Cash vs Leasing vs Hire Purchase
In a business, cash flow is everything.
There is no doubt that investment in technology and resources can bring about marked efficiencies and financial savings. If you look at your current running and maintenance costs and output and productivity data, and then compare this information to projected figures based on new or upgraded equipment, the difference is usually quite marked.
However, survival and growth depend on cash in exceeding cash out. There is no point in having great efficiencies if you can’t pay the bills at the end of the month. Therefore, if you know that your business and consequently customers would benefit from an investment in new equipment, what is the best method of financing the investment in technology?
The discounted cash flow analysis is a recognised method that compares the cost of each alternative. The annual costs of the various methods are calculated after allowing taxation deductions or offsets. These annual costs are reduced to their present value by the discount analysis method.
The analysis considers:
The timing of the payments.
- Tax benefits.
- Interest rate on a loan.
- Lease payments.
- Other financial conditions in your business.
Option 1: Cash
Let’s consider a generic example of investing $100,000 (ex GST) in new equipment, based on a solution that will work for the business for at least five years. Do you draw on hard earned funds, and maybe put pressure on the overdraft? Are you relying on customers paying overdue accounts to bolster the cheque book?
Many companies can well afford to take this route – but is it the most financially viable? Also if the financial forecast is based on an ongoing optimistic profitability and cash flow forecast, what happens if the market drops or other unplanned expenses are encountered? You must have a contingency for tougher times. Alternatively you can consider financing the equipment, matching long-term finance to the working life of the equipment. What finance does is break down a large capital cost into smaller affordable chunks. But, you ask, what about the ongoing cost of interest? How do you know if you’re ahead compared to Option 1?
Option 2 – Leasing
- The benefits of leasing are quite marked compared to Option 1.
- A finance lease is an agreement with fixed payments over the term and a Residual Value payable at the end. The Residual Value is generally determined by the effective life of the equipment.
- The effective life is calculated using Australian Tax Office guidelines. If the goods are used to earn assessable income, the payments can be claimed as a deduction.
Option 3 – CHP
Similar to leasing, the benefits of commercial hire purchase compared to Option 1 are in your favour. A CHP contract is an agreement with fixed payments over the term. Ownership is “implied” from day one. The hirer claims interest and depreciation against income during the term of the agreement.
Comparing the options
A cash purchase will almost always be more expensive than a lease or CHP option due to the immediate loss of funds. Finance acts as a hedge because the payments are fixed. The net present value model compares the decreasing value of money today to each year in the agreement. In our example, $1 today is worth 90 cents after year 1 and 81 cents after year 2 and read more