasing period. The agreement may vary depending on the company’s policies. It may also include the management of the fleet on behalf of the lessor.
Moreover, the lessor holds the responsibilities of the servicing and maintenance of the fleet. The more established companies with a more extensive fleet, the provider may add the fleet management service in the agreement.
DIMS: The Assets You Can Finance
Generally, a vast number of valuable physical assets can be considered as the potential security for finance but should meet the basic structure of DIMS. DIMS refers to the criteria an asset must have while being offered or demanded.
DIMS is the abbreviated form of any asset that is durable, identifiable, moveable, and saleable, hence DIMS. It acts like a definitive test to help lessors to decide whether an asset is worthy or suitable for leasing or not. It eliminates any potential risks for the lenders in the contract.
Related: Learn more about the meaning behind “assets” and other key terms used in Accounting and Taxation
However, with the vast range of new business ideas and ventures in new markets have shaped the framework and theoretical perception of DIMS. Financers are taking an interest in non-conventional products and are considering them as valuable assets. For example, softwares are now regarded as a valuable resource within the domain of asset finance.
Apart from these criteria, two major categories will help you understand the options available while considering applying for finance. These categories are hard assets and soft assets. In the traditional analysis, the relationship of both these assets is dependent on the cost value of each other.
Most financiers believe that the cost value of soft assets drops when hard assets achieve higher cost value and vice versa. However, with the rapid change in the business market, this may not be the case always, as fund providers have also experienced the direction of these two assets moving in the same direction simultaneously.
Hard Assets are the traditionally perceived physical assets that hold some kind of visual existence. Any heavy machinery, building, processing units, mining equipment are the general hard assets. The Lessor takes these physical assets as highly valuable items and mostly deals in the traditional hard asset financing to eliminate any ambiguity regarding the cost value and the profit generation.
Hard assets are perceived as the definitive and well-grounded form of guarantee for the financing companies. These physical assets present a remarkable cost value even on the edge of the total lifespan or after the usable life period.
These are intangible assets like brands, images, bonds, stocks, information technology, medical devices, and skills. Unlike hard assets at the end of their usable life period, the sale value of these assets reduced to little or none. These kinds of assets tend to have low-security value for the financers because of low resale value. That is why most financers avoid taking risks by providing funds against soft assets.
The financers consider other factors to tackle the issue of risking too much while considering to provide finances against soft assets. One or multiple of these factors may influence the final decision of the lessors regarding the investments. These factors usually comprise of the contemporary market shape and value, the capability of the lessee to pay back, or alternative securities to minimize the risk.
Aside from the traditional and soft assets, businesses can even avail asset finance on second-hand materials, in particular cases where purchasing brand new equipment might be a more significant risk than an old one.
When Would A Business Need Asset Finance
Asset finance is an excellent option for any business in dire need of immediate money infusion without compromising cash flow or the available resources. In the case of having a small business, it might be too risky to purchase costly equipment and machinery. Therefore, it is for the best that you opt for suitable asset finance while having a balanced cash flow.
In some cases, the equipment needed to expand the business may cost the entire life savings, and this may increase psychological pressure. Moreover, it may create a suffocating environment for the business owners to the point that they consider quitting as the only solution.
Instead of risking it all, leasing may contribute to the growth of the business while acquiring proper resources and controllable payback plans. For example, a production unit for natural stone may need the latest model of the natural stone cutting machine. The addition may help the growth of the business; however, to withdraw such lump sum money may cost more than it can generate later.
Related: If you want to expand your business, have a look at our guide on how to grow your business.
Therefore, to counter this problem, asset finance is by the best option where you, at the end of the day, are purchasing the equipment. However, spreading out the cost value will give you the liberty to acquire the latest higher specified model of the cutter to generate more substantial revenues immediately.
Advantages and Disadvantages of Asset Finance
Asset finance offers plenty of advantages to businesses depending on the market. However, every good thing comes with some disadvantages. In this section, we will guide you to both sides of the coin.
- Availing asset finance reduces the enormous upfront costs visibly while simultaneously allowing businesses to acquire expensive equipment.
- Payment plans broken down into monthly/quarterly payments decreases the impact on the cash flow and low-interest rates.
Related: You can know more about how cash flow forecasting might be affecting the growth of your business.
- Fixed instalments are highly manageable and not a burden on the budget.
- In most cases, the hirer holds the responsibilities of insurance and maintenance of high-end equipment.
- The equipment itself works in favour of the lessee. In most agreements, the purchased material is considered as the security of the lease.
- It helps in saving significant working capital rather than wasting on the purchase of equipment. This capital can be used later in other essential purchases for the business.
- Asset finance is more accessible to acquire than any other option available for the businesses as it only needs some kind of valuable asset as a surety.
- It avoids deprecation as it quickly reduces the cost value of assets within a short period. The depreciation can severely impact the business value if it decreases rapidly.
- The first and foremost disadvantage of asset finance would be the deprivation of long term ownership.
- The constant fear of removal of vital equipment to the business, in case of failure to pay back the loan. Failure to pay may end with the confiscation of the asset.
- In some cases, you are just renting the equipment and may never get the ownership of the asset, unless stated otherwise.
- Asset finance is a longer-term solution, and most companies have set the minimum agreed period to 3 years to help the lessor gain more time to recoup the original price of the purchase.
- Unfortunately, the agreement does not cover the accidental damage in the financer’s responsibilities of maintenance and security and therefore results in loss to the lessee.
How to Apply For Asset Finance
The following fragment of the guide will help you construct a successful application.
1. Do extensive research:
Study about asset finance and the available options as much as you can to understand the type of your need. This understanding will later help you decide on what kind of asset-based financing would be preferable for the business.
It is imperative to be clear about the listed finances and assets to avoid any future damage to the business. Double-check the presence of the investments before applying for asset finance.
3. Do not restrict yourself:
While doing the research, make sure you look for an alternative wide range of methods present in the market suitable for your business type like bank loans.
4. Do your homework:
Compare different finance providers and discuss their contracts to avail the best possible opportunity.
5. Read the contract thoroughly:
Read the agreement carefully and consult the respective department for any help to ensure that you and the financiers are on the same page.
6. Prepare for the legal formalities:
Layout the additional details required for the financers as the procedure of asset financing has become much complex. This paperwork may include any details regarding your business, clients, details about asset proposed, bank statements, or any currently existing finance agreement.
Asset finance, no doubt, helps a business grow with leaps and bound while balancing the cash flow. However, proper homework and professional consultation would reduce the chances of any confusion regarding the type of funds you want to avail for the business.
Clear House Accountants are specialist Accountants based in London with extensive experience of working with numerous businesses with diverse backgrounds. The company has always considered the audience’s interest and hence provided comprehensive guides for the budding businessmen. This guide is one of the many initiatives that Clear House Accountants has taken.