Asset finance denotes the use of a business’s assets to obtain the equipment it needs to grow. Typically, asset finance includes a firm’s short-term investments, inventory, and accounts receivable to use as collateral for borrowing the funds. Asset finance normally involves a charge for the use of the asset over a fixed term, thus enabling the company to avoid the costs of buying the equipment outright. Finally, the company requesting funding must provide the financier with a security interest in the assets.
Types of asset finance
Generally speaking, asset finance options include finance lease, hire purchase, operating lease and commercial loan. Each option addresses different needs and accommodates different commercial circumstances. Below is an introduction to these four types of asset finance.
- Finance Lease
Finance Lease, also referred to as a capital lease, is a commercial agreement between a finance company (lessor) and a borrower (lessee) for the acquisition of a financial asset (equipment, software, vehicle) for a structured payment over an agreed term (lease). The lessee is obliged to make a series of payments for using the asset and the lessor covers the ownership costs while holding the responsibility of maintenance, insurance, and taxes.
- Hire Purchase
Hire Purchase, also known as leasing, is a purchase contract that allows firms or individuals to own and control an asset during an agreed term while paying installments to cover the asset depreciation and interest to cover capital costs. The term is similar to “rent-to-own” term that is mostly used in the United States. Under a hire purchase contract, the lessee (firm or individual) leases the asset and the lessor owns it until the final installment is made. Then, the lessee can obtain ownership of the asset for a lump sum.
- Operating Lease
Operating Lease is an agreement between a lessee and a lessor to rent an asset for an agreed term. The lessor retains ownership of the asset during the life of the agreement and the lessee has the right to use the asset without any right of ownership. At the end of the agreement, the asset is returned to the lessor with no option to purchase the asset at a lower price nor the option to transfer ownership to the lessee. Generally, operating leases have tax incentives, but to enter such an agreement the life of the lease must not exceed the 75% of the life of the asset and the present value of the installments must not exceed 90% of the market value of the asset. In fact, an operating lease is more suitable if the lessee does not need the asset for its entire working life.
- Commercial Loan
A commercial loan is a financial arrangement for the funding of major capital expenditures and operational costs that the company cannot afford to fund on its own. Typically, commercial loans are short-term (3 to 12 months) and have an interest rate based on the prime rate. To secure a commercial loan, the business is expected to pay the prime rate agreed at the time the loan is issued and to submit monthly financial statements throughout the agreed term to guarantee that the loan will be repaid at maturity.
When should you offer asset finance?
Asset finance enables you as a financier to grow your sales, cut your sales cycles and improve your cash flow. At the same time, it offers businesses the ability to acquire the necessary equipment without the need to pay the entire amount in cash. In addition, the various forms of asset finance are first-rate budgeting tools, especially when installments are fixed because they allow effective cash flow management. More specifically, the main advantages of asset finance are:
- Financial agreements are custom-made to meet the business’ needs, thereby terms and repayment schedules are different.
- Assets are funded from income stream (not capital).
- Agreements have normally lower interest rates than any other financial agreement.
- Tax advantages are provided in some cases.
Businesses are seeking for a financial solution that can provide value for money. This means that you should be able to demonstrate how you can support the firm’s purchasing plans with asset finance. The earlier you promote asset finance in the sales cycle, the better control you have over the total cost of the purchase. This allows you to break down a better repayment plan for the customer. In doing so, you improve your ability to offer tailor-made solutions to meet a business’s individual needs.
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