Carl Taylor Accountant and Business Consultant

Decisions about when and how much to invest in new equipment, property or software systems, are a critical aspect of running a manufacturing business. Capital Expenditure (CapEx) often determines whether production schedules are met and allows a business to pursue larger orders instead of missing out due to a lack of capacity.

Deciding exactly how to finance your manufacturing business’s capital purchases, however large or small, is a delicate balance between maximising tax deductions, minimising the cost of finance (i.e. interest payments) and maintaining maximum flexibility. It’s not an easy job.

Below we’ve outlined the possible financing options for CapEx, and the pros and cons based on the above criteria.

Financing it out of cashflow

What is it
This is where you finance your CapEx from your cashflow. It’s the simplest and easiest form of finance if you have free cash available; if you don’t have free cash then this simply won’t be an option.

Flexibility
You have total flexibility – you own the asset, so you can do what you like with it, including disposing of it whenever you like.

Cost of finance
If you’ve got free cash available, this will potentially be the lowest cost financing option, as you won’t be paying a financer any interest at all.  

The tax implications
Provided your business is eligible, and you time your expenditure right, then you should be able to claim AIA which means you get a 100% tax deduction in the first year, you can read more in this article.

The bottom line
This is a great form of finance if you have available cash, as it is low cost and allows you to get a 100% tax deduction for your asset in the first year.  If you don’t have the liquidity, it simply won’t be an option.

Bank loan

What is it
You buy the asset, and the bank provides a loan, most likely secured against the asset, and you can set the term and repayments to suit your plans, and the expected lifetime of the asset.

Flexibility
If the bank has a charge over the asset, you won’t be able to do anything with the asset (i.e. dispose of it) until the loan is repaid and the charge is released.

Cost of finance
You will have to pay interest over the term of the loan, this can vary significantly between lenders, so it’s worth doing your research and getting at least 3 comparative quotes to make sure you’re getting the best value.

The tax implications
You still get a 100% tax deduction in the first year under AIA, which can bring forward thousands of pounds in tax deductions, provided you are eligible and have AIA available.

The bottom line 
This works well if you have a good relationship with your bank, and they’re prepared to lend, as you’ll get the benefit of a 100% tax deduction in the first year under AIA.

Finance lease

What is it
Broadly this is where you effectively rent the equipment, and you essentially pay for the depreciation of the asset while you’re using it, and you may have an option at the end to make a final payment to own the asset.

Flexibility 
You’ll be tied in with the finance provider over the period of the contract.

Cost of finance 
You will have to pay interest over the term of the loan, this can vary between lenders. It’s not always immediately obvious what the interest rate is, so it’s worth doing your research and getting at least 3 comparative quotes to make sure you’re getting the best value.

The tax implications
Broadly speaking (this depends on the length of the lease) you’ll get a tax deduction for the lease payments you make as you make them, as opposed to getting a 100% tax deduction in the first year.

The bottom line
This can work well if you’re not eligible for AIA, as this will give you a tax deduction for the lease payments you’re making. However, if you are eligible for AIA, you’re best to go for a financing route that give you a 100% tax deduction in the first year (i.e. a loan, or HP).

Hire purchase

What is it
This is similar to the bank loan option, you take on the asset, and make repayments and by the end of the agreement you’ll have fully paid for the asset and will own it at the end.

Flexibility
You’ll be tied in with the finance provider over the period of the contract so you won’t be able to do anything with the asset (i.e. dispose of it) until the loan is repaid and the charge is released without speaking to the finance provider.

Cost of finance
You will have to pay interest over the term of the loan, this can vary between lenders, and its worth doing your research and getting at least 3 comparative quotes to make sure you’re getting the best value.

The tax implications
You still get a 100% tax deduction in the first year under AIA, which can bring forward thousands of pounds in tax deductions, provided you are eligible and have AIA available.

The bottom line
A hire purchase can work well if you can get a good deal, as you’ll get the benefit of a 100% tax deduction in the first year under AIA.

What’s next?

To make sure you are choosing the best finance option for your capital expenditure, ensure you speak to your accountant or advisor who should be able to provide an in-depth review of the CapEx options most viable for your business needs.