Times have been tough over the past year or so, so to spread the cost of investment in new warehouse equipment many companies have opted to lease rather than buy. And to make the balance sheet even more favourable many have chosen an operating lease over a finance lease meaning assets and liabilities don’t have to be shown on their statement of financial position. Instead, the lessee simply has to account for the lease payments as an expense over the lease term.
However, all that could be about to change following the publication of an exposure draft by the International and Financial Accounting Standards Boards (IASB and FASB) in August 2010, which suggests that a consistent accounting model should be implemented for both lessees and lessors, meaning all leases would need to be recorded on the balance sheet.
It’s a significant change. Lessors and potential lessees are busily analysing the impact to understand the full implications. Lessors, in particular, are stressing the other advantages of leasing over outright purchase.
Mark Richards, commercial manager of GE Capital’s lending segment believes that the greatest impact will be on major investment decisions.
“I don’t think the proposed changes to lease classification will have a significant impact on the majority of the market. Largely the decision to opt for leasing is driven by convenience, flexibility and low cost of acquisition.
Lessors will continue to take residual value risk in assets to give customers the benefit of reduced payments regardless of potential changes to balance sheet treatment.
“It is more likely to impact on larger projects, if a company is equipping an entire warehouse or if it is buying a building and wants to know how it will affect the balance sheet. If a company is just looking for half a dozen forklift trucks it’s not going to be as big a consideration.”
And Richard Gilliard, managing partner of Renovotec, which supplies mobile computing and automated data capture systems, says: “In 17 years I don’t think one customer has come for the tax position, we have proposed it, but it has always been the flexibility of the lease that has drawn people in. Within the third party logistics sector for example, if the number of devices a company needs changes, we can easily add an extra 45 devices to a lease agreement, which would work out as something like £195 more a month, rather than a large one off payment.”
Nene Group, the Daventry-based materials handing and storage equipment company, offers Rentarack, which allows companies in the UK, Ireland and the EU to rent racking and shelving for any size of facility from two weeks to ten years.
Ancillary equipment such as guards, mesh, decking, signage and netting can also be included as part of the contract, and existing storage systems can be supplemented with beams or decking to cover short-term requirements when needed.
It says that one of the benefits of Rentarack is that it enables companies to claim 100 per cent capital allowances from the Inland Revenue for the rental, which can work out cheaper than paying cash.
Paul Fagan, managing director of Nene Group, says: “To help small companies, the government has increased the amount of capital equipment that can be purchased on 100 per cent allowance against corporation tax from £50,000 to £100,000. This figure for 100 per cent allowances is on the total capital spend for one company or a group of companies (only one allowance for the group) over a 12 month period.
Contract hire costs
“This will be the same for contract hire costs for racking which again are all allowed at 100 per cent but are unlimited in terms of amount of hire cost per annum.”
However, Fagan warns that these allowances are only good for companies who pay corporation tax, although some allowances, depending on circumstance, can be carried forward into the next tax year.
“The main advantage for hiring racking comes into place when you consider that the normal company setting up a warehouse would spend much more than £100,000 in doing this and indeed over a year would spend much more than £100,000 on capital purchases. Therefore any costs after that £100,000 would only be considered for the normal first year 20 per cent allowance. However the rack hire, which in the case of the average warehouse would ensure that the full 100 per cent allowance is available on all costs associated with the hire and does not reduce back to 20 per cent even when more than £100,000 has been spent.”
In summary, Fagan says: “Except for a very small company with a very small capital spend per annum rack hire still offers far more tax advantages over outright purchase to those companies paying corporation tax. And for those smaller companies with a lesser capital spend per annum it doesn’t offer anything less.”
Steve Richmond, general manager of Jungheinrich’s systems and projects division agrees that leasing, particularly for racking and shelving systems, is becoming a more attractive option.
“While other materials handling products, most notably forklift trucks, are very often acquired using some form of finance package, racking and shelving systems have traditionally been seen as an outright capital purchase item.”
However, he says this is changing, driven in part by the current trading conditions. “There are still companies that are happy to write a cheque for new racking systems, but we have noticed an increasing trend among customers to look for some form of finance agreement.
“It’s easy to see why flexible finance packages that allow the full costs of the system to be paid over a number of years are attractive. However, choosing the best funding option is sometimes less than straightforward.
There are a variety of packages available and it is important to pick a scheme that suits your company’s needs. It is certainly beneficial to deal with a supplier with experience in putting together finance packages who can tailor a scheme to meet both the requirements of your business and the changing needs of the marketplace.”
Clive Fearn, marketing director of The Barcode Warehouse, agrees. “Traditionally big capex items such as fork trucks have been financed but, now we are seeing everyday items such as printers, scanners and mobile terminals being considered for finance.”
And it’s a trend that is set to continue, according to Marie Dunkley, head of sales at Hitachi Capital Business Finance. “The proposed cut of £75,000 in a company’s annual investment allowance is expected to make leasing more attractive than either using their own cash, or borrowing through hire purchase to fund new assets. Profitable companies will be affected by the reduction, from £100,000 to just £25,000, of the amount of capital expenditure that can be offset each year against taxable income.”
Traditional hire purchase
She says that traditional hire purchase users will still be able to offset the interest element of repayments against tax and claim annual writing down allowances, which are currently at 20 per cent, but are set to reduce to 18 per cent in 2012.
“In contrast,” she continues, “finance leases of less than five years and some operating leases allow companies to offset one hundred per cent of the rentals as an allowable business expense. We are seeing an increase in leasing by profitable companies who have traditionally paid cash or used hire purchase for new assets. The numbers make sense to do so. Ultimate ownership of an asset is becoming less attractive than making money from using it. Once profitable companies see the effect of lower tax bills then the leasing decision rests easy on the busy finance director’s desk.”
The recession has affected the way companies look at investment. Dunkley says: “With some companies experiencing lower profits and pressure on margins and cash flow, it’s not surprising to see companies spreading the cost of investment over a known and budgeted period of time. In boom times they may well have simply reached for the cheque book to fund a planned investment programme or equipment replacement. Today a mix of funding options is considered and asset finance looks a safe and attractive option.”
TDG procurement director Jonathan Fletcher says: “We moved to operating leases because of margins. It allows forward thinking companies to stay ahead of the curve. From a procurement point of view we would look at continuing leases as the transparency it provides is hugely beneficial, as is the fact that maintenance, disposal costs and residuals are all included. Customers can see the total cost from cradle to grave. And because we don’t own the equipment we are able to embrace new technologies to our advantage. However, you have to be shrewd to make sure you are delivering the right value to the customer at all times.”
Fletcher advises companies to look out for flexibility and the conditions of returns because while things might be transparent on the initial transaction there could be a risk if returns conditions aren’t fair. “If you lose a contract for example, you could potentially have to give back unneeded equipment which could cost a significant amount.”
Flexibility, it seems, is the key to getting the most from a leasing agreement. Renovotec’s Gilliard highlights the of providing bespoke contracts that suit the individual needs of each specific customer. “We recently did a deal with a client which had 27 months remaining on a contract, so we agreed a term over 27 months in case the contract wasn’t renewed so the company wasn’t left with nine months to play out needlessly.”
It’s also important to understand the impact of the residual value – the expected market value of a product at the end of the lease period. A higher residual value will enable the lessor to offer lower monthly payments. Getting the residual value wrong can have unfortunate consequences.
John Maguire, sales and marketing director of Flexi Narrow Aisle, warns that some forklift companies are undermining the resale value of their existing ranges in their rush to bring new ranges and highly customised products to market.
“If I were a truck user or rental company who had been sold something that I thought represented the latest technology only for the product to quickly become all but obsolete, I would be very unhappy. With any significant capital equipment purchase, the buyer needs to have the reassurance of knowing that the product he or she is buying is not going to be two or three models out of date when the time comes for it to be resold. If it is, the resale value will be seriously undermined. Quite simply, changing a forklift model too quickly destroys the product’s used equipment value.”