Leasing: A creative financing model

SMEs should not solely rely on bank loans

SMEs should not solely rely on bank loans

Dr Sanderson Abel
Business require financing for asset acquisition, working capital and trade activities. There are different types of financing that you can choose depending with the agreement with your bankers. For example, in acquiring business equipment, fixtures and fittings, you can choose to finance the acquisitions through an industrial hire purchase, leasing or a term loan.

The ability of businesses to access finance is important for funding business investment, ensuring businesses reach their growth potential, and for facilitating new business start-ups. Lack of finance can constrain cash flow and hamper businesses’ survival prospects. By their characteristics, SMEs are not able to raise money directly in the capital markets and are therefore mainly dependent on traditional bank financing, which is itself limited as they do usually conform to the bank criteria because of their perceived risk.

SMEs should not solely rely on bank loans and advances given the associated challenges faced by banks in assisting this sector but rather by some creative financing mechanisms including leasing. Leasing is an alternative instrument for facilitating access to finance; it enables in particular, new enterprises including those without credit track record and limited possibilities to provide collateral, the use of capital equipment as security for loans.

As such, it also mitigates market weaknesses of SME lending. Leasing is referred to as “creative financing” because payments can be tailored to a project’s cash flow, in addition to some tax advantages associated with lease structuring.

Lease financing is a contract between the owner of an asset and the user of asset. In this contract only rent is paid at periodical intervals for using of asset by the user. If the user of asset has no money to pay initial amount of leasing contract, he can also do contract with third party such as a bank to pay initial amount or specific period rent of the lease.

There are many advantages of using lease financing especially for those in the informal and SMEs sector. These advantages include;

A leasing agreement is a medium term funding facility, which cannot be withdrawn, provided the business makes the payments as they fall due. The uncertainty that may be associated with alternative funding facilities such as overdrafts, which are repayable on demand and charge variable rates of interest, is removed.

Lease finance maybe easier to get than a loan for buying fixed assets. Monthly rent payment for lease finance are also regarded as operating expenses and will be deducted from total income, so the lessee can get some tax benefits from the lease financing.

Leasing is a more flexible way of finance. You can fix your need of asset and get it on lease through lease financing. Since leasing generally provides 100% financing, companies are attracted by the minimum upfront expenses and down payments required by other financing alternatives. Tangential out-of pocket expenses like shipping, freight, installation and engineering can be included in the financing.

Leasing normally results in a fixed predictable expense. With the uncertainty of interest rates it is sometimes advantageous to lock into predictable long term expenses for better cash-flow management.

Leases can offer flexible repayment structures. Some businesses tend to be seasonal in terms of cash flow. With leasing, you may be able to match your lease payments to your cash flows or budget requirements. You may arrange to skip payments, make annual payments or defer payments as part of lease structuring.

Under leasing, the finance company retains legal ownership of the equipment, at least until the end of the agreement. This normally gives the finance company better security than lenders of other types of loan or overdraft facilities. The finance company may therefore be able to offer better terms.

In most cases the payments are fixed throughout the hire purchase or lease agreement, so a business will know at the beginning of the agreement what their repayments will be. This can be beneficial in times of low, stable or rising interest rates but may appear expensive if interest rates are falling.

Successful financing mechanisms including leasing require that the SME sector be well organised. Resources have a tendency to follow where there is order and sanity. With properly organised structures, the players in the sector should be in a position to enter into mutually beneficial agreements such as leasing as a group rather than as individuals.

The concept of economies of scale comes into play as bigger machines on lease can be shared by group hence leading to increased capacity utilisation.

Under organised structure arrangements, the group members can act as the co guarantors of each of the members in the event that they fail to honour up on the monthly repayments. With the various trades being found in the SME sector it is important that the various trades associations should be formed which should be run professionally by the membership contributing through regular subscriptions. With such cohesive structures, it is easier for group members to understand each other well before venturing into innovative financing mechanisms such as leasing.

An organised group has the potential or greater chance to manage repayments as and when they fall due through covering for one another among the members sharing the leased equipment especially for those in the same line of trade. The methods of collection and transfer of such equipment acquired through leasing and the control of utilisation can be easily negotiated among members. This can also form the basis for the fragmented informal organisations to be formalised and become corporates.

 

Dr Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on [email protected] or on numbers 04-744686 and 0772463008.

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