Starting any business requires a lot of financial planning in order to purchase fixed assets such as land, plant, machinery, etc which means a lot of entrepreneurs are apprehensive of capital-intensive projects due to the big financial commitments. So, when large capital is present, as an entrepreneur you may wish to spread the acquisition cost of fixed assets over a more extended period. This is where lease finance or hire purchase comes in, spreading the costs of those assets.

In lease financing and hire purchase, both the terms vary in many aspects, such as; ownership of the asset, depreciation, rental payments, duration, tax impact, repairs and maintenance of the asset, and the extent of finance. The aim is to match the commitment with the revenue generated per year so that the payments are easily managed without any cash flow mismatch.

Lease and Hire purchase are a solution to that kind of financial arrangement where the cash commitment is spread over the asset’s life. On top, lease financing also does not require any initial capital outflow. Hence under the lease, the entrepreneur can use his capital for other working capital requirements.

So let’s look at Leasing

In simple terms, a Lease is a financial contract between the business customer (user/lessee) and the equipment supplier or lender (normally owner/lessor) for using a particular asset/equipment over a period against the periodic payments called “Lease rentals.”

The lease generally involves two parties, i.e., the lessor (owner) and the lessee (user). Under this arrangement, the lessor transfers the right to use to the lessee in return for the lease rentals agreed upon. A lease agreement can also be flexible to meet the financial requirements of both parties.

A lease also acts as an alternative to financing business assets. There are many options for a finance manager to choose from. He can opt for equity finance, debt finance, term loan, hire purchases, or many others. All the means of financing differ due to their different characteristics. There are some advantages and disadvantages of leasing.

What about Hire Purchase?

A hire purchase is a type of instalment purchase where the businessperson (hirer) agrees to pay the cost of the equipment in different instalments over a period of time. This instalment covers the principal amount and the interest cost towards purchasing an asset for the period the asset was in use. The hirer gets possession of the asset when the hire purchase agreement is signed. He becomes the owner of the equipment after he makes the last payment. The hirer has the right to terminate the contract before taking the title or the ownership of the asset.

So what’s the difference between Lease Financing and Hire Purchase?

Owning the Asset

In a lease, ownership lies with the lessor. The lessee has the right to use the equipment and may have the option to purchase it. Whereas in hire purchase, the hirer can purchase the equipment outright. The hirer becomes the owner of the asset/equipment immediately after he/she pays the last instalment.

Depreciation

In lease financing, the depreciation is claimed as an expense in the lessor’s books. On the other hand, the depreciation claim is allowed to the hirer in the case of the hire purchase transaction.

Rental Payments

The lease rentals cover the cost of using an asset. Commonly, it is derived from the cost of an asset over the asset life. In the case of hire purchase, instalment includes the principal amount and the interest for the time the asset was in use.

Duration

Generally, lease agreements are for a longer duration especially for larger assets like land, property, etc. Hire Purchase agreements are primarily for shorter duration (2-5 years) and cheaper assets like hiring a car, machinery, etc.

Is there a tax impact?

In the lease agreement, the total lease rentals are shown as expenditures by the lessee. The hirer claims the asset’s depreciation as an expense in hire purchase.

Who’s responsible for repairs and maintenance?

Repairs and maintenance of the asset in the financial lease are the lessee’s responsibility, but in an operating lease, it is the lessor’s responsibility. In hire purchase, the responsibility lies with the hirer.

The Extent of Finance

Lease financing can be called the complete financing option in which no down payments are required, but in the case of hire purchase, normally, a deposit is required to be paid upfront by the hirer.

Summary

As an entrepreneur starting up a new business, assets and cash flow are two key components to success, but do you want to swallow up all your cash reserves from the get-go? Leasing or Hire Purchase are great ways to get your assets in place, allowing you to spread the costs over an agreed period. Get in touch with us if you want to know more and see how we can help organise financing to get your business started.