Tectona is delighted to announce the launch of a new service designed to help you get your finances sorted out.
Submit a question to “Ask the FD” and we will provide a quick answer and perhaps a pointer to useful material to give you chapter and verse.
It will not be advice or recommendations but will be practical, useful guidance on what to consider, what steps you may wish to take and/or where to look further.
Here are 2 of the early questions we have responded to together with our answers:
In the current financial climate, the most obvious answer to this question is quite possibly why?
With the base rate still at 0.5% there’s little point leasing a piece of equipment if you have the cash to buy it.
Asset backed lending – a fancy term for leasing – can be relatively cheap if the asset in question has a good and easily realisable second hand market value. The lenders used to love fancy IBM mainframe computer hardware as it could be repossessed and sold-on if the lease went bad. It’s not quite the same these days with £500 servers, but the principle remains.
The interest rates you get charged on a lease can vary wildly depending on the asset security, term and risk the lender sees in you the borrower. Rates will often exceed 10%, which is easily achievable when customers have no option but to lease and the lease values are small and relatively expensive to administer.
Modelling a lease-buy scenario is quite easy with a bit of Excel know-how and each case is probably best looked at in isolation. YouTube has quite a wealth of content on the subject, some of which looks pretty daunting and probably confusing.
The bottom line is buying involves cash outlay now with a VAT recovery (for equipment not cars) a month or few later. Leasing (HP or rental) involves payment of a deposit and fees now and then a rental stream over a period and maybe a balloon payment at the end. Ownership may pass to you or not and this will impact the VAT treatment. You are trading one set of cash flows for another.
A business we know has an HP agreement for an industrial floor cleaner which helps illustrate this. The cleaner cost £5,800 plus VAT of £1,160 (recovered by the company). The business paid the lease company a deposit of £1,496 and now has 35 rentals to pay of £185.60 each with a final purchase payment of £75 at the end.
If you do the sums you will see the finance cost is £1,107 (an extra 19% on the cost of asset) and the annual rate of return for the lender is 13.4%. For a business sitting on cash at the moment, it’s not quite clear why they took the lease option. They certainly did not consult Tectona at that time.
There are other tax related considerations in a lease-buy decision which depend on the type of lease and the business tax allowances you get. Buying could bring a 100% tax deduction in the year of purchase but you might not see the cashflow benefit of that for well over a year. With a lease with no change of ownership at the end, the rentals themselves are tax deductible.
There will be spreadsheets out there that will do a calculation for you, but beware. They may not be detailed enough to cover all aspects of your lease option and they may not cover the tax properly. If it’s a big decision for you, come and talk to one of our FDs.
An organisation should project its cash requirements on a rolling basis assuming a “reasonable estimate of the worst case” and ensure that it has sufficient cash reserves to see it through. Remember that banks are not going to be sympathetic to borrowers who are fast, or unexpectedly, running out of cash.
A rule of thumb is to have cash (or overdraft facilities or other guaranteed liquid resources) to cover three months of normal expenses. If your projection gives a requirement less than this, question strongly how you expect to pay the salaries and the rent – not to mention any cost of business activities – until money starts coming in.
Even if you have three months’ costs covered, you should be planning on a broad brush basis for 6 months, a year, and longer. If your business is going to expand, your working capital needs are like to expand at the same time while the increase in income is likely to come a few months later. You do not need an exact calculation, but you should aim to quantify your approximate cash needs in each period and ensure that you have cash or borrowing capacity to cover. If you do not, then you need to start making alternative arrangements now.
Top Tip: One to be avoided (and a classic route to bankruptcy) is to grow a business rapidly without adequate cash in hand; this is called “overtrading”.
Put us to the test: click here to ask us whatever you want about finance and we will respond quickly. It’s free.
P.S. Please feel free to send this on to your clients – they will thank you for it.