Study Notes: Business Finance & Accounting

Advantages of using leasing & HP as a source of finance

Introduction

As we discussed in our introduction to asset finance, the use of hire purchase or leasing is a popular method of funding the acquisition of capital assets. However, these methods are not necessarily suitable for every business or for every asset purchase. There are a number of considerations to be made, as described below:

Certainty

One important advantage is that a hire purchase or leasing agreement is a medium term funding facility, which cannot be withdrawn, provided the business makes the payments as they fall due.

The uncertainty that may be associated with alternative funding facilities such as overdrafts, which are repayable on demand, is removed.

However, it should be borne in mind that both hire purchase and leasing agreements are long term commitments. It may not be possible, or could prove costly, to terminate them early.

Budgeting

The regular nature of the hire purchase or lease payments (which are also usually of fixed amounts as well) helps a business to forecast cash flow. The business is able to compare the payments with the expected revenue and profits generated by the use of the asset.

Fixed Rate Finance

In most cases the payments are fixed throughout the hire purchase or lease agreement, so a business will know at the beginning of the agreement what their repayments will be. This can be beneficial in times of low, stable or rising interest rates but may appear expensive if interest rates are falling.

On some agreements, such as those for a longer term, the finance company may offer the option of variable rate agreements. In such cases, rentals or installments will vary with current interest rates; hence it may be more difficult to budget for the level of payment.

The Effect Of Security

Under both hire purchase and leasing, the finance company retains legal ownership of the equipment, at least until the end of the agreement. This normally gives the finance company better security than lenders of other types of loan or overdraft facilities. The finance company may therefore be able to offer better terms.

The decision to provide finance to a small or medium sized business depends on that business' credit standing and potential. Because the finance company has security in the equipment, it could tip the balance in favour of a positive credit decision.

Maximum Finance

Hire purchase and leasing could provide finance for the entire cost of the equipment. There may however, be a need to put down a deposit for hire purchase or to make one or more payments in advance under a lease. It may be possible for the business to 'trade-in' other assets which they own, as a means of raising the deposit.

Tax Advantages

Hire purchase and leasing give the business the choice of how to take advantage of capital allowances.

If the business is profitable, it can claim its own capital allowances through hire purchase or outright purchase.

If it is not in a tax paying position or pays corporation tax at the small companies rate, then a lease could be more beneficial to the business. The leasing company will claim the capital allowances and pass the benefits on to the business by way of reduced rentals.