The FleetPro Blog: How To Finance Your Fleet

How To Finance Your Fleet

14 September 2020

No, We're Not Mad

Though looking at our headline you might think that we've made a complex question absurdly simple.

How can there be a simple answer to financing a fleet of vehicles?

Well, the answer might actually be simpler than you think.

Simpler, that is, once you've made some basic decisions about what you do and don't want from fleet finance.

So let's dive right in by asking the key questions you should ask about your business and your fleet.

Focussing on these guiding principles will take you to right finance approach for your fleet:

1. Does our cash earn more than the cost of money?
2. Do we need to own our vehicles?
3. Do we want the lowest total finance cost?
4. Do we need the lowest monthly payments?

We'll look at each of these issues in turn, and give you a basic rule of thumb to use when deciding how to finance your fleet.

Does Our Cash Earn More Than The Cost Of Money?

If your business can generate cash, but it can't get a significant investment return from that money, then buying your vehicles with your own cash would make sense.

Paying interest to a finance company to fund your fleet could cost you money in real terms over and above what you could earn from re-investing the money in your business.

And that means you will be paying someone else money to fund your fleet that you can't recoup from business income.

Conversely, if your business has a low income stream but a high profit element then tying up money in vehicles could be the fast lane to disaster.

In this scenario, every penny of cash brought into the business from revenue needs to be utilised in the best way to maintain your profitable income stream. Tying that money into vehicles wll drag down your free cash-flow.

Using someone else's money to fund cars or vans could be a way of preserving your hard-earned revenues for use elsewhere in your business.

Let's look at both of the above examples.

Scenario 1:
Your business earns a 5% return on every widget it sells and can borrow money at 3%.
Using your own money to finance your fleet won't make sense.

You're earning more on your widgets than it would cost to service the debt on your fleet and, assuming there's a thriving market for widgets, you probably should be thinking about spending any cash reserves you have on buying more widget making machines rather than on your fleet.

But what if the reverse is true?

Scenario 2:
You make 3% on each widget and borrowing would cost you 5%.

In that case you can't make enough money fom selling your widgets to pay for funding your vehicles, so buying vehicles yourself would make more sense, assuming you have the cash available to do it.

Do We Need To Own Our Vehicles?

Why wouldn't you want to own your vehicles?

Well, that's because the issue of owning a depreciating asset like a vehicle fleet comes down to risk.

When you own your fleet you take on the risk of depreciation, because the vast majority of cars and vans go down in value as they get older.

And that exposes your business to unexpected downturns in the used car and van market which could cost you more than you expect, or more than you have provided for in your business accounts.

So, ask yourself if your business wants the risk of depreciation on its vehicles, or would you prefer someone else to take on that risk for you?

If you'd prefer someone else to take the depreciation risk then contract hire or contract purchase may make more sense than direct ownership.

With these finance methods the finance company owns the vehicle during the finance agreement and takes on the depreciation risk.

And whilst we're on the subject of alternatives for ownership, there's one further factor to consider.

Your employees could take the depreciation risk instead of your business.

Well, not directly, but a further option for vehicle ownership could be swapping to cash allowances instead of company cars, with employees contracting for cars under personal versions of contract hire or contract purchase.

And whilst the topic of providing cash allowances instead of company cars will be the subject of an upcoming detailed post on our blog, it's worth saying here that you shouldn't rule out employee ownership as an option for financing your fleet.

Do We Want The Lowest Total Finance Cost?

That might sound an odd question.

Of course you want the lowest total finance cost.

But a deal with the lowest total finance cost doesn't always give you the lowest monthly finance payments.

How so?

Well, modern vehicle finance products like contract hire or contract purchase reduce the monthly payments by leaving some of the purchase price outstanding until the end of the deal.

In contract purchase, when you finish the finance agreement you decide whether to pay off the remaining money or hand back the vehicle instead.

In contract hire, when you finish the finance agreement that's it - you hand back the vehicle and move on to the next one (assuming the vehicle is in an age/mileage appropriate condition).

But in these deals you still pay interest on the outstanding money (the vehicle's residual value) throughout the term of the deal.

As a result, the total interest charges are higher than traditional vehicle finance such as Hire Purchase agreement, even though the monthly payments are lower.

This is because the money left outstanding still carries an interest charge from the start to the end of the agreement.

As a result, a deal with lower monthly payments may actually cost more in total interest charges.

And the reverse could be true - a finance product like traditional Hire Purchase (where you pay the whole price of the car in equal monthly instalments) may have higher monthly payments but cost less in total finance charges.

Let's revisit our widget maker to see how.

What if you can accelerate the manufacturing of widgets though buying more widget making machines, but selling more widgets requires you to discount the price to sell more?

In that case you may need to look for finance with the lowest total cost (such as hire purchase) to maximse your profits from widget making, even though the monthly payments may be higher.

Do We Need The Lowest Monthly Payments?

Obviously you can stretch the buying power of your fleet finance further if you can get the payments lower each month.

Shopping around on finance deals will help, but to make a serious difference to your fleet spending power you probably need to use a deferred finance deal.

These are designed specifically to give a lower monthly payment (and therefore give you a bigger monthly spending power) by putting off payment of part of the price of the vehicle until the end of the finance agreement, or eliminating it altogether.

With contract purchase, for example, when you get to the end of the deal you can choose to either pay the outstanding balance and keep/sell the vehicle, or hand back the vehicle in lieu of the final payment and then finance another one.

Alternatively, in contract hire you avoid the need for a final payment altogether.

These types of finance product increase your buying power (because your monthly payments are lower) but, as we said earlier, you usually pay more interest overall when compared to hire purchase.

So if you are considering a deferred finance product, just remember that you are usually trading better buying power for higher total finance costs.

Our widget maker will help put this into context.

Say the cost of widget raw materials fluctuates, but you can get materials at a cheaper price buying in bulk in advance.

To free up cash-flow to buy raw materials in bulk at a lower price you use contract hire or contract purchase to pay less each month to fund your vehicles, even if this costs you more in the longer term.

This is because you're now turning out widgets at a higher profit margin (due to lower raw materials costs), so you can cover those extra finance costs with more profits.

How Does Finance Compare To Cash?

Well, if you have cash available to cover your fleet purchasing then you will avoid interest charges on finance agreements and you can concentrate on haggling over vehicle prices or trade-in values.

This is true even if the dealer or lender is offering 0% finance.

That's because, in 0% finance, the dealer usually uses money that would have been offered to you as a discount, or as part of your trade-in valuation, to pay for the 0% finance deal (there's no such thing as a free lunch in fleet finance).

So how do you compare the true cost of a finance deal with paying cash?

Well, first you need to work out how much you will lose by paying cash.

In other words, if your business uses its own cash then the money is no longer sitting in the bank (or invested in more widget machines) and earning a return.

You've lost the opportunity to earn a return on that cash by using it for fleet purchasing, and the cost of that lost return is called the 'opportunity cost'.

You can work out the opportunity cost of taking cash out of your investment pot by calculating the interest (or widget return) lost and adding it to the price of your fleet purchases.

This principle applies to any form of investment from which you took the cash to buy the vehicles.

So, for example, if your business is spending cash on company cars rather than on extra machinery to make new widgets to sell to customers, the profit you now won't get from the widgets you aren't now selling is your opportunity cost.

You therefore need to add that opportunity cost to the actual cost of the cars to get the true cost of buying outright.

Hopefully you're still with us after that, because now you need to compare your opportunity cost of using cash to the opportunity cost of using finance.

It becomes a little more complicated when you're working out the opportunity cost for finance, because you need to reverse the process compared to paying cash.

Instead of adding the opportunity cost you deduct it; you take your widget-making returns away from the total cost of the vehicle finance (because you've earned extra money with the cash you freed), and the result is your true cost of a finance agreement.

Now you can compare the true cost of a cash deal with that of a finance deal to see which one will really be more expensive.

(When you're doing this, don't forget to include all your finance costs, including any finance arrangement fees as well as the direct interest charges you will pay.)

As A Rule Of Thumb ...

In general terms:

The higher the rate of return you get on the cash your business generates compared to your cost of borrowing, the lower the 'real' cost of using vehicle finance instead.

In other words:

When your profit rates are more than your cost of finance then using someone else's money to finance your fleet makes more sense.

And the reverse is true:

The lower the rate of profits you make, the harder it will be to cover the interest costs on external vehicle funding.

And so:

When your profit rates are less than your cost of finance then using your own money to finance your fleet makes more sense.

Don't forget the effect of taxation - if your business is paying profits taxes then your net investment return will be lower, so using finance will correspondingly be more expensive (even though finance charges are usually tax deductible).

And make sure you take account of the different rules on tax relief on buying compared to leasing vehicles.

The rules differ significantly according to factors such as the type of vehicle (car or van) and, for a car, its CO2 output and whether it runs on fossil fuels or electricity.

There are also variations in VAT recovery for car purchases to take into account.

Finally, remember that once you've spent your money on a fleet the money is gone - you can't get your money back without selling the fleet if business conditions turn down, revenues drop and you need to raise cash.

If you leave your cash where it is (or invest it in profit generating equipment or people), and then use vehicle finance instead, your money should be earning a return to cover your fleet financing costs anyway.

One Last Hurdle

How you finance your fleet has a hidden cost beyond the direct charges for finance and opportunity cost.

When your business accounts are prepared, vehicles you own sit as assets on the balance sheet and strengthen the look of your business, even though cars and vans depreciate.

However, if you finance your fleet then your need to continue making future payments to the finance company typically sits as a liability on the balance sheet, weakening the appearance of your business.

Some finance methods don't currently need to appear on the balance sheet as liabilities, principally operating leases (e.g. contract hire).

This means you can finance a fleet through operating leases and they won't pull down the strength of the balance sheet.

However, this is changing for companies that report to international accounting standards, where operating leases now have to be disclosed as liabilities as from 1 January 2019, and it's likely that this principle will be cascaded down to all businesses over time.

For the moment though, smaller companies which still report under the UK's Generally Accepted Accounting Principles won't need to change their reporting of operating leases until 2022/23.

Do It The Easy Way

Don't worry if the process of evaluating cash funding of your fleet vs external fleet finance sounds like too much hard maths - we've already done it for you.

Our 'lease or buy' calculator will work out the cost of using finance (such as leasing or contract purchase) to fund a car or van compared to the cost of buying with your own cash.

You can set the investment rate you would get if you left your money in your company or put it into machinery, etc, and also your business tax rate and VAT recovery too.

We'll also work out the true cost of a fleet finance deal, taking account of;

• the interest rate you are being charged on a finance deal; or
• the monthly lease rentals you have been offered on a contract hire agreement; and
• any finance arrangement fees.
• business tax relief and VAT

Finally we'll compare the costs of everything side-by-side - cash purchase, leasing, HP and contract purchsse - to see which would have the lowest overall cost to your business.

And don't worry if you haven't got the cash anyway - our calculator will also compare the costs of finance for leasing, contract purchase and hire purchase so you can see which finance route will cost you less.

Why not try it now and work out which finance method will suit your fleet best?