There are a number of different ways of paying for purchases, especially those of a higher value. These should be considered when determining how to fund a major procurement. They are more likely to relate to equipment or major building projects. The main methods are
The equipment is paid for at the time of its purchase using the available funds. In some cases the funds will be borrowed under a bank loan, if this is the case, then the cost of repayment interest needs to be taken into consideration when calculating the total cost of the payment.
With hire purchase [HP] a finance company purchases the requirement. It then belongs to the finance company which allows the ‘hiree’ (you) to use it in return for regular payments. The payments consist of a proportion of the initial capital cost and interest due over the period of the HP contract. When all the payments have been made the hiree becomes the owner either automatically or on payment of an agreed option-to-purchase fee.
The main benefits of financing equipment under a HP scheme are that the full purchase price is not needed at the beginning and subsequent payments are spread out over a period of time. This can be useful where funding is tight or there is an anticipated income stream from which the payments can be made. It is important to ensure that there will be funds available to make the regular and final payments.
The downside of a HP scheme is that the overall cost of the purchase will be higher than if the equipment was paid for outright at the start and, should the need for the goods cease during the period, as they belong to the financing company payments will have to continue even if the equipment is not being used.
An operating lease commits the leasee (you) to a short-term contract or one that may be terminated at short notice. The finance company expects the arrangement to end before the end of the life of the equipment and will expect to make arrangements to dispose of it on the second-hand market. Operating leases are useful where there is a short-term requirement, for example, in a research project rather than buying equipment that will not be needed later.
Finance Lease (also called a capital or full payout lease)
Here the finance provider expects to recover the full cost of the equipment, plus interest, over the period of the lease. The leasee usually has no right of cancellation or termination and bears the ‘risk and rewards’ of ownership and is responsible for insurance, repairs etc
Your Finance Department should be involved in any financial costings of options for major projects.