Small business owners often don’t have the funds available to purchase business assets outright without impacting their cash flow. Yet ownership can be attractive.
So should you lease or buy?
You may not always have timely access to cash to buy business assets outright, or you may have more productive uses for your funds. There’s a range of options when it comes to buying and financing business assets.
Equipment loans: If you want to immediately own a business asset such as key plant or equipment, then you might opt to take out an equipment loan. The interest payable on the loan generally attracts a tax deduction.
HP agreement: A hire purchase (HP) agreement may be more suitable if you ultimately want to own the asset, but don’t want to tie up available cash. With HP agreements, the bank or financier purchases the equipment and initially hires it to your business for an agreed period of time.
Finance lease: A finance lease can also ultimately result in ownership of the asset, whereby the bank initially owns the asset and agrees to lease it to you for a prescribed period. The rental payments on a finance lease can be structured with a residual value balance, allowing you an option to purchase at the end of the agreement. This has the advantage of making the initial cash flows more manageable.
Or you may simply choose to lease an asset for an agreed term, which can have its own advantages, such as flexibility and certainty of cash flow.
Should your buy your premises?
Potentially one of the most significant decisions facing a small business is whether to buy or lease business space. Owning commercial real estate can be appealing; the premises may become a significant asset for your business, bringing potential for capital growth whilst negating the need to pay rent.
Owning your premises may also bring a welcome feeling of security. It also means you have control over how the space is laid and fitted out.
Purchasing your premises may also allow you to borrow against the asset in order to fund business expansion, while in some circumstances there may be advantages to purchasing business premises as part of your superannuation fund.
Disadvantages to ownership
One of the hurdles to purchasing of business space is the large cash injection that is typically required. The lender or mortgage company may also require a personal guarantee, which could put your home at risk in the event of business failure.
Naturally this could place additional pressure on your business and its cash flow; and not only at the point of purchase, since there will likely be fit-out and set-up costs to account for.
Cash flow is also less certain with ownership, as borrowing costs may be variable. The owner also retains responsibility for other variable costs such as rates and repairs.
Ownership may also present reduced flexibility if your business needs to relocate, upsize or downsize. If your business is specialised in its nature or operations, it may also be difficult to quickly sell a niche asset.
Finally, the injection of cash into a premises purchase can have an opportunity cost; it could reduce the potential for investment in other productive parts of your business. Small business owners need to question whether they should focus on their core business competencies instead of real estate ownership and fit-out.
For younger businesses in particular, the flexibility gained through a shorter-term lease may be preferable until the business is established.
Tax and structure
It is vital to understand all of the different tax and ownership structure implications before making financial decisions. Therefore you should consider engaging a licensed taxation accountant or financial planner to advise you where appropriate.
For example, the small business owner who purchases a business asset may be able to claim depreciation of fixtures and fittings, but when leasing assets the rental cost may instead attract a tax deduction in the financial year to which the cost relates.
Different purchase or financing strategies may be appropriate for various business asset classes. For example, where the employees of a business use cars, a novated lease agreement between the business owner, employer and financier may offer flexibility for the employee, as well as reduce administration costs.
On the other hand, in the fast-moving world of information technology, a small business may choose to lease assets for shorter time periods, in order to reduce the risk of obsolescence since some IT equipment dates quickly.
Cash flow needs
The decision whether to rent or buy business assets will ultimately be decided by the type of business you operate and which method provides opportunities to optimise your cash flow.
Consider how and when your business assets will generate cash for you. As a rule of thumb, it does not make sense to finance an asset for a term longer than its useful economic life.
Also consider your cash flow. Do you have predictable and steadily consistent cash flow, or is your business subject to wide seasonal variations? Ideally you need to prepare detailed forecasts to compare scenarios and plan accordingly.
Choosing how and when to purchase assets are key financial decisions for your business so consult with your accountant, financial planner, and in some instances, your small business banker.