Asset finance can offer companies an affordable way to fund business-critical assets.
In this guide, we look at how asset finance works in practice, from the different types of asset finance that are available to the factors to consider when deciding if asset finance is right for your business.
What is asset finance?
Asset finance is a form of financing for businesses that enables you to acquire the use of business-critical assets, such as machinery, equipment or vehicles, by spreading the cost of these assets over their useful operating life. This type of finance could be used, for example, by a small cafe owner to purchase new catering equipment. It could also be used by a much larger e-commerce firm to invest in a brand new fleet of vehicles for its deliveries or to acquire the latest technology necessary to give the company a competitive edge.
How does asset finance work?
Asset finance is a popular way to acquire vital assets for a business without substantial or prohibitive upfront costs that can put a strain on cashflow or working capital, or on other lines of credit.
However, asset finance is distinct from asset-based lending, where the latter encompasses a much broader financing concept. While asset finance and asset-based lending sound similar, they have very different roles, applications and advantages for businesses. With asset finance, businesses secure assets through financing, where a business can choose to either own or rent the asset in question. In contrast, with asset-based lending, businesses are securing financing through assets that they already own, using these to guarantee payment, where the funding raised can be used in a number of different ways to help the business.
Still, both types of financing facilities can not only be used to keep a business running smoothly, but to expand and grow. This is because with the use of additional assets or funds to support the business, this can equate to increased production and higher sales.
What are the different types of asset finance?
There are two ways in which you can obtain business-critical assets through the use of asset finance: hire purchase and finance lease agreements.
Hire purchase is when you agree to buy an asset from the lender over a specified period. As such, this represents a straightforward method of financing the purchase of an asset without the need for any large capital outlay, although there may be an initial down payment by way of a deposit. The cost of the asset to be acquired is spread over the agreed term and paid by fixed monthly instalments, together with interest. As the name suggests, with this form of asset finance, you will own the asset once all the instalments have been made, although there may be a small additional fee to secure title to the asset.
In contrast, finance leases are a form of rental rather than purchase agreements. Here, the leasing company legally owns the equipment or vehicle, where you simply pay for the use of the asset for a fixed or minimum term. As such, leasing allows a business to use an asset in exchange for rental payments over an agreed timescale where, at the end of that period, the business may have the option to continue renting, or to return or take a replacement.
There are in fact two different types of leasing options:
- A finance lease: where you will be responsible for paying for most of the asset’s cost over the period of its life, and for maintaining the asset as if you own it, where the lessor transfers all of the risks and rewards of ownership to the lessee;
- An operating lease: where you will not be required to pay for the full cost of the asset as you will be renting it for a period that is shorter than its economic life. As such, the lessor will retain the risks and rewards of ownership, including responsibility for maintenance.
Leasing and hire purchase agreements are suitable for businesses in all sectors and at all stages of trading, from startups to established businesses, as long as they can demonstrate their ability to make payments for the hire purchase or leasing term agreed. However, these options are typically used by businesses that need machinery, equipment or vehicles immediately to operate, or continue to operate, but cannot afford to buy outright.
Pros and cons of asset finance
There are a number of pros and cons when it comes to asset finance. On the plus side, this type of finance will allow you to obtain the assets required to meet customer demand that you may not otherwise be able to afford. Assets are vital to any business operation, whether this be IT or other equipment, vehicles, or large plant and machinery. However, most vital business assets tend to be fairly expensive, especially for SMEs who are on a tight budget. Fortunately, whether you are using financing to purchase or lease assets, you will obtain immediate use of the asset needed, while conserving any capital budget for other things.
By securing assets through financing, there will also be minimal upfront costs, with fixed monthly instalments that will not usually increase, enabling you to budget with certainty. By releasing working capital in this way, spreading the cost of an asset over time, this can help to boost cashflow and/or to facilitate the growth needed for a business.
There are good rates of approval with asset finance, where success rates are high for hire purchase and leasing applications, and there is typically a quick turnaround time, where for standard pieces of equipment, such as a van or car, it could take just a few days. This type of finance is available to any type of business, regardless of sector, size or age, and you have the flexibility to either own the asset at the end of the agreement (with hire purchase) or rent it for as long as you need it (with a lease) and, in some cases, without the responsibility or risks associated with ownership.
On the downside, with both forms of asset finance, these represent medium to long-term financing solutions. Hire purchase or lease agreements tend to be over several years, and although the cost is spread over a period of time, the overall cost to the business can exceed using other types of financing to buy an asset outright. This is because the total interest accrued on monthly instalments, over say 5 years, can be significant.
However, perhaps the biggest risk to business owners when using asset finance, whether this is by way of a hire purchase or leasing agreement, the asset provider may seize the asset from you if you default on payment. For business critical assets required for the effective and smooth running of the business, in some cases this could bring operations to a standstill. By defaulting on your agreement, this will also impact your credit rating which, in turn, is likely to make it far more difficult to secure alternative financing elsewhere.
Is your business eligible for asset finance?
There are relatively few restrictions when it comes to applying for asset finance, although there may be certain limitations on the type of business assets that you can fund.
The eligibility criteria differ from lender to lender for both leasing and hire purchase agreements, and will depend on the nature and value of the equipment that you are looking to acquire. However, rather than focusing on your size or trading history, it is your ability to meet the monthly payments, together with your credit rating, that are typically the most important factors for lenders when assessing any asset finance application.
As such, when looking for asset finance approval, you will need to ensure that you have up-to-date accounts and financial statements, where this information must clearly demonstrate sufficient turnover and profit, or enough money coming into the business to be able to pay what would fall due each month by way of instalments. In many cases, you do not need to be profitable, just cash positive, where you have more money coming in than going out. A finance asset provider may also consider the revenue that the use of the asset may generate for your business and the impact this will have on your ability to service the agreement.
Is asset finance right for your business?
To help decide if asset finance is right for your business, there is a useful finance finder tool on the British Business Banking (BBB) website. The BBB is a business development bank owned by the government that offers free financial tools and expert guidance to help support SMEs. When using the online tool, you will be required to respond to a number of questions to help establish the right type of finance to meet your business needs. You will be asked to identify your business sector and location, the reason for seeking finance and the amount sought, if your business is not yet profitable or profitable and expecting some growth after securing finance, and whether your business already owns certain assets.
Even if your business has never made a profit since it started trading, and you have no available assets against which finance can be secured by way of asset-based lending, the finance finder tool should list leasing and hire purchase as possible options. There may also be other funding options available, such as angel investment and corporate venture capital.
Things to consider before getting asset finance
Before proceeding with any form of asset finance arrangement, in addition to establishing if your business is likely to qualify for this type of finance and whether this form of financing is right for your business, you should consider exactly what assets you need, how many and for how long. As such, you should always first ask yourself the following key questions:
- Are your finances in order and can you prove that you will be able to meet your monthly repayments (where your accounts and financial statements will need to reflect this)?
- Do you have a good credit history (where a poor credit rating may not necessarily result in rejection, although you are likely to get less favourable terms)?
- Do you understand the hire purchase or leasing deal on offer (where you will need to get to grips with the terms and conditions and ensure that you are happy with these)?
- Do you know what the total cost of the arrangement will be to your business (where the overall cost will be based on the interest rate and length of the contact set)?
- Do you know who is responsible for maintaining the asset during the course of the agreement (where maintenance could be your responsibility or the lease providers)?
- Do you know how you will use the asset(s) and how this will benefit you (where you will need to forecast how the asset will positively impact your business)?
- What will happen at the end of the contract (where you will need to ensure that you are happy with the final outcome, for example, owning the asset or being able to return it)?
- Are there any hidden charges (where there may be an early repayment charge or a fee to acquire the title to the asset at the end of the agreement)?
These questions can also be used as a checklist to provide you with a clearer idea of what you need to do to prepare your business for asset finance if you do decide to proceed.
How to apply for asset finance
When it comes to asset finance, both leasing and hire purchase agreements are available via brokers, equipment suppliers and specialist lenders across the UK. You can find these by searching online, where this type of lending is available in any region and for any sector.
Alternatively, if asset finance is not suitable for your business, either because the business is not eligible due to affordability or a poor credit rating, or you would simply like to explore alternative options, there are plenty of other types of funding available that can be tailored to your business needs. By seeking expert advice from a financial specialist, you can explore all available financing options, together with the pros and cons of each.
Asset finance FAQs
What is an example of asset finance?
Hire purchase agreements are an example of asset finance, where the cost of the asset to be acquired is spread over the agreed term and paid by fixed monthly instalments. The asset will be owned upon final payment.
What are the different types of asset finance?
There are two types of asset finance: hire purchase (HP) and finance leases. With HP agreements, the cost of buying an asset is spread over an agreed term, while a lease is a form of rental rather than purchase agreement.
What is the difference between loan and asset finance?
Asset finance refers to acquiring business-critical assets through either a hire purchase or leasing agreement, spreading the cost of these assets over their useful operating life, whereas a loan is money borrowed from the bank to buy an asset outright.
What is the difference between asset finance and leasing?
Asset finance is the term used for the different ways in which a business can acquire the use of business-critical assets, where leasing is one the main forms of asset finance, allowing a business owner to rent equipment or vehicles.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert professional advice should be sought.