Car leasing – a credit lifeline for SMEs

Car leasing – a credit lifeline for SMEs

Acres of newsprint have been devoted during the last four years to small and medium businesses’ struggle to secure adequate financing from the banks.

But these media stories often overlook the availability of alternative sources of funding that SMEs can still tap into. For example, a recent survey found that nine out of 10 fleet decision-makers in SMEs still prefer to buy company vehicles outright rather than leasing them.

This preference for ownership is long-standing among smaller businesses but it has definite financial drawbacks. In particular, it ties up large sums of money that could be put to more profitable use elsewhere in the company.

Buying, managing and selling vehicles is also a time-consuming business. At a time when many companies’ revenues and margins are under unprecedented pressure, directors might well ask whether their business should be running what is essentially a vehicle trading side-line alongside its core activity.

Even if a company is relatively "cash rich" it is questionable whether company cars are the best capital investment. Naturally, a new car will depreciate whilst incurring costs for servicing, maintenance and repair.

Spreading the cost of buying cars with Hire Purchase helps to smooth out cash flow. But the cost of HP is usually higher than a lease, unless the customer puts down a large deposit on the car – which, again, represents tied-up money that could have been used more profitably somewhere else.

If we compare an operating lease (Contract Hire) against outright purchase, we see that the lease offers some immediate advantages for the small business:

Less money up front

. Typically, customers choose to between 3-6 monthly payments as deposit, though it is possible to pay as little as 1 month in advance.

Lower monthly payments

. Lease payments are usually lower than HP because the contract funds only the car’s depreciation over a set period of time, not its full purchase price.

Fully predictable cost of ownership

. Although HP and leasing both offer predictable payment schedules, with HP (or full up-front payment) you only discover the car’s full cost to the business when you sell it. With Contract Hire (especially when maintenance is included) you can confidently budget ahead for everything except the cost of fuel.

Lower administrative burden.

If you go to the right supplier, Contract Hire is now as much a service as a product, with online reporting and ordering, service booking for drivers and the opportunity to add other products and services in fixed monthly rental payments. Alphabet even offers, uniquely, to include comprehensive motoring insurance.

Tax advantages.

It’s very rare for an employer to be able to recover the VAT on a vehicle they’ve bought (there has to be absolutely NO private use by any employee, which rules out VAT-recovery on most outright-purchased company cars and many vans). But leasing companies can reclaim VAT on new cars: allowing them to pass the 20% saving on to your business in the form of lower monthly rentals. Lease customers can also claim 50% of the VAT on the finance element of monthly lease rentals and 100% of VAT on the maintenance element (if included). For corporation tax purposes, companies can set the full amount of finance rentals on cars that emit less than 130g/km of CO2 and 85% of the rentals for vehicles over130g/km of CO2 against taxable profits.

Flexibility.

Contrary to popular belief, leasing doesn’t lock customers into rigid time and repayment parameters. If a customer’s circumstances change, most leasing companies will sit down with them to review their arrangements (e.g. extending contracts). Optional safeguards like early termination insurance also eliminate any worries about having to return cars early.

In short, car leasing offers a potential credit lifeline to any business that’s concerned about its cash flow and borrowing. And, unlike bank loans and overdrafts, lease financing for vehicles is still readily available to SMEs. On top of that, businesses can usually release cash tied up in existing fully-owned vehicles by selling them to a leasing company and leasing them back.

All of which begs the obvious question: if outright purchase has so many drawbacks compared to leasing – especially in the current financial climate – why do nine out of 10 small and medium businesses still believe that outright purchase is best?

One can only speculate that the reason is ownership itself. Many small business owners like to feel that they have full control over their vehicles and that no-one can take them away from them. Also, in some cases, companies want to show company cars as assets on their balance sheets (which, of course, they can still do under certain types of lease).

But car ownership comes at a high price, especially when often-unseen costs like administration are taken into account. And if companies exercise the option to keep vehicles longer than the typical three or four year span covered by a lease agreement, the car will further depreciate and incur unforeseen costs, whose net contribution to the business’s performance might easily be negative when all factors are taken into account.

In healthier economic times, before the banks pulled the plug on a very large slice of SME financing, the tail risks of outright purchase were, if not necessarily financially justifiable, at least affordable. Today, however, with the economy flirting with another recessionary dip, lower-cost, lower-risk lease financing is surely the sensible and correct way to fund business vehicles.

Leasing advantages checklist

Accurate monthly budgeting, VAT recoverable on services, Improved cash flow, Minimal capital expenditure, Gap insurance (optional), Fixed interest rate, No depreciation risk, No vehicle disposal problems, Fixed cost maintenance (optional), Reduced Administration, VED included, Preferential rates on vehicle hire.