Sale and leaseback as a concept has been around for almost as long as vehicle leasing itself, but there are still many organisations that could be taking advantage of this that haven’t taken the plunge. In this blog we take a look at how this type of finance works and examine the advantages and disadvantages of sale and leaseback.
Need to free up capital? – Sale and leaseback could be the solution
For many companies, particularly SMEs, finding the funds to invest in key areas of their business, or to fund expansion, can be a real issue. One answer could be to release capital tied up in vehicle assets.
As lines of credit from traditional providers, such as banks, have become more difficult to access, organisations have increasingly looked for alternative ways of raising finance, through asset finance companies and contract hire providers.
One way of releasing funds is to make company-owned assets work to your advantage, and one of the biggest assets for many companies is their vehicle fleet. For companies that own their vehicles outright, a sale and leaseback arrangement can provide the means to free up cash to re-invest in core activities or to fuel expansion. We look at the sale and leaseback advantages and disadvantages in detail below.
Sale and leaseback definition
Sale and leaseback is a financial arrangement whereby a company sells the vehicles it owns to a third party contract hire company. The contract hire company will value the fleet and offer a realistic market value for the vehicles. Then, on completion of the leaseback transaction, they will take ownership of the vehicles in question and lease them back at an agreed rate and over a pre-agreed period of time.
The lease payments will be based on the term of the agreement, the mileage to be covered and the estimated future value of the vehicles.
What are the main advantages of sale and leaseback?
Immediate cash injection
The key advantage of sale and lease back agreements is that they provide an immediate cash injection into the business, while removing the risk of fluctuations in the future value of the asset. And, as this is a paper-only transaction, the seller continues to have use of the vehicles throughout the transfer process and there is no driver inconvenience or disruption.
When new vehicles are added to the fleet, as the existing ones reach the end of their pre-agreed working lives, they can simply be leased from the outset, rather than outright purchased, meaning no capital outlay.
Off-balance sheet funding
A further advantage is that, for many organisations, it enables heavily depreciating assets to be removed from the company balance sheet; improving key accounting ratios and potentially making additional lines of credit easier to secure. It’s important to note that organisations reporting under IFRS16 may face different reporting requirements around leases – click here to read our blog on IFRS16.
A decision as to whether this is one of the advantages or disadvantages of a sale and leaseback transaction for your organisation should be taken following professional accounting advice.
The switch to leasing can help make fleet budgeting much more straightforward, as all costs are incurred on the basis of fixed lease payments and have a known value without any hidden or unexpected charges.
Another of the advantages of sale of assets is that the seller will also remove an element of risk for the organisation. By selling your vehicles and transitioning to leases, you have effectively passed over the responsibility of vehicle disposal to the contract hire company. This means that they bear the risk of fluctuating residual values over the life of the vehicle.
Vehicle maintenance options
Contract hire contracts can usually include a fixed cost maintenance package, to iron out any peaks and troughs in maintenance expenditure. Alternatively, a pay-on-use maintenance programme can be provided, along with a host of other fleet management services such as accident management, short and medium-term vehicle hire, driver training and breakdown assistance.
Expertise and stress-free transition
An experienced leasing company brings with it vast expertise in the management of business fleets. With a sale and lease back agreement, you hand over the responsibility of the vehicles to your leasing company and they ensure that the fleet is efficiently managed and that your drivers are given the support required to work effectively.
With the support of the right fleet partner, there should be no interruption to your internal processes or the day-to-day work of your drivers. The transaction to move from owning the asset group to leasing the asset back should be seamless and any additional support given to your drivers, such as maintenance and training, should be clearly communicated by the provider.
Are there any disadvantages of sales and leaseback?
Excess mileage fees
When you purchase your own fleet vehicles, there is no limit to the mileage you travel. When you enter into a new leases you will need to estimate your annual mileage as accurately as possible. This will help you to avoid excess mileage fees at the end of your lease agreement. A good leasing company will work with you over the course of each vehicles’ contract period to monitor mileage and also, if required, amend the agreement mid-term to avoid this.
Under the terms and conditions of the vehicle asset lease agreement, you’ll find that the leasing company stipulates that vehicles should be returned at the end of the pre-agreed period in a suitable condition. This is usually referred to as ‘fair wear and tear’ in line with the age of the vehicle and the amount of mileage that it has covered.
If any of your vehicles are damaged beyond the agreed level of wear and tear, then you will incur charges. However, these additional payments can be avoided with the right fleet policy and clear communication to drivers in place. Obviously, the cost of this damage would also have been felt at the point of disposal even if the vehicles had remained in company ownership.
Sale and leaseback advantages and disadvantages at a glance
Advantages of sale and leaseback
Delivers a cash injection to the business enabling money to be put to use in core activities or fund expansion
Protection from the risk of fluctuating future residual values
Removal of heavily depreciating assets from the balance sheet
Improvement in key business ratios such as return on capital employed (ROCE) and gearing
Budgeting is simplified with fully inclusive monthly payments
Delivers cost, time and administrative savings
Instant access to maintenance savings delivered by the leasing provider
Detailed management reporting facilities from day one
Disadvantages of sale and leaseback
Need to provide an accurate estimate of annual mileage use to avoid additional fees
Fair wear and tear guidelines must be adhered to in order to escape repair charges at the end of the contract
Is this right for my business?
The minor disadvantages of mileage restrictions and vehicle damage charges do little to outweigh the cash flow, budgeting, risk and convenience advantages that use of this form of financing transaction can provide. Obviously, every organisation is unique and may have a specific set of requirements in considering the advantages and disadvantages; that makes seeking professional help about the implications of such an agreement essential.
If you’d like to read more about the advantages of vehicle leasing click here.
If you’d like to know more about vehicle financing options and leases available to your business, simply fill in the form below to contact the team of experts at Maxxia.