AmeriQuest Transportation’s Patrick Gaskins examines issues confronting financial executives in the commercial trucking industry and discusses considerations they must weigh before making decisions about equipment replacement and acquisitions.
Every well-run business systematically surveys and interprets relevant data to identify internal and external strengths, weaknesses, opportunities and threats. But what is a company to do — especially one in the commercial trucking industry — when nearly every data point involved is in a major state of flux?
Federal tax reform, lease accounting standards, new EPA regulations and equipment productivity and rising costs are just some of the major issues the commercial trucking industry faces right now. Ultra-cautious executives might be tempted to retreat and postpone big decisions about the equipment replacement and acquisition process until these issues are resolved. But by doing so, their fleet may end up with operational deficiencies that have a negative impact on the bottom line.
FASB 13 & Truck Leasing
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)’s proposed overhaul of the existing lease accounting standards aim at eliminating off-balance sheet leases through capitalizing all operating leases. The Truck Rental and Leasing Association (TRALA) and Equipment Leasing and Financing Association (ELFA) have focused their attention on opposing unnecessarily complex requirements in the new rules that will be an extraordinary accounting burden for lessees and lessors alike. The accounting boards’ “decision to allow lessees to account for real estate leases using straight-line expensing but requiring lessees to account for equipment leases using an amortized, front-loaded expense model … distorts the true value of the asset and the lease transaction,” TRALA wrote in a recent article.
The trucking industry views straight-line lease expensing as a more accurate reflection of the economics of the transaction than FASB’s proposed interest and amortization model does. FASB and IASB expect to issue a final standard in early 2014, so what this will mean to companies that lease their fleets remains to be seen.
Awaiting Decision on Tax Reform
Fundamental tax reform is being negotiated on Capitol Hill, with changes proposed that will affect more than 50% of the members of TRALA and the trucking industry as a whole. This concerns an income tax rate change that will directly impact companies that are pass-through entities, such as S-Corps, LLCs, Partnerships and Sole Proprietorships, all of which file taxes at the same rate as individuals. For those making more than $400,000 annually and married couples making more than $450,000, rates would rise from 35% to 39.6%. In addition, pass-through companies making more than $250,000 annually face an additional 3.8% increase on investments, dividends and other “unearned income” as part of the new healthcare law.
Issues being targeted by the present U.S. administration, including accelerated depreciation, the deductibility of interest when utilizing debt financing and LIFO accounting, are vital to the commercial truck industry. While the government has said it would focus on cutting traditional C-Corp tax rates, this change will force many pass-through companies to file as C-Corp, placing family-owned businesses, which are common in the trucking industry, into a double taxation situation.
Federal Excise Tax on New Trucks
A third financial issue that can seriously impact the future of the trucking industry is the status of the federal excise tax (FET). There have been proposals about reducing or eliminating the 12% FET on the purchase of new trucks and replacing it with an increase on diesel fuel tax. Other legislators have discussed increasing FET as a way to raise revenue for the Highway Trust Fund.
Various organizations in the trucking industry support the lowering of the FET to encourage fleets to add newer vehicles and spur the introduction of newer EPA compliant engines and safety technologies onto the nation’s highways. Today’s generation of trucks with clean diesel engines are exceeding the expectations of manufacturers and users. The executive director of the Diesel Technology Forum points to a study showing that 2010 and later model year engines are registering near zero emissions for fine particles and are substantially below levels required by law.
Lease or Own Assets?
With so many significant issues still up in the air, is there a way for a private fleet or trucking company to insulate itself from the uncertainty in the marketplace? Leasing offers more flexibility in times of uncertainty by enabling a company to gain access to the newest technologies and to size the fleet for maximum capacity without large capital investments.
Among the top reasons to choose leasing over buying new replacement vehicles is that it serves as an alternate form of financing and instills a discipline for regular equipment replacement evaluations. With capital being in limited supply, the investment needed for a new vehicle — $110,000 for a day cab or $115,000 to $130,000 for a sleeper — is huge. In a walk away lease (closed-end lease), the lessor assumes the market risk for the asset at the end of the lease, removing the risk of loss on the sale of the used asset from the lessee. The walk away lease also provides the lessee with the most flexible lease end options, if properly structured.
A walk away lease for transportation assets is not always the optimum methodology. In many cases where fleets drive relatively few miles and have specialized equipment a TRAC lease (open-end lease) or ownership many be a better option. The residual or resale risk remains with the fleet at the end of the TRAC lease term or at the end of the asset lifecycle, and the lease end options are limited.
Companies that do own their assets will typically use short-term financing, such as a revolving line of credit from their primary bank to finance their equipment. But to find the best source of financing, some turn to fleet management service providers that specialize in identifying the best credit resources for their particular needs.
At this time, trucking companies are finding credit tight, while well-run private fleets have much better access to funding and lower interest rates. The combination of low financing rates and effective asset management will make the justification of the private fleet much easier and provide a company with a more competitive and efficient transportation resource.
However, getting approval in the company’s annual budget for the replacement of existing equipment can be a challenge for private fleets. A manufacturing company, for example, may feel it can get a better return on a large financial investment by improving a manufacturing process versus buying a $110,000 truck. One way to help the company identify the best way to invest funds is by calculating the weighted average cost of capital (WACC), which is a combination of the after tax actual cost of funds (borrowing rate) and the opportunity cost of funds (return on investment). Identifying the WACC is the first step in the lease versus buy evaluation.
Calculating Cost of Running Old Versus New
The topic of return on investment brings the reader back to the evaluation of when is the optimum time to replace assets. Executives looking for data to support a decision of whether to keep existing units or replace them with new should conduct a Run Cost Analysis. This analysis evaluates each individual asset, tracking each and every per-mile cost involved with operating the vehicle.
When performing a Run Cost Analysis fleet executives must first determine each asset’s individual fixed costs. Fixed costs are items such as monthly depreciation and interest expense or a lease payment. The next step is identifying the variable costs, which include maintenance and repair and fuel costs. Fixed and variable costs are then added together, divided by the number of miles the vehicle ran. The final figure is what it costs to operate the equipment over each mile it runs, or the Total Cost Per Mile.
Determining the fixed cost of a new tractor is fairly simple, but forecasting the variable costs can be much more challenging. This is where utilizing the services of a strong asset management company can prove to be invaluable. Benchmarking data from other fleets operating similar new equipment can provide the fleet executive with a wealth of information.
A new vehicle providing an increase of just two MPG can save a fleet well over $20,000 per year for just one vehicle. Even when factoring in the increased fixed costs associated with a more expensive new asset, the increased efficiency of the new asset and the lower variable costs will outweigh the increase in fixed expense and will point to the replacement of the older asset. The key is determining the optimum point in time and mileage.
With bottom line savings like these, fleet owners and managers need to continue to be proactive in analyzing their cost data. Even when faced with uncertainty in the market, the operational efficiencies of new equipment can provide a fleet with tremendous cost savings. By not doing so, they are losing out on potentially tens of thousands, if not hundreds of thousands, of dollars in overall savings.
Patrick Gaskins is vice president of Financial Services of AmeriQuest Transportation Services, a provider of fleet management services. For more information visit www.ameriquestcorp.com/transportation.
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