Should my charity lease or buy assets or capital equipment?

This is a guest post by Hayley Simpson FCCA, Manager at McCabe Ford Williams, Registered Auditors, Licensed Insolvency Practitioners & Chartered Accountants based in Kent. A fellow chartered certified accountant and manager with 13 years of experience, Hayley’s focus is helping charities make informed financial decisions, achieving this through developing efficient accounting processes, and working with clients on what can appear to be daunting financial decisions.

Buying versus renting equipment?

Charities, like profit making enterprises, will on occasion need to acquire assets or capital equipment, such as a plant or machinery in order to deliver its charitable objectives. Assets such as freehold and leasehold property are not considered in this article. We are simply focusing on movable assets such as office furniture, computer equipment, vehicles and office equipment.

You could buy all of this equipment outright, using your own resources which could include using either general or if permissible, restricted donations, or you might decide to rent or lease it instead. There are advantages and disadvantages in both options and the implications of each are discussed here.

Asset purchase and replacement should be covered in your charity’s risk assessment document, since there are financial risks associated with different purchasing options and also risks associated with debt overhang. This is where a borrowing term exceeds the useful life of the asset being purchased and in some cases can lead to cashflow or borrowing issues when the asset needs to be replaced, as a borrowing could still exist on an old asset when new additional finance is then needed to replace the asset.

Your charity should also have a policy on asset replacement that deals with the matters such as the process to be used in determining how financing options should be evaluated and how asset types should be assessed for suitability and relevance to your charity.

Buying an asset outright

Buying outright is generally the cheapest option if your charity has the funds available, or if it is essential that your charity owns the equipment. However, capital expenditure of a significant level when compared to the size of your charity will of course adversely affect your charity’s short term cashflow and the management of charity funds must be undertaken with adequate planning and care.
It may be more cost-effective in the long run to rent or lease certain items.

Buying an asset outright – advantages:

• the asset is fully owned by your charity
• the charity will not be tied into a long-term agreement which may be difficult to terminate, and
• the asset will cost less overall than if it were acquired via a lease or hire purchase arrangements.

Buying an asset outright – disadvantages:

• payment will be up front which can affect your cashflow
• an overdraft or loan may be required to fund the purchase. There is a risk that an overdraft may be withdrawn at short notice and in some cases early repayment of loans can be demanded causing cashflow and potentially going concern issues
• smaller charities may not be able to access cheaper deals
• if you do not have good product knowledge and experience you could make an unwise choice and you may end up buying equipment you don’t need
• the matching of the expenditure with the timing of income maybe be difficult to achieve leaving potential for cashflow volatility at the time of purchasing the asset
• the charity will be responsible for the maintenance and repair of the asset, which can be a risk if the equipment breaks down or needs replacing.

Hire purchase and lease arrangements

Avoiding the large one off payment that would arise through buying outright will leave your charity with more cash available to use for other purposes, but because interest on hire purchase and lease arrangements will be paid as part of each repayment, your charity will pay more for the assets in the long run.

With a leasing option, your charity may never own the asset outright, although some lease arrangements let you buy the asset at the end of the agreement with the payment of an additional final amount. However, you can often update your equipment without the expense of buying newer models.

With hire purchase, the charity will legally own the asset once all the payments have been made.

Care should be taken to compare the interest rate being applied by the finance company with the interest likely to be charged by your bank on a loan or overdraft arrangement as this could affect the choice that you make. In addition to interest, there may be other additional fees which should of course also be taken into account when looking at options.

Types of leasing

There are different kinds of lease arrangement. It makes sense to consider them all to see which is best suited to your charity and the asset that you are acquiring.

The two main types of leasing are finance leasing and operating leasing.

Finance lease:

• the lease should usually match the expected life of the equipment, perhaps three years or more, after which you pay a nominal rent or can sell or scrap the equipment – the leasing company will not require return of the asset
• the leasing company recovers the full cost of the equipment, plus charges, over the period of the lease through periodic payments which are usually monthly
• maintenance and insurance of the asset are the responsibility of the charity, even though legal ownership of the asset will not be yours

Operating lease:

• these are particularly beneficial if the asset is not required by the charity for its whole useful life
• the leasing company will take the asset back at the end of the lease
• maintenance and insurance of the asset will not be the responsibility of the charity.

You should think about leasing or renting equipment that has high maintenance costs, can quickly become outdated, or is only used occasionally. These would typically include computer and other IT equipment. It is now sometimes cheaper over a period to rent IT solutions rather than to buy the licences, depending upon the size of your charity.

There are several advantages of leasing or renting assets:

• no full cost of the asset up front, so cashflow is improved
• access to a higher standard of equipment is possible which would otherwise have been too expensive for your charity to buy outright
• cashflow budgeting is easier since the charity is paying for the asset over the fixed period of time that it is in use for
• as interest rates on monthly rental costs are usually fixed, it is easier to forecast cashflow
• the cost can be spread over a longer period of time and payments matched to income in the same accounting period
• the leasing company carries the risks if the equipment breaks down
• if you need to upgrade or replace the equipment, you can simply make a small adjustment to your regular payment rather than invest a lump sum upfront.

However, there are also some disadvantages of leasing or renting equipment:

• there will usually be a requirement to put down a deposit or make some payments in advance
• it usually will be more expensive than buying outright
• your charity can be locked into inflexible medium or long-term agreements, which may be difficult to terminate
• when your charity leases an asset, it will not own it, although it may be possible to buy it at the end of the agreement.

Conclusion

Evaluation of whether to lease or buy assets may produce different decisions at different times, depending on how the charity wishes to use an asset. This can include considerations such as whether the asset is solely for use on a single project which has a finite lifespan, or whether it is for general use in the charity for a longer undefined period.

Cashflow availability will also feature in any decision making process. It could be that funds have been designated or donations received for replacement of a specific asset in which case outright purchase would usually be the option taken.

However if an asset is to be acquired from the free reserves of your charity, a more in depth decision making process could result in either outright purchase or a leasing arrangement depending on the factors referred to in this article.

I  hope that this article has proved useful and has clarified some of the issues to be considered when making asset purchases.

Thanks to Hayley for sharing her advice with us. If you are after more inspiration then try our further reading list.

Further reading

• Find out how loans and other finance can help your organisation
• Read NCVO’s 10 step risk management framework