In simple terms, asset finance is used by businesses to attain equipment of a high value they require to achieve growth. In practice, this means (also known as machinery finance or equipment finance) an asset finance provider will purchase equipment outright on behalf of a business, in the turn the business agrees to lease or rent the equipment for a certain period.
The business then makes regular use payments over the agreed period (usually the usable life of the equipment). The financier also typically agrees to insure and maintain the asset over its lifespan. The majority of asset finance providers/brokers can provide / source between £1,000 to £10,000,000 in financing. Asset finance is typically provided between 1 and 7 years (in rare cases longer for extremely high-value assets), this period allows the finance company enough time to recoup the purchase cost of the equipment plus interest.
The length of financing is determined by the usable life of the asset and how long the financier is willing to allow for full payment to take place (usually calculated on the acceptable level of risk and profit/interest allowed by a particular provider). Additionally, to gain asset financing, it is extremely important to a financier when considering approving an asset financing contract that a business can demonstrate its ability to make the regular payments agreed to (the payments are affordable for the business).
Types of Asset Finance
Principally there are 3 different types of asset finance available to businesses. This includes Hire Purchase, Finance Lease and Operating Lease (there are also several other types of more specialised asset finance). As well as the three primary types of asset finance, there a range of more specialised asset financing options, some are variations designed to offer more flexibility of existing asset finance types, some are designed to finance specific types of assets or sectors. We’ve detailed the most common these types below.
Hire Purchase
With Hire Purchase, the business agrees to lease an asset from an asset finance provider, who in turn agrees to purchase and provide the asset for the business to lease. During the leasing period, the asset is owned by the provider (who is responsible for insurance and maintenance), and the business makes regular payments to the provider for the use of this asset. At the end of the leasing period, the business takes ownership of the asset.
A Hire purchase agreement will typically allow a business to structure the payments flexibly to minimise cash flow impact from payments. For instance; A business could reduce the monthly/quarterly rental payment by agreeing on a large final payment at the end of the leasing period (known as a balloon payment, it takes into account the residual value of the asset at the end of the leasing period).
Additionally, from an accounting point of view, during the lease period, the asset will be listed on the business’s balance sheet as both an asset and a liability, with the leasing cost (rental) being shown as an expense of the business and passed through the P&L (Profit and Loss) account.
Finance Lease
With a Finance Lease, a business and an asset financing provider agree that the provider will purchase an asset outright for the business, who in turn agrees to lease the asset over a fixed period, with the business providing a regular payment for the use of the asset over this period. At the end of the leasing period, the provider sells the asset with the business and provider generally both benefiting the from the sale of the asset (i.e. the business receives a reduction in final payment or a cash payout).
A Finance Lease differs to higher purchase as, during the leasing period, the business is given full ownership and responsibility for the asset when the lease begins, meaning they’re fully responsible for the asset (insurance, maintenance costs…). Additionally, there is never any intention or mechanism that allows the business leasing to gain ownership after the leasing period has ended, even at the point where the asset has reached the end of its usable life (the intention is always to sell unless the agreement is modified).
Operating Lease
An Operating Lease is most suitable for businesses where they will not need the asset for the entirety of its working life. It is a more specialised version of a Finance Lease designed for businesses which as per above do not seek the asset for its working life and require the asset to service a new or existing contract the business has.
Operating leases offer benefit over Finance Leasing in the situation above, as the base rental costs are calculated on the value of the asset over the period you’ve agreed to lease it for (your rental cost is not based on the full value of the asset, significantly reducing the cost to the business). Operating Leases also allow businesses to directly associate rental to revenue generated by the assets your leasing.
As with a Finance Lease for the leasing period, the business typically takes ownership of the asset (meaning the business has responsibility for the maintenance/insurance costs, however in some cases, this can be shouldered by the provider if agreed).
Contract Hire
Contract Hire is a more specialised of Operating Lease; it is exclusively used for the leasing of vehicles (often referred to as vehicle asset finance). In a Contract Hire situation, a business will approach an asset finance company looking to attain a vehicle or many vehicles. The asset finance company will then source and provide the vehicle/s to the business and also provide maintenance and disposal of the vehicle asset/s when the end of the leasing period happens (fleet management may also be included as part of the agreement.)
The advantages of Contract Hire are that businesses do not have the burden of sourcing the vehicle, the provider takes responsibility for the care of the vehicle, and the provider can usually get a better price through an existing supplier network than the business could achieve when purchasing the vehicle.
Refinance
Refinance although residing within the area of asset finance, can more specifically be defined as a form of asset-based lending. Refinance is when a business agrees to sell an asset/s to an asset finance provider, who in turn provides a lump sum to the business to purchase the asset/s.
In turn, the business agrees to lease back the asset they have just sold and provide regular use payments plus interest to the asset finance provider (paying back the initial lump sum paid). Refinance allows businesses who are asset rich and require capital to quickly raise large sums from their existing assets, without giving up the use of these assets. It can be particularly useful for businesses who have experienced a downturn and require a large cash injection but cannot afford to relinquish their existing assets.
It can also be a useful form of finance for businesses who have poor credit or financial history and have been turned down for other forms of finance such as commercial loans. This is because the asset finance provider will base the lending on the value of the asset, not any previous financial records.
Assets That Can Be Financed
The majority of assets of physical assets with a high value can be financed but must meet certain basic industry criteria of being durable, identifiable, moveable and saleable (DIMS for short).
This criteria effectively acts as a basic litmus test for asset financiers to determine whether an asset is appropriate for financing (with the aim of reducing the risk for the financier). However, in recent years the DIMS framework and the perception of what constitutes an asset has become more flexible, with a larger range of providers offering finance on assets that traditionally would not have been viewed as appropriate for asset finance (i.e. software). When it comes to asset financing, there are now two broad categories of assets that are financed; this includes soft and hard assets.
Hard Assets
Hard Assets are physical items of high value. Examples of Hard Assets include agricultural machinery, heavy goods vehicles, printing presses, recycling processors, CNC controls for machine lines, manufacturing systems and equipment, production and plant equipment, construction vehicles, light goods vehicles and mining equipment.
Hard Assets act as reliable security for financiers as they provide a significant amount of security in their sizeable and continuing value even at the end of their usable life. In particular hard assets that are revenue producing can retain significant value for long periods (i.e. manufacturing equipment). The majority of asset financing provided is for hard assets, in particular, hard assets that meet the criteria of the DIMMS framework.
Soft Assets
Soft assets are assets with little or no second-hand value when they come to the end of their usable life (the end of the leasing period). Examples of soft assets include information Technology (hardware & software), office furniture, medical devices, air conditioning systems, security systems (including CCTV), Electronic point of sale (EPOS) systems
Soft Assets reduce the security the asset can offer against the finance being provided, making soft assets a much riskier proposition to finance. To counter this increased risk, asset finance providers tend to base financing decisions on several different factors current/projected situation of the business (ability to payback). They also usually require some form of additional security to offset the risk, this might be a director’s guarantee, another asset as collateral or an upfront deposit of up 20% on the value of the asset.
Can Second-hand Equipment Be Financed?
Yes, asset financing is typically available to acquire used equipment (i.e. refurbished IT equipment). This because financiers understand that in many situations with larger equipment purchases that purchasing new might not be the best investment for them or you (although sometimes it is), thus they are flexible when purchasing new or old equipment and instead focus on the condition, remaining usable life and suppler provenance when agreeing to purchase an asset.
Summary and FAQs
Traditionally asset financing had only been available / used by large businesses and corporations for financing equipment of significant value. However, as awareness, the number of independent asset financing companies and the minimum level of finance available has significantly decreased, so has the demand for and use of asset finance by small and medium-sized businesses.
In recent years this mirrors the significant growth in the use of more alternative forms of business finance to acquire high-value equipment (e.g. machinery, computer systems, vehicles). Among these, asset finance has arguably become the most prevalent. When it comes to asset finance, there are often several niche questions that go unanswered, below we’ve covered the frequently asked of questions and the answers to them.
Can Capital Allowances Be Applied Towards Asset Finance?
Yes and no, the HMRC currently capital allowances can be applied against certain assets businesses attain through asset financing, providing a certain proportion of tax relief on a business’s profits over the course of an accounting year against applicable assets (reducing your tax bill on taxable profits). Eligible assets for capital allowances are covered in three main categories, being equipment, machinery and business vehicles.
Can I Finance My Existing Assets Owned?
Yes, in many cases businesses can sell your assets to a financing company and agree to lease them back, this is called refinancing, detailed further in the types of asset finance section. It can be an extremely useful way for businesses generate large sums of capital quickly to deal with unexpected costs or deploy for new growth opportunities (while retaining use of the asset).
