Growth takes money. This is a simple fact of doing business. The trick is to spend that money in the right way. To protect your cash flow, financing your growth is often the best solution.
There are a number of reasons why growing businesses may need to raise finance, from bridging a temporary cash flow situation to a more long-term need, such as funding a major expansion.
Research from over 5 000 businesses applying for finance reveals that the top eight reasons for raising capital are:
- Purchasing equipment and machinery
- Funding business expansion
- Working capital/cash flow assistance
- Franchise funding
- Buying a building
- Funding a contract
- Property development
- Import financing.
Buying Equipment or Machinery
When exploring the finance options, the cost of the equipment or machinery you are wanting to buy will help guide your choice of funding.
For smaller capital outlays, amounts under R50 000, it’s often easier to fund these via credit card facilities, business overdrafts or term loans.
Larger capital spends are best funded by dedicated asset funders or funding facilities provided by the equipment/machinery manufacturer.
There are a number of lenders that provide asset funding.
Asset funding options
There are three basic ways formal asset financiers structure their loans — financing for an outright purchase, rental agreements or leasing options. Which finance option suits your specific business need?
Financing an outright purchase of the equipment or machinery is done via a prime-linked loan from a lender you repay in equal instalments over an agreed period plus interest. The period can vary from one to five years, or more, depending on the life of the asset.
The duration of the loan is usually equated to the lifespan of the asset. IT equipment is depreciated over three years and so a shorter-term loan applies. While you’re repaying the loan, the lender owns the asset; if you can’t repay the loan, the lender is entitled to sell the asset to recover the outstanding money.
You can’t sell the asset without the lender’s consent. Once you’ve repaid the loan, the ownership of the asset reverts back to you. When you buy an asset outright, the maintenance and ongoing running cost are your responsibility.
Renting is suited to situations where the equipment or machinery is for temporary use or where the use of expensive equipment or machinery is needed for short periods. Rental prices can be high as the company that rents the equipment to you has to recover their costs and make a profit.
Renting is ideal if you need expensive equipment (e.g. a crane) for a short period. There is no need to buy the asset or even lease it for several years, so a short rental is appropriate, albeit at a higher price.
Rentals suit industries with rapidly evolving technology i.e. computer equipment.
In some industries assets become outdated within a year or two, and a lease could leave you with outdated assets for five or ten-year terms. Rental costs are expensed on the income statement for both accounting and tax purposes.
Leasing is a contract to rent an asset for a set period, with set payment terms. Leases include conditions that govern use of the asset. A typical lease is long-term, ranging from one to ten years.
Significant penalties can be incurred by the lessor or the lessee if either violates the lease.
The asset may revert to the lessee at the end of the lease automatically or for what is termed a ‘bargain purchase option’ where it can be bought for significantly less than it is worth. However, when considering the lease payments, this is often for far more than the asset was actually worth.
Related: DTI Funding
From an accounting and tax perspective, leases fall into two main categories, operating leases and capital leases. If the lease terms meet certain criteria the lease will be considered capital, including; 1) the value of the lease payments makes up most of the fair market value of the asset, 2) the life of the lease makes up most of the effective useful life of the asset, and 3) there is a bargain purchase option.
Capital leases require you to record the leased asset as a fixed asset on your financial statements and the lease obligation as a liability. Over time the value of the asset is amortised and the lease obligation decreases through payments made. An operating lease has no such requirement and you can expense the lease payments as they are made, for accounting and tax purposes.
Rent vs lease
The decision to lease vs rent depends on your needs. If the asset is integral to your business and you need it there all the time, leasing is ideal. The security and guarantee provided by a lease is important, and it ensures your business has what it needs.
For short-term periods where you don’t need an asset in your business year-round, renting is a better option. Renting may cost more over that short-term but the total cost to you will be lower since you won’t have the asset for many years.
From the lender’s perspective
Always do a proper financial analysis before making your funding decision. For example, while owning an asset will add to the value of your business, and the interest portion of the repayments, the depreciation, maintenance and running costs are tax deductible, it will require a large cash outlay upfront that can impact your cash flow.
When lenders assess the merits of an asset loan application, they will expect you to provide proof that the business can afford the equipment.
Asset funders are particular about the type of equipment or machinery they are prepared to fund. The first consideration is whether the asset has a good resale value. Items that are highly specialised and cannot easily be sold will incur a higher rate of collateral. If the asset has a good resale value the collateral will be lower or, the asset can be used as collateral.
Before making a decision consider buying second-hand equipment. If you are in the construction or manufacturing sectors, good second-hand equipment may be a more cost-effective option. However, lenders don’t typically fund the purchase of second-hand equipment and machinery due to its limited resale value.
What asset funders require from you
The type of equipment and machinery needed by the business will dictate the process to apply for asset funding. Highly specialised equipment or machinery is best handled by specialist asset funders or direct enquiries to the manufacturer.
Most manufacturers of capital intensive equipment or machinery have partnerships with selected lenders and they can guide you on available funding options and the application process. Likewise, specialist asset funders have procurement partnerships and they will assist with the relevant options and the application process.
For other types of equipment or machinery you will be expected to provide quotations that detail the type of asset and the landed costs.
There are three steps to finalising asset funding:
- Evaluate the value of the asset.
- Evaluate the business risk involved in lending finance to your company.
- The financial offer will be prepared based on the assessments outlined above.
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