By eliminating most, if not all, the year-to-year volatility associated with funding fleet replacement expenditures, a reserve fund increases the likelihood sufficient funds will be available to replace all fleet vehicles in a timely manner. Annual funding requirements are predictable under this financing approach, making them less susceptible to competition from other spending requests and less a target for decision makers who may equate ad hoc funding requests with ad hoc – which is to say discretionary – spending.
An added benefit of using a reserve fund and charge-back system to finance fleet replacement costs is the payment of regular lease charges for the use of vehicles encourages fleet users to pay attention to fleet utilization levels. Under a cash financing approach, in contrast, users often see little benefit in disposing of underutilized vehicles. Users view the purchase price of these vehicles, paid in full at acquisition, as a sunk cost. Organizations that have instituted fixed monthly charges to finance fleet replacement costs have seen voluntary reductions in fleet size of as much as 20 percent.
A major drawback of reserve funds, however, is they are costly to establish if an organization has already developed a large backlog of replacement needs. Large amounts of cash (the cash “infusions” shown in Chart 4) must be deposited in the fund or charge-back rates must be set artificially high to provide the working capital needed to start replacing vehicles.
Another drawback is many organizations do not know how to calculate and apply charge-back rates properly. Some set rates too high, with the result that the fund balance becomes too large. Others set them too low, resulting in insufficient money to replace all vehicles according to the replacement cycles on which the internal replacement charges are based.
Even when rates are calculated properly, a fleet replacement fund may be “raided” during an economic downturn to meet other funding needs, undermining a well-designed replacement program in a single year. Both revenue shortfalls and fund balance raids can seriously damage the goodwill of fleet users who have faithfully made monthly payments to the reserve fund expecting to replace their vehicles in accordance with specified replacement cycles. These and other factors can make reserve funds difficult to set up and administer.
â– Leasing and Loans
Like a reserve fund, leasing, loans, and other types of debt financing allow an organization to spread out the capital costs of fleet vehicles over a period of several years. Rather than accumulating reserves internally to purchase replacement vehicles, however, these approaches involve tapping into the capital markets for the money to acquire vehicles.
The impact of leasing on the long-term replacement funding requirements of the 160-unit fleet we have been discussing is illustrated in Chart 5 (see pdf). As shown, this financing approach is similar to a reserve fund in its ability to eliminate most of the volatility in year-over-year replacement funding requirements. As such, it offers many of the same benefits as a reserve fund without a reserve fund’s drawbacks.
Foremost among the benefits of leasing and debt financin
g is consistent and predictable – and therefore unobtrusive – annual fleet replacement costs. Remember the dramatic peaks and valleys in funding requirements under a cash financing approach (i.e., like those shown in Chart 3, see pdf) and the ability to avoid making substantial outlays of cash in a particular year by simply postponing replacement purchases are the two primary causes of organizations cutting fleet replacement funding in a down economy. As demonstrated in Chart 5 (see pdf), even a tenfold increase in replacement spending requirement costs between 2011 and 2016 has a relatively small impact on replacement funding requirements when vehicles are leased rather than purchased using ad hoc cash appropriations.
Chart 5 (see pdf) also illustrates another reason leasing and debt financing are particularly worthy of consideration at a time when many organizations are deferring fleet replacement purchases to balance budgets. Switching from cash financing to leasing generates sizable near-term budget savings. These savings result from the fact that buying involves paying for the full capital cost of replacement vehicles before they are used, whereas leasing and loans permit an organization to pay this cost as the vehicles are used.
Thus, transitioning to leasing permits an organization to shift most of the capital cost of a vehicle put into service this year to future years in which the vehicle will remain in its fleet. For instance, in our sample fleet, the cash required to replace the fleet under a cash purchase versus leasing approach are: $500,000 (cash purchase) versus $30,000 (leasing) in Year 1 and $2.94 million (cash purchase) versus $1.49 million leasing in Years 1-5.
Chart 6 (see pdf) shows a side-by-side comparison of the long-term funding requirements under these two replacement financing approaches. Some people might argue this chart illustrates little more than budgetary sleight of hand, in the sense that switching from buying to leasing (or loans) simply moves some fleet costs otherwise incurred today to future fiscal years.
