1. What is leasing?
Your business might need to acquire assets (like furniture, computer equipment or company vehicles) or capital equipment, such as plant or machinery.
You could buy your assets or equipment outright, or you might decide to rent them instead. This allows you to get the equipment and assets you need that you might otherwise be unable to afford. It can also free up working capital for use in other areas of your business and save you from having to take out a large loan to buy equipment outright.
You may want to lease or rent equipment that has high maintenance costs, can quickly become outdated, or is only used occasionally.
There are 3 main types of lease agreement – finance leasing, operating leasing and contract hire – and you should carefully consider which one is right for your business.
2. Types of leasing
There are different kinds of lease arrangement. You should consider them all to see which is best suited to your business and the asset that you are acquiring.
Finance leasing is a long-term lease over the expected life of the equipment, usually 3 years or more, after which you pay a nominal rent or you can sell or scrap the equipment - the leasing company will not want it any more. Although you don't own the equipment, you are responsible for maintaining and insuring it.
You must show the leased asset on your balance sheet as a capital item, or an item that has been bought by the company.
Leases of over 7 years, and in some cases over 5 years, are known as 'long funding leases' under which you can claim capital allowances as if you had bought the asset outright.
With operating leasing, the leasing company is responsible for maintenance and insurance, and they will take the asset back at the end of the lease. You don’t have the show the asset on your balance sheet.
Operating licensing is useful if you don’t need the equipment for its entire working life.
With contract hire, the leasing company takes some responsibility for management and maintenance, such as repairs and servicing. You don’t need to show the asset on your balance sheet. Contract hire is often used for company cars.
3. Pros and cons
- you don't have to pay the full cost of the asset up front, so you don't use up your cash or have to borrow money
- you have access to a higher standard of equipment, which might be too expensive for you to buy outright
- you pay for the asset over the fixed period of time that you use it, which helps you budget for the future
- interest rates on monthly rental costs are usually fixed, so it is easier to forecast cashflow
- you can spread the cost over a longer period of time and match payments to your income
- you can usually deduct the full cost of lease rentals from your taxable income
- if you have not bought the asset outright, you won't have to worry about any overdraft or other loan taken out to finance the purchase being withdrawn at short notice, forcing early repayment
- if you use an operating lease or contract hire, you may not have to worry about maintenance
- the leasing company carries the risks if the equipment breaks down
- the leasing company can usually get better deals on price than a small business could and will have superior product knowledge
- on ‘long funding leases’ - finance leases over 5 (or sometimes 7) years - you can claim capital allowances on the cost of the assets
- if you need to upgrade or replace the equipment, you can just make a small adjustment to your regular payment rather than invest a lump sum upfront
- you can't claim capital allowances on the leased assets if the lease period is for less than 5 years (or sometimes 7) years
- you may have to put down a deposit or make some payments in advance
- it can work out to be more expensive than if you buy the assets outright
- your business can be locked into inflexible agreements, which may be difficult to terminate
- leasing agreements can be more complex to manage than buying outright and may add to your administration
- your business normally has to be VAT-registered to take out a leasing agreement
- when you lease an asset you don't own it, although you may be allowed to buy it at the end of the agreement
4. Common mistakes
Leasing is most useful for equipment and assets that you can’t afford to buy.
You may want to buy equipment or assets rather than lease them if you don’t want to enter into a long-term leasing agreement or want to keep your long-term costs down – it is often more expensive to lease equipment or assets than to buy them outright.
5. Funding sources
The types of companies that offer hire purchase and leasing contracts include:
- subsidiaries of major UK banks
- providers owned by manufacturers, such as car manufacturers
- non-UK banks
- independent finance houses
- equipment suppliers
- members of the Finance and Leasing Association (FLA)