Hire Purchase Misconceptions
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NOW that there is a renewed threat of rate cutting, partly as the result of nationalization and its cramp
. ing effect on. traffic, the problem of hire-purchase is again•looming large in the minds of those concerned with the maintenance of stabilized rates. Lack of new vehicles is, to a certain extent, preventing operators from engaging in such transactions. This limitation, however, is not so powerful as might be thought for the reason that the market in used vehicles is correspondingly active and many are being bought on the instalment plan.
My postbag tells me that interest in the subject is growing and that some old misconceptions are still rife, It
may be helpful, therefore, if I make some attempt to clear these up.
First, let us deal with the widely held belief that hire-purchase leads to rate cutting. . Many people think that small operators begin to cut rates as a result
of the following procedure: Probably quite soon after the commencement of a transaction of this sort, the haulier has to meet a hire-purchase instalment, but, not having enough money in the bank to do so, he accepts any job which offers, even though the rate may not be an economic one, in order to obtain the necessary funds. This is the first step along the downward path towards chronic rate cutting, and as the interval between one hire-purchase instalment and the next is brief, the second, and third and subsequent steps along the path become inevitable.
Whilst I am well aware that this used to happen in the old days and am willing to believe that it occurred too frequently for the good of those who followed this course, I doubt whether it be so important a factor in rate cutting as is often thought. Time has shown that quite a number of big haulage businesses have been built up on hirepurchase. Indeed, many big free-enterprise businesses to-day still acquire their vehicles by that method. It is held by some to be inimical to the best characteristics of the industry. Can it be that many of these big businesses have been built on rate cutting?
. Instalments out of Net Profits
I believe, myself, that because he has certain substantial monthly payments to make, the haulier is saved from falling into the error of imagining that everything he receives after paying for petrol, oil and wages is net profit. In other words, his hire-purchase payments, for the period of the contract, take the place of contributions which he should make to a sinking fund to cover depreciation, maintenance, tyres and other items of operating costs which are so often forgotten and overlooked.
B42 In theory, even this attitude is wrong. To achieve absolute financial stability, the haulier should pay his hire-purchase instalments out of net profits after making provision for incidental costs, current and future. But even if this is impossible he is at least on the right path if he manages to make those payments, keep his vehicle in reasonable condition, provide for all the current outgoings and still be able to show a moderate profit.
As .a matter of fact, it is almost impossible to make full and adequate provision for all the budgeted operating costs, pay large hire-purchase instalments and make a profit. To put it another way, it is practically impossible for an operator to make profits so great as to allow him to pay the hire-purchase instalments out of those profits and still carry on in the proper way with his provision for operating costs.
In passing, and to show how complicated are the ideas which prevail on this matter, I will refer to a question which has come to me recently from an operator. Referring to "The Commercial Motor" Tables of Operating Costs, and in particular to the item of interest, he pointed out that, in the case of an operator who acquires his vehicles by hire-purchase, interest would be a much larger item. He suggested that in stabilizing rates, the higher rate of interest, namely, that which is to be paid on a hire-purchase transaction, should be taken as a basis for computing cost of operation. This suggestion is in startling contrast to the view still wrongly held by some operators that there is no justification in calculating rates, for interest to be allowed as an operating cost at all.
Support for the Customer Certainly, I do not agree that the much greater figure for interest involved in hire-purchase should be debited against operating costs when calculating fair and proper rates. For once I am taking up cudgels for the customer. I told the inquirer that it was unfair to expect a man to pay more for his transport because some haulage contractors are short of capital and have to borrow it at high rates of interest in order to carry on their businesses.
Haulage rates should be stabilized at a fair and remunerative level and on a reasonably economic basis. To try to establish them on artificially computed costs inflated to take into consideration such matters as this, will have the effect only of diverting traffic from the haulier and, possibly, making the customer consider the possibility of acquiring his own vehicles and operating under C licences.
In any event, this suggested modification of the item of interest in order to provide for the extra expenditure involved• in a hire-purchase transaction. violates one of " The Commercial Motor's first principles of accountancy, which is that the figures relating to the cost of operation must be self-contained and entirely free from extraneous item; of cost.
When a man enters into a hire-purchase agreement he is, in fact; acquiring a loan to enable him to run his business. The interest on that loan, euphemistically referred to by the companies concerned as the finance company's charges, is an establishment cost and has nothing to do with the cost of operating the vehicle. If operators were to examine, whenever the opportunity arose, balance sheets of haulage companies, etc., they would frequently find the item—interest on loans. That is justifiable in a statement such as a balance sheet: it has nothing to do with the operating costs of a vehicle, and so far as we are concerned must come under the heading of establishment costs. To include that exceptional amount of interest in the vehicle operating costs would be to exaggerate those expenses and to bring about a false idea of the total cost involved in running a vehicle.
Need to Revise Operating Costs
There are two important disadvantages which would accrue from the course which was suggested. First that an unnecessary fluctuation would have to be taken into con sideration when hire-purchase agreements were completed. Suppose an operator had a vehicle under an agreement which terminated in 18 months, and during that time he debited the hire-purchase interest against the operating costs of his vehicle, using the total arrived at, as a basis for his charges. At the end of 18 months, when the necessity to pay the extra interest has disappeared it would be advisable for him.
3 f he is to know hOw he stands as regards possible profit
from any job of haulige, to revise his operating costs, diminishing them by the amount of interest, a process which in volves complications which are better avoided. Secondly, direct comparison between the operating costs of one vehicle and another, so essential for efficiency of operation, would he made difficult, because of the effect of the varying amounts debited against interest on first cost.
Another suggestion which follows on these lines to a certain extent, is raised in a letter from another friend of mine. In his experience, he says. there were many hauliers, most of them owner-drivers, who, having acquired a vehicle on hire-purchase terms, regard the instalments as correspond ing with the, amounts that they would normally have to spend on maintenance, depreciation and tyres, making no separate provision for any of these items.
Moreover, at the expiry of the hire-purchase agreement, these operators sell their vehicles and enter into new agree ments of the same type. In his opinion, this would lead to disaster in the end and he has asked me to deal with this particular aspect of the hire-purchase problem.
Let us take a straightforward example and compare it with a similar case in which the vehicle is purchased outright, to clarify the point. I shall assume that we are concerned with a 5-ton vehicle the first cost of which is £1,000 in cash (I am taking a round figure to make subsequent calculation easier to follow).
Monthly Instalments of £35
If it be purchased through a finance company and paid for over two years, the initial deposit will be about £280 and the company's charges will total £120, so there will be a balance of £840 to be made after the initial payment. That means that the monthly instalments will be £35, After two years, the operator, according to the procedure envisaged by my inquirer, sells the vehicle or disposes of it in part exchange for another, presumably of about the same type and the same price, and gets £400 for his old one.
A good deal of the strength of the argument concerning this method of carrying on a haulage business turns upon the mileage covered during the period of ownership. That factor may turn the scale one way or another. Assuming the average mileage to he approximately 24,000 miles per annum, the vehicle will have run 48.000 miles by the time the hire-purchase agreement is concluded. Now I want some figures for cost of operation. It is not quite fair at this juncture to take those which appear in the :urrent edition of "The Commercial Motor" Tables of Operating Costs, because there have been some fairly considerable increases recently. I will therefore approximate.
Let us take a fieure For the total to be debited for maintenance, depreciation and tyres during the period in question. For tyres Tam going to take 0.80d. per mile, for maintenance 1.48d., and for depreciation 1.80d. The total is 4.08d. per mile. In the course of 48,000 miles the total provision for those three items should therefore be £816.
Running Costs and. Maintenance Now to turn to the expenditure which is likely to have occurred, and which would be unavoidable. It is extremely unlikely that the vehicle owner will be able to pass through the period in question without having to fit at least one new set of tyres, costing £100. In addition, of course, he will have to Spend something on maintenance even for •a vehicle which is not yet two years old. Again I must make an estimate, and I shall take the same amount as 1 have for tyres, namely, £100.
Not less than 10s. per week will have to be spent, on washing and polishing and similar operations, which in two years will total approximately another £50. Out of the £816 which has been presumed to be saved as the result of this method, £250 has been disbursed as outlined, reducing the net saving to £566. The expenditure on petrol and oil in covering 48,000 miles will approximate to £450, and the normal standing charges during that period will total £750.
The aggregate outlay in connection with the vehicle, ' therefore, will be first. £450 for petrol and oil, and 1750 for standing charges plus £250 actual expenditure in respect of maintenance and new tyres and £1,120, which is the total amount paid for the vehicle, including the "down payment and the subsequent instalments. ' The grand total is £2,570.
Now consider the case of the operator who buys the vehicle outright and proceeds along, what I suggest, should be regarded as the orthodox lines, that is, making adequate provision for the various items of operating costs as has been described. His initial outlay will be £1,000. It is fair to assume that, during two years, he will spend the same amount (£250) as his contemporary, on maintenance and Lyres. He will have been putting by on account of tyres, maintenance and depreciation, 4.08d. per mile, totalling £816 for 48,000 miles. Out of that fund, however, he has actually spent £250 on maintenance and tyres, leaving him with £566 in cash against the time when further expenditure is needed.
Used-vehicle Values
He still has, as an asset, a vehicle which, according to the same reckoning, is worth the difference between £900 (the initial cost less the £100 which is taken as the value of a complete set of tyres) and the amount dissipated in depreciation, namely, 48,000 miles at 1.80d. per mile, which is £360, leaving £540. He has, therefore, as assets, £566 cash and a vehicle worth £540, making a total of £1,106.
He has actually spent £1,000 on the vehicle, £450 for petrol and oil and £750 on standing charges, total £2,200. (The £250 on maintenance and tyres is already accounted for and does not come into this calculation). His expenditure, therefore, is £370 less than that of the other man, and moreover he has in addition a vehicle and £566 in the bank.
There is also another point. If he wishes to commence the third year of his operations on level terms with his hirepurchasing contemporary, he is just as able to obtain £400 on disposal of his machine, that is, he loses £140 of his assets (the £540 machine less the £400 obtained for it) and his two years of operation have cost him £2,340 against £2,570 spent by the man who buys his vehicle under hire purchase. The hire purchaser has nothing in the bank. The man who has made proper provision for the three essentials of expenditure on maintenance, tyres and depreciation has £566 in the bank.
Actually, this financial situation, together with a vehicle which has only covered 48,000 miles, would encourage the operator to keep the vehicle for another year at least, but that does not affect our present argument which is to compare the one operator with the other on equal terms. This is a difficult period in which to deal with a matter of this sort because, as I have pointed out, new vehicles are not easy to get. In two years from now, however, it is anticipated that the situation will be different, and the figures I have given will apply.