What is Asset Finance and How Does it Work?

Asset finance is a vital funding facility for UK businesses as it makes it easier to buy big-ticket items such as vehicles, plant machinery, equipment or premises. According to The Finance & Leasing Association, asset financing has become the core driver of the UK economy, with leasing and hire purchases reaching record levels in 2019 of £35.6 billion, 6% higher than in 2018.

In industries where cash flow is tight but necessary to carry out services, asset financing allows businesses to avoid high up-front costs but instead spread them over an agreed time period in smaller instalments.

In this article we will be covering the following:

• What is asset finance?
• How asset finance works
• What an asset is/what types of support can be used for finance
• What the different types of asset finance are
• Why you should use asset finance
• Advantages and disadvantages
• Whether you can get asset finance with bad credit
• Whether your asset can be repossessed
• Asset financing vs asset factoring
• Short-term asset loans

What is Asset Finance?

Asset finance is a form of funding which allows businesses to purchase an asset(s) - or lease it - over an agreed period of time in return for a fee, typically in the form of interest payments. Asset funding is invaluable to for enabling businesses to grow faster, stay ahead of the competition, or simply cope with maintaining or replacing existing assets such as machinery, vehicles, equipment, etc as they reach the end of their natural life.

How Does Asset Finance Work?

Asset financing is often associated with purchasing high-value assets for a business where the company may have insufficient funds to buy the asset outright. It can be used as a source of financing to help a business grow whilst also minimising the impact on cash flow. A business could also use pre-existing assets as security against a loan from an asset refinancing provider.

A business that requires the purchase of new assets can look to a finance provider to purchase such assets, repaying them in regular instalments over a fixed period of time.

Depending on the type of asset finance a business chooses, the asset could end up being owned by them, or sold back to the provider (leasing). We will delve more into the different types of asset financing later in the article.

Is Asset-Based Lending the Same as Asset Finance?

No. Asset-based lending utilises an asset which a company already owns to be used as security against funding for another purpose, such as purchasing a new asset. In contrast, in asset finance it is normally the asset which is being funded which provides the security for the loan. 

What Are Assets and What Types of Assets Can You Use for Finance?

An asset can be described as an object/resource that has a value which can be converted to cash.

Generally, providers consider assets which have a high value such as vehicles, machinery, plant and equipment. These assets must meet DIMS criteria which means that they are:

• Durable
• Identifiable
• Moveable
• Saleable

Assets can also be classified as ‘hard’ or ‘soft.’

• Hard assets involve high-value, physical items (vehicles, machinery, buildings etc.)
• Soft assets typically represent a higher risk when used for security as they are less durable with limited saleable value by the time the financial agreement ends (catering equipment, warehouse racking, office furnishings, etc.).

What Different Types of Asset Financing Are There?

There are 6 key types of asset financing you should be aware of:

• Hire purchase (HP)
• Finance lease
• Equipment leasing
• Operating leasing
• Asset refinance

Whether a form of asset finance is practical for your business will depend on several factors, such as cash flow, age of the business, business size, what you require an asset for and so on.

Hire Purchase (HP)

Hire purchase, sometimes also referred to as “equipment finance” (not to be confused with “equipment leasing”) is where you agree for a third party to finance the purchase of a new asset, and then you repay the loan in instalments over a fixed time period. Vehicle asset finance is one of the most popular sub-types of hire purchase agreements for businesses.

Once the asset has been repaid in full, the ownership of the asset is transferred to you. This transfer of ownership often requires an Option to Purchase Fee. Throughout the repayment period, any maintenance issues and upkeep falls under your business's responsibility, not the provider's.

The core defining feature of hire purchase is that the objective throughout is for you to own the asset by the end of the agreement period.

Finance Leasing

Finance leasing (sometimes referred to as a “capital lease”) is where a leasing firm purchases an asset for a business on their behalf, which they subsequently rent to them. Vehicle asset financing can also fall into the category of finance leasing.

Payments are made from the business to the leasing firm for a ‘primary rental period’ until both the asset and its interest are repaid. At the end of the primary rental period, the business can choose to extend the rental period and return the asset. With finance leasing, your business never owns the asset, but you are responsible for its insurance and maintenance.

The core defining feature of hire purchase is that the objective throughout is that you are only ever renting the asset for the agreement period and have no requirement or intention of purchasing it.

Equipment Leasing or Personal Contract Purchases (PCP)

Equipment leasing or PCP (Personal Contract Purchase) agreements are similar to finance leasing, however with each of these methods you have the option to own the asset once the contract has ended and repayment is made in full. Again, payments are made in smaller instalments over a fixed period agreed in the contract. The firm is responsible for maintenance issues and equipment upkeep.

At the end of the leasing period, your business has several options. You can choose to extend the lease, return it to the leasing firm, upgrade it or buy it outright. PCPs for vehicles often come with a restriction on mileage, and have a final “balloon” payment.

However, because the lease agreement is based on the depreciation of the asset as opposed to the full cost, monthly payments tend to be lower than with other types of financing options. Again, the leasing firm is responsible for an asset’s maintenance during this repayment period.

This type of asset financing is not limited to larger companies like other financing options can be, often being favourable for early-stage companies.

The core defining feature of equipment leasing is that it provides flexibility to determine how you wish to proceed with regard to ownership of the asset at the end of the agreement period.

Operating Lease

An operating lease is similar to a finance lease, but the key difference is that operating leases tend to be shorter term and you as the lessee are responsible for any maintenance costs.

Asset Refinance

Asset refinance falls into two primary categories:

1. A company pledges its assets as security against a loan - the asset is considered ‘collateral.’ The lender can sell these assets to recover funds if you fail to make a repayment and default on the loan. If you pay off the loan in full as agreed by the contract, the asset returns to you. This type of loan tends to have lower monthly repayment costs in comparison to other types.
2. The second form is based on the idea of ‘asset-based lending.’ Your business sells a hard asset to a financing company in exchange for a lump sum. You can then lease this asset from the provider until the repayment is made in full. The benefit of this is that it frees up large sums of cash which you can use elsewhere within your business. Repayment is made in small increments over a fixed time period and you have access to the asset throughout the leasing period.

Should You Use Asset Finance?

As a business owner, any significant expenditure can be intimidating, especially considering the nature of many businesses where cash flow is restricted. Thankfully, asset financing can help relieve some of the stress for your business if you can find one suitable for your needs.

You need to make sure that before signing any contract you are able to make the agreed monthly repayments and that you have read all the terms and conditions to ensure that you fully understand your liabilities. Failure to make repayments may pose serious risks to the reputation, operation and credit score of your business.

Advantages of Asset Finance

Asset finance offers a number of advantages for businesses including:

• Providing an alternative to paying up-front. Smaller payments spread costs over a time period which helps reduce any impact on cash flow
• Regular and fixed payments make budgeting and planning easier for businesses
• Can make use of pre-existing assets by using them as security for a loan
• Sometimes easier to secure compared to bank loans, and often have lower interest rates compared to bank overdrafts
• With leasing and hiring, maintenance costs are usually the responsibility of the provider which can reduce operating costs
• If an item needs replacing or updating, this is usually the responsibility of the provider
• Often depreciation-related risks fall with the provider

Disadvantages of Asset Finance:

Asset finance may not be the best choice for all businesses or situations. As with many things, it’s important to consider if it’s the right tool for the job or the right choice for you. Some of the disadvantages include:

• Failure to pay will result in equipment being taken from possession - this equipment could be vital to the business or service
• Leasing and hiring often involves paying for an item that you will never own outright
• Not usually suitable as short-term solution as repayment is typically spread over several years
• Any damage not covered under servicing or maintenance agreement does not usually fall to the responsibility of the provider

Can You Get Asset Finance With Bad Credit?

This really depends on the type of asset finance you are seeking, as well as the status of your business. If you’re looking at asset refinancing, the provider will consider the value of the asset as collateral, not your individual credit rating. In other types of financing options where you are operating as a sole trader or partner, your credit score is more likely to play a factor in the agreement. Limited companies need to have good credit scores as this is important for lenders.

Lenders usually want to check business accounts regardless of the type of loan you are seeking to ensure you’re reliably able to make repayments.

If you’re worried about whether you will be able to secure funding for your business due to past poor credit history, contact us and we will be happy to help advise.

Can Your Asset Be Repossessed?

With any asset financing, the asset is owned by or transferred to the lender during the leasing period. If you breach the contract or default on the loan, the lender may repossess assets to recoup the funds. This can be particularly harmful to your business if the asset is vital to how it operates.

How is Asset Financing Different From Asset Factoring?

Both forms use assets as security for a loan, however, they differ in their benefits, costs and associated risks.

With asset factoring, also known as “invoice factoring” or “invoice finance”, a business sells its accounts receivables to the lender, who then sends back a percentage of each invoice to the business. Depending on the financial strength of its customer, this can vary between businesses but is often around 70-85%.

This differs from asset financing as businesses don’t offer up their own assets as a form of collateral and involve a company’s customer base when structuring payments. Loans don’t purely depend on the value of a company's assets.

What Are Short-term Asset Loans?

A short-term loan typically lasts for less than 12 months but could last up to 36 months. It provides cash to a business that offers its assets as collateral or provides a short-term lease of equipment that a company requires for a short period of time. Short-term asset loans will generally have a higher interest rate as the lender has less time to make reasonable returns on interest payments. This helps support cash flow or fund an immediate need.

Is Asset Finance Regulated in the UK?

Financial services firms are regulated in the UK by the Financial Conduct Authority (FCA). They ensure that the services are fair for individuals, businesses and the economy alike. From an asset finance perspective, consumer lending (such as hire purchase for a vehicle) is considered to be a ‘regulated activity’ and therefore will be authorised and regulated by the FCA.

Get Started With Your Asset Finance Request Today!

If you want to check your eligibility for asset finance, or simply want to find out more about how it might benefit your business, get in touch with one of our expert account managers to see how Union Business Finance can help.