Construction Plant Acquisition and Finance
Introduction
Contractors have two options in acquiring plant: They may either own their machinery and equipment or hire it
In recent years, the growth of the independent plant hire sector of the construction industry has greatly facilitated the latter option, and approximately 50-60% of plant presently used on projects is hired. Many Contractors, however, prefer to hire only those items of plant which are required to meet peak demand or specialized activities. The alternative decision to purchase will have important financial consequences for the Contractor, since considerable capital sums will be blocked up in the plant, which must be operated at an economic utilization level to produce a profitable rate of return on the investment.
When considering the need to own plant, the Contractor must check the following points:
- Will the item of plant generate sufficient turnover to provide an adequate rate of return on the capital employed?
- Is it absolutely necessary for the business to own the plant rather than obtaining it through other means?
- Is outright purchase the only way of acquiring the plant?
If the answer to the above questions is not a sure and positive reply, then there should be some other sound commercial reason for making the purchase.
The Contractor, having made the decision to purchase rather than hire a piece of
plant, has the following methods of arranging the finance:
- Cash or Outright Purchase
- Hire purchase
- Leasing
- Finance lease
- Operating Lease
The Plant may be paid for immediately at the time of purchase, thereby
providing a tangible asset shown on the Balance Sheet. This option is only
possible when cash is available, either from profits gained from previous
projects, or from investors such as shareholders, bank loans etc. The Contractor
should carefully consider the expected level of return from the investment
before deciding to purchase, to ensure that using the capital in this way is the
most profitable method of investing.
Purchase of plant by the method of Hire Purchase involves a
contract between the Contractor and the supplier of finance, in which the
Contractor pays specified rentals during the contract period. At the end of this
period the title of the asset may be transferred to the Contractor for a
previously agreed sum, which is often nominal in amount. The Hire purchase
option does not require a large capital sum as in the case of outright purchase,
though it involves high rates of interest.
A Leasing arrangement differs from either outright purchase or Hire purchase in
that the title theoretically never passes to the lessee (The Contractor). A
lease may be defined as a contract whereby, in return for payment of specified
rentals, the Contractor obtains the use of a capital asset owned by another
party (the lessor). There are two forms of lease that are appropriate for
construction plant acquisition, namely finance lease and operating lease.
Finance lease is an arrangement by a financial institution and the rental
charges will cover the asset's capital cost, except for its residual value at
the end of the lease. in addition to a service charge designed to meet
overheads, interest rates, servicing costs and profit.
Operating lease is an arrangemnet by manufacturers or suppliers of the asset, whose purpose would be to assist in the marketing of the item. This type of lease is most appropriate for large and/or technically sophisticated plant items where the manufacturers have skilled personnel and are capable of carrying the required servicing and maintenance.
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