On or off the balance sheet
Aligning your financing strategy with your business goals starts with choosing the right type of funding. Four common types of vehicle and equipment financing are:
- Commercial Hire Purchase
- Chattel Mortgage
- Operating Lease
- Finance Lease.
Each has its own benefits and implications for your business, so when making your choice consider how the product will be treated in your financial statements.
Commercial Hire Purchases, Chattel Mortgages and Finance Leases will go on the balance sheet.
Under a Hire Purchase you eventually own the asset at the end of the lease. With a Chattel Mortgage, you own the asset from the start.
Operating Leases are typically treated as expenses in your financial statements and not recorded on the balance sheet. In this way, an Operating Lease is similar to a rental agreement.
With a Finance Lease, the lessee retains the residual risk (ie guaranteeing the financier a nominated future or residual value for the asset). If you intend to own the equipment at the end of a finance lease, this can change how it is treated in your financial accounts. It will need to be included on your balance sheet since you will be provided the option to take possession of the equipment when the lease expires.
When making your choice consider how the product will be treated in your financial statements
The different accounting treatments are known as on-balance-sheet financing and off-balance-sheet financing. These accounting concepts can affect your business’ capacity to borrow, such as if you are looking to expand your business with a loan, banks usually review the level of debt on your balance sheet.
Generally, larger sized businesses - such as ASX-listed companies - use off-balance-sheet financing for debt purposes. If you are unsure how to treat asset financing in your financial statements, talk to your accountant about the best option for your circumstances. Regardless of the size of your business there is more to financing than accounting rules.
The different outcomes
Different financing options can also have different tax outcomes for businesses.
For example, rental payments in respect of a lease may be deductible for income tax purposes and are often reflected in what is called a ‘straight-line claim’ for the life of the loan. The Goods and Services Tax (GST) payable on the rental may also be creditable at tax time.
Another example is Chattel Mortgages where interest payments and capital allowances may be deductible for income tax purposes. Often these claims decline in line with the value of the loan. The GST paid on the purchase of the vehicle or equipment may be claimable depending on your circumstances.
For tax advice relevant to your business situation, start by talking to your accountant or business adviser.