Mark Harwood, partner at accountants Hazlewoods LLP, has three very simple rules when considering business-related capital expenditure.
Firstly, he says to only buy something if it’s needed, not just to save tax as “too often the tax tail wags the investment dog. The trouble is that the tax saving is less than the cost of the investment being made”.
Next, he is a firm believer in setting a budget and preparing projections to assess how affordable the plans are. As he points out, whether “setting up a practice or planning a significant capital project, working with an advisor to prepare integrated profit and loss, cash flow and balance sheet projections on a monthly basis can be really helpful”. And a function of doing this is to consider different potential scenarios in terms of turnover growth and how much the practice spends.
An allied point is made by Paul McPherson, director of brokerage SME Loans and JPM Capital, which has a number of veterinary clients. He sees lenders with different and varying criteria, especially when it comes to providing loans to businesses that have been trading for less than six months. He said: “However, a business plan and cash flow forecast will usually be required when applying for a start-up business loan regardless.”
Cautious approach
This cautious approach to lending follows on, in Mr McPherson’s experience, from a lack of trading history, knowing that firms can fail – especially during a pandemic – and businesses that have not started trading aren’t generating turnover to repay a loan.
As a result, he said: “A business plan and cash flow forecast signify to a lender that a business has what it takes to be a success and to ultimately pay off the loan.
“Lenders want to see a well-researched and comprehensive business plan and a realistic cash flow forecast before they consider lending.”
Cash or finance?
Back to Mr Harwood and his last rule. Here, he says to think about ownership. He said: “It’s important to look at the rate of technological change and the time before equipment is superseded; future second-hand values; the costs of maintenance over time; likely usage; and, importantly, the effect on practice cash flow.”
The whole point of the projections is to be able to assess whether the purchase will leave a comfortable cash buffer. If this is in bounds, then, as Mr Harwood highlights, “there is a school of thought to buy in cash, thereby saving the interest costs of financing”.
He added: “One standout point during the pandemic is that those practices with healthy positive cash balances typically found the initial spring 2020 lockdown period less stressful than those in the red.”
For Mr Harwood, the use of an overdraft to finance assets is a possibility, but “it does mean less headroom should profits take a downturn”. Further, and this should be obvious to those who have used them, there is also the interest cost of running an overdraft that can often be higher than other forms of finance.
In contrast, though, Mr McPherson sees asset financing typically used by businesses needing access to essential equipment that is usually very expensive to purchase.
He said: “Some smaller businesses just do not have the capacity to internally source funding for new equipment without it having a large and potentially risky impact on their cash flow or cash reserves.”
For Mr McPherson, asset-based funding allows a practice to spread the cost of equipment over more manageable payments.
The route to finance
Based on current law, Mr Harwood knows that a loan or hire purchase is likely to result in a faster tax saving compared to a finance lease. The decision, he reckons, then comes down to what terms can be obtained. By this he is referring to the interest rate, length of term or agreement and any early repayment fees – these determine whether it might be best to go for a loan or hire purchase.
Mr Harwood said: “This does not mean that a finance lease is not the way to go, as a particularly attractive interest rate under such an agreement might sway the decision-making balance, but it is often the case that hire purchase, or a loan will be more attractive.”
Mr Harwood offers a warning though. He said: “Care is needed regarding finance agreements called ‘lease purchase’. These are often hire purchase in disguise but could be finance leases. If you want a hire purchase agreement, ensure that what you are signing up to is actually a hire purchase agreement.”
It’s rare to find an entrepreneur who hasn’t used credit cards at some point. And there was a time when it was possible to take a 0% deal and move borrowing from card to card without cost. However, that time has passed, and, as Mr Harwood advises, “great care is needed as interest rates can rapidly spiral upwards when the 0% term comes to an end; this can result in borrowing being more costly than other forms of finance”.
Mr McPherson looks at it another way. He says that having some debt – overdraft or credit cards – makes it easier to access funding, assuming the debt is not considered burdensome. However, he says that this form of borrowing is, by nature, designed to be a safety net and especially so for an overdraft.
He said: “Becoming reliant on it can cause problems, especially if an unexpected crisis, such as a pandemic, should befall a business.” Even so, he thinks that “having headroom on overdrafts and credit cards as a ‘rainy day’ fund makes a lot of sense”.
Government-backed loans can also be considered. For established businesses, the Bounce Back Loan and Coronavirus Business Interruption Loan Scheme, have been replaced with the Recovery Loan Scheme, which will allow businesses to borrow between £25,000 and £10 million, with an 80% guarantee to the lender from the Government.
This may be worth considering as another option. On this form of finance, Mr McPherson suggests Government-backed schemes will always have a place, as they are typically low interest.
He said: “But typically they would not have the reach of the open market and the application process is usually more time-consuming and labour intensive than a traditional unsecured business loan.”
There is, of course, logic, as Mr Harwood says, in speaking with a specialist in financing options and obtaining terms of finance. He said: “There are specialists in the veterinary funding market, such as Shire Finance Brokers, that can guide you on the best deals that are available. The funding market is often fast moving, and therefore speaking with someone is worthwhile and they can put you in touch with lenders that can best support you.”
What’s the score?
Referring once more to interest rates, Mr McPherson says they depend on the lender, the product, and the business making the application. He said: “A credit score can have a large impact on the quality of the loan or even decide whether a company is accepted for a loan. So, it is a good idea for a business to check their credit score using a credit score checker.”
He adds that once the credit score has been identified, the business can seek to improve its score. He said: “Simple steps to improving your score can be paying your bills and invoices on time, reducing the number of applications you apply for, and checking your personal finances for any irregularities.”
Another option Mr McPherson points to is to establish credit by taking out an affordable loan and repaying it accordingly.
He said: “This is the best indicator to future lenders that they can be trusted to repay loans.”
Even so, in Mr Harwood’s experience, lenders are likely to request copies of recent year-end accounts and any management accounts. And if a practice is looking to finance significant sums, financial projections could also be requested, and it may be that the advisor could also support an application with a borrowing reference.
It should be noted, Mr Harwood says, “that lenders will normally ‘stress test’ projections to consider whether the practice could still afford repayments if cash flow was not as favourable as being projected”. Again, taking guidance from an advisor is a good idea.
Have good timing
Finally, cash is king, and so cash outflows from capital expenditure should not be set up to create unnecessary cash pinch points around other outgoings, such as payment of tax liabilities. Mr Harwood doesn’t ban this per se, but suggests that “it is certainly something to be mindful of when looking at your projections”.
Timing expenditure before, as opposed to after, the next financial year, will often result in a tax-saving earlier. However, practices should have an eye on forthcoming changes that may affect the tax treatment of a purchase. Ultimately, it is the timing of when the asset is brought into use and invoiced for, as opposed to when payments are made, that drives the timing of the tax saving.
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