In order to run a successful company, financial management, and the procurement of a viable method of finance, is paramount. Company directors must be able to raise capital and use it to fund projects, be it to expand operations, or shore up inventory. However, this is easier said than done, especially for small businesses; many options are off the table, and some are simply too costly to make financial sense. In such cases, businesses will have to look elsewhere to solve their financial needs.

One such solution is finance leasing. Unlike other options, finance leasing facilitates the leasing of physical assets to businesses in exchange for monthly payments and interest. In many cases, businesses will also have the option of purchasing these assets towards the end of the term. In this article, we will discuss finance leasing in detail, explaining what it is, how it works, and how it can benefit your business. Let’s get started.

What is finance leasing?

Finance leasing is a practice that, while unique, is being increasingly used by businesses. The practice involves businesses leasing assets, most often equipment and machinery, from a lender. These assets will be leased in exchange for monthly repayments and are subject to certain terms. Moreover, the specifics of a lease are influenced by its type; some leases fall under the category of an operating lease, while others are considered finance leases. Each lease has its advantages and disadvantages, making your business’s scenario and requirements the deciding factor.

As a finance lease essentially loans assets to a business, it can be considered a form of secured loan. This comes with certain risks, which should be considered before you decide to use finance leasing. Firstly, by using finance leasing, you must keep up with payments in order to retain the use of the equipment or machinery you have borrowed. If you default for whatever reason, you can expect your lender to seize the asset from you.

Also Read: Are Bridging Loans Risky?

Naturally, this can be devastating to small businesses that rely on the asset to operate. While this risk is obvious, the second risk is a bit less so. As you are the operator of the equipment or machinery you borrowed, you agree to transfer the pros and cons of that asset to you. For all intents and purposes, you are the owner of that asset, and so assume the responsibilities; if anything goes wrong, you can’t shift the blame to your lender in the vast majority of cases.

How does finance leasing work?

Finances leases tend to operate over a long period of time. As such, it is a type of lease that works quite differently from other types of lease that are specialised towards a shorter duration. One of the most notable qualities of a finance lease is responsibility, as we mentioned earlier. With finance leasing, you will assume responsibility for the asset you borrow, essentially acting as if you own it. You will take on any associated risks of operating the asset, enjoy the rewards of doing so, and make a note of it in your company accounts. Your costs of borrowing, operating, and maintaining the asset should be marked as a liability, as opposed to rent.

When taking out a finance lease, you will have to decide which type suits your business best; a lease that will be fully amortised, or one based on a balloon rental. A lease that will be fully amortised will see you essentially pay off the value of the asset, plus interest. With such a lease, borrowers typically have the option to purchase the asset at the end of the lease, once all payments have been made. This is typically for a low price, but will ultimately depend on the terms of the lease.

Also Read: Do Banks Offer Bridging Loans?

Monthly Repayments

On the other hand, a balloon rental, also known as a balloon payment, works differently. Instead of a structured set of monthly repayments, borrowers will instead pay small repayments at first, then steadily build up to larger repayments as the lease goes on. This typically results in borrowers paying off their debt earlier, but it will also mean the final months of the lease will see a much higher rate of expenditure. For some businesses operating on a  particularly tight cash flow, this may be unfeasible.

At the end of the lease, borrowers will have to make a decision. They can choose to extend the lease, renewing it based on the previously agreed-upon terms, purchase the asset outright, or sub-let the asset. If the borrower is not interested in renewing the lease, and is indecisive about purchasing the asset, they may find that the lender sells it to another party interested in the asset. As such, it is important to have a plan in mind for when the lease ends, avoiding any unpleasant surprises.

If the lender opts to purchase the asset outright, they can expect to pay a bargain price, one that often makes it the most financially sound course of action. However, there are cases where the borrower might not have any use for the asset. In this instance, they can opt to sub-let the asset to an interested party, even if the lease has not yet expired. This is heavily contingent on your particular lender, however; some will not allow the sub-letting of their assets.

Obtaining a finance lease – notable criteria

When searching for a finance lease, you should keep a few criteria in mind. These criteria will heavily influence whether a finance lease is suitable for your situation, and include:

  • Record keeping – Despite being the borrower, you must keep a record of your loaned asset. This record will consider you to be the owner of this asset, with any associated expenditure being classed as a liability. Furthermore, you will be responsible for the asset, its maintenance, and any associated risks.
  • Economic life – A finance lease will typically last most or all of an asset’s economic life. This can lead to a lease lasting well past ten years, which could be detrimental for some businesses.
  • Transferral of ownership – Many finance leases are drafted with the assumption that asset ownership will be transferred to the borrower at the end of the term.

Wrapping up

Finance leasing can be an excellent solution for small businesses looking to purchase equipment or machinery, but lack the funds to do so. With finance leasing, they can borrow assets vital to their operation, with the option to purchase the asset outright at the end of the lease. However, it is a long-lasting solution, and can sometimes last over a decade. As such, it is important to consider your business’s situation and requirements when considering finance leasing.