Types of finance
Hire Purchase is a repayment contract where you ultimately own the asset at the end of your agreement.
Benefits of Hire Purchase
- Flexible funding – repayments can be structured to suit your cash flow.
- Fixed or Variable Rate options may be offered.
- Tax advantages – normally you can claim capital allowances and the interest element of monthly repayments is allowable against taxable profits.
- Ownership – the asset can be shown on your balance sheet.
A Finance Lease is a rental agreement that allows you to use an asset without having the risks associated with ownership. The Lessor retains title to the asset and at the end of the primary period of the leasing agreement you have the option of extending your rental agreement into a secondary period. Lease payments are subject to VAT, but the customer doesn’t pay the purchase VAT.
Benefits of Finance Lease
- Lease rentals can usually be offset against taxable profit (special rules apply to cars).
- Flexible repayment structure – rentals can be tailored to suit your cash flow.
- Shown on balance sheet.
This is a rental agreement which differs from a finance lease in that the primary period rentals do not cover all of the capital cost. Contracts normally include a usage clause.
Benefits of Operating Lease
- Improved cash flow as payments are lower than on equivalent Hire Purchase or Finance Lease agreements.
- Tax relief is usually available in respect of lease rentals (special rules apply to cars).
- VAT is reclaimable on rentals.
- No residual risks and no disposal worries.
Around 400,000 UK businesses use equipment/asset finance.
What type of equipment finance is likely to be most suitable?
- If a business has lots of cash available and is not operating on an overdraft, it is usually better to purchase outright.
- If the business wishes to own the equipment and doesn’t have lots of cash, then Hire Purchase (HP) – sometimes called Lease Purchase – is usually the best option. HP always includes the right to purchase, usually for a nominal extra payment.
- If the business only wishes to use the equipment (rent/hire) then a lease is usually the best option. In the UK a lease cannot provide an option to purchase the equipment. There are two main types of lease: A lease for a fixed period with an option to extend the agreement or a lease for a minimum period that automatically extends at the same monthly cost.
Your company tax position can change things. For example a business that can’t afford to pay all the VAT upfront (e.g. because it can’t reclaim the VAT) or that can’t offset capital allowances against its taxable profits, might find it best to Lease not HP – especially if it is not important to actually own the equipment.
How long should an agreement last?
Normal finance periods range from two years to five years. Shorter agreements will obviously cost you more on a per-period basis, but will then allow you to make more frequent equipment upgrades without penalty. Longer periods will cost you less each month, but could lead to a settlement figure, if you then want to change the equipment earlier than expected.
What happens if there’s a problem?
Problems are rare but can occur. If there’s a problem with the equipment the finance company may not be able to assist. So make sure you choose the equipment you want from a reliable supplier. Your statutory rights persist. In general an equipment finance agreement has to be paid regardless of any problem with the equipment. For other problems, such as billing difficulties, contact the finance company.