Finance matters: Contract hire is cheaper in the long run

BY PETER HOLLINSHEAD, HEAD OF VEHICLE FINANCE, HSBC BANK PLC

While contract hire is the most popular funding method for company cars in the UK, there are still a number of organisations that continue to fund their vehicles via outright purchase.

Why is this?

In recent months we have seen a significant decline in used vehicle values.

Not only have values reduced but it is becoming increasingly difficult to sell a used car.

There are a number of reasons why they may choose to purchase company cars outright.

Often the argument is made that the overall cost can be lower, as the company may be cash-rich and does not need to borrow to finance the acquisition of vehicles.

This means that they would save the interest charge built in to lease rentals.

It is also not unusual for companies to want to control or manage their fleet in-house without losing the ability to make changes to how the fleet is run.

While organisations may initially have concerns about the loss of control they could experience from outsourcing the running of their vehicle fleet to a third party, a robust service level agreement can ensure that operational needs continue to be met.

Leasing companies with a good service and support capability should be able to develop a service level agreement which meets the needs of the customer.

Even disregarding the recent fall in used car values the arguments put forward by companies do not always stand up to scrutiny.

The NPV cash flow analysis above shows a comparison of funding for a popular vehicle via contract hire and via outright purchase.

While in the example the absolute cost is lower under outright purchase, this ignores the time value of money.

Even for cash-rich organisations, there is an opportunity cost of tying up funds in company vehicles when they could put the funds to better use through investment projects with a view to improving shareholders’ return.

The example above shows that when the time value of money is taken into consideration, contract hire proves to be more cost-effective.

There are further benefits of contract hire over outright purchase.

Residual value risk is outsourced and budgeting of costs can be undertaken with more certainty.

Cash flows are even and not affected by significant fluctuations during the funding period, and there is the potential to free up internal resources to focus on more added-value activities.

Overwhelmingly the case stacks up for contract hire.

The days of outright purchase are going and it is very difficult to justify owning vehicles as the best option.

Small details make a big difference