Choosing between finance options
Discussion
I'm pretty sure this isn't a difficult thing to resolve, but I've got myself in a complete muddle.
I can pay for a new asset over 4 years or 5 years. There's barely anything in it between the applicable interest rates: the difference in total repayments is just £1359.
If I pay over four years, the asset is available for use with much reduced overhead (or disposal) after 48 months.
If I pay over 5 years, my profitability is improved by five and a half grand a year during the first four years, but then I have the full cost of repaying the finance in Year 5.
There's the throwaway advice that while money is cheap, extend borrowing as far as possible. And operating margins are tight, so lower repayments would certainly help.
But I can't help but feel that if I keep the asset for, say, six or seven years, repaying the debt earlier means more years to use it with no replayment overhead at all!
So which repayment profile should I take? (and what kind of calculation should I be carrying out to help me make that decision?)
I've included the residual value of the asset after 4 and 5 years. To what extent does this persuade the decision? And what about if the difference was smaller or larger than my assumptions?
I can pay for a new asset over 4 years or 5 years. There's barely anything in it between the applicable interest rates: the difference in total repayments is just £1359.
If I pay over four years, the asset is available for use with much reduced overhead (or disposal) after 48 months.
If I pay over 5 years, my profitability is improved by five and a half grand a year during the first four years, but then I have the full cost of repaying the finance in Year 5.
There's the throwaway advice that while money is cheap, extend borrowing as far as possible. And operating margins are tight, so lower repayments would certainly help.
But I can't help but feel that if I keep the asset for, say, six or seven years, repaying the debt earlier means more years to use it with no replayment overhead at all!
So which repayment profile should I take? (and what kind of calculation should I be carrying out to help me make that decision?)
I've included the residual value of the asset after 4 and 5 years. To what extent does this persuade the decision? And what about if the difference was smaller or larger than my assumptions?
I don't think there's a calculation as such that would help with your decision.
The main thing in my mind is what is the asset, and what is the useful life of it? Some assets start to need expensive maintenance after x years - thinking expensive machinery, cars and so on. In this case, you might want to pay off the machinery whilst it is in warranty, and then dispose of/sell the asset as it comes to the end of that period. This is where your calculation of residual value might be useful; because some equipment is worth much more within a certain time period and then drops off a cliff edge as it becomes more expensive to maintain. Some assets become out of date technologically - perhaps IT equipment or servers. These tend to depreciate much more quickly and the residual value here is probably a lot less important.
The other thing with the decision is the opportunity cost increased payments over 4 years vs 5 years. You'll have an extra £5k a year in your business for 4 years. Whether you spend that on increased marketing, partially pay for another staff member or just have a bigger cash buffer is up to you. If you were able to spend that £5k on growing the business, the compounded effect of that growth could be much bigger than the £1300 extra you're paying in finance over the whole period. One other factor is that also in 5 years time, that final £23k will actually be comparatively less to your business because of inflation.
The main thing in my mind is what is the asset, and what is the useful life of it? Some assets start to need expensive maintenance after x years - thinking expensive machinery, cars and so on. In this case, you might want to pay off the machinery whilst it is in warranty, and then dispose of/sell the asset as it comes to the end of that period. This is where your calculation of residual value might be useful; because some equipment is worth much more within a certain time period and then drops off a cliff edge as it becomes more expensive to maintain. Some assets become out of date technologically - perhaps IT equipment or servers. These tend to depreciate much more quickly and the residual value here is probably a lot less important.
The other thing with the decision is the opportunity cost increased payments over 4 years vs 5 years. You'll have an extra £5k a year in your business for 4 years. Whether you spend that on increased marketing, partially pay for another staff member or just have a bigger cash buffer is up to you. If you were able to spend that £5k on growing the business, the compounded effect of that growth could be much bigger than the £1300 extra you're paying in finance over the whole period. One other factor is that also in 5 years time, that final £23k will actually be comparatively less to your business because of inflation.
Really appreciate the considered response 
and it reinforces many of the competing thoughts I've been having.
The item in question is a truck. And there's 17 of them, so I really need to get it right.
In the past, the company has tended to take 4 year finance and then dispose of the truck at the end of the finance (and warranty!) period, in order to create solid deposits for replacements. I've joined the company on a growth/expansion ticket, which means that the full ex-VAT cost of the truck is financed.
I also want the company to run trucks for 6-7 years. You can buy extended warranties for that period: they're not cheap but they're much cheaper than the finance cost on a new truck. Which means that the older trucks produce a much better margin.
I guess the quid pro quo is: do I want an enhanced margin in the early years (5 year finance) or do I want more years of post-HP service with no finance cost?
and it reinforces many of the competing thoughts I've been having.The item in question is a truck. And there's 17 of them, so I really need to get it right.
In the past, the company has tended to take 4 year finance and then dispose of the truck at the end of the finance (and warranty!) period, in order to create solid deposits for replacements. I've joined the company on a growth/expansion ticket, which means that the full ex-VAT cost of the truck is financed.
I also want the company to run trucks for 6-7 years. You can buy extended warranties for that period: they're not cheap but they're much cheaper than the finance cost on a new truck. Which means that the older trucks produce a much better margin.
I guess the quid pro quo is: do I want an enhanced margin in the early years (5 year finance) or do I want more years of post-HP service with no finance cost?
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