More and more businesses are moving towards the flexibility of pay-per-use models, also called consumption-based models or subscription models. These models charge customers for specific usage of a product or service.
The question is: Why this shift?
In the previous two articles of this three-part series (The implications of acquiring new equipment and The next steps in acquiring new equipment), we looked at the types of questions small-to-medium-sized business owners should be asking before acquiring new assets or equipment.
One of the most important considerations is how it will be financed. It is, therefore, vital that businesses’ decision-makers understand the pros and cons of the three main financing options—an overdraft facility, an instalment sale, and a fixed-term rental lease—before making a commitment.
The important facts about financing solutions
According to Kuben Rayan, CEO of RentWorks, there are advantages and disadvantages to each of these options:
- An overdraft facility
Most small-to-medium-sized South African businesses opt for this financing solution as it is the easiest. An overdraft facility is usually meant for short-term working capital requirements. However, as a long-term solution this means that, if used too aggressively, it can result in cash flow problems for a business.
- An instalment sale
This is a great funding option. Unfortunately, most South African credit providers require a deposit, which can be prohibitive on a business’s cash flow. Another challenge is that, if a business is dealing with an asset that needs to be refreshed on a regular basis, an instalment sale requires that a business takes ownership of that asset.
- A fixed-term leasing arrangement
There are various benefits of a leasing agreement, five of which have been highlighted and briefly explained below.
The long-term business benefits
Rayan notes that there are five solid benefits for small-to-medium-sized business owners who decide to pursue the rental route:
- Optimise cash flow: By spreading the payment for the asset across its useful life, cash flow is optimised, giving business owners the opportunity to save cash for working capital, or for pursuing the company’s core business activities.
- Mitigating against obsolete assets: As mentioned earlier in the article, more assets are becoming obsolete more quickly. If businesses procure their equipment through a rental arrangement, they may have the option to return the assets they no longer require at the end of the initial rental term, and upgrade them to the latest or more appropriate versions, which will optimise their business operations, as well as profits.
- Maximise purchasing power: With a rental agreement, cash constraints won’t require business owners to settle for underspecified equipment, or to delay the roll-out of an asset acquisition project until the next budget cycle.
- Capitalise on IFRS: Where an asset is funded using an IAS17-compliant rental arrangement, companies will be able to make use of an off-balance sheet structure, which will have a positive effect on a key ratio – such as Return on Asset (ROA), Return on Equity (ROE) and Debt/Equity Ratio.
- Ditch the deposit: Rental financing arrangements usually don’t require up-front deposits, freeing up cash for business owners to pursue their operational interests and successfully follow their company’s strategic direction.