How to Successfully Optimise Your Balance Sheet
Effective financial management becomes increasingly important in an environment of rising interest rates and inflation. And one of the most important things to manage to keep a business’s finances strong is the balance sheet. The health of a balance sheet impacts a company’s ability to fund its operations and expansion and its borrowing capacity. Whether a business is looking to consolidate its finances to ensure it can weather economic uncertainty or it’s looking toward its next phase of growth, establishing strong systems and processes to manage the balance sheet effectively is critical. Quadrent, in collaboration with Deloitte, recently hosted a webinar outlining how companies can optimise their balance sheets.
View the webinar recording here and keep reading below for a summary of what was discussed.
What is the market seeing that is affecting organisations’ financial decision-making?
Sentiment across businesses is currently varied, depending on sector, business model and ability to adapt. In sectors with a more pessimistic outlook, there are opportunities to strengthen governance, whether strategic, financial or operational, to help the company navigate challenges. For enterprise and established companies, in particular, leasing is an effective way to diversify funding sources and lower the cost of capital. This is because, with assets such as technology devices in an operating lease structure, the lessor has an investment in the underlying asset, allowing for interest rates close to 0% in some cases.
Companies can also use leasing to transfer the ownership risk for assets to the lessor. This deleverages the company and reduces financial pressure. Further, in an uncertain environment, it’s often not prudent to commit large amounts of working capital to purchase assets. Leasing allows companies to use the assets they need without sacrificing working capital and taking on ownership risk.
Amongst banks, there has been a reduction in lending. For companies that don’t have a specific purpose for more debt that will fit the bank’s stringent lending criteria, it’s prompting decision-makers to look for other funding sources, such as private equity, venture capital, leasing, and green-linked debt. These alternative funders structure transactions linked to specific outcomes and a return on investment (ROI) rather than a set interest rate, as stipulated by a traditional bank. Similarly, leasing is structured to meet the needs of the lessor and lessee, ensuring both parties get the best ROI possible from their assets.
What is leasing, and can it be an alternative capital management tool?
Leasing is fundamentally about transferring the risks inherent in asset ownership. The level of risk transference depends on the structure or features of a lease and ultimately affects the pricing of the lease. With a finance lease, where a company gets the title to the asset at the end of the lease, the interest rate is typically comparable with the market. In contrast, with an operating lease, the lessor has a residual investment in the asset, reducing the total cost of ownership (TCO) and transforming asset use into a lifecycle where both the lessor and lessee derive the best ROI possible from the assets. The risk and tolerance levels of all parties will vary based on the entity, asset class, location, and economic conditions, but overall, implementing operating leases for suitable assets is cheaper than bank finance and a finance lease.
Understanding the asset lifecycle
In recent years, asset lifecycles have shortened as technology has become obsolete faster. For example, laptops once typically had a useful primary life of four to five years, while mobile phones had a useful life of three years. Today, laptops typically have a primary life of three years and mobile phones have a primary life of two years. Factors driving the reduced useful life of commoditised devices include increased usage, work-from-home (WFH) requirements, and the need to keep technology current to protect companies against cybercrime. With a full-service operating lease provider, companies can structure their asset lifecycles to align with their needs.
Understanding total cost of ownership analysis – lease vs. buy
When considering leasing, companies need to complete analysis on a like-for-like basis and regularly review the analysis to account for changing market conditions. For example, an asset’s TCO considers more than the acquisition price. When companies assess the economics of leasing an asset, they should take into account the other factors, such as:
- asset decommissioning and responsible e-wasting (where applicable)
- who will maintain and repair devices
- being strategic about vendor management.
What have been the main impacts of IFRS 16?
The implementation of IFRS 16 drove changes in how companies are accounting for and managing assets. Now that the initial compliance exercise of the IFRS 16 transition has passed, there’s an opportunity to leverage the centralised data gathered throughout the transition process and regular compliance tasks to gain actionable insights. These insights can drive stronger commercial decision-making and balance sheet management. Further, regulatory change continues to drive attention to IFRS 16, with rating agencies now considering the IFRS 16 standard for company’s reporting covenants. Companies should consider how their borrowing capacity and banking covenants may be impacted when banks eventually move away from the frozen GAAP model for credit assessment.
How can lease portfolio decisions drive value and have a positive impact on organisations?
The lease accounting systems and software that companies have implemented as a result of IFRS 16 provide a centralised hub of data from which valuable insights can be drawn. Companies should use this data to assess how changes in costs, such as building rent, will affect their finances. Similarly, lease data for vehicle fleets and other assets can be analysed to ensure the company gets the best rate possible, potentially opening the doors to negotiate contracts to receive better value. This demonstrates the power of taking a longer-term view of leasing data beyond monthly reporting to meet compliance requirements.
Why is leasing important in the current environment?
When a company deals with a lessor, they get access to leasing experts who help businesses derive the most value possible from their assets. Further, choosing leasing can help organisations proactively address underexplored areas where leasing can strategically benefit companies. These areas include funding diversification, environmental, social and corporate governance (ESG), and the emergence of as-a-service models across various products and sectors. Similarly, innovative funding structures such as green leases are helping companies transition to greener energy and get ahead of further changes, such as the eventual introduction of mandatory climate reporting.
Strengthen your balance sheet management with Quadrent
Seeking alternative funding sources, such as leasing, is helping enterprise and established companies access the assets they need without sacrificing working capital or bearing the ownership risk. By working with a lessor to structure lease agreements that maximise the ROI of assets, companies can strengthen their financial management and reduce reliance on incumbent traditional funding sources. Further, pairing a lease with full-service tools, such as IFRS 16 lease accounting and asset management software, makes leasing a strategic choice that drives stronger financial management.
Quadrent works with businesses helping them to accurately manage their leases, improve IFRS 16 compliance data inputs and proactively manage their ESG risk. 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 increasing ESG requirements.
To strengthen your balance sheet management with Quadrent, click here for more information.
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