How Leasing Helps Cash flow
It comes as no surprise that more and more people and companies now choose to lease items rather than purchase them outright.
This is primarily because there’s a lower upfront cost, which means you don’t have to save up and pay a large lump sum to get whatever asset it is you want – you and your business can have it instantly and choose to pay weekly or monthly. It’s now possible to lease almost anything you could buy. This includes cars, property, telecommunication and IT equipment, printers, machinery, furniture as well as construction equipment. The list can go on and on.
With so much available on the market, it’s no wonder that many businesses like yours are now embracing the advantages of leasing rather than purchasing assets. A lease means committing to and paying monthly or weekly rentals for the item, and it can have a number of advantages as it spreads the cost. However, the main benefit that companies like yours see from leasing is that it allows for better management of cash flow.
Whether you lease, purchase assets outright or do a combination of both, it all depends on the cash you have available in your business and whether you want to tie up the full amount in fixed assets at the current time.
Ways in which leasing helps cash flow include:
- Simplified Budget Management – helps match revenue to expenditure
- The Business Spend Is Known
- Overall Spend Is Distributed Wider and can be budgeted to be flatter
- No Balloon Payments
- Smaller Monthly Payments rather than lumpy outlays
Let’s look at how leasing helps cash flow in more detail.
Simplified Budget Management
In this scenario, let’s say your business is reliant on hardware to make your business operate. With ever-changing technology growing more and more frequent and expensive, your business might need the latest equipment to continue operating effectively. However, you might not be able to afford all the upfront costs which might take a large chunk of the company’s budgeted spend – something the finance team or the board might not be willing to do.
Although in certain circumstances you might end up paying more through leasing, though with effective lease management there is no reason you should, explaining that you need a few hundred pounds extra per month to bring in the latest technology will probably sit well with the company and the board, rather than asking for tens of thousands of pounds at once.
For your business and finance team this eases the management of your cash flow, and also makes it easier for you to scale since leasing allows you to rapidly acquire the equipment you need while your enterprise grows. With typical leases lasting around 36 months, for example, you’ll have a lease duration that perfectly coincides with the typical life-expectancy of most equipment.
By the end of your agreement, you’ll be in the perfect position to reinvest in newer and better equipment. Focusing on the budget side, paying a set amount weekly or monthly makes it much clearer for your business to see what the expenditures are, and the finance team can begin to budget around the leases you’re paying. This makes budgeting much easier for your business, as opposed to having to budget around much larger outright payments for equipment and they can focus on investing that in other departments.
Plus, if you’ve purchased equipment at a significant price, then you’ll have to pay even more to have it repaired or replaced which can further impact your budget. If you’ve leased any equipment that needs repairing or replacing, then it will work out much cheaper in the long run and it won’t have a major impact on your cash flow.
Business Spend Is Known
Leasing equipment helps manage your cash flow much better because your exact business spend is known and you can see exactly where your money is going and match it to the income the assets may be generating. With IFRS 16 rapidly approaching, all of your lease agreements will now be moved onto your balance sheet. Misunderstanding the raft of changes involved means that IASB compliance is voided – additionally, the definition of what constitutes a lease and a service agreement is changing, which will impact not just cash flow but other financial metrics.
IFRS 16 is going to shift the entire categorisation of lease agreements away from risk and reward of ownership onto who controls the right of use of the asset. The fact that some lease agreements have been to date categorised a certain way will be changing, meaning financial ratios are going to be impacted. However, with lease agreements moving onto balance sheets with the implementation of IFRS 16, businesses like yours will be able to see where your business is investing, what your business is spending, and where it’s being spent.
Before the move onto balance sheets, it was more difficult to understand where your company’s budget was being spent as lease agreements didn’t need to be on there. With the upcoming changes, all lease agreements will be visible and in turn, it allows you or the finance team to see exactly how much money is leaving the business, and exactly where it’s going which helps manage your cash flow better as you can begin planning future budgets around the current expenditures.
To help educate your team or colleagues on IFRS 16 and the changes it will bring, we have produced IFRS 16 At A Glance, a document which you can distribute in your next meeting, so everyone is aware of what’s changing.
Overall Spend Is Distributed Wider
Another way leasing helps cash flow is that the overall spend of your business is distributed wider. Again, leasing equipment means you’re not having to tap into your company’s valuable cash resources and take out a large chunk to assist in one area of the entire operation to make it function. When you’re purchasing equipment, the entire cash flow of the business is impacted because one large outgoing payment is going to impact how much other departments are able to spend.
That’s the benefit of leasing, as one particular department shouldn’t be responsible for another not being able to purchase equipment because there simply isn’t enough money left for them to spend. With leasing, you’re able to distribute the overall spend on a much wider and flatter scale because you know you’ll have money to spend wherever needed each month, even after lease payments are being regularly taken out.
Through leasing, this also means that other areas of your business will have a chance to lease more equipment because there is money in your budget available to spend. This domino effect can massively help cash flow within your business, without living in the worry that bigger outright purchases will have a negative impact on your cash flow and continue to stretch your budget into the minuses.
No Balloon Payments
You often see balloon payments more popularly be associated with car leasing, which is a term used for a final payment at the end of a hire purchase or personal contract purchase. Here, a final, large payment must be paid in order to take ownership of a car – but this term can be used in another case.
In a lease purchase agreement, the customer must either pay the balloon payment, or they can choose to refinance the payment. For example, a car lease under a PCP agreement means customers have the option to either make the balloon payment and take ownership of the car, hand the car back to the leasing company once the duration is complete, or part-exchange the car and use any equity left in the vehicle to go towards the deposit for a new car finance agreement. The important thing to note is that a balloon payment costs a lot, and once it has been paid, it means you will have taken ownership of whatever it is you’ve leased.
Leasing helps cash flow because your business won’t need to make a balloon payment, or if there’s an option to make the balloon payment to own the equipment, then it’s not vital that you make the payment if it has an unwanted impact on your cash flow. Again, your business might be reliant on technology to operate and you don’t want to be stuck with equipment that will quickly become outdated while there are newer models being released, which can have a more positive impact on your business.
When you don’t make the balloon payment, whatever you’ve leased will go back and you won’t own the item. So, your budgeted cash flow will be intact and it gives you an option to identify newer equipment which will be available on a lease by the time your current lease is over and you won’t be having to pay a lot to own equipment you will no longer need and will need to dispose of.
Smaller Monthly Payments
Sometimes, businesses make the mistake of ignoring a leasing option and instead, they take the route of taking out larger loans from a bank and choose to repay those instead. While the assumption might be that repaying a loan to a bank is a cheaper alternative, that’s not always the case as it can have a negative impact on your cash flow depending on its duration, interest rate (fixed or variable) and status (secured against the asset or otherwise).
Leasing means paying smaller regular monthly payments to use the equipment for a fixed term and this ties in with the previous points. If you’ve taken out a loan to purchase any equipment you’ll need, then not only will you be paying the bank, but you’ll end up owning the equipment too. So, you’ll be stuck with the loan repayment as well as the equipment, so you might end up taking another loan out when there’s newer equipment out there that your business might need. This can snowball into much larger debt and with the ever-changing interest rates, you could end up paying more and more each month.
With leasing, you’ll always know what you’re paying as the rates would have been agreed upon beforehand, so your cash flow won’t be hit with any surprises when you least expect it. These monthly payments allow you to plan for the future, such as leasing even more equipment or planning what to do when your lease agreement ends, and you have the option to upgrade, without having to actually own the item and be stuck with it when there might be no use for it or it might be costly to dispose of.
Take Note Of Changes To Lease Accounting
As the popularity of leasing has grown rapidly over the past couple of decades, accountancy standards have had to change in order to better reflect the financial habits of businesses across the world.
In essence, historically speaking, businesses may have only leased certain high-ticket items that would not be worthwhile owning, like a contractor leasing a tower crane for the duration of a high-rise hotel build, for example.
But as everything from mobile phones to passenger jets are now leased by businesses, accountancy standards are changing and how leases are reported in IASB compliant financial documents will change when IFRS 16 comes into force.
How Can You Prepare For IFRS 16?
Make sure to download a FREE copy of the 7 steps to new lease accounting compliance so you’re prepared early. Putting everything on the balance sheet will give your business a realistic understanding of assets, operating costs, cash flow, and expenditures overall, so long term it’s a great idea. But it takes a while to get compliant so start today.