If you’re looking to acquire capital assets for your business, you may find that you’re also seeking appropriate Asset Finance. Here is a quick guide to the principles and types of products in the rapidly growing market for asset based lending in the UK.
What is an asset?
Broadly speaking, when you acquire something for yourself or a business, it will probably be categorised for taxation and accounting purposes under one of two general headings:
- expensed items;
- capital assets.
An expensed item is typically one that you’ll take, in its entirety, as a single entity and financial ‘hit’ onto your profit and loss accounts in a given year. Such acquisitions usually (but not always) involve moderate cost items and things which have no realisable value of any significance – in other words, they can’t be easily sold and they don’t increase the valuation of your company on your balance sheet.
Examples might include consumables, such as stationery supplies, travel costs, contractors’ bills for labour or utilities such as gas and electricity costs etc.
By contrast, capital assets are usually tangible things that can be seen, touched and if necessary disposed of or used as security against business loans etc. Examples might include plant, company vehicles, new buildings and so on.
In terms of accounting, their cost is usually written off over several years in your P&L through a process called “depreciation”. They do have a material effect on your balance sheet’s asset versus liability company valuations.
The taxation (capital allowances) and accounting regulations / implications relating to the capitalisation of assets are complex. If this is all new to you, you should consult your accountant for more information.
From this point on, we’ll say no more on expensed items and concentrate on genuine capital assets and their acquisition.
Acquiring capital assets
Comparatively few companies are in the position of being able to purchase expensive assets outright from their own cash reserves. Even if they can, it’s not necessarily the most effective use of cash in the bank.
Instead, typically they will look at one of several ways of financing the acquisition, including:
- Lease Purchase;
- Hire Purchase;
- Lease Finance.
Each one of these products essentially involves borrowing money, in one asset finance form or another, in order to get hold of the asset required. Each product has advantages and also issues to be considered.
Lease purchase
This is a simple and effective method for acquiring assets. Typically you will:
- agree the terms of a lease with the funds provider;
- you will pay an agreed set amount per month and during that period, the asset remains the property of the lender;
- at the end of the period, the asset legally becomes yours once you have made the final payment;
- typically this is not subject to VAT, as it is legally a form of purchase plan;
- typically you don’t have the right to return the asset early, as you’ve contracted to buy it.
Note that UK accounting regulations require the lease valuation commitment to be capitalised through your balance sheet and treated as an asset (with a debt liability).
An exception to this though is what is called an “operating lease”, as the item doesn’t become legally yours at the end of it.
Hire Purchase
This is probably the most familiar form of asset finance for business.
Typically:
- you select an asset and pay a deposit;
- your HP funding provider retains ownership of the asset;
- you pay them an agreed amount each month for the hire of the asset;
- you may have options to return the asset to them before the end of the term as you are renting (though that might still have cost implications for you);
- at the end of the term, the asset legally becomes yours;
- the HP agreement allows the asset (and its debt liability) to be entered onto the balance sheet and used for write-offs in terms of capital allowances.
Lease finance (or finance leasing)
In reality, this option includes a significant number of potential variations because such lease agreements are sometimes constructed for an individual client on a bespoke basis.
Typically though:
- you agree a lease fee up-front with the funds provider. You may have options to choose whether this is based upon the total asset price or a lesser sum (thereby significantly varying your monthly repayments);
- you’ll pay an agreed monthly amount to lease the asset;
- the asset remains the lenders but at the end of the term, you may have options to pay a final balloon payment and then to continue renting the asset for a nominal sum or to sell it to a third party for profit. You’re essentially buying a share of the risk/reward from the funding company;
- typically the payments will be subject to VAT but proportions of this can be recovered.
The treatment of lease finance in accounting terms can be complicated, though in principle it is entered as a balance sheet item again.
Choosing
The above three generic solutions may suit some companies better than others. Much will depend upon your company’s legal status and its existing finances.
Acceptance criteria will apply to all applications. Typically they would all result in financial penalties and/or the legal seizure of the asset if you fail to maintain payments in line with the agreement.
Given the complexity of some of the issues associated with making your decision relating to asset finance for business, it’s highly advisable to consult a very experienced provider for an initial consultation and to take the advice of your accountant in advance before making a commitment.