by Frank Hogg and Steve Usselmann
January 2, 2010

The lesson learned through the peaks and valleys of business cycles is that strong cash flow can be the difference between success and failure for a construction company. During the leanest of times, poor cash flow can result in business failure more so than any other attribute of a business model. So in today's economy, it's more important than ever for contractors to closely monitor their operations and determine how they can improve their cash flow.

For many contractors a fleet of vehicles may represent one of their largest costs. Vehicles can require a considerable amount of funds upfront and demand a continuing amount of time and resources to manage. Controlling the costs of owning and running a commercial fleet should be a focus for construction owners. The starting point for controlling fleet costs is analyzing the different alternatives for acquiring vehicles.

This definitely is true for Western Construction Group, which has thirty-nine offices coast-to-coast. Based in St. Louis, MO, Western Construction takes advantage of Enterprise's buying power to obtain vehicles with the right options at the best possible prices and terms, as well as manage licensing, registration and disposal.

Western Construction, specializing in restoration and preservation, has established a separate line of credit for fleet management, instead of tapping its working capital or lines of credit to fund its fleet, which is a rapidly depreciating asset. This frees up cash that Western can use to invest in personnel or equipment to help increase revenues. In addition, Western relies on their fleet manager to set proper residual values to help avoid losses at the end of the lease. 

Mike Harmon, chief financial officer for Western, understands that the consequences of not keeping vehicles properly registered can be significant, from paying extra charges because of penalties to reducing drivers' productivity if their vehicle is stopped for not being properly registered.

"Instead of having a fleet manager in all thirty-nine offices, [our fleet management company] manages all the various requirements and terminology regarding emissions, license plates and taxes, which can vary state by state and county by county," said Harmon. "It creates a seamless, standardized process, so our people have more time to service customers instead of spending their time on local motor vehicle issues."

Because every contractor brings its own unique circumstances to the lease/buy decision, it is highly recommended that construction companies consult with their professional advisors in making these decisions. An option to consider is funding vehicles through a professional fleet management company. Construction owners, who decide that leasing makes economic sense in comparison to an outright purchase, should also consider the different types of leases.

There are two primary types of leases: open-end leases and closed-end leases.

  • Open-End Lease - With an open-end lease, the contractor has a vested interest in the leased vehicle at the end of the term. When this type of lease is established on a vehicle, the vehicle is usually purchased for a specific customer and customized for the business's needs, and both the contractor and lessor have a mutual interest in the vehicle at the end of the lease term. If the vehicle sells for more than the reduced book value (RBV), the profit goes to the contractor. If the vehicle does not sell for an amount equal to the RBV, the contractor must pay the difference between the sale price and the residual. Thus, with an open-end lease, contractors share in the benefit of the value of the vehicle at the end of the lease-or in the risk. The use of a professional fleet management provider can allow for the vehicle to be sold at an amount that is higher than the vehicle's actual worth, and the profit from that sale would go back to the contractor.

 

  • Closed-End Lease - In a closed-end lease, the contractor is not held responsible at the end of the lease for the difference between the vehicle's residual value and sale price. The contractor is only responsible for mileage over the contracted amount and any abnormal wear and tear. It is important to note however, that although the contractor has the ability to work with the lessor to set the specific mileage for the lease, once the mileage is chosen it becomes part of the contractual agreement. Because of the lack of residual responsibility by the contractor, this lease type is also known as a "walk-away" lease.
    One of the main factors a construction owner should consider when deciding which kind of lease to select is how the contractor's vehicles will be used. An open-end lease allows contractors flexibility in determining depreciation rates, matching the vehicle's use with its wear and tear, mileage and useful life. Accurately considering these factors should ensure that the contractor will not owe money at the end of the lease. Since an open-end lease agreement will not incur any over mileage charges, construction companies with employees who do a lot of driving will probably get more benefit from this type of lease, particularly if vehicles are well maintained by employees.

In using leasing as an additional source of capital, a separate line of credit is established with the fleet management company to acquire vehicles. As a result, contractors can avoid incurring additional debt to fund large capital expenditures such as fleet acquisitions. By requiring a smaller capital expenditure upfront, leasing can allow contractors more funds to invest in their day to day operations, which is very important given the current economic environment.

In addition to initial cash flow savings, the outsourcing of fleet management activities to professional fleet managers can provide contractors with improved cash flow over the life of the vehicle. The key to attaining this improved cash flow is the achievement of certain operational efficiencies resulting from the outsourcing of fleet management. These operational efficiencies can include:

  • Saving both the hard and soft costs associated with the administration of fleet purchases - For example: the amount of time the construction company owners or employees must spend on issues related to acquiring and disposing of vehicles, as well as managing maintenance appointments and invoices, insurance and vehicle registration and reporting.
  • Saving on opportunity costs - Holding on to high-mileage vehicles can reduce productivity and result in higher maintenance and fuel costs, frequent breakdowns and expired warranties.
  • Providing a replacement strategy that will ensure vehicles are replaced at regular intervals to increase the efficiency of the fleet for optimal performance and resale value - By monitoring factors, such as the time of year, mileage, vehicle type, age and maintenance history, the guesswork is eliminated. A cycling program looks at things like future trends, the current used vehicle market, warranties, mileage and the potential wear and tear a contractor will inflict on each vehicle.
  • Monitoring and ensuring regular service checks, scrutinizing invoices and using its experience and expertise to guarantee the most economical, timely and high-quality repairs for fleet vehicles - This includes arranging maximum warranty benefits, rebates, price breaks and other opportunities to minimize expenses.
    In addition to these potential cash flow savings, the outsourcing of these fleet management functions allows construction owners and their employees to focus on their core, day to day operations, which is critical given today's challenging economic environment.

Construction Business Owner, January 2010