Vehicle Funding

Finance lease

Similar to contract hire, a finance lease allows the lessee to hire a vehicle for a fixed monthly fee. One of the main differences is that the risks and rewards of ownership of the vehicle are transferred to the lessee.

A finance leased vehicle will show on the lessee’s balance sheet; outstanding rentals will be represented as a liability. Generally, a finance lease will follow one of two standard formats – the residual value lease or the fully amortised lease.

Residual Value Lease – the declining value of the vehicle is exhibited in the monthly rental, with a final balloon payment covering the estimated residual value at the end of the finance period. The lessee acts as a sales agent for the leasing company and sells the vehicle. If the sold price is above the pre-determined balloon payment, then the leasing company will generally refund a percentage of the proceeds to the lessee. If the sold price is below the balloon payment, then the lessee will be liable to pay the shortfall to the leasing company.

Fully amortised lease – the full value of the vehicle is taken into account and there is no balloon rental to consider at the end of the term. The lessee can still sell the vehicle and take a percentage of the proceeds of the sale as above.

When the end of the primary lease period is reached, the customer can request to lease the vehicle for a secondary period at a nominal ‘peppercorn’ rental. If the finance lease is a residual value lease, the lessee must pay the balloon payment before entering the secondary rental period. With the fully amortised lease, the lessee can enter into the secondary rental period immediately.

Some finance companies will provide maintained finance lease contracts, of which the lessee will be able to reclaim 100% of the VAT.

Pros

• Fixed monthly rentals
• 50% of VAT can be reclaimed on the finance element
• Rentals are usually Corporation Tax deductible
• Potential to carry on using the vehicle at the end of the primary lease period
• Additional line of finance that may not affect core banking arrangements
• Car appears as an asset on company books

Cons

• Risk of fluctuations in the used car market
• Monthly rentals appear as a liability on balance sheet

Lease purchase

This is a method for acquiring ownership of a vehicle, it can be referred to as lease purchase (LP) or hire purchase (HP).

With these agreements, the purchaser hires the vehicle from a finance company with an option to purchase it at the end of the hire term. The agreement generally requires a deposit anywhere from three month’s rentals up to 20% of the capital cost of the vehicle and will usually terminate with a balloon payment – normally equivalent to the forecasted residual value of the car. By increasing or reducing the deposit and balloon payments, the monthly repayment amount can be varied to suit the purchaser’s budget. There is an option to purchase fee at the end of the term that can vary greatly between finance companies.

This method of finance will be attractive to businesses that wish to retain ownership of their vehicles, want to avoid mileage restrictions and do not want to use their capital or overdraft to pay for them. This funding method presents a residual value risk and requires in-house expertise and management to write the value of the vehicle down monthly on the balance sheet. The interest rate on a hire purchase agreement can be fixed and therefore create fixed monthly instalments, eliminating exposure to fluctuating interest rates.

Pros

• Purchase cost may be Corporation Tax deductible thorough capital allowances
• Interest elements of monthly payments may be Corporate Tax deductible
• Can benefit from higher residual values

Cons

• At risk from lower residual values
• Outstanding instalments appear as a liability on the balance sheet
• Not VAT efficient
• Vehicle appears on balance sheet
• Cost of in-house management