Fleet News

Rising interest rates put focus on funding

INTEREST rates are just about to get interesting for fleet decision-makers.

Amid fears that the housing market is overcooked and retail spending is still out of control, putting consumer debt at record levels, the Bank of England is taking action.

Last month, it put the base rate up to 4.5%, with some of the more pessimistic pundits predicting they could reach 10%. For those with short memories, this isn't beyond the realms of possibility.

Although interest rates were as low as 3.5% in July last year, flip the calendar back a few pages and you will find a very different market.

Historically, interest rates over the past decade have settled at between 5% and 7%, but in the late 1980s and early 1990s, they soared up to 15%.

They are unlikely to rise that far, but fleets need to take account of a number of scenarios when looking at what they are doing with their money. Company cars and vans are an expensive part of any business's operation, with only wages costing more.

How firms fund those assets is a decision that not only affects how much the fleet costs to run, but also how the entire company performs.

For outright purchase fleets which have funded their vehicles through variable interest rate loans, the cost of the fleet could be about to increase.

These circumstances present rich pickings for leasing companies, which offer a haven from varying vehicle costs by offering vehicles for fixed monthly payments for a set period.

Many report that fleets are now approaching them to ask about alternative fleet funding methods. According to Arval PHH, one of the largest contract hire firms in the country, when interest rates were lower, especially during 2003, some companies with outright purchased fleets were taking advantage of low bank overdraft rates to pay for new vehicles or replace existing ones.

However, a changing economic climate is a good reason to review this policy and look for other financing methods.

Rising interest rates mean that vehicles funded by bank loans may not be as financially viable as they initially seemed.

Indeed, Arval warns, any company with assets tied up on their balance sheet should look carefully at whether this is the most effective way of funding its operations.

Louise Dickinson, managing director of Arval PHH's major customer division, said: 'Our customers, like all companies with vehicles, want to protect their fleets against external economic influences as much as possible. No one method of finance suits every business, but there are ways to mitigate the effects of rising interest rates.

'We have found that for several customers with purchased vehicles it makes sense to carry out a sale-and-leaseback arrangement.

'The fleet remains the same, but moving to leasing packages such as contract hire eliminates the company's exposure to the risk of further interest rate hikes.

'It also releases investment capital that would otherwise be tied up in depreciating assets.'

There is some consolation, though, as outright purchase is more flexible, so a fleet can decide at the last minute not to replace vehicles, without worrying about excess mileage charges or fees for additional wear and tear.

But Dickinson added: 'Assessing fleet funding methods can be a difficult task, but now is an especially good time for companies to question what they have done historically.

'Outright purchase, in particular, may be significantly less viable financially because of current economic conditions.

'More companies need to take a long, hard look at their current funding method and determine if it is still consistent with the current position of their business.

'I'll bet that several can and should be taking advantage of alternative ways of financing their cars and vans.'

The pros and cons

OUTRIGHT PURCHASE

Pros

  • Hands-on control
  • Flexibility of supply
  • Easily changed fleet replacement cycle
  • Direct benefit from savings

    Cons

  • Exposure to risk
  • Labour intensive
  • Depreciating asset on balance sheet
  • No VAT reclaim on purchase
  • High upfront outlay

    CONTRACT HIRE

    Pros

  • Fixed costs, low risk
  • Buying power of leasing provider
  • Easy to implement
  • Wide range of additional services
  • Lots of suppliers
  • Leasing firm reclaims VAT to reduce costs

    Cons

  • Excess mileage and damage recharges
  • Varying quality of suppliers
  • Potential savings may go to someone else
  • Can be inflexible
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