When you are ready to expand your business, your greatest problem will probably be finding enough cash to upgrade existing equipment, or to buy additional equipment.
The alternatives available to you include:
- Using your own money
- Bank loan
- Hire Purchase
Using your own money
If you have enough available cash this is the simplest solution. However, you may have a more productive use for your money and you will also need to maintain liquidity. Therefore, you may prefer to finance these assets.
It is relatively easy to borrow for capital expenditure because the assets are identifiable and have resale value.
Getting a bank loan
A bank loan is usually the cheapest form of external finance. The bank may ask you to come up with a down payment and require you to pledge other assets, such as your house or an outside investment, as collateral. Banks also usually demand that directors of small companies provide personal guarantees.
Banks publish a base overdraft rate, to which they add a margin depending on how much risk the banks feel applies to each loan. Bank loans for the purchase of assets are usually for set periods of up to 10 years and are paid off by set monthly payments. Interest rates may vary during the life of the loan.
Hire purchase is often preferred for financing long-term moveable assets. It requires you to make a down payment and to pay off the rest (both interest and capital) over a period, usually five years or less.
The interest rate charged is usually higher than for a bank loan, but repayments are fixed under the initial contract. The hirer retains ownership of the asset until the final payment is made and may repossess the asset if payments fall behind.
You may claim depreciation against tax on assets acquired under hire purchase.
You may prefer leasing because it lets you avoid technical obsolescence without overspending – for example, a large percentage of computers are leased and replaced or upgraded within 24 to 48 months – so you could lease a computer and replace it regularly.
Leases require no down payment and normally no collateral. When you lease equipment, a leasing company either buys or already owns the equipment. At the end of the lease you usually have the choice of buying the equipment, returning it or extending the terms of the lease.
Most leases include periodic maintenance, insurance and discounts on consumable parts.
In addition to freeing up your cash and leaving your conventional lines of credit open, lease payments are usually 100 percent tax-deductible as a business expense. Compare this to bank loans where only the interest portion is deductible.
However, you cannot claim for depreciation on leased equipment, unlike equipment purchased under a loan or hire purchase agreement.
Before you sign any lease, be sure you understand all the terms and conditions of the agreement. If you decide two months after you sign the lease that you don’t need the equipment or need another type, you could experience problems.
Some companies won’t release you from the contract, which could leave you paying for unneeded equipment for years, others will charge you a hefty fee to terminate the contract.
Your accountant can help you decide whether leasing is a good option for you and recommend the types of leases that suit your specific needs.
Go over the following questions with him or her, then question the company you plan to lease from.
What specific types of equipment do I need to grow my business, and for how long will I need this equipment?
What can I afford in monthly payments?
How are the payments calculated?
What are the tax pros and cons?
Can I get a sample copy of the lease being offered so my accountant and I can study its terms at our leisure?
How is this lease terminated?
What are the buyout options? Are they negotiable?
Can I upgrade at no cost? If so, within what time limits?
How flexible is the payment schedule?
Are there any incentive programs available?
What’s the average turnaround time on my application?
What are the conditions for servicing or replacing the equipment? Is there a 24-hour maintenance service?
What are the maintenance estimates on the equipment? Am I responsible for ordering and paying for replacement parts, such as printer toner?
Are shipping costs, installation, training or warranties included in the payments?
Will I be charged documentation fees? What are the late-charge fees?
Once you’ve answered these questions, slow down. Don’t jump into the first lease offered. Take the time to shop around for the equipment you need and the lease that is most appropriate for your cash flow, business needs and income.
When you accept delivery, check out the equipment thoroughly to make sure it meets your specifications.
Ask questions and get responses in writing, if necessary. Leasing equipment can be a boon to business people who are short on capital but long on potential; just make sure you understand how it affects your financial picture and future growth.
Above all, don’t sign up until you understand every clause in the lease you’re considering and its implications for your future growth.
Renting and hiring
Short term rental of equipment, such as computers or extra vehicles, can be worthwhile to deal with very busy periods and for specialised tools and equipment which are rarely used.
Hiring is usually expensive but it is a viable option when it is only a short term need. All costs are tax-deductible.