A More Holistic View Needed for Proper Equipment Finance Decisions

by Sean Storey

Sean Storey is Vice President of Capital Equipment at Corcentric. He provides industry analysis and guidance specific to capital equipment for Corcentric and NationaLease fleet customers.

When it comes to determining whether to add a fleet asset, basing the decision on initial purchase price alone is risky business. While all the risks cannot be eliminated, looking at both financial and operation data will result in the right sized fleet with financial commitments that fit the business’ cash flow and debt strategy.

The analysis must include not only what the truck is going to be used for in the near-term, but also any anticipated changes in its duty cycle over the course of its life. Then there are operational costs to consider like maintenance, licensing and permitting fees, fuel as well as the amount of fuel an asset will consume.

There can be a tendency to only look at the big picture and focus on all assets as a whole when making financing decisions. However, to make the most effective decision, it is best to drill down on to each specific unit and its duty cycle. Something as simple as the geography or climate where an asset will operate can impact what it will be worth at the end of its lease.

Mileage is another factor to consider. While the number of miles an asset will accumulate over the course of its life is important, don’t forgot to factor in what type of miles those will be. Is the truck mostly going to operate over the road or will it see a lot of city miles?

Of course, vehicle specifications need to be factored in as well. A bare bones truck will have a lower initial cost, but will it last for the duration of the lease or will excessive maintenance and repair costs mean that “cheaper” asset is going to end up costing more in the long run?

The fleet needs to spec something that is going to function well in all of its applications for the desired lease term and lenders must understand this. The financial institution will look at the vehicle specifications and set a residual value for the asset at the end of the financing term with the estimated mileage at lease end being a major factor. The monthly payments are based on four key components: purchase price, financing term, interest rate and residual value.

Historic data about the performance of previous similar assets, usage standards and other industry benchmarks can also be helpful in determining an asset’s true cost of operation. It is important to understand the life cycle of each individual asset along with understanding the data on a fleet-wide basis.

One mistake that is commonly made is that once an asset is procured, no one ever reviews how it is doing compared to expectations that were made at the time financing was obtained. A regular — I suggest quarterly  — review of each asset’s operating costs will give the fleet the true picture of what is happening with each asset and will allow for adjustments to the lease.

This is the time to look at things like mileage, fuel consumption, maintenance and repair cost to see if they are in line with the assumptions made at the time the asset was initially financed.

Let’s use this example: It is assumed that a truck will accumulate about 100,000 miles a year and will be leased for five years. This means at the end of the lease it is expected that the truck will have accumulated approximately 500,000 miles. The anticipated residual value of the truck was based on that assumption. However, as it gets closer to the end of the lease, it turns out the truck has 700,000 miles on it. In simple terms that means that an asset that was expected to have a residual value of $30,000 may only be worth $15,000.

In this example, if a regular review had been conducted, the asset could have been retired early to prevent the fleet from losing money on it.

These reviews allow the fleet to also see if an individual truck or a group of trucks is being underutilized. While they can’t change the fixed costs, they can look at whether it makes sense to run a lease extension so that instead of running them for five years they extend the lease for another 12 to 24 months.

Failure to take a holistic view of the total life cycle of an asset during the asset acquisition process means the fleet will not be making the right decisions at the right time. Fleets should have a steady cycle of new trucks being brought in and old trucks being taken out and that can’t simply be based on financial calculations alone.

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