Cash flow can often be the guiding factor
By Ron Coleman
In part one of this article we explored many of the issues regarding buying versus leasing commercial vehicles. There was no clear winner. Each business needs to make its own decision. However, one deciding factor could be cash flow.
Two of my HVAC contractor clients take opposing positions on this issue. One leases while the other purchases.
The one argues that leasing is the right plan of action. For instance, leasing is the perfect option for my one client because they do not put on excessive mileage. Their leases only last for three years and, since they lease only newer vehicles, there is virtually no downtime due to vehicle failures. Cash is then generating profits because the business isn’t tying things up in the vehicles. At the end of the lease, they are not stuck with a vehicle that isn’t wanted and don’t have to deal with the hassle of selling it.
The client that argues for purchasing tends to keep their vehicles for a bit longer. Typically, they keep them for a minimum of five years. This contractor uses the opportunity of owning the vehicle by branding on the outside of the vehicle, which is good for them because they typically use an excessive amount of mileage. At the end of the day, they say that they have an asset that is well maintained. They believe that this option is cheaper than leasing because there is a five-year commitment that can be extended at convenience. There is always the option to trade vehicles at any time.
Fleet management
Rather than going directly to an auto dealership, contractors can work through a fleet management company. Fleet management-style businesses are growing. They provide businesses with an array of services such as capital leases for vehicles, seasonal leases, step-up leases, vehicle purchases and a host of other services.
They work directly with auto manufacturers to get deals for their clients. For example, the Heating Refrigeration, and Air Conditioning Institute of Canada (HRAI) has a member partner program for fleet management and vehicle leasing with Addison Fleet. The Mechanical Contractors Association of Canada (MCAC) also has a similar program for their members. MCAC also works with Chrysler to get benefits for their members. Fleet management businesses also provide solutions for operating costs. Make sure to compare the options with associations and what it would cost to go directly to the dealership.
Whether choosing to lease or buy, developing a long-term relationship with a supplier may be the best bet. They will be more flexible with end of lease charges and with changes to lease agreements. They want to retain business by making the relationship the proverbial win/win.
Financial responsibility
Make sure to negotiate payments when going with a lease. Historically dealers get higher prices when they make a lease rather than when they sell a vehicle. That additional $20 per month, tagged on to a lease payment adds up to almost $1,000 over a 48-month lease. You need to negotiate that down.
Leasing contracts are not standard documents; you need to understand the fine print on each lease. A common clause in lease agreements is the number of kilometres you can drive and the penalty for exceeding that limit. Can you live within the mileage limit? If not, make sure to build in an allowance for exceeding the limit. For instance, a 20,000 km excess over a four-year lease at 20 cents per kilometre will cost an additional $4,000.
When purchasing a vehicle, the dealer will usually try to get you to let them finance it. Unless they are offering a very attractive promotion, you will generally be better off using bank financing. Compare the cash price to the financed price. Here are some leasing do’s and don’ts:
Some don’ts:
- Don’t get into a lease unless you are sure that you need the vehicle for the full term of the lease.
- Don’t get into a lease unless you understand and accept all the terms of the contract.
- Don’t get into a lease if you intend to make major modifications to the vehicle.
- Don’t get into a lease if you are likely to damage the vehicle because of the type of work you do.
- Don’t get into a lease unless the buy-back value is defined and reasonable.
- Don’t pay list price or an excessive interest rate.
Some Do’s
- Once you have decided what vehicle you want, shop around for the best deal and develop a relationship with one supplier.
- Know the buy-out value at the end of the lease.
- Be aware of any restrictions and what must be done at the end of the lease before returning the vehicle, including charge for excess mileage.
- Check whether your association has a preferred program with certain dealers or fleet management companies for their members.
- If at the end of the lease your vehicle is in good condition, consider renewing the lease or buying it out. That way there may be extended value for any modifications or branding.
- When returning a vehicle at the end of the lease, make sure to return all the bits and pieces that you got with it. It is a good idea to get a checklist from the dealer. A missing key fob can cost up to $800.
- If you are leasing a replacement vehicle you should find the dealership easier to deal with as they will see the benefit in the continued relationship.
Capital leases
A capital lease gives an ownership position with the vehicle. The value will show on the balance sheet as an asset and the vehicle is not returned at the end of the lease period, whereas an operating lease is just like renting; there is never an equity position in the vehicle. There is usually an option to buy out the vehicle at the end of the lease, but you are not committed in doing so.
To make your decision-making process clearer, here are some key elements of a capital lease:
- If you are a high mileage user there is no penalty.
- If there is going to be excessive wear and tear on the vehicle there is no penalty.
- Lessee retains full equity.
- The lessee can use the equity at the end of the lease towards a replacement vehicle.
- There is no early termination penalty, thus allowing more flexibility on an ongoing basis.
- The biggest risk for the lessor is that the market value of the vehicle at the termination of the lease depends on the residual value. This is where the early termination, the high mileage and the excess wear and tear come into play.
- Do check with your accountant before signing a capital lease.
Ultimately, the decision to buy or lease is a trade-off decision that must be made depending on your specific circumstances. Weigh up the pros and cons and go with whichever route makes the most sense for your business and your drivers. The differences in whether to buy or lease is not a decision that is going to have a huge impact on your business. However, you should always negotiate the best deal and make sure you are managing your operating costs effectively.
The longer-term financing for purchasing vehicles that are now available can make the financing difference between a lease and a purchase a lot smaller. It is also important to make sure that you understand all the implications of all documents signed.