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 Leasing & Hire Purchase - What Are the Principle Advantages and Disadvantages?

Hire purchase and leasing can provide considerable benefits to businesses, but they are not necessarily suitable for every business or for every purchase. There are a number of considerations to be made.

Certainty

A hire purchase or leasing agreement is a medium term facility that cannot be withdrawn, provided the payments are made. The uncertainty that may be associated with facilities such as overdrafts, which are repayable on demand, is removed. However, both hire purchase and leasing agreements are long term commitments and it may not be possible, or could prove costly, to terminate them early.

Budgeting

The regular nature of the payments and their usually fixed amount 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. If, however, you wish to alter the payment frequency or amount, this will have to be agreed in advance with the finance company.

Fixes Rates

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 interest. In such cases, rentals or instalments will vary with current interest rates; hence it may be more difficult to budget for the level of payment.

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.

Use of Resources

If small and medium sized businesses wish to rely on a mix of finance, hire purchase and leasing can extend the range of facilities available and give them access to medium term finance.

It is, however, important to weigh up the interest and other costs of the different forms of finance available, against the benefits provided.

Hire purchase and leasing remove the need to tie up resources in capital equipment, by spreading the cost and timing of the expenditure to coincide with the expected future revenue flows of the business.

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.

Equipment Types - What Are Suitable for Hire Purchase and Leasing?

Most items of equipment in normal use within the business or industrial environment may be obtained through leasing or hire purchase. Equipment can cost as little as a few thousand pounds, or more than £100 million in the case of some major industrial plant.

Some typical items are listed below.

• Plant and machinery
• Business cars
• Commercial vehicles
• Agricultural equipment
• Hotel equipment
• Medical and dental equipment
• Computers, including software packages
• Office equipment

Leasing - What Types Are There?

Finance Leasing

The finance lease or 'full payout lease' is closest to the hire purchase alternative. The leasing company recovers the full cost of the equipment, plus charges, over the period of the lease.

Although the business does not own the equipment, they have most of the 'risks and rewards' associated with ownership. They are responsible for maintaining and insuring the asset and must show the leased asset on their balance sheet as a capital item.

When the lease period ends, the leasing company will usually agree to a secondary lease period at significantly reduced payments. Alternatively, if the business wishes to stop using the equipment, it may be sold second hand to an unrelated third party. The business arranges the sale on behalf of the leasing company and obtains the majority of the sale proceeds.

Operating Leasing

If a business needs a piece of equipment for a shorter time, then operating leasing may be the answer. The leasing company will lease the equipment, expecting to sell it second hand at the end of the lease, or to lease it again to someone else. It will, therefore, not need to recover the full cost of the equipment through the lease rentals.

This type of leasing is common for equipment where there is a well-established second hand market, such as cars and construction equipment. The lease period in this case will usually be for two to three years, although it may be much longer, but is always less than the working life of the machine.

The business would not enter an operating leased asset on its balance sheet as a capital item.

Contract Hire

Contract hire is a form of operating lease and it is often used for vehicles. The leasing company undertakes some responsibility for the management and maintenance of the vehicles. Services can include regular maintenance and repair costs, replacement of tyres and batteries, providing replacement vehicles, roadside assistance and recovery services and payment of the vehicle licences.

Leasing & Hire Purchase - What Are They?

Leasing and hire purchase are finance facilities for business to use an asset over a fixed time period, for regular payments. The business customer chooses the equipment and the finance company buys it on behalf of the business.

Leasing

The fundamental characteristic of a lease is that ownership never passes to the business.

The leasing company claims the capital allowances and passes the benefit on to the business, by way of reduced rental charges.

The business can generally deduct the full cost of lease rentals from taxable profits, as a trading expense.

As with hire purchase, the business will normally be responsible for maintenance of the equipment.

Hire Purchase

After all the payments have been made, the business becomes the owner of the equipment, either automatically or on the payment of an option to purchase fee.

For tax purposes, from the beginning of the agreement the business is treated as the owner of the equipment and so can claim capital allowances. The business will normally be responsible for maintenance of the equipment.

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