The whole life cost of fleet management

Cost remains the key issue for fleet decision-makers, so using whole-life costs as the basis to select new vehicles is crucial, alongside assessing whether they are fit-for purpose. ACFO’s John Pryor examines what to consider when looking at buying low-emission and alternatively-fuelled vehicles.

Funding is bespoke to individual organisations and while tax changes can trigger a switch in funding routes so can alterations in an organisation’s status and attitude. That might include, for example, its ability to borrow money and its own cash situation, its attitude to financial risk and its level of internal fleet expertise, as well as changes in its VAT or corporation tax position.

Today contract hire (also sometimes known as operating lease) is the most popular fleet funding mechanism followed by outright purchase. However, there are also many other funding option available including: contract purchase, finance lease, lease purchase and hire purchase.

Furthermore, some organisations have opted for a sale and leaseback arrangement with a chosen vehicle leasing company, while other businesses may opt for so-called flexible rental – effectively long‑term rental without the constraints of a formal contractual arrangement. ACFO is also aware of some fleets adopting ‘blended financial solutions’.

That means they are looking at the tax position of vehicles and leasing companies – leasing companies are unable to claim 100 per cent first year writing down allowances on low emission cars – as well as their own financial/tax position and ‘picking and mixing’ funding routes to maximise any tax benefits.
It is not for ACFO to prescribe which funding solution is best for any individual organisation. Indeed, there is no one size fits all financial solution.

Instead businesses should look at the legislation and their own tax and financial position and take a view on how specific groups of vehicles may be funded with cashflow improvements and tax savings the key benefits.

Cashflow benefits
Contract hire is the number one fleet funding mechanism because it delivers monthly fixed cost motoring with no residual value risk – it is a known quantity that delivers cashflow benefits to businesses.
Although organisations must be aware of potential end-of-contract charges in respect of breaching pre-agreed mileage parameters and vehicle damage. Indeed, at an ACFO seminar last year delegates highlighted end-of-contract charges, particularly those related to vehicle damage, as the ‘cause of the biggest degree of conflict’ between fleets and leasing companies.

The major problem is that there is no uniform approach by vehicle providers to the levying of ‘fair wear and tear’-related charges, but they cost many fleets a fortune and must be tackled. Fleets want to understand how costs are calculated and ensure they are transparent and fair.

ACFO believes that in many cases, vehicle drivers do not recognise ‘damage’, particularly in relation to stone chips and alloy wheel scuffs, even though they resulted in a charge being levied.

Following the call for action at the seminar, ACFO deputy chairman Caroline Sandall has held a discussion with British Vehicle Rental and Leasing Association (BVRLA) representatives. They took away a number of action points, primarily around education and further supporting existing documentation as an interim step with the aim of enabling drivers to better understand fair wear and tear and the calculation of costs. We await developments with interest.

Salary sacrifice
Meanwhile, salary sacrifice is increasing in popularity as a funding option. A handful of major organisations have or are replacing their entire company car fleet with a salary sacrifice solution, although most employers provide car salary sacrifice as a benefit to staff who do not qualify for a company car.

Public and private sector interest in salary sacrifice schemes continues to grow, but it is not a new form of funding. Salary sacrifice is a flexible benefit offered to employees. However, what is new is that we finally know the outcome of the long-running debate on the International Accounting Standards Board’s proposals to bring all leased assets on to a company’s balance sheet.

The measure is intended to give a more complete picture of a business’s financial commitments and thus greater transparency as to the financial health of any organisation.

The new approach to lease accounting, called the ‘right of use’ model, differs substantially from the current standard, which does not require operating leases (contract hire) to be reported in company accounts. Finance leases and corresponding obligations to make lease payments have to be recognised on a company’s balance sheet.

Announced earlier this year, the new standard, following a 10-year review, becomes mandatory from 1 January 2019, but as with any other change to accounting standards, companies will need to ensure that they produce a set of comparative accounts for 2018.

Some businesses will be concerned that including vehicles that are on contract hire on their balance sheets will impact on their gearing and ability to borrow money.

However, our BVRLA colleagues are on record as saying that leasing and rental will retain their status as essential forms of vehicle finance despite the long-awaited publication of the new lease accounting standard.

The BVRLA has also said that it is confident that its members will be able to adapt their business processes to help customers with the new financial reporting requirements.

The final version of the standard also includes some welcome major simplifications which mean that short term hire vehicles, informal vehicle extensions and ancillary leasing services such as vehicle maintenance and accident management as well as excess mileage payments do not have to be reported. It also gives fleets the option to report leases on a portfolio level rather than individually.

The BVRLA has pointed out that the main value of contract hire comes elsewhere, sheltering companies from the risk of fluctuating vehicle values, providing them with extra flexibility and purchasing power and freeing-up precious working capital that would otherwise have been spent buying an asset. That is certainly correct but, nevertheless, businesses will need to ensure they report on their liabilities – rental payment arising under the lease – and their asset – the right to use the leased asset.

Initially, the new standard will only apply to public sector organisations and firms that report to International Financial Reporting Standards (IFRS). Publicly listed companies already have to make a note to the annual report, which reflects any operating lease rentals payable. Most UK firms report to the UK’s Generally Accepted Accounting Principles (GAAP) and will be unaffected until such time as they converge with the IFRS standard.

Whole life costs
Finally, irrespective of the funding mechanism adopted by fleet decision‑makers it is imperative that company car choice lists are compiled using whole life costs. Cost reduction remains fleet decision-makers’ agenda-topping issue, so using whole life costs as the basis to select new vehicles versus existing models is a key parameter in the detailed analysis that must be undertaken alongside the wider business need.

At another ACFO seminar it was suggested that hundreds, and possibly thousands, of businesses were potentially ‘wasting’ money because they were failing to use whole life costs as the basis for company car selection. In many cases that was because organisations did not employ fleet expertise, particularly in the SME sector, to manage, their company car operations.
Whole life costs represent the most effective way of operating and managing a fleet/allocation policy because it provides the best forward estimate of the real costs to the business, in delivering business mileage, over the period for which the vehicle will be retained. 

Whole life costs reflect all the projected, vehicle-specific costs associated with operating a vehicle over its fleet life, including depreciation (the total difference between the original cost and the residual value projected), funding, service, maintenance and repairs, VED, insurance, fuel (at least the fuel for the business mileage) and Class 1A NIC payments. Also VAT on the fuel scale charge for private use if this is provided. 

If the vehicle is contract hired, then the rental will normally include the depreciation, funding, service, maintenance and repairs and VED. Costs can be shown as per annum, per month, or per mile.

In conclusion, however organisations choose to fund their fleet vehicles there are a myriad of options that each require careful analysis. There is no correct answer, but the cost of getting it wrong could be enormous.

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