How do I finance a commercial vehicle?

By Colin Windell

Obtaining the capital necessary to purchase, lease or rent a truck is not a hugely complex subject on its own, but there are a number of factors that need to be carefully considered before a decision is made.

In the main cars owned by a company – whether one-person, small, medium or large – are obtained via a financial structure that involves lease or rent and are in the books as a depreciating asset or ‘cost to company’ and financed to allow a rollover to a new car every three to four years.

A truck, on the other hand, needs to be funded as this must provide a return on investment (ROI) for the company or operator since it is a primary function in the income generation of the business.

It is not just a matter of determining whether to lease or own; funding your fleet involves a great deal more analysis and research and choosing the best method is an important fleet management responsibility.

“From a trading aspect one of the biggest effects on the TCO (total cost of ownership) of a vehicle is that of ‘specials’ or excessive discounts,” says Johan van Niekerk, CEO of FleetBase. “Protecting the residual value of the vehicle by the manufacturers/importers is paramount.

“Naturally, having a well maintained truck with a correct service history also contributes significantly to the end resale value. This assists with lower maintenance and better safety in the form of reduced accidents, fuel costs, incentive schemes and driver behaviour.”

That said, determining whether to own or lease company vehicles; is a good starting point. to either buy them or lease them. Each of the above, however, contains further questions that need to be answered, as both offer several options.

Bob Cavalli, VP/Sales, Indirect & Cobrand for  Voyager Fleet Systems in the USA, put it clearly when he wrote: “Fleet managers have a role in the analysis and in most companies they are subject matter experts providing the assumptions and data (ie, vehicle cost, projected residual value, lease rate factors, etc.) to someone who will create the actual financial model. It is a good idea, however, for the fleet manager to at least have a basic understanding of that process and what it represents.

“In its simplest terms, the financial analysis of; lease versus own dilemma is a comparison of the present value of the net after tax cash flows of both options. There are certain tax benefits to both, and since one of those (leasing) involves payments made over a period of time, the flows must be compared using the present value of both.

“The cash flows of an owned fleet are relatively simple; there is an outflow of cash on the first day the vehicle is purchased, followed by the tax benefit of accelerated depreciation over time, with the final cash inflow when the vehicle is sold (on which tax must be paid). The cash flows generated by a lease will depend upon whether or not the lease is a capital or operating lease.

“For an operating lease, the monthly payments are expensed, that is, each month they are treated as an expense in the same manner as are other categories of expense, such as salaries, benefits, the cost of goods sold, etc. Taxable revenues are reduced by deductible expenses to net pre-tax revenue; the company’s tax rate is applied to this revenue, resulting in net after tax income.

“For a capital lease, the vehicle is treated for accounting purposes as an owned asset on the company balance sheet. The value of the asset on the left side, the lease obligation as a liability on the right side, and any difference will increase or reduce net worth. The asset is reduced each month by depreciation (at a rate chosen by the company), and the lease obligation is reduced as payments are made.”

Very simply, there are just two methods of vehicle funding – cash or borrowing from the bank or other funding entity.

The cash decision obviously requires the company has sufficient funds and use of these will not impact the daily operational needs of the business. However, there still is a ‘cost’ to using cash and that is the loss of any earnings on the net after tax profit margin because this will not be reinvested into the company – often referred to as the ‘opportunity cost’.

If the opportunity cost is less than the cost of borrowing, it is more cost effective to pay cash. If it is greater, it is better to borrow funds.

“Transport plays an integral role in the economy and is the life blood of the country, moving people and goods to various destinations.  When it comes to financing Commercial Vehicles, buyers in the market have to fully understand their decisions and options before committing oneself to a particular purchase,” says  Toni Fritz, Executive Head: Commercial Asset Finance for Standard Bank.

“Before approaching ones’ financing house, take the appropriate time to prepare and investigate the respective lenders requirements. Whilst affordability is a significant factor, one must also understand the importance of contract evaluation by lenders.”

Below are some guidelines.

• Term

Is the term aligned to the finance Period? The suitability of the prime mover and trailer must be taken into account regarding kms and age relative to the life cycle considered when assessing funding periods and contract terms.

• Track Record

Is it a brand new contract or is there a relationship? If so, the sub-contractor would have gone through the ‘learning curve’ and the risk is lessened.

• Product: The product been transported has a bearing on the depreciation of an asset.
• Rates of the Contract:

There is a concerted drive in the industry to ensure that volumes or tons per kilometre as well as fixed costs are set out in the agreement to ensure viability to the transporter. This relates specifically to:

• Quantity/Volume/Tonnage to be delivered;
• Number of Loads to be delivered;
• Routes, in terms of kilometres, to be utilised
• Payment Terms:

Supplier payment terms can have an effect on a transporters Cash Flow. Payment terms can range from 14 to 30 and at times 45 days.

• Obligatory Performance Clauses:

Clauses that form the basis of the client specific performance on the contract:

-Quarterly Meetings to discuss with the Transporter any compliance or remedies of operational/safety/legislative requirements to ensure continuity and quality control and reduce shortfalls/losses that may accrue

• Risk [Monetary] Clauses

Clauses that may affect the Transporters cash flow due to penalty clauses for non-compliance/non-performance/no delivery.

• Termination:

Clauses that allow grounds for the termination of an agreement

Added to this is the Breach and/or Arbitration Clauses.

• Rate Escalation

Is an important factor in any contract? No contract is a contract if it does not contain this clause.

Fixed Rate Contracts are risky if the Rate is fixed for the life of the contract [Municipal/Road Works]. Clients must factor CPI costs in said instances.

• Fuel Adjustment Clause

Is a pivotal factor for any transporter.

Escalation clauses for Fuel must be adjusted as per increases or decreases.

• Automatic Renewal Clause:

Does the contract allow for a renewal after the primary period? What time frame is allowed for the renewal or new tender process?

• Exit or Hardship Clause

Does the contract have an ‘notice period’ in favour of the contractor which allows exit should the market change, demand decrease, irrespective of performance? Are there penalties involved? What is the contractor’s options regarding the asset?

“It is important to remember the points above are guidelines and one should talk to their preferred finance provider whom can advise on what best suites their business needs. This will save time and money in the long term,” adds Fritz.