Asset finance is funding that businesses can use to pay for the machinery, equipment and vehicles that they need without having to worry about the upfront cost of it all. As a business owner, you could also use asset financing to release cash that’s currently tied up in the value of your assets. Read on to find out more about asset finance, and how it could help your business.
In this guide:
- What is asset finance?
- How can I use asset finance to get new equipment or machinery?
- Hire purchase
- Equipment leasing
- Finance leases and capital leases
- Operating leases and contract hire
- What is asset refinancing?
- Why should I use asset finance?
- What are the advantages of asset finance?
- What are the disadvantages of asset finance?
What is asset finance?
Asset financing can refer to either borrowing of funds used to pay for new equipment for a business, or the use of existing assets or equipment as security against a business loan. The second type of asset financing is also known as refinancing.
Asset financing can be an easy and secure way to gain working capital for your business, providing you with the liquidity necessary to get hold of new equipment. Businesses borrow money in order to pay for new equipment (e.g. machinery or vehicles), and then repay the lender over time.
How can I use asset finance to get new equipment or machinery?
Finding the cash to pay for new equipment or machinery upfront can be unaffordable, making it a risky move that can cause cash flow issues. It may be that your company simply doesn't have the working capital for a large purchase - but equipment finance could be your saving grace.
Hire purchase (HP) is an easy way to purchase a new asset and spread the cost over time. You pay for the HP asset in instalments (normally monthly) and you gain full ownership of the item once the balance is paid off. As the item is paid for monthly, it will appear on your balance sheets, and because you own the item you will also be responsible for all maintenance and insurance costs.
When you lease equipment, the lender buys the asset that you need and proceeds to rent it to you. This means that you have the asset right away, but only need to pay a fraction of the total amount upfront. Normally, you pay the first month's rental cost, and then spread the VAT over the whole period. Once the lease has ended, you have several options. You can either continue leasing the item, buy it outright at an agreed price, or upgrade to a new piece of equipment on a new lease. If you want to follow none of these options, you can also simply return the item.
Leasing is a popular choice for businesses because as well as being able to spread the cost over time, you can adapt your agreement to your company's situation. For instance, if a delivery company leased a van and found at the end of the term that their business was booming, they could then choose to get a larger vehicle, or even multiple vehicles, on a new lease.
Finance leases and capital leases
These two types of leases fall somewhere between equipment leasing and hire purchase. These are longer term leases designed to last for most of the asset's life. You get complete use of the asset and pay for its full value over time, but you don't technically own it. Therefore, it doesn't appear on your balance sheet. This means you can potentially offset rental costs against profit and claim VAT. Depending on your situation, this can be very tax efficient.
Operating leases and contract hire
These two deals are a more familiar form of equipment leasing. An operating lease is a rental agreement that has a set term, where maintenance is normally handled by the lease company rather than you. Much like finance leases, operating leases don't appear on your balance sheet (which potentially can bring some tax benefits). Operating leases can be more affordable, as you don't have to pay for the item's full value.
What is asset refinancing?
This is essentially the process of securing a loan against valuable items that your business owns. If you don't keep up with your loan repayments, then the lender takes your asset away to recoup the money that they're owed. Because you're essentially 'unlocking' cash from your asset, the amount you can borrow is dependent on the value of your assets. Asset-backed lending is occasionally used for debt consolidation.
While some lenders specialise in certain areas of asset refinance, others can finance almost anything that has a resale value. There are a huge variety of asset finance products available, and it can be a flexible arrangement that works for your business' needs. But there are some limitations - normally, the asset secured must be critical to your operations, and must also be removable so that it can be potentially taken away.
Why should I use asset finance?
Many businesses use asset refinancing as a short-term funding solution to help with various bills, such as paying employees or suppliers, or to finance further growth. Asset finance used for equipment purchase can allow a business to grow and increase output while sidestepping initial cashflow issues. Asset financing is a more flexible way to borrow when compare with traditional bank loans. Asset finance can be especially useful for growing businesses and start-ups, as it’s an easy way to produce working capital.
What are the advantages of asset finance?
- Asset refinancing is much easier to obtain than traditional bank loans, because it is secured against what you already have, so banks can rest assured they will get their money back.
- Asset finance repayments tend to be fixed, which makes budgeting and cash flow rates easy to manage.
- Most asset finance agreements have fixed interest rates, so you won’t wind up paying much more than you expected to.
- Failure to pay up will simply result in the loss of assets - there are no further consequences.
What are the disadvantages of asset finance?
- You risk losing important, valuable assets that are required to run your business. For example, if you run a factory and take out asset finance against your machinery, losing this would result in you being unable to do business.
- The value of the assets which a loan is secured against can vary. So, it’s possible you could get a low valuation and therefore a smaller loan than you desire.
- It’s not an effective option for securing long-term funding.