Problems of the
Page 77
Page 78
If you've noticed an error in this article please click here to report it so we can fix it.
HAULIER and CARRIER
Explaining a Much-discussed Item of Standing Charges, Namely, the Interest on Capital Outlay as Applied to Vehicles Acquired on the Hire-purchase System
T AM always willing and 1. anxious to learn, so that, as a general rule, if I receive a letter 'from a haulier and I note that, according to my views, he is negligent of some important matter in connection with his business: I do not immediately write to tell him that he is wrong. I take, instead, the line of suggesting to him that there may be something not quite as it should be in his attitude, towards that particular matter and my method generally takes the form of a question.
In that way I find that not only do I help a good many readers, sometimes without their even knowing or realizing that they have been helped—but that in several cases I am helped myself by being given new lines of thought and new suggestions whereby I can help a number of other hauliers.
Just such an occasion as this arose a short time ago when I was in the middle of a series of letters to a north-country haulier, a man who, as I had already gathered, knew enoughof his business to be able to make a living at it. That he can make a success of his business, even to the limited extent which is indicated by that bare assertion, is quite enough in these days to make me respect his opinions and be quite ready to read with care anything that he might have to say on any point.
Consequently, when he wrote to me, giving me some details of his costs of operation, and when I noted that nowhere in those costs was there any provision for the item of interest on capital outlay on his vehicles, I did not immediately write to him and say: "Your statement of cost is incomplete, for it lacks any
reference to the item interest." I wrote, instead : "There is no provision for the item interest in your statement of costs. What is your practice in regard to this matter?"
His reply was such as to repay me many times over for being so restrained in ray attitude, for it raised two points sufficiently important to warrant their careful consideration.
First of all, he advised me that it was his custom to keep his vehicles for five years and depreciate them evenly over that period, so that at the end of the fifth year they stood, in his books, at nil. He then sold them and set off the sum accruing from the sale against whatever he might have lost by not keeping an account of the interest on the initial outlay. He H was
the more justified in taking this attitude, he wrote, because he usually acquired his vehicles by hire-purchase. That meant that the initial outlay was comparatively small. He quoted an example of a vehicle costing, all told, £400. The initial outlay would be £100 and at the end of five years his experience was that he could usually obtain about £40 for the machine, and he thought that £40 was a reasonable sum to offset against the interest on £100 for five years. That, the second point, reminded me that I had never seriously considered what effect a hirepurchase deal might have on this item of interest on first cost. It was clear, at any rate, that if, for the moment, I disregarded the question of hire-purchase and considered only the value of the vehicle when new, and the sum obtained c30
for it at the end of five years, that sum does not adequately compensate for interest, because the interest on £400 amounts to considerably more than £40, 'even if it be calculated upon the most favourable basis—favourable, that is, in the sense of reducing to a minimum the amount due under that item.
Before I can properly discuss these points, I must first of all establish once more that which is meant by interest on first cost and how, according to circumstances,-it should be calculated. The interest on first cost is the annual amount that would be earned by the money spent upon the vehicle, had it been invested in some safe, interest-bearing stock. It is customary to reckon that money so invested would bring in, at a reasonable estimate, interest at a rate of 1 per cent. more than the current bank rate. To-day, therefore, the figure for interest on first cost is 71 per cent.
Actually, nowever, the calculation is not so simple as that, but is dependent upon the provision made for depreciation. If the owner of the vehicle establishes wkat is called a sinking fund and puts away at regular intervals an amount equal to the depreciation which his vehicle is presumed to have suffered, the sum thus set aside may itself be earning interest at the said percentage of one more than bank rate. If that be done, it is taken that the loss arising on account of the interest on first cost is diminished accordingly.
The Calculation of Interest.
I dealt at length with this matter in an article on page 503 of the issue of The Commercial Motor, dated May 21st, 1929. I then showed that, for the exact calculation of the interest, in those circumstances, the
L + 1 P x 0 • formula — x should be used.
(L is the assumed life of the vehicle in years, P is the capital sum invested, C is the rate of interest. The solution Of the formula is the average amount—not rate—of the interest on first cost, calculated according to the plan.)
If, however, no provision be made for a sinking fund, the full amount of interest on first cost is presumed to be spent and must be set accordingly against the operating cost of the vehicle.
In the case of the 1400 vehicle which we are considering-, 71 per cent, would be £30 per annum and that, in five years, calculated only as simple interest, would amount to 1150. Even if the particular owner I have in mind were to make provision for a sinking fund—and he did not—the amount would still be £90, in accordance with the formula, so that in neither case would £40 be adequate compensation.
It is obvious that the matter is complicated enough without being made more so by introducing the prebletns involved in a hire-purchase transaction, but I think that I can, perhaps, simplify matters if I demonstrate merely that the conditions instead of being improved by buying a vehicle in that way are made just a little worse. That is not to be interpreted as an argument against the purchase by instalments of a heavy
The Case of the £400 Vehicle.
Take the case of this 1400 vehicle. For the sake of simplicity I will consider that no provision is made for sinking fund and that the interest on first cost is, therefore, 10 be reckoned in full.
There is first of all the capital outlay of £100. On that sum the interest amounts to £7 10s. per annum— £37 10s. for the whole period of five years, The £300 which is temporarily supplied by the finance company in respect of the hire-purchase agreement will be subject, on its account, to what is called an accommodation charge, which is usually in excess of the basic interest rate of one above the bank rate. For the sake of argument we may take it that it is the same, namely, 71 per cent, per annum, and that will have to be paid, no matter what may be the period over which the instalments are spread.
When the payment of instalments is complete, the total amount, principal and Interest, is the same as though the vehicle had been bought for cash. That is the most favourable condition. Generally, the finance company's charge is greater than that which would be involved by reckoning 1 per cent, above bank rate and the purchaser's commitment is, therefore, greater in hire-purchase transactions than it would otherwise be.
I think that I have now made clear the two points which were raised in the correspondence with this reader and have established the fact that the revenue from the sale of second-hand vehicles is not sufficient to justify the owner in ignoring the item interest on first cost and that the purchase of a vehicle by instalments does not improve hat actually aggravates matters in that particular respect. S.T.R.