Hire purchase is a form of asset finance which is commonly used to acquire new equipment or vehicles. One of the key benefits is that it helps organisations to expand or upgrade by spreading the cost of purchasing new assets and easing the impact on cash flow.
This form of finance agreement is well established and is simply a form of payment in instalments, allowing for payment of an asset over a set period of time. Once the final payment is made, ownership passes to the hirer, meaning you own the asset. Terms can be flexible and can allow you to set the initial deposit, regular monthly payments and the final balloon payment to be adjusted to suit your requirements.
Hire purchase is popular with businesses of all sizes; it’s widely used for business equipment and also a popular way of funding vehicles.
BENEFITS OF HIRE PURCHASE
What is hire purchase?
A hire purchase agreement is a type of asset finance arrangement that contains an option to purchase. At the beginning of the agreement an initial deposit is usually paid, the amount of which can vary, for example, you might choose to pay a higher deposit in order to reduce the on-going monthly payments.
Ownership passes after all the instalments have been made and the hirer exercises the option to purchase the goods from the finance company. The option to purchase is normally a nominal fee that has no bearing on the market value of the goods.
The instalments will amortise the hire purchase agreement balance outstanding down to zero (including if it includes a contractual balloon instalment).
Find out how Hire Purchase could help your organisation
How does it work?
Funding via a hire purchase agreement will usually involve a deposit on the asset or assets, after which your monthly payments will be calculated, depending on the amount of time you would like the hire purchase contract to cover. The duration of the agreement can vary to suit your budget and your business needs. The interest rates charged as part of the hire purchase terms can be either fixed or variable.
The payments (including a possible balloon payment at the end of the contract) will cover the original cost of the asset plus interest charges.
Although the business won’t own the asset until the final payment is made, taxation and accounting treatment will apply as if you had already purchased the item.
Accounting, VAT & Tax Treatment
- Asset appears on balance sheet
- Purchase amount is shown as a liability, reduced in line with repayments
- Depreciated over time as an expense in the P&L
- Tax liability can be reduced as interest (and non-recoverable VAT in the case of exempt businesses) can be claimed as a business expense
- Equipment, machinery and commercial vehicles financed on hire purchase will usually qualify for 100% first-year allowances via the Annual Investment Allowance (AIA)
- You will normally pay VAT on the value of the item along with the first instalment, but it is recoverable in the normal way if you are VAT registered.
- For hire purchase on cars, when used purely for business purposes (e.g. as a taxi, driving school car or hire car) then 100% of the VAT is recoverable. Where there is also private use, then VAT is not reclaimable.
- The finance company will often provide an option of financing the irrecoverable VAT on car hire purchase, or deferring the VAT payment until the date of your next VAT reclaim, where it is recoverable.
What are the Advantages and Disadvantages of Hire Purchase?
A feature of a hire purchase agreement is that you are able to own the asset at the end of the agreement. This can be useful as you may be able to use this as part exchange when you reach the point of replacement.
However, it is important to note that you will be responsible for the servicing and maintenance of the asset, especially when it comes to vehicle hire purchase (unless a specific maintenance contract is entered into).
In summary, this type of funding appeals to companies that want to retain ownership of their assets, but spread the payment over a period of time. However, you will bear the residual value risk and be responsible for all the servicing and maintenance requirements which may require in-house expertise and management resources. However, this may be advantageous if you would prefer to deal with specialised equipment in-house to avoid any delays with repairs or servicing.
Hire Purchase Benefits
You can spread the cost over regular instalments over the course of the HP finance agreement
It frees up vital working capital in the business
Low deposit often available
Fixed and variable interest rate may be available
Business purchases may benefit from corporation tax savings. The hirer can set the interest off against taxable profits and claim capital allowances.
On-balance sheet funding allows you to maximise your asset base
Lending will be subject to credit status
The security taken by the lender is the asset, rather than a charge over the business as a whole
Ownership of the asset at the end of the agreement (subject to payment of all instalments and the option to purchase fee)
It’s simple to arrange and understand
With hire purchase you will be responsible for insuring the asset and take the risks and rewards of ownership
Many business assets will depreciate in value over time. By the time you have made the final payment and the asset is yours, it may not be worth what you expected.
You will be entering into a fixed contract. If your financial situation changes and you are unable to make the agreed monthly repayments, the asset may be removed by the finance company.
The total amount you will pay for the asset will be more in comparison to paying in cash, as you will be paying interest in return for spreading the cost
You will not own the asset until the final payment has been made
It’s important to assess the asset finance options to determine whether hire purchase is the right fit for your business. There are other alternatives which may suit better. Contact us to discuss your requirements.