RSS feedsOne in three new businesses will have ceased operating by the end of their third year, often because they have exhausted their cash resources.
New business owners often fail to appoint an accountant until they receive tax demands, which is often 12 or 15 months after they have started. The lack of a financial adviser often means companies have to rely on a provider for advice, which is hardly an impartial source.
If they had sought the advice of an accountant before starting the business, they would have been asked whether they had a sensible business plan, what research they had undertaken regarding its viability and how much finance they had allocated to startup costs. Seeking independent guidance from an accountant about the various sources of business finance advice would enable them to explore asset finance.
Businesses faced with the acquisition of a business asset tend to finance the asset according to pre-determined expectations. So, for example, a car is often leased or acquired on contract hire, regardless of whether that is the most appropriate financing arrangement. Equipment or plant machinery is also frequently purchased with little regard to the financing.
Buying an asset outright is often the cheapest option, but given a lack of working capital, is it wise to tie up finance that may be needed for other purposes? As well as affording the opportunity to defer payment, leasing arrangements can be set up quickly.
Almost anything can be leased, and there are a number of tax advantages to doing so. Leasing companies, in effect, lend the business the total cost of the asset and the business gains access to the asset straightaway.
With direct leasing the business decides on the asset it wants, and the leasing company buys it and rents it to the business. Many businesses selling plant, machinery and equipment offer financing packages, but it is important to seek competitive quotes from other companies.
An asset purchased outright can be refinanced later, but the amount offered for plant or equipment as part of a secured loan is usually less than the purchase price. Hire purchase is an option if the business wants to own the asset eventually. The interest rate on hire purchase is cheaper than a loan to purchase the asset outright.
Under the UK FRSSE, assets acquired by outright purchase must be capitalised and depreciated in the business’ accounts. The financial statements must disclose the basis for the depreciation charge. Hire purchase contracts that are of a financing nature should be accounted for on a similar basis to that for finance leases. Other hire purchase contracts must be accounted for on a similar basis to operating leases. Finance leases must be recorded in the balance sheet of a lessee as an asset and an obligation to pay future rentals. At the inception of a finance lease the amount to be included as an asset and as a liability is normally the fair value of the asset.
The rental under an operating lease should be charged on a straight-line basis over the lease term, even if the payments are not made on such a basis. An asset leased under a finance lease should be depreciated over the shorter of the lease term, or its useful life. In the case of hire purchase contracts having the characteristics of a finance lease, the asset should be depreciated over its useful life.
Many accountants play an active role in educating startups in financial management and control. Nowhere is that guidance needed more than in understanding the importance of cashflow management and appropriate use of all the available sources of finance. Being able to advise clients on the choices available for financing the acquisition of tangible assets is a vital service.
Tax implications
Purchase
Assets purchased – either outright or on hire purchase – are usually eligible for capital allowances. The rate of the allowance will depend on the type of asset, with a first-year allowance of 50% in place for plant and machinery pu rchased in the 12 months from 1 April 2006. In the case of hire purchase, the appropriate interest element is allowable as a deduction against taxable profits. More generous allowances are allowed for certain energy-efficient assets.
Leasing or hiring
In the case of leasing or hiring, the full cost is usually allowable as a deduction against taxable profits. The lease or hire cost of an expensive car (a car where the original market value exceeded £12,000) is restricted, however.
Capital allowances for buying such cars are restricted to a maximum of £3,000 in the early years of ownership but, in effect, full relief for the cost is given eventually. Once again, taking professional advice before making the financing decision can save clients money.
Tax considerations regarding financing choices may be of secondary importance if the business is making losses, which is sometimes the case with startup businesses.
Clive Lewis is head of SME issues at ICAEW technical strategy directorate
