Lease or buy? Essential questions to consider before deciding
Sep 1, 2008 12:00 PM
Truck and Engine manufacturers have introduced numerous innovations in new truck models in responding to ever-changing environmental regulations and the need to reduce the greenhouse gases that contribute to global warming. And with the price of diesel fuel at record levels, they're working to provide new technologies that maximize driver productivity and fuel economy.
At the same time, the complexities of choosing and servicing these new truck technologies, and balancing them with the company's transportation needs, can be challenging.
“Truck leasing can be a crucial strategy in accomplishing a company's transportation needs, particularly if it wants to take advantage of emerging technology, which is rapidly advancing in trucks in shorter and shorter cycles,” said director of sales for PACCAR Leasing (PacLease) Olen Hunter.
Before making the decision about whether to lease or buy a new piece of equipment, Hunter suggested that fleet managers answer five key questions.
What is the best use of your company's capital?
Because every company is different, how it is capitalized and how it measures the success of business activities will determine the best use of capital, he said.
When buying new equipment that depreciates, such as trucks, most organizations seek to gain a maximum amount of return on their investment. That's why financial decision makers will evaluate whether the investment in equipment offers their companies a return higher than their “hurdle rate.” That rate is usually defined as the company's weighted average cost of capital plus a nominal premium.
“If they determine the equipment doesn't offer a return that's higher than the hurdle rate, then leasing may offer them a great alternative.
“Additionally, many financial decision makers will perform a net present value analysis of the lease or loan payment stream, which allows them to review the payments in today's dollar value.”
If a company is in similar circumstances when considering a lease or purchase decision, Hudson said it's important to conduct an ROI (return on the investment) calculation to determine whether the company should use equity or debt to finance the equipment.
Lease accounting treatment, which falls into two main categories — on-balance sheet and off-balance sheet, can favorably impact a company's key financial ratios such as ROA (return on assets) and ROI. “If a company is measured on a key financial ratio favorably impacted by lease accounting treatment, it should take this into consideration.”
Most leasing companies can assist with such ROI analyses for leasing and purchasing.
Is transportation your core competency?
Companies must ask themselves: Are we a trucking outfit or are we in another line of business?
Many organizations have determined that by leasing their trucks and assigning their maintenance, roadside service, fuel tax reporting, and other administrative headaches to leasing companies, they can focus their employee and manager energies on activities central to their business. They also have time for activities that help the company gain new business.
For many companies, investing time and resources in trucking related activity can be a slippery slope. Specifying the right equipment for trucks and handling maintenance requires the right knowledge. Transportation managers must keep up with the latest developments in trucking technology. Maintenance facilities must be properly equipped and staffed with well-trained technicians.
“By outsourcing non-core functions related to trucking through a full-service lease, companies can fill the driver seats with their own people, while taking advantage of their leasing provider's equipment know-how, plus equipment buying power and expertise.”
Leasing companies, due to their sheer size, can negotiate better pricing on equipment, maintenance items, and expendables, and pass those economies of scale onto their lease customers.
What is the true cost of ownership? More specifically, what are the maintenance costs of your company's equipment?
“Most organizations have a good handle on their financing costs, and typically, equipment financing is a fixed known quantity. Unfortunately, the cost of maintenance is often not well known or understood, although it should be.”
Large fleets that have a good accounting department know down to the penny, on a unit-by-unit basis, how much they spend on labor, parts, tires, and outside repairs for their trucks. They also know how those expenses are trending compared to their annual budgets. Think of this as a profit-and-loss statement on each truck.
Such companies can track trends that indicate poorly running units and units that experience repeat repairs. These types of trends influence future component purchasing and maintenance practices. Trends also help guide organizations to make replacement cycle decisions.
“By having a handle on these types of trends, organizations can fine-tune their trade cycles and optimize their operating costs.
“For small fleets, many lump all of their transportation expenses into general accounts. So they have no real way of identifying costs on a per-unit basis.”
Full-service lease providers can help fleets identify their true maintenance costs. Most have software they use for predicting and budgeting future maintenance costs.
What information or data is needed to make a lease/own comparison?
Twelve basic items or costs — seven for ownership and five for leasing — must be quantified to perform an accurate comparison, Hudson said.Ownership
Initial cost of equipment: the original purchase price, including taxes, and additional equipment such as auxiliary power units, refrigeration units, etc.
Interest rate if considering a bank loan, length of loan, and downpayment.
Length of asset life — how long will the equipment be utilized.
Corporate tax rate (used to determine a company's net, after-tax benefits of depreciation write-off).
Maintenance costs over the equipment's life.
Administrative costs for licensing and tracking DOT compliance, plus the general and administrative costs associated with managing a fleet's maintenance.
Net present value calculation of the monthly payments, finance cost, and maintenance cost over the equipment's lifetime.
Variable cost (mileage rate) if a full-service lease.
Length of the lease.
Net present value calculation of the lease payments over the equipment's lifetime.
Residual responsibility. Is it yours or does it belong to the lessor?
“It is vital to tally all associated administrative expenses under ownership and lease before a comparison is made,” he said. “Once this data has been gathered, a net present value on the lease payment, the finance cost, and the maintenance cost over the equipment's lifetime can be calculated.
“It's also important to look at the net after-tax cash flows under ownership and leasing. This will give the true picture of how depreciation impacts ownership and leasing cash flows.“
The net present value calculation will estimate the future cash flows of ownership and leasing in today's dollars so informed financial decisions can be made.
Most leasing companies have lease/ buy tools that a fleet can use to load its data to perform these calculations.
What are the perceived benefits of ownership and leasing?
Truck ownership has been perceived to provide better control, which may or may not be the case. In many situations, there is inherent risk associated with owning trucks.
Some of these risks include the value of the equipment at trade-in time, unpredictable maintenance costs over the equipment life, obsolete or stranded assets due to improper replacement cycle, and increased costs caused by hiring, training, and tooling technicians to keep up with ever-changing truck technology.
Those risks can make it difficult, if not impossible, for a company to maintain a stable cash flow.
Equipment failures, even when they're covered under warranty, can create delivery delays and adversely affect a company's income.
Often, leasing can provide flexibility to meet short-term and long-term equipment needs by custom tailoring a lease and maintenance package that matches the truck's useful life, he said.
Leasing can also allow for a more stable cash flow as fleets make one monthly fixed payment for their trucks and their maintenance.
In many cases, a leasing company can offer a lower monthly payment than what a fleet might pay to finance a truck since it uses the truck's residual value in determining the lease payment.
Some leasing companies offer substitute vehicle programs that can provide comparably equipped replacement units while a fleet's trucks are being serviced.
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