In today’s competitive landscape, businesses rely on costly assets such as cars, vans, plant, and machinery to manufacture and provide their products and services.
With finance leasing, you can break free from financial constraints by purchasing essential assets over time, starting with a low deposit.
Gone are the days of crippling upfront costs that drain your resources. Say goodbye to the financial crunch that often accompanies acquiring major tools for your business.
Finance leasing empowers you to maintain a healthy cashflow while securing the critical assets your operations depend on
How does a finance lease work?
When it comes to asset financing, the term “finance lease” has emerged as a versatile umbrella term encompassing various options beyond dedicated purchase agreements like hire purchase.
In fact, there are three primary types of finance leases designed to cater to different business needs and preferences.
Let’s delve into each one:
- Finance Lease: A finance lease grants your business the opportunity to utilize an asset for a fixed period, all while enjoying the benefits of a predetermined monthly rental cost. At the agreement’s conclusion, your business retains the option to purchase the asset for a pre-agreed sum. This type of lease enables businesses to distribute the cost of the asset over time, resulting in lower monthly payments compared to an outright purchase. In many cases, businesses can even reclaim 100% of the VAT element of the monthly cost, including any associated maintenance charges, excluding company cars.
- Operating Lease: Similar to finance leasing, an operating lease offers the advantage of lower monthly costs. However, there are a few key distinctions. With an operating lease, you, as the lessee, do not have the option to purchase the asset at the contract’s end. Furthermore, the agreement incorporates a Residual Value, which takes into account the lease duration and the estimated value of the asset upon contract completion. At the end of the agreement, the finance company facilitates the sale of the asset to a third party. If the asset sells for a price exceeding the Residual Value, a percentage of the surplus is refunded to you. Conversely, if the sale falls short of the Residual Value, an additional payment to the finance company may be required. Depending on the leased asset, operating leases may include maintenance and repair services. Moreover, similar to finance leases, businesses can often reclaim 100% of the VAT element of the monthly cost, excluding company cars.
- Contract Hire: Simplicity and convenience define the contract hire lease. This option functions as a long-term rental agreement, where your business leases the asset for a fixed term, typically spanning 2-3 years, and pays a predetermined monthly fee for its usage. The package typically encompasses maintenance and repair services, ensuring hassle-free operations. At the end of the contract, the asset is returned to the lessor without any residual value obligations or the opportunity to purchase. As with the other lease types, businesses can often reclaim 100% of the VAT element of the monthly cost, including maintenance charges (excluding company cars).
No matter which type of finance lease you opt for, you can seize the advantages of acquiring essential assets without burdening your cashflow or facing significant upfront costs.
Moreover, the potential VAT reclamation further enhances your financial flexibility. Get in touch with us today to explore the perfect finance lease option that aligns with your business objectives and fuels your growth
Finance lease a car
Finance leasing for company cars operates similarly to the aforementioned lease types, often encompassing maintenance and repair services, as well as a mileage cap. Lessees who surpass the mileage limit will incur additional charges for each extra mile driven. Depending on the specific finance lease arrangement, the lessee may even have the option to purchase the vehicle at the end of the contract period, providing added flexibility.
It’s important to note that company cars are subject to distinct tax regulations compared to other business assets. Despite being leased by the organization, which could be a limited company, PLC, partnership, or sole trader, the business may only be eligible to reclaim a portion of the lease cost. The extent of reclamation depends on the proportion of business versus personal use of the car. Furthermore, in most cases, businesses can only reclaim up to 50% of the VAT element of the monthly cost, as this takes into account any personal usage of the vehicle.
Finance leases present an advantageous option for businesses seeking to distribute the cost of utilizing a company car over time, resulting in lower monthly expenses compared to purchasing the vehicle through a hire purchase agreement. In many instances, the initial deposit required for a finance lease equals one month’s lease payment, making it a manageable investment for businesses of all sizes.
Don’t let the burden of upfront costs deter you from acquiring the company car you need. Embrace the convenience and affordability of finance leasing.
Finance lease a van
Finance leasing for vans and other commercial vehicles follows a similar structure to leasing for company cars, with one notable distinction lying in the tax implications. The tax status of the lease brings about a significant benefit for businesses in this domain.
When it comes to vans and commercial vehicles, the lease cost can often be fully offset against tax. This means that businesses can deduct 100% of the lease cost from their taxable income, resulting in potential tax savings. Moreover, for VAT-registered businesses, the benefits extend even further. These businesses have the opportunity to reclaim 100% of the VAT charged on the monthly lease fee, allowing for enhanced financial flexibility and optimization of cashflow.
By opting for finance leasing, businesses can access the vehicles they need for their commercial operations without incurring the substantial upfront costs associated with outright purchase. This cost-effective solution enables companies to spread the financial burden over time, resulting in lower monthly payments and improved cashflow management.
Whether you require vans, trucks, or any other type of commercial vehicle, finance leasing is a powerful tool that empowers your business. Contact us today to explore our tailored finance lease options and discover how you can maximize tax benefits and VAT reclamation while equipping your business with the essential vehicles it needs to thrive.
An example of finance leasing
The Benefits of Operating Lease for Your Business Van: A Case Study
- The ABC Company plc, in need of a new van, decides to explore leasing options instead of making a cash purchase or opting for a hire-purchase agreement.
- They choose an operating lease agreement, which offers lower monthly payments and flexibility.
- The details of their operating lease deal are as follows:
- Van Cost: £20,000
- Monthly Lease Payment: £350, inclusive of service costs
- Lease Duration: 48 months
- Residual Value: £4,000
- To secure the lease, ABC pays a one-month deposit of £350 and drives away with their new vehicle.
- Over the course of the 4-year lease, ABC pays a total of £16,800 for the use of the van.
- At the end of the lease contract, the vehicle is sold for £5,500 – £1,500 more than the agreed Residual Value.
- The lessor refunds 95% of the surplus amount to ABC, which totals £1,425.
- ABC utilizes the refunded amount to lease a new vehicle and reinvests the surplus cash back into their business
Pros and cons of finance leasing
As with any type of financial product they come with advantages and disadvantages.
Here are a few:
Pros of Finance Leasing:
- Enhanced Cashflow Management: Finance leasing allows businesses to acquire necessary assets without making a significant upfront payment. This helps to preserve cashflow and ensures that capital remains available for other critical business operations and investments.
- Tax Benefits: Depending on the jurisdiction and specific lease terms, businesses may be eligible to claim tax deductions on lease payments, thereby reducing their overall tax liability. This can result in substantial savings and improved financial performance.
- Flexibility and Up-to-Date Equipment: Finance leasing enables businesses to stay up-to-date with the latest technology and equipment without the burden of ownership. As leases typically have fixed terms, it becomes easier to upgrade to newer assets at the end of the lease term, keeping the business competitive in its industry.
Cons of Finance Leasing:
- Long-term Financial Obligations: When entering into a finance lease agreement, businesses commit to making regular payments over an extended period. This can tie up funds and limit financial flexibility, especially if the business encounters unforeseen challenges or changes in its operational needs.
- Limited Ownership Rights: Unlike purchasing an asset outright, finance leasing does not grant immediate ownership. This means that businesses do not build equity in the asset during the lease term and may have restrictions on modifying or selling the asset without the lessor’s consent.
- Potential Higher Costs: While finance leasing can offer lower monthly payments compared to outright purchase or hire purchase, it can still be more expensive in the long run. Businesses may end up paying more over time due to interest charges and fees associated with the lease. Careful evaluation of the total cost of the lease compared to alternative financing options is crucial to ensure it aligns with the business’s overall financial strategy.
It’s important for businesses to carefully consider their specific needs, financial situation, and long-term objectives when deciding whether finance leasing is the right option for them. Consulting with financial advisors and thoroughly assessing the terms and conditions of lease agreements is recommended to make an informed decision
What is the criteria for a finance lease?
The criteria of a finance lease (not an operating lease or contract hire agreement) are:
- Ownership Potential: In a finance lease, the lessee has the opportunity to become the owner of the asset at the end of the lease term. This grants businesses the option to retain the asset’s value and continue utilizing it beyond the lease agreement.
- Bargain Purchase Option: A key feature of a finance lease is the inclusion of a “bargain purchase” option. This provision allows the lessee to acquire the asset at a price below its market value. By exercising this option, businesses can secure ownership of the asset at a favorable cost.
- Significant Lease Duration: Finance leases typically extend for a substantial portion of the asset’s economic life. This indicates a long-term commitment by the lessee and signifies the intention to utilize the asset for a significant duration.
- Substantial Portion of Fair Value: The total lease payments made by the lessee under a finance lease represent a significant proportion of the asset’s fair value at the commencement of the lease. This demonstrates that the lessee is effectively financing the majority of the asset’s cost through lease payments.
- Limited Residual Value for the Lessor: The asset being leased under a finance lease is of such specialized nature that it holds no or minimal residual value for the lessor at the conclusion of the lease term. This implies that the lessee assumes the majority of the risk associated with the asset’s value fluctuations.
By considering these distinguishing criteria, businesses can ascertain whether they have opted for a finance lease rather than an operating lease or contract hire agreement.
What is the difference between a finance lease and an operating lease?
One of the key advantages of a finance lease is that it grants the lessee the invaluable option to purchase the asset at the conclusion of the contract. This empowers businesses with the flexibility to acquire ownership of the asset, should they desire to do so. By providing this choice, finance leases enable lessees to seamlessly transition from leasing to ownership, aligning with their long-term business objectives.
On the other hand, an operating lease takes a different approach. With this type of lease, the asset always returns to the lessor, who serves as the lender. The lessee enjoys the benefits of utilizing the asset without the burden of eventual ownership.
Additionally, an operating lease incorporates a Residual Value, which represents the projected worth of the asset at the end of the contract.
Should the actual value of the asset be lower than the Residual Value upon contract termination, the lessee is typically responsible for making an additional payment to bridge the gap.
Finance lease vs hire purchase
A finance lease offers individuals and businesses a convenient long-term rental agreement, providing them with the flexibility to purchase the asset at the end of the contract period. On the other hand, a hire purchase agreement empowers buyers to gradually acquire an asset through equal and manageable instalments.
The significant advantage of a hire purchase agreement is that the buyer gains complete ownership of the asset upon the contract’s conclusion. Additionally, finance lease monthly payments are typically more affordable than those of hire purchase agreements. This is due to the lessee only being responsible for paying down a portion of the asset’s overall value, allowing for greater financial flexibility.
Finance lease vs contract hire
In the realm of long-term rental agreements, a finance lease presents an enticing opportunity for lessees, as it allows them the option to acquire the asset at the contract’s culmination. On the other hand, contract hire, another form of long-term rental agreement, offers a comprehensive package that often includes maintenance and repairs. Notably, at the end of the contract, the asset gracefully returns to the lessor, freeing the lessee from any residual payments typically associated with other agreements.
Finance Lease and Contract Hire
While a finance lease grants the lessee a long-term rental agreement with a purchase option at the contract’s conclusion, contract hire offers a similar long-term rental agreement that encompasses maintenance and repairs. Notably, in contract hire, the asset is always returned to the lessor at the end of the contract, eliminating the need for residual payments.
Finance Lease and Capital Lease
Although finance leases and capital leases are similar types of loans, a capital lease holds a unique recognition as a purchase for tax purposes. As such, the leased asset must be recorded on the balance sheet as a taxable item. Capital leases also offer greater flexibility regarding eventual ownership and the calculation method used to determine the monthly cost.
Is a finance lease the same as lease purchase?
Yes, a finance lease is akin to a lease purchase. Both arrangements involve long-term rental agreements with an option to purchase the asset at the contract’s culmination. However, a lease purchase encompasses elements of hire purchase, including a balloon payment structure. In this scenario, the lessee pays lower monthly instalments compared to a typical hire purchase agreement and makes a larger payment, known as a ‘balloon,’ at the end of the contract to acquire full ownership of the asset.
PCP as a Finance Lease
Undoubtedly, PCP (Personal Contract Purchase) and finance leasing exhibit similarities, offering lessees the opportunity to pay for asset usage over time at lower monthly payments compared to hire purchase. At the contract’s end, both PCP and finance leases present the lessee with the option to purchase the asset from the lessor. It is worth noting that PCP leases are more commonly utilized by private buyers rather than businesses.
UK Accounting Treatment for Finance Lease
In the United Kingdom, IFRS 16 is an accounting standard employed to accurately report lease transactions and provide comprehensive information on cash flows. Under this standard, a lessee recognizes assets and liabilities resulting from a lease by recording the present value of all lease payments as the lease’s cost. Additionally, the interest portion of each payment is treated as an expense, and the asset is depreciated over its applicable write-down period. Disposal of the asset is recognized upon retirement.
Tax Treatment of Finance Lease in the UK
UK businesses can claim tax deductions of up to 100% on the value of lease payments, depending on the leased asset type. However, certain assets, such as company cars, may have distinct tax treatment, and the business must account for personal use, which cannot be deducted for tax purposes.
VAT and Financial Leases
VAT registered UK businesses may reclaim varying percentages of the VAT element of lease payments, typically up to 100% for most assets. However, for assets like company cars, the VAT reclaimable is limited, usually up to 50%.
Capital Allowances on Finance Lease
In the UK, finance leases are often treated as alternative forms of purchase, resulting in the inclusion of these leases as assets and the denial of capital allowances. Nevertheless, the depreciation of a finance lease recorded in the accounts is generally permitted as a tax-deductible expense.
Explaining a Finance Lease with a Balloon
A finance lease with a balloon payment structure is akin to a Hire Purchase agreement combined with a balloon payment or a Lease Purchase arrangement. In this scenario, the lessee pays lower monthly installments than in a typical Hire Purchase agreement, and the contract concludes with the option to purchase the asset by making a larger final payment, known as the ‘balloon.’
Ownership at the End of a Finance Lease
Ownership of the vehicle at the end of a finance lease depends on the lease type. While a finance lease allows the lessee to choose to purchase the vehicle, an operating lease or a contract.
Conclusion
In conclusion, a finance lease can be a valuable tool for business owners seeking flexibility and financial advantages. By opting for a finance lease, business owners can access the assets they need without the burden of a large upfront purchase.
The option to buy the asset at the end of the lease term provides a pathway to ownership, allowing businesses to benefit from long-term asset utilization. Additionally, the lower monthly payments associated with finance leases compared to hire purchase agreements can improve cash flow and enable businesses to allocate resources to other critical areas.
Moreover, the tax benefits, such as deducting lease payments, may further enhance the financial advantages of a finance lease. Overall, a finance lease empowers business owners with a cost-effective solution to acquire essential assets, enhance operational efficiency, and drive business growth.
Lee Jones is a seasoned expert in the field of business finance with over two decades of experience. With a keen understanding of financial markets and a passion for helping businesses thrive, Lee has become a trusted advisor to countless companies across the United Kingdom.