Why might you want to use a hire purchase arrangement?
What is a hire purchase?
It is a method of purchasing expensive consumer items in which the buyer pays a down payment and the rest over a period of time, including interest. Ownership of the goods does not technically pass to the buyer until all payments have been made under a hire-purchase arrangement. With a hire purchase plan, a company can maximize working capital, improve its financial presentation to investors, and have the option of flexible payment terms.
Here are five of its benefits:
Reduce Upfront Payments
The most significant advantage of a hire purchase plan for a company is that it removes the need for a large upfront payment.
This is especially beneficial for businesses that need expensive equipment but lack the immediate funds or prefer to avoid additional debt. By spreading out the cost, businesses can manage their finances more effectively.
That also means your business can now access higher quality equipment that might otherwise have been unaffordable.
Access better equipment
The most obvious advantage of a hire purchase plan for a company is that it does not have to pay the entire purchase price upfront. For a company that needs to buy expensive equipment but doesn’t have the money or doesn’t want to take on additional debt, this can be a great option to consider. Equipment lease payments and equipment ownership costs can sometimes be removed from a company’s books, resulting in better-looking return on assets (ROA) ratios.
Using hire purchase might give your company access to some really top-notch equipment. You might not be able to afford to buy the very best equipment via a one-off cash purchase, but with hire purchase, you can buy a high-specification item, start using it immediately, repay the purchase price in installments over several years and then become the owner of the asset at the end of the term.
You may be able to get your hands on some high-quality equipment if you use hire purchase. Purchasing the greatest equipment on a one-time cash basis may be out of the question; however, with hire purchase, you may purchase a high-end item, begin using it right away, pay for it in installments over a period of time, and eventually own it.
Improve cash flow
Another adverse impact of purchasing an item with a one-off payment is that your cash flow could be impacted. You can avoid making a large single payment with hire purchase, so hopefully, your cash flow position will be much healthier.
Buying anything with a one-time payment can also have a negative influence on your cash flow. Hire buy allows you to avoid making a huge single payment, which should improve your cash flow.
Fixed repayments
A hire purchase lender will not alter your interest rate during the term. This means budgeting is straightforward and there won’t be any nasty surprises – you know exactly what you will be paying back each month for the rest of the term. Hire purchase plans often include maintenance in the contract, which means that the company does not have to worry about expensive repair costs that may arise. In some cases, it may be more tax-efficient to expense the rental payments rather than purchase and depreciate the equipment. The company is not required to keep the equipment under a hire purchase plan, and payment terms can be flexible.
During this period, a hire purchase lender will not change your interest rate. So, budgeting is simple and there are no surprises — you know precisely how much money you’ll be paying back each month for the remainder of your term.
Lower rates of interest
Hire purchase interest rates are often lower than for overdrafts, credit cards, and other forms of finance. Furthermore, payments are likely to be lower than for a leasing arrangement as there is no VAT with the hire purchase. You can also pay off the loan at any time if you have the means to do so, and this way, you might receive a significant interest rebate.
Unlike overdrafts, credit cards, and other forms of financing that charge higher interest rates, hire-buy interest rates are typically cheaper. A hire purchase agreement does not have to pay VAT, so monthly payments are likely to be lower than in a leasing arrangement.
Repayment flexibility
You might be able to enter into a slightly different repayment arrangement, which will further reduce your monthly repayments. Your agreement might allow for a larger final payment to be made (known as a balloon payment) to compensate for the fact that you’ve made lower repayments throughout the term. If you cannot make the final balloon payment, then the lender will repossess the item, but you’ve still benefited from using the asset throughout the term.
To further minimize your monthly installments, you may be able to negotiate a new repayment arrangement. Because of your reduced monthly payments, you may have the option of making a higher final repayment in order to compensate.
Credit Management
Using hire purchase can help your business build a positive credit history.
As long as you are able to consistently make the agreed payments over time, a hire purchase agreement can boost your business’s credit score.
This will improve your creditworthiness over time and make it easier to secure future financing at more favourable terms, including lower interest rates and better repayment conditions.
They can also add diversity to your credit portfolio, improving your general credit profile and proving that your business can manage various forms of debt responsibly.
In the long term, this leads to enhanced negotiating power when dealing with lenders, as well as more stability during times of financial uncertainty.
Tax Benefits
Another interesting benefit of hire purchase is the ability to claim depreciation on the asset.
Depreciation is a non-cash expense that reduces taxable income, therefore reducing your tax liability. By spreading the cost of the asset over its useful life, businesses can enjoy tax savings each year.
Matching the expense of the asset with the revenue it generates also provides a more accurate picture of your business’s profitability. This principle complies with accepted accounting standards, providing a clearer view of your financial health.
This can also lead to improved pricing and cost management strategies.
Increased Asset Base
A larger asset base can enhance your company’s financial stability and strength, making it more attractive to investors and lenders.
This is particularly important when seeking out additional financing opportunities.
Banks and financial institutions prefer lending to businesses with a solid asset foundation, as it reduces their risk. This leverage can deliver more favourable loan conditions, such as lower interest rates, longer repayment periods, and reduced collateral requirements.
Finally, with an increased asset base, your business gains greater capacity to invest in your chosen growth opportunities by giving you the necessary financial foundation.
Future Planning
Because hire purchase agreements include clear, predictable terms, your business can forecast and plan for future expenses, tax liabilities, and cash flow needs more accurately.
This foresight goes a long way in helping to set strategic goals, secure financing, and maintain financial stability over the long term.
It also provides a more cost-effective and flexible way for businesses to upgrade to new equipment as technology evolves, ensuring they remain competitive and up-to-date with ever-evolving industry standards.
Disadvantages of hire purchase
However, there may be reasons why hire purchase isn’t an appropriate solution for your business circumstances:
- The asset involved is security for the loan, so it could be repossessed at any time should you fail to maintain your payments
- The lender is the legal owner of the asset until all repayments have been made
- Failing to maintain repayments will adversely affect your credit rating
- Given the total amount you’re likely to pay in repayments over the full term of the arrangement, this can be an expensive way of purchasing an asset
- By the time the repayment term ends, and just as you become the asset’s legal owner, the asset could have depreciated in value or become obsolete. This might be especially true given the length of most hire purchase agreements
How does hire purchase work?
With hire purchase, you enter into an agreement to purchase an asset. Instead of paying the purchase price as one lump sum, you instead pay the purchase price, plus interest, in equal monthly installments over a specified term. Usually, you pay a deposit, perhaps 10% of the purchase price, at the start of the agreement.
A typical repayment term might be two to six years – clearly the longer the term, the lower your monthly repayments will be.
Sometimes, the final repayment is for a larger amount, known as a ‘balloon payment’.
Fixed and variable rate options are available with hire purchase agreements.
Throughout the repayment term, the lender is the legal owner of the asset. Then once all repayments have been made, your business becomes the legal owner. You are normally responsible for insurance and maintenance of the asset during the repayment term.
Please contact our team at Funding Bay for a free consultation to learn more about the benefits for your business!
