Running a business involves numerous financial decisions, including how to acquire equipment, vehicles and machinery in a cost-effective manner.
The hefty upfront costs associated with purchasing these items can often pose a challenge. Fortunately, there’s a financial lifeline known as asset finance and leasing that not only eases the burden on your cashflow but can also open doors to growth opportunities.
In this blog, we’ll explore the ins and outs of both asset finance and leasing, shedding light on how they work and the various options available.
Understanding asset finance and leasing
Asset finance allows businesses to use equipment without depleting their cash reserves. The mechanics are straightforward: a business uses its existing assets as collateral for a new loan.
This arrangement allows for manageable payments in instalments over time, sparing you from the financial strain of making a lump sum payment.
Depending on the specific asset finance option chosen, you may either own the item outright after completing payments or return it to the provider, offering a level of flexibility that resonates with many business owners.
Types of asset finance and leasing
Asset finance comes in different flavours, but three main options dominate the landscape:
- Hire purchase: This option enables you to pay for an asset in instalments, with ownership transferring to you upon completing payments. However, be prepared for the responsibility of maintaining the asset.
- Finance leasing: In this scenario, a leasing firm purchases the asset on your behalf and rents it to you. After the agreement period, you can extend the rental, return the equipment, or even sell it on behalf of the leasing firm.
- Contract hire: Tailored specifically for vehicles, this option involves making regular payments to a provider who procures and maintains the vehicles for you. Once the lease period ends, the provider assumes responsibility for the vehicles.
Is leasing an option?
Asset leasing involves acquiring the temporary use of machinery, equipment or vehicles rather than outright ownership. The two primary lease types, operating leases and finance leases, differ in their accounting treatment.
In an operating lease, the lessee (the party leasing the asset) avoids assuming ownership risks and rewards, essentially entering into a rental agreement. Lease payments are treated as operating expenses, and the leased asset is typically excluded from the lessee’s balance sheet.
On the other hand, a finance lease sees the lessee taking on ownership risks and rewards, often using the lease for asset acquisition financing.
Here, the leased asset is recognised on the lessee’s balance sheet as both an asset and a liability. Depreciation and interest on the lease liability impact the income statement.
The accounting landscape shifted with the introduction of international financial reporting standard 16 (IFRS 16) in January 2019. Under IFRS 16, operating leases must now be recognised on the balance sheet, aligning them with finance leases for a more accurate financial representation.
IFRS 16 marks a revolutionary change in lease accounting, implementing the ‘right-of-use’ model. If a company controls or has the right to use a leased asset, it must be recognised on the balance sheet, eliminating the previous practice of keeping significant financial liabilities off-balance sheet.
This standardisation aims to bring transparency to companies’ lease assets and liabilities.
As companies navigate these changes, it’s crucial to stay updated on accounting standards and consult the latest guidance for accurate and current information.
The shift toward the ‘right-of-use’ model reflects a comprehensive effort to provide a standardised and transparent approach to reporting leased assets, fostering financial clarity in the business world.
Looking ahead: Pros and cons of asset-based finance
While asset finance is a cost-effective solution for many businesses, it’s crucial to weigh the pros and cons before making a decision.
In an upcoming blog, we’ll provide a comprehensive guide to navigating asset-based finance, delving deeper into its advantages and potential pitfalls.
At Cottons, we specialise in partnering with SMEs and startups to achieve their growth goals. If you’re considering asset finance and leasing or have questions about the best financing route for your business, reach out to us.
We’re here to help you make informed decisions for a prosperous future.