Overview of Employer Options Providing Vehicles

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1 Overview of Employer Options Providing Vehicles (Chapter 2 from NAFA s Fleet Manager s Manual) One decision every company must make is how to provide the vehicles for transporting its sales or service personnel. Vehicles can be supplied in three ways: company-leased, company-owned, or driver-provided. A firm must evaluate all factors of each approach and determine which method is best for that company. Leased Vehicles Automotive leasing has grown to be a major factor in the fleet profession. Fleet managers and their superiors are frequently approached by leasing companies promoting programs. Management periodically requests that fleet managers prepare evaluations and recommendations. A qualified fleet manager must be able to supply answers. The following material will provide helpful information for study. Considerations Financial Issues Leasing releases capital. These three words probably summarize most of the financial considerations of leasing. To own a fleet, a firm must invest capital, which may come from company reserves or be borrowed. If, for some reason, borrowing is not possible or practical, leasing may be the answer. With leasing, funds are available, when required, on a unit-by-unit basis. Leasing may be more expensive than the basic borrowing rate, but will be less expensive than issuing additional equity or debt and will produce lower overall cost. When leasing, depending on the terms of lease, fleet managers must keep in mind that this is a recurring cost until the lease ends and must budget for the full term of lease for all vehicles. Management Service Issues Fleet management should be a managerial, asset management and cost-control function. Fleets should maintain records, which may be analyzed for controlling costs. With the proper information from fleet management companies, fleet managers are better able to control costs. Most leasing companies and several other vendors offer fleet administrative assistance. These companies may place the fleet s orders for vehicles, manage vehicle resale, handle titles and registration with all states and provinces, manage fuel service programs, process and approve maintenance under established procedures and limits, manage warranty NAFA s Driver Transportation Options Page 9

2 recoveries, supervise accident repairs and subrogation, offer or assist with driver training programs, manage vehicle relocation, etc. All these services are provided to clients regardless of fleet size or whether the vehicles are leased or owned. However, the fees charged by leasing companies usually exceed the expense of a fleet department. A smaller firm with no fleet manager may benefit from the full services of a fleet management company and produce savings in fleet operations. Tax Requirements It is a difficult task to maintain records of sales and use tax laws that vary from state to state or city to city and which may change frequently. Specialized leasing company tax departments monitor these regulations, keep their clients informed and, when possible, pay the taxes. In some states, due to individual tax laws, it is more advantageous to lease rather than own vehicles. Taxes on monthly lease payments may be less than the sales tax on the purchase price of owned vehicles. Lease Types In 1976, the Financial Accounting Standards Board (FASB) established new rules for the accounting treatment of leases (FASB Statement 13 Accounting for Leases). Full text of the statement and updates are available at Leases were classified into two categories: Capital Leases and Operating Leases. Capital leases must be capitalized and shown on the lessee s balance sheet as assets. Operating leases may be shown as expense. In Canada, the Canadian Institute of Chartered Accountants (CICA) ruling #3065 applies the same definitions. Capital Lease If one or more of the following criteria exist, the lease is defined as a capital lease. Otherwise it may be considered an operating lease. Ownership is transferred to the lessee by the end of the lease term. Lessee has the option to purchase the leased property at a price expected to be significantly lower than the fair market value of the property. The lease term is equal to 75 percent or more of the estimated economic life of the property. The present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property. Page 10 NAFA s Driver Transportation Options

3 Operating Lease Under an operating lease, the equipment is not considered a company asset and the lease charges are considered operating expense. The use of an operating lease has several effects upon a firm s balance sheet. For instance, when a firm converts from ownership to an operating lease, the firm s asset value is reduced. In addition, if funds for the owned vehicles had been borrowed, liabilities are also reduced since operating lease payments are not considered as liabilities on the balance sheet. Lastly, if the lessor purchases the fleet from the lessee, the lessee s cash is increased by the value of the sale. Leasing Advantages One of the greatest values in leasing is having funds available to acquire or replace a vehicle at the proper time. Under ownership, management frequently finds better uses for its fleet replacement funds, which may result in vehicles not being replaced at the most economical time. There is also a tendency on the part of some employers to spread expenditures over the entire fiscal year. Lessor funds, however, are available at all times, at no cost, until used. Thus, vehicles can be acquired or replaced as needed. Leasing Disadvantages Some vendors claim that leasing reduces paperwork. This statement should be carefully reviewed since tasks such as processing requisitions, verifying orders, reviewing and processing monthly leasing invoices and reviewing reconditioning charges may result in an even greater workload. If a fleet acquires its own vehicles, the fleet manager generally deals with and establishes a close rapport with dealers. The introduction of a third party, the leasing company, may reduce that relationship and can cause delays, additional clerical work and cost. All leasing companies attempt to achieve savings in vehicle acquisition and disposal. They relieve the lessee of the task of negotiating new and used vehicle prices. However, the lessee thereby loses direct control over the prices the company is charged for new cars, the reconditioning charges on used cars, and the price recovered for used vehicles. Because of a fleet manager s personal interest in obtaining maximum value for the fleet, he or she may be able to negotiate better prices than leasing companies for new and used vehicles. Full Service Leases Full service leases are generally for a fixed period of time, such as 12, 24 or 36 months. (These leases, along with net leases, are known more broadly as closed-end leases). They NAFA s Driver Transportation Options Page 11

4 typically include the acquisition and disposal of the vehicle, full maintenance, tires (in some cases), depreciation, interest and overhead, all at a fixed monthly payment. If requested, insurance, licensing and towing can be included at an additional cost. As these costs become less predictable, lease rates must be increased to cover the higher risk. Some lessees feel that closed-end leases protect them from fluctuations in the used vehicle market. If the market declines, the loss is absorbed by the lessor. However, unless the lessor has made allowance for possible declines, rates on the subsequent leases may increase. With a nationwide full service lease, maintenance is usually performed at local shops or national account stores at the same prices available to the lessee. Lessors can do little to achieve economy unless the maintenance is performed in their own shops. Full service leasing is not as popular as in the past, due primarily to its generally higher cost. Many companies find open-end finance leases more cost effective. In spite of higher costs, full service leasing may appeal to firms who cannot afford fleet supervision. Many of these firms, however, do not realize they are paying a premium for the service. Net Leases As an alternative to high cost full service leasing, some lessors offer a net lease (also known as closed-end, walk away, etc). Under this type of lease: Lessee is responsible for maintenance. Lessor provides specific vehicle for predetermined period, at predetermined fixed rate. Lessor assumes depreciation risk. Lessee must pay for abnormal wear and tear at termination. Lessee must pay for mileage in excess of contract limit. Advantages Lessee is not responsible for vehicle disposition at the end of the lease term. Lease cost is predictable for lease term. Cost is lower than full service lease. Page 12 NAFA s Driver Transportation Options

5 Disadvantages Lessee must manage maintenance. Charges for abnormal wear and tear are unpredictable. Penalty for excess mileage. Finance (Open-End) Leases A finance lease is actually a cost plus lease in which the lessee assumes all risks. The lease rate includes buying and selling fees, monthly depreciation, interest, and profit. Monthly fees are generally expressed as a percentage of the lessor s capitalized cost. The lease term is open-ended, with termination at the lessee s discretion. These leases include a terminal rental adjustment clause (TRAC) to adjust differences between remaining book value and used car selling price. Occasionally, lease agreements require a division of the resale profit between the lessor and lessee to create a theoretical incentive for the lessor to obtain maximum used car recoveries. Finance leasing provides an excellent method of supplying vehicles to fleets willing to assume the risks of ownership without involvement in buying, selling or owning cars. Lessors have broad knowledge of the industry, which enables them to offer sound advice to clients. They arrange local delivery and service on a broad range of makes and models at low prices. Employee Provided Vehicles Companies that do not provide company vehicles for personnel require employees to use personal vehicles, and in most cases, reimburse them for business use. Some companies may choose not to reimburse sales personnel for use of personal vehicles if they are paid on commission and often earn high incomes or where they sell directly to consumers. There are three basic types of reimbursement programs (also referred to as driver allowance or advance programs): 1. Flat rate - fixed sum to cover vehicle expenses (regardless of miles driven) considered taxable to the employee. 2. Cents per mile/km paid to driver for business miles/kilometers driven 1) in accordance with current IRS Optional Standard Mileage Rate/Canadian Department of Finance Automobile Expense Deduction Limit, or 2) any amount as determined by the employer. NAFA s Driver Transportation Options Page 13

6 3. A combination of flat rate plus rate per mile/km which can follow the Fixed and Variable Rate (FAVR) program designed by IRS revenue procedures. (Details on the various types of reimbursement programs are contained in NAFA s Personal Use CD. Also refer to Significant Tax Regulations & References section of Driver Transportation Options.) Advantages A major company advantage of employee provided cars is the lack of capital investment, which could otherwise restrict expansion or limit operations. Other advantages to the company of employee provided vehicles are: Ease of administration. Company has no responsibility for vehicles. Drivers handle purchasing, selling, maintenance, license, taxes. Company pays no bills except reimbursement. Auto expenses are simple to forecast and budget. Company has minimal record keeping. Company pays for business use only. Sales force can be expanded rapidly by hiring employees with vehicles. Morale may be high if employee has unlimited car choice. Morale may be high if employee feels the reimbursement is higher than necessary to cover costs. Seasonal businesses can expand or contract a sales force without vehicle concerns. In firms with high employee turnover, reimbursing drivers for use of personal vehicles can avoid problems of vehicle transfers, increased wear and maintenance and poor morale. In a firm that provides vehicles, surplus vehicles would be transferred to new employees. Vehicles transferred between several drivers generally have higher maintenance costs and are typically in poorer condition. Also, a new employee assigned a vehicle driven by a former employee is frequently unhappy with the vehicle. Disadvantages While advantages exist for a firm using employee provided cars, there are also disadvantages. For instance, the company can hire only sales persons who can provide a vehicle. The firm may lose a competitive edge in recruiting highly qualified personnel. The Page 14 NAFA s Driver Transportation Options

7 firm may be hiring less qualified personnel than competitors. To attain top-notch personnel, some firms loan drivers the funds to buy cars - restricting the firm s capital. Customers often assume companies provide cars for sales personnel. On occasion employee provided vehicles may not be suitable for the job, may be very old or in very poor and unsafe condition, thus creating an unfavorable company image. Customers might presume the firm skimps on vehicle repairs or replacements and neglects driver and passenger safety. Unless standards are established, the company has little control over the age or condition of employee vehicles. Drivers control their expenses for future maintenance and vehicle replacement. If they are overpaid, they can treat the funds as supplementary income, and if underpaid they may not give their vehicle the appropriate level of service and care. Should customer service become questionable, management may be required to assist drivers with funds for repairs or vehicle replacement. The company needs to set a firm policy, which outlines exact guidelines for their reimbursement program. Drivers transferred or promoted to an office position frequently are given additional compensation to cover the loss of reimbursement, which was considered supplementary income. Varying State/Provincial vehicle licensing requirements, type of areas covered (for example, city vs. rural) and varying mileage between territories make it difficult to establish equitable fixed (flat) reimbursement rates. Differences in operating costs between territories make identical reimbursement rates inequitable to some and equitable to others. Mileage allowances tempt drivers to report extra mileage to earn additional income. Firms found that reported mileage dropped when they switched from reimbursement programs to company supplied vehicles, sometimes as much as 25 percent. Drivers may make unnecessary trips to accumulate additional miles, thereby wasting productive selling time. In other cases, in order to increase mileage, drivers make more calls, spending less time on each call. Employee provided vehicles do not reduce a company s exposure to liability. If the vehicle is being used for business purposes, regardless if it is employee owned or company owned, the company becomes liable. Under reimbursement, the company assumes a greater insurance risk. In the event of an accident where the driver s insurance is inadequate to cover the liability, the company could be held responsible for the excess. Shopping for a new vehicle and disposing of the used one will probably be done on company time time which should be used for company business. A reimbursement program shifts fleet administration to the employee who has limited tools to negotiate additional discounts and services. NAFA s Driver Transportation Options Page 15

8 Automobile dealers do not consider individuals as fleet buyers, although, technically, they are buying cars for the company. Individuals pay higher prices. Individuals pay full retail price for parts and repairs, while the company may obtain discounts. Individuals pay higher interest rates than companies to finance cars. Individuals who choose to lease their vehicles will bear charges/penalties for excessive mileage over contracted limit and abnormal wear and tear when the lease term is up. Adequate business insurance coverage is costly to the individual. Individuals do not have volume leverage to negotiate improved warranty adjustments. Employees who own their vehicles may not be in a position to get the best price when selling their used vehicle. Reasons for Employee Provided Vehicles Although employee provided cars are generally considered the most expensive, there are situations when they are practical. When a business car is needed infrequently. Temporary hires. When employee turnover is high. When cars are needed for short time periods (i.e. when company car is in shop for extended periods). When cars are needed for seasonal use or short-term projects. When cars accumulate low annual mileage. If employees sell high priced or prestige items and demand luxury cars, it may be less expensive to reimburse rather than provide high priced cars. Company provided cars may not be practical if the firm needs capital. When employees, for their own reasons, wish to use personal cars at rates acceptable to management. Page 16 NAFA s Driver Transportation Options

9 Company-Owned Vehicles Another alternative to acquiring vehicles is through direct purchase. However, it is recommended that a company-owned fleet have a qualified fleet manager to manage the various services required to maintain a fleet as well as have the ability to perform analytical studies to evaluate the fleet s operating costs. If a company is unable to hire a fleet manager, there are fleet management services available through fleet management companies. The company should evaluate very carefully the cost advantages of hiring their own fleet manager vs. using an outside fleet management company and also look at the availability of services being provided by the fleet management company. Ownership does not guarantee lower costs. In firms without a fleet manager, fleet administration is often assigned to other departments such as the Purchasing Department. Although purchasing can frequently obtain low new vehicle prices, they may not be automotive experts. They may not know the best models to purchase for maximum resale or they may select models or equipment that result in high depreciation. In smaller firms, drivers or local managers may be authorized to negotiate the vehicle purchases. Obtaining multiple bids from local dealers does not ensure lowest prices. An integral part of fleet management includes processing titles, license renewals and record keeping. These functions are performed by the leasing company for leased vehicles, but for company-owned vehicles it is the responsibility of the company to perform these tasks. Another area of knowledge necessary for a company-owned fleet is vehicle replacement schedules. The correct replacement schedule can keep maintenance cost and depreciation low and resale values high. An ill-timed replacement schedule, or no schedule, can result in high maintenance costs, higher depreciation and lower resale returns. If operating costs are to be kept low, items such as fuel, oil, tires and maintenance must be controlled. Without supervision, drivers often purchase premium gas, oil and tires when not needed. Preventive maintenance schedules are very important to keeping repair costs down and downtime to a minimum. Advantages Company ownership has the following advantages over driver provided vehicles: Company can compete with industry peers to attract and retain qualified personnel. Increases employee morale and productivity. Less expensive than driver provided. Company provides vehicles that are suited for the job. NAFA s Driver Transportation Options Page 17

10 Avoids reimbursement inequities and pressure for higher allowances. Guarantees protection of company image through proper vehicle selection. Vehicles better maintained: fewer breakdowns. Liability exposure is reduced with controlled maintenance and replacement policies. Company able to hire individuals who don t have personal vehicles. Company carries adequate insurance. Company has better control over the vehicle and its operation (personal use vs. business use). Company ownership may have one key advantage over finance leasing: the company may be able to obtain lower cost of capital than a lessor. The firm may use surplus capital and pay no interest, or using the vehicles as collateral borrow from financial institutions at lower rates than those charged by lessors. Compared to full service leasing, ownership provides the company complete control without lease restrictions. The company has unlimited selection of makes and models. Vehicles can be replaced at will to satisfy the needs or convenience of the fleet. Disadvantages Often a concern for a company is obtaining funding for the capital investment required to acquire a fleet of vehicles. A company will need to look at the options available to them and consider their cost of money. Coupled with this is the form of depreciation that will be used. The fleet manager should work with the company s finance department to determine the best funding options available. When vehicles are capitalized, it is sometimes difficult to obtain funding to replace them when appropriate. A misconception is the belief that keeping vehicles in service as long as possible will reduce costs. What the company fails to understand is that older vehicles require more repairs to keep them in safe operating condition. Company Ownership Summary A company considering ownership of the fleet must make several decisions, including: Does the fleet structure justify a professional fleet manager or fleet management firm? Can administration costs be recovered by other savings? Page 18 NAFA s Driver Transportation Options

11 Does the company have surplus capital to invest in the fleet or available funds at low interest rates? Do vehicles operate sufficient annual mileage to justify the company provided vehicles? Will vehicles be retained more than 12 months? High first year depreciation could be very expensive. Will vehicles remain idle for extended periods? If so, employee provided vehicles might be less costly. Are drivers being paid high reimbursement rates for employee provided vehicles? Ownership might be less costly. A fleet that is large enough to justify professional fleet management and has a source of low cost capital might consider company ownership. Professional management, with adequate cost controls may achieve substantial cost savings over other methods of providing vehicles for personnel. Conclusion No two organizations are identical. Each has different structures, finances, objectives, products, images, etc. There is no one method of providing cars that would be best for all situations. The above material should help any manager determine which method would be best for his or her firm. NAFA s Driver Transportation Options Page 19