Driven by years of accommodative monetary policy and low borrowing costs, the current period of prolonged inflation and rising interest rates could result in a global recession. In times of economic uncertainty, it’s critical for businesses to manage their cash flow proactively. By managing cash flow proactively, the levers that a company can pull to ensure financial stability are clear. For most businesses, minimising expenses and reducing debt are two key ways to weather a tough economic environment. Leasing can achieve both of these objectives. Keep reading to learn why leasing is one of the most effective ways that companies can effectively manage their cash flow in a time of rising inflation.
Central banks worldwide have tightened monetary policy to curb inflation by stopping quantitative easing and raising interest rates simultaneously. As a central bank’s cash rate rises, these rates flow through to lenders, which means borrowing becomes more expensive. And in an inflationary environment where interest rates are higher, traditional financiers may reduce acceptable loan-to-value ratios (LVR). This means loans require a larger deposit on top of the security needed to collateralise the debt. In these cases, the business has significant cash outflows before it’s started generating revenue or productivity gains from the asset.
Leasing often doesn’t require a deposit, and monthly repayments can be lower than traditional bank loan repayments, due to the lessor investing in the asset’s residual value. Further, leasing allows a company to fix the interest rate for the term of the lease, which keeps repayments fixed even if further rate hikes occur.
Assets or equipment in heavy use, whether company laptops or manufacturing equipment, require regular maintenance. If maintenance schedules aren’t adhered to, the equipment can work inefficiently or break down, requiring costly repairs or replacement. When a company leases equipment, its useful life and optimal maintenance schedule are factored into the lease term. At the end of the lease term, the lessor can manage responsibly decommissioning and disposing of the equipment or renewing it for a “second life”. This further reduces an asset's total cost of ownership (TCO) while removing the responsibility and expense associated with end-of-lease activities.
For most businesses, the value of assets and equipment is derived from operation, not ownership. This makes the accounting treatment of assets a critical part of efficiently managing cash flow. When a company purchases equipment using traditional finance channels, depreciation and interest expenses are tax deductible, but the principal payments remain on the balance sheet. In these scenarios, depreciation deductions must follow a depreciation schedule.
With IFRS 16, the accounting treatment of operating leases now mimics that of an asset with interest and depreciation deductions. However, unlike an asset, it is only the present value of the asset that is depreciated. In addition, there is also a low value or short-term exemption for leases which enables the full cost to be taken to the profit and loss and hence as a deduction. Many companies are not aware of this, and the common misconception is that a low value asset is less than $5k. In truth the amount can be higher based on materiality, and it applies to multiple low value assets. A good example would be the complete fleet of a company’s end-user-compute devices, this could be fully written off over the term of the lease amounting to hundreds of thousands per month.
When a company deals with a lessor, it’s dealing with professionals who understand the equipment you are accessing. A better understanding of the equipment and appropriate lease terms means that a suitable financing arrangement can be finalised within a much shorter time frame compared to a bank loan. With supply chain delays continuing and interest rates likely to continue rising, the speed at which leasing arrangements can be organised means a business can quickly organise access to new assets. And for lease terms that span three years, it means a company can stabilise some of its expenses over a period where continued inflationary pressure is likely.
One of the biggest keys to managing inflationary pressure is keeping costs fixed or minimal. Leasing allows a company to get the assets and equipment they need for a fixed monthly fee while the lessor manages the end-of-lease activities. This helps businesses proactively manage their cash flow in a challenging economic environment. Further, to make lease management and accounting accurate and efficient, Quadrent’s lease accounting software (LOIS) makes IFRS 16 compliance simple while helping companies to build up a wealth of lease management data that can later be analysed to make better commercial decisions.
Quadrent works with organisations helping them access assets without sacrificing cash flow and addressing their ESG risk in the process. With a team that has in-depth leasing knowledge and specialised accounting backgrounds, we’ll help you get the most value out of your assets while addressing growing ESG requirements and reporting expectations.
Proactively manage your cash flow in a challenging economic environment with Quadrent. Click here for more information.