CHAPTER 13 Financing the business 547Instalment loans
Instalment loans differ from business loans in that fixed repayment schedules are negotiated at the
outset. Minimum loan amounts vary between financial institutions and may be as low as $10 000 with
some suppliers, and $50 000 from others. The loan periods also vary between suppliers, but are often in
the range 1–15 years.
Interest-only loans
Interest-only loans are taken out to finance special situations. During the term of the loan, only interest is
paid, while the repayment of the principal amount is made in full at the expiry of the term. These types
of loans are suitable for situations where, say, an asset is bought (and used) for a specific period, with
the expectation that it will be sold at the end of the period. The sale of the asset then provides funds to
repay the loan. Thus, the payment of interest in the intervening period may be considered a holding cost
for owning the asset.
Fully drawn advances
Fully drawn advances (FDAs) are a major form of entity financing. Amounts available from some
institutions may vary from as low as $5000 to any amount at all. Terms are normally for up to 10 years.
Rates are normally variable. Often, financial institutions will set a system where interest is charged to a
separate account, while the FDA account merely keeps track of the balance of the principal. Normally, a
regular repayment schedule is set up, so that the balance in the FDA account decreases continually over
the term of the loan. FDA loans are usually secured.
Leases
Leasing is a significant form of finance for entities. The major financial institutions provide a full range
of leasing options and products to complement their other loans, and to assist entities with financing
specific assets such as motor vehicles, construction and manufacturing plant, and IT and office equip-
ment. What is meant by the term lease? A lease is a contract by which an owner of property (‘the
lessor’) allows another person or entity (‘the lessee’) the use of the asset for a specific period in return
for rent or lease payments.
Two examples of leases are a novated lease and a hire purchase agreement. A novated lease involves
a three-party agreement between an employee, an employer and a financial institution. Novated leases
are normally used to provide motor vehicles to employees as part of salary packages. The cost of pro-
viding the vehicle is part of the employee’s salary, but is paid directly to the financial institution. The
employee is able to select the vehicle of choice and to reduce annual taxable income. The financial insti-
tution is able to claim from the ATO the GST component of the new price of the vehicle, and this credit
effectively reduces the lease payments. Novated leases are normally fully portable between employers,
at least from the point of view of the financial institutions.
In this case, the underlying assets are owned by the financier and used by the customer in return for a rental
payment. The rental or lease payments are tax deductions for the customer in both cases. There are no tax
deductions for interest or depreciation, and there is no guarantee of ownership of the assets at the end of the
period by the customer. The fact that there is no such guarantee, however, does not mean that the customer
cannot purchase the assets. Often, they do, by paying a final lump sum, ‘balloon’ or residual payment.
In contrast, under a hire-purchase agreement, a financial institution buys equipment required by the
customer, then hires it to the customer for use during the agreed period. At the end of the period, the deal
is settled by the payment of any outstanding balances and ownership passes to the customer. The pay-
ments made by the lessees are treated as ownership costs, and deductions are allowable for interest and
depreciation. Consistent with this view, ownership at the expiry of the terms of the agreements resides
not with the financial institutions but with the lessees.
All of the forms of leasing discussed earlier may be classified as finance leases. Finance leases
are non-cancellable contractual obligations to make payments in return for the use of an asset for the