Financing the assets used in your business can provide value in a variety of ways.
As an opportunity cost to using cash reserves, asset finance can preserve cash flow for other operational or expansion needs of the business. It can also deliver favourable tax outcomes too if structured correctly.
Fundamentals of Asset Finance
Before diving into the different structuring options, a word on key financing fundamentals. Unfortunately so many businesses get this wrong.
i) The Asset Life Cycle
The life cycle relates to the time over which the asset will contribute to business operations. More broadly, the full asset life cycle also refers to the acquisition, use and disposal of the asset within the business too.
Before you even think about buying and financing any assets, think it about its life cycle first.
ii) Debt Structure
Asset or Equipment Finance is often more flexible than longer term financing structures such as mortgages. This means a better ability to align repayments to suit cash flow.
The term of the loan and its repayment program needs to therefore need to align to the asset's life cycle. This practice ensures that the repayment of the debt on the asset are finalised before the asset no longer exceeds its life cycle.
Often where business go wrong is funding long term assets with short term financing facilities or vice versa.
Types of Asset Finance Options
The differences in financing structures appear subtle, and indeed repayments look similar, but they can be significantly different from an accounting and tax perspective.
Most structures allow 100% of the purchase price to be funded, secured by the asset itself, with a fixed loan term. The comparisons between these structures is demonstrated below:
|FINANCE TYPE||OWNERSHIP||TAX STATUS||DEPOSIT?||RESIDUAL?|
|CHATTEL MORTGAGE||Yes||Claim Interest & Depreciation||Yes||Yes|
|COMMERCIAL HIRE PURCHASE||Yes - at end||Claim Interest & Depreciation||Yes||Yes|
|FINANCE LEASE||No - option to buy||Claim Payment as Deduction||No||Yes|
|OPERATING LEASE||No - option to buy||Claim Payment as Deduction||No||No|
i) Chattel Mortgage
You take ownership of the asset, and the financier takes their interest over it by way of mortgage. Once the contract is completed, the security interest is removed giving the customer clear title to the vehicle.
Potential Benefit – For businesses registered for GST on a cash basis, they may claim back GST in full in their next Activity Statement. Gives certainty of ownership and ability to contribute a deposit.
ii) Commercial Hire Purchase
The financier purchases the asset on behalf of the customer, and then hires it back over an agreed term. After the residual is paid, the customer assumes ownership.
Potential Benefit – Gives some certainty of ownership at end, but generally less tax effective than a Chattel Mortgage option. Not a widespread product option currently.
iii) Finance Lease
The financier retains actual ownership of the asset with an option to purchase at the end of the term.
Potential Benefit – A good option if you update equipment or vehicles on a regular basis. The financier retains ownership of the asset, so you only finance the purchase excluding GST. You may also not want ownership for legal or accounting reasons too.
iv) Operating Lease
This options means that you will not own the asset. This is commonly referred to as being “Off Balance Sheet” and you can simply return the goods at the end of the term. Generally this structure is delivered at a higher cost.
Potential benefit – An option when you are turning over equipment regularly, need greater flexibility and want one simple repayment.
The taxation treatments associated with ownership of equipment can be unique to your personal circumstances. Make sure in considering debt you seek accounting advice too.
This may assess whether the benefits associated with asset ownership of equipment, outweigh any benefits of a full deduction of payments through leasing.
Contact Christian Delange
P: (03) 9620 2001