If you’re on the way to starting your business – or you’re up and running but don’t yet own any business assets – you may not yet know much about asset finance.
That’s about to change.
In this article I’ll cover what asset finance is, where to get it and the pros and cons, as well as taking a look at the different types of asset finance you can choose from.
Let’s start with the basics.
As a small business owner, asset financing could be a really useful tool. You can use it to help you get the assets you need to run or grow your business, or to keep up to date with evolving technology.
But what, you might be thinking, do I mean by ‘asset’?
In a business context, an asset is any possession you’d record on your balance sheet. It could be a valuable resource like a building, a vehicle or a piece of equipment or technology. Or it could be something that fluctuates, like the stock in your warehouse or the cash in your bank account.
But when it comes to asset finance, I’m referring to the type of assets that cost a fair bit of money and have a reasonable life span – so cars, machinery, IT and equipment.
Without these assets you may not be able to operate your business or offer the same level of service as your competitors. They are a vital investment – but it can be hard to find the money to pay for them up front.
That’s where asset finance comes in.
What exactly is asset finance?
Asset finance is a category of business loans that:
Are secured on the asset you’re financing
Allow you to spread the cost of the asset over its expected lifespan.
Here’s an example of asset finance in action:
You need several computers to operate your business, and you’ll probably need to upgrade them every two or three years. The cost of the new equipment is $10,000 but you use asset financing to spread the cost over two years, repaying a manageable $470 a month including interest, rather than $10,000 as an up-front lump sum. At the end of the two years you refresh your equipment, taking a new financing contact to spread the cost once again.
Asset finance has some advantages over other types of business loan, but I’m afraid there are (inevitably!) some pitfalls too.
One more thing.
Like any form of business finance, using asset finance can put a financial strain on your business. Unless the asset you want to buy will you help generate enough extra profits (not turnover!) to cover your repayments, it could plunge you into a cash flow crisis.
I thoroughly recommend that you prepare a business case for buying the asset, including cash flow projections, before you start looking for finance. If in doubt, get some professional financial advice about whether it’s the right move for your business at this time.
Ok, so you’ve run the numbers and decided asset finance could be for you.
Where and how to get asset finance?
If you decide to apply for asset finance, you’ll need to find the right lender and product. You could approach your high street bank, or look to the alternative finance market for a lender. You’ll also find that many vendors (such as car dealers) will offer you asset finance.
Taking out finance through the vendor can be super convenient, but it’s unlikely to be your cheapest option. My advice is, shop around and explore your options before you commit. Be sure to find out about all the costs and charges (including any hidden ones), and the terms and conditions too. Watch out for early termination fees, and find out exactly what would happen if you had to default on a payment.
Once you apply, your lender will assess your application based on the ‘five Cs of business credit’, just as they would with any other form of business finance. Mostly, they’ll look at:
The value and lifespan of the asset you’re buying (collateral)
Your credit history and financial position (character and capital)
Your capacity to repay the loan (based on your income and expenditure)
If they like what they see they’ll then set the conditions of the loan to compensate them fully for the level of risk they decide you present.
They’ll also need the answers to some important questions:
- How much capital are you going to need?
- How long will you need this equipment for?
- How often will you need to upgrade it?
- Do you want to own the asset at the end of the contract?
The answers will help you decide what type of asset finance to apply for.
Here are some of your options:
Five types of asset finance
1. Commercial hire purchase
With hire purchase finance, the lender will buy the asset from the vendor and then sell it on to you over a period of time. You’ll make a series of regular payments and they’ll automatically transfer ownership of the asset to you once you make the final payment. At that point you can sell it, or continue to use it in your business.
You and the lender will agree upon the terms up front – including the loan period, how much deposit you’ll pay, and whether you’ll pay the entire loan off in equal instalments or make a larger final payment (known as a balloon payment).
A word of warning here – if you opt for a balloon payment your monthly payments will be lower, which can make the finance seem more affordable, but overall you’ll pay more, because you’ll be paying interest on a larger balance for longer. On the plus side, though, if you’re planning to sell the asset at the end of the contract, you may be able to use the proceeds to cover the cost of the balloon.
You need to be aware that you probably won’t be able to get out of hire purchase agreement early without paying a hefty early termination fee, which could be a problem if you no longer need (or can’t afford) the asset. And if you don’t keep up your repayments, the finance company may sell the asset (which still belongs to them, remember) to cover their costs.
The tax treatment of a hire purchase agreement can be complex. Even though you won’t legally own the asset you may be able to claim input GST credits and a tax deduction for deprecation, because the Australian Tax Office treats hire purchase contracts as ‘notional sale and loan transactions’.
2. Operating lease
An operating lease is great for assets that you might want to upgrade regularly, like vehicles and IT. It’s a useful option if you know you won’t need the equipment for the whole of its lifespan, and don’t want to get stuck with assets that have become obsolete.
The most common types of operating lease are:
- Fleet operating asset lease, for business vehicles
- Technology rentals, for IT equipment
Like with a hire purchase agreement, the finance company will buy the asset from the vendor on your behalf, and will then rent it to you in exchange for regular payments.
Unlike hire purchase, ownership of the asset will never pass to you, so you won’t have anything to show for your money at the end of the contract. That’s great if you just want to upgrade and move on, and don’t want the hassle of disposing of the asset – but it does mean you’ll be forced to take out more finance and replace the asset if you still need it.
Some operating leases include service and maintenance, so you won’t even have to worry about that – but you can expect to pay dearly for this extra perk.
Since you won’t own the asset, you’ll record your lease payments through your profit and loss account rather than your balance sheet, which can help your debt ratios and make it easier to access other business finance.
In most cases you’ll be able to get a tax deduction for your lease payments.
3. Finance lease
The main difference between an operating lease and a finance lease is what happens at the end of the contract. With a finance lease you’ll have the option to buy the asset at the end, and you also have the chance to make a profit on that purchase.
Well, with a finance lease you’ll pay close to the full value of the asset (plus interest of course) over the course of your contract (which can make it a pretty expensive option). Your lender will decide at the start of the contract how much they expect the asset to be worth by the end, and your final payment will be based on that anticipated value.
If the asset turns out to be worth more when the contract ends, you’ll only have to pay the amount agreed in advance, and you can then sell the asset for its full, higher value. But, if the market value is lower, then your business will have to take the hit.
Of course, If you want to keep using the asset at that point, it won’t really matter how much it’s worth!
Even though the asset doesn’t belong to you until the end of a finance lease you’ll have to show the lease on your balance sheet as if it were a business loan – as well as recording the rental payments through your profit and loss account. In most cases you’ll be able to claim a tax deduction for your lease payments.
4. Novated lease
Novated leases can be a valuable staff incentive to help you attract good people to your team, and maintain them. They let you add something, such as a car, to your employees’ salary packages.
Be wary though – the lender may dictate where you can go to buy the asset, which can restrict your options or even mean you don’t get the best possible price.
As with other types of lease, your third-party lender will buy and own the vehicle, but you and your employee will sign a novation agreement saying that you will share financial responsibility for it.
Once you’ve all signed the novation agreement, you’ll deduct the lease payments from your employee’s salary. If they leave your company during the contract they’ll have to take the lease over and continue payments themselves. At the end of the lease, the employee will usually have the option to buy the vehicle.
Novated leases generally last between 12 months and five years, and there are strict ATO guidelines on how you need to treat them. They’re usually of most interest to employees who fall into a high tax bracket.
5. Chattel mortgage
A chattel mortgage is a pretty straightforward business loan secured on the asset you’re buying. If you opt for this type of finance you’ll borrow funds to buy the asset, so you’ll own it from the outset. The term of the loan will be tied to the life of the asset – up to five years is common, but it could be much longer (for example for a piece of farm machinery with, say a 15-year lifespan).
You’ll usually be able to negotiate a repayment schedule to suit your income patterns, so you can structure the payments to leave you with plenty of working capital during the times of year when you don’t expect to generate as much profit.
You can expect to pay a lower interest rate on a chattel mortgage than for a hire purchase or lease agreement. Since you’ll own the asset you’ll be able to list it on your balance sheet and claim tax deductions for depreciation – but you’ll also have to record the mortgage on your balance sheet, which will affect your debt ratios.
You may also find it slower to arrange a chattel mortgage than hire purchase or lease finance, and you could have to plough through more paperwork, which can make it less appealing.
Asset finance can be a great way to help fund expensive items for your business and take away the stress of trying to come up with a substantial amount of money in one go – especially if you’re just starting up.
It allows you to spread the cost of the asset over its lifespan, making affordable monthly payments instead of a large up-front investment – and since you’ll be using the asset itself as security it can be easier to access than some other forms of business finance.
There are several different types of asset finance, so you should be able to find one that suits your business needs, whether you want to own the asset long-term, or simply use it for a period of time and then upgrade it.
But asset finance can be complicated and expensive, so it’s really important that you get a full, clear picture of all the costs and conditions before you sign up. And like any form of finance, it can put a strain on your financial position, so you need to be sure that the asset you’re buying will help you generate enough return to cover those extra costs.
Before you make any decisions I strongly recommend that you speak to an expert to see what will to work best for you. If you don’t yet have an independent advisor, JustBusiness is a great place to start looking for one.
Have you ever used asset financing? If so, was it successful? Please share your experiences in the comments below.