Deciding the right approach to funding for your company cars or vans is quite complex - for most businesses the key factors to be taken into account are:
- Affordability and Cash-Flow
- Accounting treatment
- Business tax relief
- Value Added Tax (VAT)
The traditional forms of fleet funding for cars and vans have their own advantages and disadvantages in each of the above categories.
You can read more about the main types of vehicle funding by clicking on the links in the text below, but the key principles to consider for your fleet are:
Do you want to take the risk on losses from vehicle resale values? In other words, can your business stand the financial impact of an unexpected drop in vehicle resale prices (known as 'residual values') when the time comes to sell?
For one vehicle or a small fleet this may not be a major issue, but if you have hundreds of cars or vans then the effect of a major drop in the market for used vehicles could be a significant detrimental impact on business profits.
Alternatively, if you think you can manage the disposal of your vehicles, in particular the vehicle condition and mileage and the timing of disposals to market, then you may be able to achieve higher residual values than typical market rates and profit from how you dispose of vehicles.
If you are happy to accept the risk from fluctuating residual values then buying outright, finance leasing and hire purchase offer the opportunity to profit from upward movements in market residuals but equally leave you exposed to losses from downward movements.
To avoid risk on residual values you need to use a funding method which guarantees the residual value at the end of the vehicle lifecycle.
The two funding options that do this are contract purchase and contract hire.
With contract purchase you are guaranteed a resale value for the vehicle at the end of the finance agreement, known as the 'minimum guaranteed future value' (MGFV), subject to the vehicle meeting the finance company's mileage and condition requirements.
This means your risk is fixed at the agreed MGFV.
With contract hire, in your monthly hire payments you simply pay for a fixed amount of depreciation over the life of the hire contract, plus interest and VAT. As with contract purchase, as long as the vehicle meets the mileage and condition requirements at the end of the hire term that's all you pay.
Affordability and Cash-Flow
If you have spare cash reserves in your business then using this to buy assets such as cars or vans outright may at first sight appear to the cheapest form of funding a fleet.
However, this ignores the value of money invested in your business and whether or not you can afford to have money tied up in vehicles which could be used elsewhere in your business to generate revenue and profits.
If you can achieve a high rate of return on money invested in your business then it may be more effective for you to use a finance company's money to fund your cars and vans and use your own funds to generate more revenue and profits.
Alternatively, if money invested in your business earns a lower rate of return then purchasing vehicles outright will avoid the costs of interest charges from finance companies to pay for them to fund your fleet.
If you simply don't have the spare cash available to fund vehicles then using a finance company's money may be unavoidable.
You can use our 'Lease or Buy' analyser to decide whether it would be better from a cash-flow perspective to use your own money or external finance.
Follow this link for more about cash-flow management.
When an item such as a car or van is purchased it becomes an asset of the business and its value is shown on the balance sheet.
However, because cars and vans generally depreciate over their useful lives, the value of a vehicle shown in the balance sheet drops each year.
In addition, the annual amount of the drop, called depreciation, is charged against the profits of the business each year.
This means that the value of a car or van shown in the balance sheet declines each year and the profits each year are lower because of the depreciation.
The same principles apply whether you buy vehicles with cash or on finance.
In addition, when you use external finance such as finance leasing, contract purchase or hire purchase to fund a car the obligation to pay the finance company for the duration of the finance agreement is shown on the balance sheet as a liability.
The precise way the liability appears on the balance sheet depends on the individual finance method and agreement.
The only exception to this requirement under current accounting rules is for 'operating leases', of which contract hire is a variant.
Operating leases at present do not need to be disclosed on a balance sheet as a liability (though this will change for larger companies that are subject to international accounting conventions).
This means that companies which buy outright, use finance leasing, contract purchase or hire purchase will see the transactions impact on the balance sheet, whereas contract hire agreements will not under current rules.
Business Tax Relief
When company cars are bought (using finance or from cash reserves) or leased the business can claim a deduction against taxable profits each year for part of the purchase cost or lease payments.
The rules vary according to the finance method used, with the effect that choosing whether to lease or buy can impact on the tax liabilities of a business each year.
In turn, the timing of the tax relief can impact on the cash-flow of a business as tax relief tends to be deferred on cars that are bought when comparised to the timing of tax relief for cars that are leased.
Follow these links for more about busines tax relief for cars bought or leased.
Value Added Tax (VAT)
Unfortunately the rules for VAT on company cars are as complex as those for business tax relief.
You can read more about the detail of VAT for company cars and vans by following the links below, but basically;
Lease or Buy Analyser
Our 'Lease or Buy' analyser can help you cut through the issues around how to finance your company cars or vans.
The analyser will assess the cost, tax and VAT implications of your vehicle funding options for a single car or a whole fleet of cars and vans.
To get started we just need you to provide below some basic details about your business.
Click on this link to try our lease or buy analyser