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Leasing
The characteristic of a lease is that buggy ownership never passes to the business.
The business can generally deduct the full cost of lease rentals from taxable profits, as a trading expense.
As with hire purchase, the business will normally be responsible for maintenance of the buggies.
Hire Purchase
The main difference is that after all the payments have been made, the business becomes the owner of the buggies, either automatically or on the payment of an option to purchase fee.
For tax purposes, from the beginning of the agreement the business is treated as the owner of the buggies and so can claim capital allowances. The business will normally be responsible for maintenance of the buggies.
Finance Leasing
The finance lease or 'full payout lease' is closest to the hire purchase alternative. The leasing company recovers the full cost of the buggies, plus charges, over the period of the lease.
Although the business does not own the equipment, they have most of the 'risks and rewards' associated with ownership. They are responsible for maintaining and insuring the buggies and must show the leased asset on their balance sheet as a capital item.
When the lease period ends, the leasing company will usually agree to a secondary lease period at significantly reduced payments. Alternatively, if the business wishes to stop using the buggies, they may be sold second hand to an unrelated third party. The business arranges the sale on behalf of the leasing company and obtains the majority of the sale proceeds.
Operating Leasing
If a business needs a buggy for a shorter time, then operating leasing may be the answer. The leasing company will lease the buggy, expecting to sell it second hand at the end of the lease, or to lease it again to someone else. It will, therefore, not need to recover the full cost of the equipment through the lease rentals.
The lease period in this case will usually be for two to three years, although it may be much longer, but is always less than the working life of the buggy.
The business would not enter an operating leased asset on its balance sheet as a capital item.
Contract Hire
Contract hire is a form of operating lease and it is often used for vehicles. The leasing company undertakes some responsibility for the management and maintenance of the vehicles. Services can include regular maintenance and repair costs, replacement of tyres and batteries, providing replacement vehicles, repair assistance and recovery services.
Advantages and Disadvantages
Certainty
A hire purchase or leasing agreement is a medium term facility that cannot be withdrawn, provided the payments are made. The uncertainty that may be associated with facilities such as overdrafts, which are repayable on demand, is removed. However, both hire purchase and leasing agreements are long term commitments and it may not be possible, or could prove costly, to terminate them early.
Budgeting
The regular nature of the payments and their usually fixed amount helps a business to forecast cash flow. The business is able to compare the payments with the expected revenue and profits generated by the use of the asset.
Fixed Rates
In most cases the payments are fixed throughout the hire purchase or lease agreement, so a business will know at the beginning of the agreement what their repayments will be.
Security
Under both hire purchase and leasing, the finance company retains legal ownership of the equipment, at least until the end of the agreement. This normally gives the finance company better security and therefore may be able to offer better terms.
The decision to provide finance to a small or medium sized business depends on that business' credit standing and potential. Because the finance company has security in the equipment, it could tip the balance in favour of a positive credit decision.
Maximum Finance
Hire purchase and leasing could provide finance for the entire cost of the equipment. There may however, be a need to put down a deposit for hire purchase or to make one or more payments in advance under a lease.
Use of Resources
Hire purchase and leasing remove the need to tie up resources in capital equipment, by spreading the cost and timing of the expenditure to coincide with the expected future revenue flows of the business.
Tax Advantages
Hire purchase and leasing give the business the choice of how to take advantage of capital allowances. If the business is profitable, it can claim its own capital allowances through hire purchase or outright purchase. If it is not in a tax paying position or pays corporation tax at the small companies' rate, then a lease could be more beneficial to the business.
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