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Pros & Cons: Buying VS. Leasing

May 3, 2017
Financial payoffs or access to 'young' equipment?

Pro: Why you should buy your equipment

by Pat Gaskins, senior vice president of financial services, AmeriQuest Transportation Services

When you are thinking of acquiring a new piece of equipment, be it a straight truck, tractor, trailer, or any capital asset, you need to decide what is the best financing option for your business, as well as the best option for the specific asset type and use.

Based on how a company is structured, and its current tax situation, you may want to consider the following in your lease-versus-buy analysis:

◗ Tax benefits. Loans and capital leases will help companies shelter taxable income and enhance EBITDA (earnings before interest, tax, depreciation and amortization). By taking depreciation on assets through ownership, a company can reduce its tax base. In recent years, depreciation has been even more attractive because of bonus depreciation, which allows companies to accelerate depreciation in the primary years of the asset’s operation.

Another benefit of ownership is that it does not have a negative impact on EBITDA, whereas leasing will. EBITDA is used in many cases to measure a company’s health, and it is also a measure lenders attach to performance clauses in lending agreements.

◗ Extended trade cycles. People will also use ownership over leasing for assets with extended life cycles, typically those with a life span of 20-plus years. For example, cryogenic trailers are extremely expensive but can be operated for almost 30 years. There is no reason to have a short life cycle for that type of asset. Leasing is geared toward regimented replacement cycles where there will be a significant increase in variable expenses over time. With these long-lived assets, maintenance and repair costs do not go up significantly, so there is no need to replace them as frequently. The same may also hold true for low-mileage route delivery trucks.

When the reduction in variable operating expenses associated with a new asset does not exceed the increase in fixed financing costs, the decision should be to continue operating the current asset. Using an asset management partner will give the necessary, unbiased visibility into the fleet data producing a detailed keep-or-replace analysis.

That being said, it is always a good practice to analyze leasing versus buying on each asset in the fleet with each procurement cycle.  
Extended trade cycles with low residual values typically will force the financing of the equipment to be treated as a capital lease versus operating because of lease accounting rules. This will hold true even with the advent of the new accounting rules being implemented in December 2018.

◗ Corporate structure. For owners of S corporations, asset ownership is helpful in reducing the corporation’s tax liability. An S corp funnels all income and expenses (depreciation) through the owner’s personal tax statement. The depreciation and business expenses lower the owner’s tax base, thus reducing their tax liability.

The thought process behind an S corp is that the owner will only pay income tax once. Owners who pay themselves a salary from the company would pay tax on their personal income as well as corporate income tax on the company’s income. An S corp allows them to avoid this double tax.

◗ Type of equipment.  If the equipment you use is extremely specialized, ownership or a capital lease will make more sense because accounting rules will dictate capital treatment, and the asset will have very little to no residual value because of its unique specifications. The same applies to single-use equipment.

For most fleets, the biggest and most logical reason to purchase an asset rather than lease is the tax benefit that can be derived from ownership and the ability to maintain strong EBITDA performance.  

On the next page, read the argument against Buying

Con: Leasing will save your fleet money

by Brian Holland, president and CFO, Fleet Advantage

A leasing solution provides flexibility to adapt to changing markets and business conditions, and allows for the addition or replacement of equipment prior to lease expiration. Specifically, short-term leases reduce operating costs and allow a fleet operation to take advantage of the continuous vehicle safety improvements, improved fuel economy, and lower maintenance costs. Fleets are seeing the operational savings of shorter life cycles enabled by leasing directly hitting their bottom line, as well as  better driver retention, improved corporate image, and overall productivity.

In addition, the new lease-accounting standard instituted by The Financial Accounting Standards Board  during 2015 will continue to favor leasing over debt. Under the new rules, all leases, including those used to acquire trucks (with few exceptions), must be shown on the balance sheet as a right-of-use asset and corresponding liability, which in most cases will be less than if the trucks were acquired using debt. 

Running equipment based on economic obsolescence and integrating new equipment technologies faster continually increase fuel efficiency and have a significant financial impact, since fuel represents 60% of a vehicle’s pure operating costs. As mentioned above, a leasing solution enables shorter truck life cycles. 

As an example of the cost savings associated with a shorter life cycle, fleets that operate on a three-year life cycle see a per-truck savings over ten years of $17,040, compared with those operating on a seven-year life cycle. 

With the passing of GHG Phase 2, a new tractor four years from now is mandated to improve by 13%—almost a full 1.0 mpg. At 100,000 mi. per year, the fuel savings will equal close to $4,500 per truck. This directly correlates with a shorter asset life cycle strategy.

The same methodology applies to maintenance. The shorter life cycle that leasing affords dramatically lowers vehicle maintenance costs (a combination of newer tractors requiring less service and repair and the cost of maintenance and repair [M&R] after four years), and it allows for a more thorough monitoring of warranty recovery from the original equipment manufacturer.

Leasing provides increased flexibility to better manage the assets and increases control over the maintenance provider.  The ability to schedule preventive maintenance and warranty recovery allows fleet executives to contain costs throughout the life of the asset.

Maintenance and repair costs skyrocket in years five to eight (about three and a half times higher than years one through four), and as we see a shift to a shorter life cycle, with newer trucks continuously added to a fleet, maintenance costs and concerns are subsequently lowered.

The key to a sustainable, low M&R cost is to maintain a young fleet. Analyzing M&R data and refreshing a fleet every three to four years provides numerous benefits, including the following:

◗ Eliminates high, unscheduled repairs;
◗ Reduces size and cost of parts inventories and reduces labor requirements;
◗ Improves on-time deliveries;
◗Eliminates low-mileage “spare” trucks;
◗ Largely eliminates costly over-the-road breakdowns; and
◗ Obtains safe, reliable vehicles with newest safety technologies for drivers.

Equipment resale is the largest factor impacting a lease or purchase plan.  Gaining the highest value for used equipment is often the most neglected piece of the cost puzzle. A 5% gain in used equipment can drastically reduce finance costs throughout the life cycle of the vehicle.

Used-truck buyers pay a premium for well-maintained vehicles from nationally recognized corporate fleets. The leasing option eliminates residual risk while giving options to replace equipment quicker, providing for higher residual values at the end of the lease term.

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