Obstacle Course

Last week I had dinner with Barney Thomson, an old friend. As the evening ended Barney asked me what I was driving. I told him it was the same thing I drove the last time we were together. Then Barney said, “Automobiles are a real problem at our place.”

“What do you mean?”I asked.

“We’ve always leased cars for our principals. When we started 20 years ago, the leases cost the company about $150 a month. Now some of our people want to lease cars that cost nearly $1,000.”

“That’s pretty hefty,” I said.

“Actually, it’s not that unusual for a mid-level luxury car. For example, a fairly senior guy at our place earning $150,000 wants a $60,000 car. It’ll be worth $37,000 in 36 months at the end of the lease. That’s depreciation of $23,000. The entire lease will cost about $33,000.”

“One solution,” I said, “is to offer an amount the company is willing to pick up. If your employee wants anything more, he can pay for it out of his own pocket.”

Barry nodded. “We began a policy like that about five years ago. We offered $400 a month. The employee had to make the down-payment himself if one was required. It worked out fine until the economic downturn hit. Then we had several employees depart, and we were stuck with expensive leases. The car companies won’t let you return their vehicles early for a reduced fee. They want the full 36 months’ worth of payments whether you can use the car or not. That experience made us recognize how risky our policy really was. Since we provide many of our people with cars, we have an enormous downside. Everybody leaves eventually, and no one plans it to be on the final day of his lease. Now we figure that, at one time or another, we’ll be hit with the last 18 months of a lease for virtually every employee we have. We think that could cost $9,000 a person.”

“That’s pretty scary,” I said. “We’ve never provided leased cars for our employees. Several years ago I was a member of a small group that invested in a manufacturing business. I found out that the other shareholders were all getting leased cars, so naturally I wanted one too. The car I chose was more expensive than the car I would have bought on my own. I did it just to stay even with the other guys. That meant the company was burdened with costs it didn’t need, and our profits suffered. So I developed the idea that leasing company cars wasn’t a great idea, and I’m generally opposed to it.”

“What do you recommend?” Barney asked.

“The best economic proposition is to pay your employees an appropriate taxable car allowance and let them deal with their own cars. If they leave, they take their leases or car loans with them.”

“But the tradition of providing cars goes back a long way at our place. It would be very difficult to get rid of it.”

“In that case you might consider buying the cars instead of leasing them. Today’s cars are relatively trouble free. You could expect to keep the kind of cars we’ve been discussing for six or seven years.”

“How would that help us?”

“With 36 month leases, your cars are an average of 18 months old. If you kept your cars for six years, they’d be an average of three years old. That means your investment would be less. If an employee leaves, you could offer to sell him the car or put it on the market. It’s easier to sell a car than a lease — and it’s easier for a departing employee to afford a three-year-old car than one in the middle of a 36-month lease. Brokers will sell cars for you, so you don’t have to make an investment of your own time. Or your company could lease your cars for three years and then buy them instead of walking away. That would mean you pay the retail mark-up just once in a six-year period, instead of twice. That alone could be a huge saving.”

“Not a bad idea, Hank, but we also lease because the liabilities don’t show up on the balance sheet. If we bought cars, we might have a problem with our bank covenants.”

“I have two suggestions there. First, you should make your bank aware of the economic benefits of going the new route. They may allow you to renegotiate the covenants. Second, if necessary, you could set up a leasing company that buys the cars and leases them to your operating company. You would have to disclose your transactions with a related company, but the accounting treatment wouldn’t change from your current position — and you would reap the benefits of ownership.”

Hank Bulmash is a principal in Bulmash Cullemore chartered accountants of Toronto.