With wild swings in financial markets, the political landscape changing worldwide, oil production through the roof and the U.S. Federal Reserve increasing interest rates, how should a company adjust its asset financing structures to contend with the uncertainty? Corcentric’s Pat Gaskins suggests using a dynamic financing model that can account for unexpected change over the asset life cycle.
In a rapidly changing market where we see wild swings in financial markets, the political landscape changing worldwide, oil production through the roof and the U.S. Federal Reserve increasing interest rates, how should we adjust our asset financing structures to contend with the uncertainty?
The answer is to look at a dynamic financing model that gives you the ability to adjust asset life cycles based upon outside influences and changes in your business.
When talking about a dynamic financing model, we are trying to achieve the lowest overall cost of financing with the highest level of flexibility.
A high degree of flexibility comes at a cost. Short-term agreements are the most expensive way to finance an asset, but rental or use-based agreements give businesses the highest degree of flexibility. They can move in-and-out of assets on a daily basis. A short-term lease will give a high level of flexibility and is less expensive than rental but can still be too costly. The question is how to determine the proper level of flexibility for the appropriate cost.
This is where big data becomes your friend. The more informed you are of historical trends and future projections the better you can ultimately develop predictive asset lifecycles and the most effective financing programs.
For the transportation industry, fuel and asset costs are big drivers of overall cost. So how do we get our arms around predicting the future of these two expense items? When we look at the history of fuel prices over the past 25 years, we can see that diesel fuel maintained a pretty steady cost base from 1994 to 2004. However, we have seen $4.75 per gallon and $1.98 per gallon since then. How do we predict those types of swings? We can’t, so we need to have the appropriate level of flexibility in our asset financing program to adjust to the swings. Thankfully, these peaks and valleys have lasted, at the longest, for a period of three years, but more often, for one year.
Let’s look at fuel prices. When fuel prices are as low as $1.98, per gallon there is not a lot of economic benefit associated with an increase in fuel economy on new equipment from those low fuel costs.
As an example, if a current asset is getting 7 MPG and the new assets are getting 7.2 MPG, that two-tenths of a mile increase in fuel economy does not translate into a significant enough reduction in fuel costs (approximately $65 per month based on 100,000 mile per year utilization) to outweigh the increased cost of the new asset — the fixed financing costs.
However, when fuel is $4.75 a gallon, then that two-tenths of a mile per gallon increase in fuel economy is a phenomenal savings (approximately $157 per month based on 100,000 mile per year utilization). Increased fuel costs really have a huge impact so the increase in fixed financing costs on the new asset is far outweighed by that slight increase in fuel economy because fuel is so expensive.
Now that same argument can be used with residual values, upfront cost of equipment, and interest rates. With exceptionally low interest rates, going from a current asset to a new asset is not as painful as it would be when interest rates are exceptionally high.
When it comes to determining asset life cycles and proper asset financing, business owners should picture themselves standing in front of a long line of levers where every time one is pushed another one comes back towards them. Determining proper asset life cycle is about figuring out what is the right sequence of pushes and pulls. This is followed by doing all the analysis and math to determine what degree of flexibility is needed to finance assets while maintaining the lowest possible cost. By partnering with an asset and finance expert, the business owner can run all of the “what if” scenarios and determine the proper balance.
The biggest challenge is determining, based on historical trends, what needs to be done going forward. Once you understand that part of it, you need to figure out how to protect your business against adverse market conditions. And you want to do both of these things while having the ability to take advantage of beneficial market conditions.
If market conditions dictate a lifecycle extension, there are questions you need to ask yourself: “Am I properly staffed? Because if I hang on to my current assets longer I will need enough technicians in the shop to maintain the older assets. Alternately, if a shorter lifecycle is needed, will I have too many technicians?”
When it comes to asset life cycles and financing, there needs to be a proper mix from a flexibility standpoint. Should there be some short-term rental for peak season usage? Sure. Should there be some long-term assets that cost a lot less than that rental? Yes, absolutely. The dynamic financing model is really a mix of different financing programs and terms.
A balanced mix of financing options will give a business the highest degree of flexibility. The right combination is a mix of peak season flex fleet rentals and long-term equipment financing utilizing a flexible leasing structure.
For more information Corcentric’s work in helping to manage asset lifecyles, please visit the website.
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