Understanding Equipment Finance

Asset finance spreads the cost of equipment purchases over a number of years, which helps protect cashflow and potentially allows a business to grow at a faster rate. The 2 most common forms of asset finance are Hire Purchase (HP) and finance lease, and there are some important differences to consider;

The credit and underwriting process is the same for both. You’ll be asked for some financial information about your business and the kit that you want to purchase, and you’ll then discuss the preferred length of the deal. It usually only takes a day or so to assess and hopefully you’ll get an offer that is acceptable quickly.

The differences between HP and lease are quite subtle, but important.

Hire Purchase (HP)

The repayments are spread over the agreed number of months and on day one you’ll pay ALL of the VAT + the first payment / deposit. The VAT is fully reclaimable in your next quarter’s VAT return, assuming you’re VAT registered, and each monthly payment is made free of VAT. At the outset you know that by paying a nominal Option-To-Purchase fee with the final payment, usually around £100, you will own the equipment. It’s very clean, and clear from day 1 that you will own the kit once all the payments are made.

Finance Lease (lease)

VAT is added to each repayment, NOT as a lump sum payment on day 1. The interest rate, and therefore the repayments, are the same whether it’s HP or a lease, but VAT us added to the monthly repayment amount on a lease, which is reclaimable at the end of each VAT quarter. However at the end of a lease you do NOT own the kit. One of three things happen at the end of a lease.

  1. If you take no action the initial lease term ends, and you will then start paying Secondary rentals. This is usually an extra month’s rental, which lasts a whole year, but you still do NOT own the kit. At the end of the next year, you’ll be charged another month’s rental which will last another year but you will still not own the kit. This could go on forever.
  2. You can return the kit. You can, but why would you?
  3. Three months before the end of your lease agreement, you advise the leasing company that you wish to take ownership of the kit. They will charge you, generally it’s around an extra month’s payment, payable at the end of the agreement, and you take ownership. Choose this option.

Clearly, due to the end of lease payments, HP usually works out to be less expensive overall, but it may be that the initial VAT payment may stretch your cashflow too much, so a lease might be the best option. The choice is yours.