Equipment financing: Pros, cons and considerations
The majority of small and medium-sized businesses will quickly find that some (or a lot of) equipment is essential for carrying out their day-to-day tasks.
Some small business owners rely on their personal belongings to keep their business running day-to-day when starting out. This might mean making deliveries with their own car, using a personal computer for showcasing a product or even bringing their own vacuum from home to clean up at the end of the day. But this isn’t sustainable in the long-run.
If you’re a business owner, you’ll know how crucial it is to be able to obtain new equipment to keep up with a growing team or workload, and also to be able to replace any equipment that fails to meet standards or health and safety rules.
Whether obtaining, upgrading or replacing equipment, purchasing it outright can put a strain on your cash flow, and the money typically isn’t recovered very quickly. This is where equipment financing may be an ideal solution.
Here’s an overview of how equipment financing works, what your options are and some basic criteria for obtaining a small business loan tailored to your needs.
What is equipment financing?
Equipment financing provides funds to businesses in order to purchase essential equipment.
It gives business owners access to the equipment they need without having to pay the costs upfront, and sets them up with a repayment plan that spans a specific time period that is right for them.
The types of equipment financing
This may be the most common type of equipment financing. The financial institution you are borrowing from purchases the equipment on your behalf, and you repay a set amount of money each month, with interest added.
This is a form of secured loan as the equipment purchased acts as collateral in case the borrower defaults on the loan. The lender can sell the equipment to recover the cost of the loan.
Once the loan is fully repaid, you own the equipment so interest charges and depreciation of the asset can be claimed as tax deductions.
This involves a lender purchasing the equipment the business requires and renting it for an agreed period.
The monthly payments are calculated by taking the cost of the product—excluding GST, the term of the lease, the interest rate and any other fees into—account. Flexible payment plans are sometimes offered to match budgets.
The lender owns the equipment for the term of the lease, but some finance lease contracts offer the option to purchase it at the end of the term.
This is a type of rental agreement. The difference between a financial lease and hire purchase is that ownership is transferred to you when all repayments have been made.
In the case of a hire purchase, the lender purchases the equipment on your behalf and you pay instalments to buy it from them. A repayment plan is set up and must be adhered to until the full cost of the item has been repaid. The equipment still acts as collateral if you fail to meet the repayments.
For tax purposes, you may be able to claim equipment depreciation and interest paid against your business income but you will need to check with your accountant in each situation.
What can equipment finance be used for?
Your mind might jump to industrial and manufacturing tools when you think of business equipment, but equipment finance can be used for anything from tractors to telephone systems.
Outfitting an office with desks, cubicles, headsets and computers can be just as costly as purchasing a new forklift for a warehouse.
The pros of equipment financing
- Equipment financing can help your business stay competitive in the marketplace. Your cash flow may not stretch to those items that could make a dynamic change to how your business operates. Having access to funds to purchase this equipment could help to take your business to the next level and generate extra profit.
- There’s a wide range of options available. It’s likely you will find an option suitable for your needs and budget.
- Flexible loan contracts are offered. Repayments are usually spread across three or five years, but seven-year terms are available in some cases.
Cons of equipment financing
- It can be tempting to purchase non-essential equipment if you don’t have to pay for it upfront. Avoid entering into any contracts that you can’t afford each month. A good way to do this is to work up a plan that shows the equipment cost vs the profit it will generate. This will give you a good indication of what repayments you can afford each month.
- It may be necessary to hire an accountant. They’ll help you consider and understand all of your options, in order to get the best deal with the best potential tax benefits.
Equipment lease vs equipment loan
Asking yourself a few questions can help you to figure out whether a lease or loan will be more suitable for you.
How long do I need this equipment?
The general rule of thumb is: if you need the equipment for more than three years—and it won’t be significantly upgraded after this time—a finance loan may be a more suitable option as you will own the equipment after the agreed term.
How soon will the equipment wear out or become obsolete?
If the equipment you use wears out or gets upgraded often, a finance lease may be a better option as you won’t be left with outdated equipment that you need to dispose of or pay to upgrade.
In this situation, you want to be sure that the lease term is not so long that the equipment will wear out while you are still paying for it. Once you have entered into a contract, you are responsible for all payments until the end of the term, even if the equipment is no longer in use.
Important questions to ask before signing an equipment finance contract
Who is responsible for the equipment during the finance period?
Ask who is responsible for maintenance, repair and replacement of the equipment during the finance period. This will help you avoid being caught out with unexpected charges if any repairs need to be carried out.
Is there a downpayment?
It’s more likely that there will be an initial down payment when taking out a finance loan rather than a finance lease, but always ask to make sure.
What is the interest rate?
Ask about the interest rate so you can calculate the total cost over the whole loan term. Doing this can help you find the most competitive deal.
What is the term of the loan?
Typically loan and lease terms will span over 3 to 5 years.
What fees do I have to pay?
Ask about any applicable fees or charges. Read the terms and conditions of the loan to be aware of any upfront or ongoing costs.
Fees to look out for
- One-off fees like application fees
- Exit fees
- Early termination fees
- Ongoing fees like service fees or annual fees
What happens to the equipment at the end of the finance period?
Confirm the outcome of the finance agreement, do you want to lease the equipment for a specific time period, or are you expecting ownership to be transferred to you as soon as the final payment is made? Knowing the answers to these questions from day one will help you to plan for the future.
Do I need separate insurance for the equipment?
You may have to arrange additional coverage through an insurance company if the financier doesn’t offer insurance options.
Regardless of which option you choose, always read through the terms and conditions and ensure that you can meet the repayments.
Still have questions? Let’s talk
Confused? Not sure if this applies to your situation? Phone us on 1300 190 429 for some free, no obligation advice.
Or want to compare business loans now?
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