The question of asset financing often comes up when it’s time for a business to invest in new equipment, software or vehicles – larger outgoings that can put a strain on cash flow.
However, it can be tricky for managers and owners to determine whether they would be better off paying more in interest charges to spread their payments or covering the cost outright and juggling their cash flow around it.
Let’s look at all the pros and cons, various financing methods, and how to make informed decisions that will benefit your business.
What Is Asset Finance?
The first area to clarify is that there are multiple types of asset finance, and it can be well worth shopping around or comparing the total repayment costs of one product vs. another. Here are a few potential scenarios that are commonly offered to business clients making larger purchases:
Hire purchase: this financing agreement means the business ‘hires’ the asset from the lender, paying them in regular instalments to cover the original purchase value, plus interest. At the end of the term, the company owns the asset in full – although some hire purchase contracts involve paying interest only and then having the option of buying the asset at a discounted rate.
Equipment leases: some suppliers offer lease terms similar to hire purchase but without implied asset ownership. When the lease term ends, the business might be offered the option of buying the asset, trading it in for an upgrade, or extending the lease term.
Finance leases: this type of lease means the business owns the asset but has to maintain monthly repayments – more like a loan against the asset's value, which can be repossessed if they default.
Asset refinancing: companies can put forward existing business assets as security against a loan value, using the borrowing to purchase another asset outright. The rates payable can be lower than standard bank loans since the lender has the reassurance of being able to repossess the asset used as collateral if the business does not keep up with the repayments.
It’s also important to understand that, irrespective of the financing deal offered, you might be able to finance an investment through the supplier, their third-party financing company, or an independent lender.
Why Use Asset Finance to Cover the Cost of Business Purchases?
Many business owners assume asset finance isn't ideal since this means that the overall cost of the investment will be higher when they have accounted for interest charges and other fees such as set-up costs or asset valuations.
However, financing can be invaluable when an organisation doesn't have the cash available to pay for a new piece of equipment, or a new vehicle, upfront.
If an investment would make a significant difference to the business's capacity or productivity, this could easily offset the interest charges and help a company upscale and attract new customers, which may have been unachievable without any support with the costs of financing.
Positive Aspects of Asset Financing
Here are a few of the positives:
Preserving cash flow: if the company does not have the cash reserves to cover the cost of buying a big-ticket item, it may benefit from using asset finance rather than putting its liquidity at risk.
Clear budgeting: most asset finance agreements have set repayments over a fixed period, meaning businesses can budget ahead and spread their costs wisely.
Expedited asset investments: rather than waiting to accumulate sufficient surplus cash to buy a new asset, the business can move ahead immediately, which may be beneficial.
Improved credit scoring: although many asset finance products will rely on the business passing affordability and credit scoring assessments, maintaining regular payments can improve the organisation's creditworthiness without utilising limited lines of credit available through their bank.
Much depends on what you wish to buy and how important it is to the business. For example, if an HGV has broken down and a replacement is imperative to making on-time deliveries, forgoing asset finance and deciding not to purchase a new vehicle could be disastrous, impacting service levels, the company's reputation, and potentially losing clients.
However, if an advanced or specialist asset is a speculative investment, and isn’t crucial to the business, it might be better to weigh up the costs and decide whether it is a viable way forward.
Drawbacks of Using Business Asset Finance
We've discussed the higher overall costs and recommend comparing the total repayments carefully, ensuring you don't sign up for an asset financing agreement that is exorbitantly expensive and sometimes costs more than the end value of the asset.
Some of the other potential negatives to consider include:
Risks of penalties: if there is any doubt that the business will be able to make the repayments on time, asset finance may not be advisable. Failing to pay could mean having assets or collateral repossessed and more serious financial outcomes if the lender or supplier raises a legal dispute or claim.
Asset depreciation: depending on the asset finance term, sometimes an asset can drop in value due to natural depreciation far faster than the business repays the borrowing.
Limited flexibility: while sometimes a business may be permitted to sell an asset and repay the outstanding financing before the term ends, this isn't always the case. Companies may find they are locked into the agreement and can only upgrade assets once the loan is repaid in full.
Businesses should also assess their obligations, where a lender usually requires them to insure financed assets to a minimum level, cover maintenance and servicing costs, and comply with other conditions, such as not being permitted to customise or modify the asset while it is being repaid.
We hope these insights clarify the pros and cons of asset financing when it is advantageous and the possible pitfalls to be aware of.
Should you need any further guidance about whether asset financing is right for your business or help comparing asset financing solutions, please contact the SAS Accounting team at any time.
