BUYING OUTRIGHT VS LEASING MACHINERY & EQUIPMENT
As your capacity requirements grow, due to increased orders or growing product lines, you may be faced with the need to purchase new machinery or equipment. Business owners in this situation generally have two options: buy outright or lease.
Buying an asset outright means that you immediately own the asset and can use it in whichever way you want, but what might be the key reasons for handing over your cash to purchase it?
REASONS TO BUY OUTRIGHT
More often than not it is cheaper if you intend to use it in the long run
There is often good operating and maintenance support with brand new assets through warranties
The asset is key to business success. You are certain of its longevity and relevance
Typically, assets used for production enable you to claim immediate tax relief on your profits based on how much you spend on the assets (up to £1m*)
*during the period 1 January 2021 to December 2021
You want full control over the asset
The asset is easily adaptable if demand or tastes change
You can afford the asset and it won’t impact on your working capital capabilities
There is a second-hand market if you want to:
- Buy it cheaper than brand new
- Or sell once it has lived out its useful economic life to your business
If you buy an asset, you need to make sure you have a Plan B if it breaks. Does the product have a warranty? Do you have insurance to cover any repairs or replacements outside of warranty? Is there another way you can continue operating whilst the asset is being xed or replaced? You need to have a way to mitigate your risk, and in some cases the easiest way to do this is to turn the cost into a variable one.
Although all leases represent some form of commitment to pay a set amount of money over a de ned period of time, it is important to note two broad distictions between the types of leases.
1) The rst type of lease is the operating lease, such as a contract hire agreement, whereby your payments do not result in ownership of the asset at the end of the lease term.
2) The second type of lease is where you are nancing the purchase of an asset over a period of time, eventually owning the asset at the end of the payment period, such as a hire purchase agreement. This is known as a nance lease, and is thought of as a type of “borrowing to buy”.
By obtaining an operating lease for an asset, you usually enter into a short-term contract to rent the asset and pay monthly payments to use it, handing it back at the end of the agreement. Why might this be preferable for your business?
REASONS FOR AN OPERATING LEASE
If the asset is likely to become obsolete fast, you have more flexibility to adapt to changing requirements, such as, if:
- A newer version is required
- A new process is developed, removing the need for the asset
- More capacity is needed which can’t be solved by a simple modification
You want to conserve your cash levels by not spending it all at once
If you want to test out a process with the asset and therefore want it for a shorter time until it is proven
Your lease will likely include maintenance coverage
Leasing is often cheaper as a short-term solution
You get tax relief due to leasing costs being an expense in your P&L
The major issue here is that you don’t own the asset, and therefore don’t have full control over it. In the very short-term, operating leases will have fixed terms, and therefore there is an element of inflexibility if you need to act fast. You are paying your cash over to someone else in order to use the asset rather than directly re-investing that money into your business. What if you wanted the asset for a longer period of time? Operating leases are typically seen as a short-term solution.
If cash is the key limiting factor, but you still want to own the asset, perhaps you could fund purchasing the asset using debt instead; this could be through either a bank loan to buy it in full (repaying the loan separately) or a nance lease, paying for the ownership of an asset over a period of time.
REASONS FOR BORROWING TO BUY
This enables you to hold the asset for the long run if it is key to your business success, whilst also conserving cash.
Your payments are made over time, with interest payments usually being fixed. This can help with cashflow planning.
You can sell the asset once you have finished using it.
Tax relief can be gained in the same way as buying an asset outright.
Using a bank loan effectively makes you a cash buyer, this means you have bargaining power and you immediately own the asset upon payment.
Bank loans typically have lower interest rates than other forms of debt.
Ownership can be transferred at the end of the lease.
Finance leases can be flexible, with some allowing upgrades of the assets during the lease term.
This provides a hybrid approach to purchasing an asset, however you may need to provide security to borrow the funds. Sometimes the asset you buy is, in fact, the security. You will have to pay interest on the nance option, which will therefore make it more costly than being an outright cash buyer. When choosing to pay for an asset over time, you need to be sure that it won’t prevent you from servicing your working capital requirements.
One final consideration: do you actually need the asset at all? Or could contract manufacturing/packing be more appropriate for your business to scale up its production?
If you would like to talk to one of our Regional Cluster Managers, get in touch here.
This document is intended to be an aide-mémoire to help you consider different forms of finance and which ones might be appropriate for your business; it is not a comprehensive guide to all forms of finance. There could be different tax and legal implications associated with different forms of finance. Professional tax and legal advice should be sought to prepare for these different forms of finance.