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Small case study on hire purchase

What is hire purchase?

Hire purchase is a way to buy assets by paying in instalments over time. With hire purchase, you legally own the item once all the installments have been paid, but in certain agreements it will appear on your balance sheet at the start of the term.

Hire purchase meaning

Hire purchase is a way to buy assets by paying in instalments over time. With hire purchase, you legally own the item once all the installments have been paid, but in certain agreements it will appear on your balance sheet at the start of the term.

What is a hire purchase agreement?

Hire purchase is a type of asset finance. It’s similar to equipment leasing, but simpler (and perhaps less flexible) overall.

Rather than renting an asset, hire purchase is like making a purchase and paying in instalments, like a private customer might do for a car. Normally a 10% deposit and all the VAT is paid upfront.

Unlike leasing, with hire purchase your business owns the item, but that means there are a few other things you need to consider:

Hire purchase: considerations

Do you need the asset for the long-term?

First, will your business need the item for the foreseeable future? If the answer is yes, hire purchase could be a good fit. But if you only need it for a short time or you’re not sure, leasing might be a less risky route to take.

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Will the asset depreciate?

Second, will the asset hold its value? Depreciating items are usually leased rather than purchased — but relating to the first point above, if your business needs it for the long term that could be less important.

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Does the technology move on rapidly?

Finally, you should assess whether there will be an updated version of the asset in the near future. For example, in manufacturing, having state-of-the-art equipment is a significant advantage — while having the latest model of van might not be so crucial to your business.

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Let us help you find the best financial product in the market. We will guide you through the whole process and make sure you get the best deal.

Alternatives to hire purchase

If you need equipment finance, hire purchase isn’t your only option. You might also look into a finance lease, which is a similar long-term commitment but you won’t own the item at the end of term. On the other hand, for more flexibility, operating leases are a popular choice, because you can often get regular upgrades and maintenance included.

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Hire Purchase Agreements

Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.

Peggy James is a CPA with over 9 years of experience in accounting and finance, including corporate, nonprofit, and personal finance environments. She most recently worked at Duke University and is the owner of Peggy James, CPA, PLLC, serving small businesses, nonprofits, solopreneurs, freelancers, and individuals.

Vikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.

What is a Hire Purchase

Hire purchase is an arrangement for buying expensive consumer goods, where the buyer makes an initial down payment and pays the balance plus interest in installments. The term hire purchase is commonly used in the United Kingdom and it’s more commonly known as an installment plan in the United States. However, there can be a difference between the two: With some installment plans, the buyer gets the ownership rights as soon as the contract is signed with the seller. With hire purchase agreements, the ownership of the merchandise is not officially transferred to the buyer until all the payments have been made.

Key Takeaways

  • Hire purchase agreements are not seen as an extension of credit.
  • In a hire purchase agreement, ownership is not transferred to the purchaser until all payments are made.
  • Hire purchase agreements usually prove to be more expensive in the long run than purchasing an item outright.
Hire Purchase

How Hire Purchase Agreements Work

Hire purchase agreements are similar to rent-to-own transactions that give the lessee the option to buy at any time during the agreement, such as rent-to-own cars. Like rent-to-own, hire purchase can benefit consumers with poor credit by spreading the cost of expensive items that they would otherwise not be able to afford over an extended time period. It’s not the same as an extension of credit, though, because the purchaser technically doesn’t own the item until all of the payments are made.

Because ownership is not transferred until the end of the agreement, hire purchase plans offer more protection to the vendor than other sales or leasing methods for unsecured items. That’s because the items can be repossessed more easily should the buyer be unable to keep up with the repayments.

Advantages of Hire Purchase Agreements

Like leasing, hire purchase agreements allow companies with inefficient working capital to deploy assets. It can also be more tax-efficient than standard loans because the payments are booked as expenses—though any savings will be offset by any tax benefits from depreciation.

Businesses that require expensive machinery—such as construction, manufacturing, plant hire, printing, road freight, transport, and engineering—may use hire purchase agreements, as could startups that have little collateral to establish lines of credit.

A hire purchase agreement can flatter a company’s return on capital employed (ROCE) and return on assets (ROA). This is because the company doesn’t need to use as much debt to pay for assets.

Using hire purchase agreements as a type of off-balance-sheet financing is highly discouraged and not in alignment with Generally Accepted Accounting Principles (GAAP) unless the assets and liabilities for leases with terms of 12 months or longer are recognized in the financial statement.

Disadvantages of Hire Purchase Agreements

Hire purchase agreements usually prove to be more expensive in the long run than making a full payment on an asset purchase. That’s because they can have much higher interest costs. For businesses, they can also mean more administrative complexity.

In addition, hire purchase and installment systems may tempt individuals and companies to buy goods that are beyond their means. They may also end up paying a very high-interest rate, which does not have to be explicitly stated.

Rent-to-own arrangements are also exempt from the Truth in Lending Act because they are seen as rental agreements instead of an extension of credit.

Hire purchase buyers can return the goods, rendering the original agreement void as long as they have made the required minimum payments. However, purchasers suffer a huge loss on returned or repossessed goods, because they lose the amount they have paid towards the purchase up to that point.