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Different types of business asset finance
One of the great things about business asset finance is that there are many different types, so you’re bound to find a service that suits your particular situation. New businesses might turn to asset finance because they lack the funds to acquire a necessary asset. However, this isn’t just a service that benefits new businesses.
More established businesses with lots of assets might find themselves needing access to money to grow. They have the option to refinance them to free up necessary funds. They may also use their assets as security on a loan.
Maybe you’ve started to research asset financing but you’re overwhelmed by all the many kinds available. You’re unsure whether you need hire purchase, finance leasing, equipment leasing, operating leasing, asset refinancing, or contract hire.
That’s understandable. For newcomers to the world of business asset finance, this can be confusing. The service you choose must be the most helpful one when it comes to achieving your business objectives.
Read on to learn more about each kind and you’ll soon have a clearer idea of which asset finance service is best suited to your needs.
Hire purchase (or lease purchase)
If you’re looking to invest in an expensive asset, for example, a business vehicle, then you might consider using a hire purchase scheme to do so. This is ideal for smaller businesses that can’t afford to pay for their asset outright. They can enjoy the use of the asset despite not having the capital to buy it.
How it works is that a business can approach an asset finance provider to purchase an asset on their behalf. Then, the business pays the provider to hire the asset from them.
Usually, when companies invest in an asset, it’s because it will help their business grow. Using asset finance, a company can pursue this growth without requiring vast amounts of money in the bank. The rental fee is far more financially manageable than paying for the asset upfront.
A contract is signed between the provider and the business which determines the number of payments due, the amount of each payment, and the length of the lease.
Every asset finance provider has different terms, but these contracts generally require a larger payment to begin with, followed by a series of small payments. These continue for an agreed period.
There may be a clause in the contract that allows the business to ultimately buy the asset from the finance provider. The price at this point tends to be lower since the asset is already used.
This service makes the eventual acquisition of an asset economically easier. By the time the business is offered the opportunity to purchase it from their provider, they’ve had additional time to grow their business through the use of the asset. This is why it’s considered a convenient option by many businesses.
You’re probably familiar with the concept of leasing property, for example, you may already lease an office for your business. However, a finance lease differs from a typical rental agreement.
When it comes to asset finance, a finance lease permits a business to use an asset owned by the lender. In this way, it’s just like a hire purchase scheme.
What defines this kind of asset finance is that the business obtains this lease based on an agreement that they will own the asset before the lease expires. That means before the end of the contract, ownership of the asset will transfer from the asset finance provider to the business itself.
As well as transferring the asset itself, any risks and rewards related to the asset are transferred. What does this mean? That whether the asset appreciates or depreciates, it’s still ultimately going to be the property of the company leasing it.
Many businesses choose this agreement because it allows them to eventually own the asset. They can spread payments out over a period of time and buy it at a bargain price when the lease finally ends.
It’s easy to see how this is a good deal for the provider too. They receive monthly payments for the asset, earning them a profit, and they know that they are guaranteed a buyer at the end of the contract.
Terms vary between providers; however, a typical finance lease requires the lease term to be at least 75% of the asset’s economic life. The lease payments usually make up at least 90% of the asset’s overall value.
As you can see, this is a very different agreement from your typical office rental. After all, you don’t end up with ownership of the office at the end of your leasing contract.
Equipment leasing may be especially useful for small businesses that need to use certain equipment to build and grow their business. However, this service isn’t exclusively for small businesses.
When we hear “equipment,” we may think relatively small: a car or a computer, for example. In fact, some asset finance services permit oil and gas companies to buy assets like railcars or barges. This can also be used by rail companies to build tracks or by mining companies to construct.
Clearly, equipment leasing is useful for a range of projects, whether small or much larger scale. But what does an equipment leasing contract look like? Instead of simply obtaining a loan to purchase equipment, businesses can instead ask a lender to buy it and lease it to them at an agreed rate.
Usually, equipment leases come at a fixed rate. They’re also fixed term, and at the end of the contract, there’s no obligation for the company to buy the asset. This is a good option for an asset that’s only required on a short-term basis.
It could be a money-saving solution for a business that needs to use assets that are likely to soon become obsolete. Rather than invest in owning an item with depreciating value, companies can pay a regular fee to lease it for as long as it’s useful to them.
Because the finance company will retain ownership of the asset, they’ll be more interested in the specifics of your equipment. Some asset finance companies specialise in specific types of equipment.
It makes sense for business owners to approach finance providers with experience in their industry. This may make it more likely that their application will be approved.
Businesses that want to use an asset with short-term value will tend toward equipment leasing agreements. Businesses that want to lease equipment with the long-term objective to own it will pursue a finance lease.
What about when the asset will continue to have residual value after the leasing agreement, but the business leasing it doesn’t necessarily plan to buy it? This is where operating leasing comes in.
A common example of operating leasing is the contract hire of vehicles. Drivers may hire vehicles to perform their work, but the asset finance provider ultimately owns them.
An operating lease is different from a finance lease because it doesn’t transfer the risks and rewards of ownership onto the business leasing the item. The leasing period is less than the economic life of the asset, so the lender can expect to resell the item when the lease ends.
The amount that the item is expected to sell for at the end of the agreement is known as the residual value. This is estimated when the contract is agreed upon, and if the asset does not meet this value at the end of the agreement, this loss is experienced by the asset finance provider.
Because the lender has to take a risk on this kind of agreement, the assets it is used to lease tend to be those with a relatively static value. Equipment like aircraft or machinery has almost guaranteed value, so operating leasing is more likely to be an option for those assets.
If you’re considering an operating lease, it’s important to check whether you or the finance provider is the responsible party when it comes to the maintenance of the asset.
Sometimes, a business has lots of assets. What they lack is working capital. Asset refinancing is a way for a business to use its pre-existing assets to free up some funds. This is an especially good option for any business that has struggled to secure a typical loan due to the strict criteria enforced by banks.
Of course, to access asset refinancing, certain criteria must also be met. For example, in most cases, the business must own the asset in question outright. An asset that is subject to another asset finance agreement can’t generally be used in this kind.
The way asset refinancing works is that the business transfers ownership of an asset to a finance provider at an agreed rate. The business then buys back that asset through regular payments. When a business needs funds fast, this is one way to release the equity contained in their assets.
During the application process, lenders will ask for information about the asset to determine its value. Usually, a surveyor is asked to objectively evaluate the asset. This will dictate how much the business has to pay the finance provider to regain ownership of its asset.
This value also determines how much money the business receives at the point of refinancing its asset. The asset being eventually transferred back to the business depends on monthly payments being met. If a business is unable to make payments, it will lose ownership of its asset permanently.
When assets are refinanced, the same terms as a secured loan apply, and the loan is secured against the asset itself. This often makes it easier for businesses to obtain funds through asset refinancing instead of applying for a traditional business loan at the bank.
If your business requires the use of vehicles, you’re probably wondering whether it’s in your best interest to lease or buy them. Should you choose to lease them, contract hire is potentially the most appropriate asset finance agreement for you. It’s commonly used for vehicles.
The advantages of leasing vehicles are obvious: you don’t have to pay a lump sum upfront, monthly payments are fixed, and you don’t have to own assets that are depreciating in value.
The term “contract hire” refers to an agreement between a company and a finance provider to lease a vehicle for a set period at a fixed cost. The contract is likely to impose mileage limits since the vehicle remains the property of the lender.
In a contract hire agreement, the lender assumes all the risks and rewards associated with the vehicle. The lender will take the estimated residual value of the vehicle into consideration while determining the terms of your agreement.
Contract hire agreements can be very attractive to businesses because maintenance and servicing costs are usually covered by the finance provider, or they are asked to pay a fixed monthly maintenance fee. When a company owns its fleet of vehicles, maintenance expenses can be substantial and unpredictable.
As you undoubtedly know, every business is restricted in how much it can borrow. If businesses want to avoid pushing this limit by taking out a loan to buy their vehicles, they can use contract hire instead: it’s an off-balance-sheet financing agreement.
Terms and conditions vary between asset finance providers, so it makes sense to compare different offers. If you choose to end your contract hire agreement earlier than expected, a fee is usually imposed.
Different types of assets that can be financed
Three things define an asset. They are items with economic value; they can be bought, sold, and possessed, and they can be used to generate economic benefits.
The value of an asset depends on how easily it can be converted into money, whether they are tangible or intangible, and how it can be used.
- A current asset is one that can easily be converted into money. They’re also known as liquid assets. This category includes inventory or office supplies, for example, which could technically be covered by an asset finance agreement.
- Fixed assets cannot be converted into money as quickly as current assets can. This category might include land, equipment, or trademarks. Asset finance arrangements are often taken out on this kind of asset.
- Assets may be tangible or intangible. Tangible assets are physical, whereas intangible assets are not. Asset finance is more commonly used for tangible assets; however, there are providers who specialise in intangible assets such as copyrights.
- A business might choose to take out asset finance on operating assets: ones that are required in the daily operation of their business. This is especially true for small businesses that are just starting and need specific equipment to grow.
Different providers are willing to finance specific assets. That’s why many businesses seek asset finance providers that specialise in their particular industry.
The definition of an asset is very broad, so businesses may possess more assets than they realise. It’s worth exploring the options available. Vehicles and equipment may be some of the best-known uses of asset finance, but they certainly aren’t the only assets that can be used in this type of agreement.
Tangible assets are also referred to as hard assets. They are defined by the fact that they have fundamental value. Commodities and real estate are considered hard assets, and they can be used by businesses for a range of purposes; for example, to improve production or increase revenue.
Hard assets are usually fixed too. That means they’re long-term assets; they have an economic life of more than one year. You’ll find these assets classified as property, plant, and equipment on a business’s balance sheet.
Hard assets can be short-term assets too, though. Some hard assets are current assets with an economic life of less than a year. One example would be inventory. Raw materials could be considered short-term hard assets.
To obtain hard assets, businesses require capital to invest. They can be expensive, requiring a large lump sum to buy outright. They are part of a business’s long-term funding decision-making. Because new businesses often lack the capital to purchase necessary hard assets, they access asset financing.
Other ways businesses might access funds to obtain assets include business loans or issuing new shares of stock. Businesses buy hard assets that they believe will help them grow, therefore they will be worth the initial investment required to obtain them.
Because hard assets have fundamental value, they are easier to use in asset financing arrangements. Providers are more likely to finance this type of asset.
Soft assets are harder to quantify and assign a value to than hard assets. They can include human resources such as people and their skills and knowledge. Intangible assets like reputation and trademarks are also considered soft assets.
Because they don’t have an objective value, they don’t usually feature in a business’s accounting. They aren’t considered part of a business’s inventory. They aren’t items that could be easily resold, which makes them more difficult to finance using asset financing.
This doesn’t mean it’s impossible, however. There are asset finance providers who specialise in specific soft assets. The likelihood of securing this type of financing depends on the sector that the business belongs to. Some sectors are considered high risk, which makes them less desirable to providers.
Some tangible assets are considered soft when they won’t have value by the end of their lease. Consider assets such as office furniture or computer hardware. Although they have value, it’s short-term. They are likely to become unusable or obsolete by the end of the asset finance agreement.
One way a business might acquire asset financing for soft assets is to provide additional security such as a deposit or using another asset to secure the loan. It is more difficult to find a provider willing to finance this type of asset.