THE ECONOMIC CLIMATE is increasingly challenging in our environment, resulting in some companies streamlining operations with a view to reducing expenses and increasing overall profitability.
The provision of transportation for senior executives, middle management or even operational staff, is normally a significant cost. One of the ways in which an organisation can reduce transportation costs and improve profitability is by giving adequate consideration to vehicle leasing as opposed to purchasing or loan financing. Understanding the benefits to be obtained from exercising a leasing option requires considering the types of leases available to a company (the lessee).
There are two types of leases: finance and operating leases. Finance leases transfer to the lessee substantially all the risks and rewards incidental to ownership of an asset. With an operating lease, the risks and rewards are retained by the company leasing the vehicle (the lessor) to the lessee. While there are advantages to each category of leases, this article will focus on the benefits of obtaining an operating lease, which is the most common form available.
In simple dollars and cents, considering a car with a cost of $80 000, lease term of three years and an interest rate of nine per cent, a company can potentially save $932 monthly or $11 069 annually, if the leasing option is pursued as opposed to a finance option with the same terms. Calculations will vary according to cost of the vehicle, interest rate and term of lease.
When focus is placed on the efficient use of cash resources, leasing eliminates the need for a significant capital injection up front to purchase a vehicle; however, it still allows a company to benefit from the use of a vehicle which may be imperative to that organisation, while making manageable monthly payments.
All vehicles lose value over time; this is recognised in a company’s records through depreciation, which reduces the net income of a company. One of the benefits of leasing a vehicle is that the lessee does not recognise any depreciation on that vehicle; they only record the monthly lease installments.
The elimination of the depreciation expense can increase overall profitability. Though depreciation on a company-owned vehicle is allowable for tax purposes in the form of capital allowances, (that is, you can deduct it in calculating corporation tax payable), those allowances on vehicles only extend up to a value of $75 000, expenditure above that value is not allowable for tax purposes. With regard to operating leases, all payments are allowable for tax purposes.
Leasing allows the lessee to avoid disposal costs. These costs can include repairs to the vehicle to achieve a saleable state, commission costs, which could be incurred if a third party is utilised to sell the vehicle, and intangible costs, for example, the time spent on facilitating the sale “of the vehicle.
In this instance, the choice of a leasing option for a vehicle will allow the lessee’s resources, both cash and time, to be better utilised in other areas within the company. Disposal of a company-owned vehicle can negatively impact the profitability of the company.
Market values on vehicles differ according to year, make, model and customer preference for specific brands. These factors can lead to the diminution in value of some vehicles at a faster rate than othes. Where the diminution in market value occurs at a faster rate than the value recorded in the company’s records and the vehicle is sold with that disparity in values, a loss on disposal will be recognised by the company, which will have a negative impact on profitability.
In a leasing arrangement, the lessee will not incur this loss, the risk associated with the loss in market value will be the responsibility of the lessor. We live in an environment where needs change quickly and the ability to adapt to such changes can be key to a company’s survival.
A car may be suitable for a company in one year and by the next year an open back vehicle becomes a necessity, for improvement and expansion of the company’s operations. The leasing option gives the company the flexibility to lease a vehicle for a short period and affords the option to change if required at the end of the lease term.
This flexibility may not be readily available with a purchase or finance option without incurring some additional cost. As companies adapt to the changes in this economic environment, greater emphasis is placed on cost reduction measures to improve profitability.
The examination of operating leases has illustrated this type of leasing as one of the areas which should be favourably considered where cost reduction is of significant importance.
Operating leases have the potential to reduce unnecessary capital expenditure, save through the elimination of avoidable cost and improve profitability.
Damian Branford is chief financial officer of Signia Financial Group Inc.
