Ways to Reduce Lease Spending

Transcription

1 Ways to Reduce Lease Spending Mary A. Redmond, President Independent Lease Review 209 W. Front Street Bonner Springs, Kansas ; 94th Annual International Supply Management Conference, May 2009 Abstract: Difficult economic times present challenges for Supply Chain Managers. Our report provides an industry overview from an equipment finance perspective. In addition, there are five areas upon which to focus review activities that will yield cost savings. In our report, procurement professionals will find new tools and guides to assist them in increasing their department s contributions to the company s bottom line. Comparisons to the Great Depression cannot be ignored as we look forward into 2009 and beyond. Business owners, managers and corporate officers face decisions that just 3 years ago would have been impossible to forecast. News headlines scream the doom and gloom with words and phrases such as layoff, downsizing, restructure, unemployment on the rise, budget cuts, spending caps, foreclosures up, bank workouts increase and credit limits introduced. In the their report titled Collateral Damage,* The Boston Consulting Group compares the decline in the S&P 500 fall of 41% by December 4, 2008 to the previous worst decline in the stock market of 47% in The United States economic crisis impacts the global economy. The Organisation of Economic Co-operation & Development (OECD), an international organization of thirty countries that have a democratic form of government and who are all strong players in the free market economy report that all leading indicators for every member country show a strong slowdown. We are all in this together. The United States consumer previously could be counted upon to bail out the economy with increased demand for goods and services. Not this time. Consumer debt is at an alltime high. The American Bankruptcy Institute (ABI) reported that personal bankruptcy filings were up 35% through September, 2008 compared to the same period for The same organization reported business bankruptcies for three quarters of 2008 exceeded the total filings for all of 2007, a 61% increase over 2007 filings. Financing alternatives and the costs associated with financing are tightening. The Boston Group report that the October 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices showed that 80% of domestic respondents tightened their standards for commercial and industrial loans. Not all companies will be able to renegotiate their financing deals.

2 Equipment leasing and financing is a $650 billion dollar industry. What is the health of the leasing companies who finance the equipment needed to rebuild our economy? The leasing industry primary research foundation surveys key indicators each month. The Equipment Leasing and Finance Association (ELFA) reports the key economic activity factors in their Monthly Leasing and Finance Index (MLFI-25). This report surveys twentyfive of the leading leasing and finance companies in the United States. The organization measures monthly commercial new equipment lease activity, receivables aging, chargeoffs, credit approvals and employee headcount. The December 2008 report showed annual equipment lease and finance volume off by 13.6%, a $1.36 billion dollar drop. December is traditionally the largest volume month in the entire equipment financing year. This is due to end of year equipment discounts that drive purchasing as well as tax benefits for the leasing company. We come to the question of what steps can a procurement professional take to positively impact their employer s bottom line? I want to provide those supply chain managers a few tips to guide them in the serious work in hopes that a few of my tips will reduce corporate spending without layoffs and terminations. We suggest that managers focus on the following areas in order to reduce spending in their organizations. 1. Fit or No Fit? Deal or no Deal? Five leases and their end options. 2. Notification Requirements Add Costs if You Miss Them 3. Audit Invoices for Bottom Line Impact 4. Documentation, Communication and Tracking 5. Missing Documents Will Kill Your Budget Fit or No Fit. Five End of Lease Options: Examine and Negotiate 1. Perpetual or Evergreen Lease: These two titles are for leases that contain some unusual language that can lead to increased and unnecessary spending. To determine if you are presented with either of these types of leases, look for the following: a. Customer may purchase the equipment for the in-place and in-use fair market value, which the customer finds is neither fair nor representative of the current used equipment market value. b. If the equipment is not purchased under the terms of a above, the lease renews for 12 additional months at the same original monthly payment. At the end of the renewal period, the Fair Market Value option is again offered.

3 c. If a or B are not selected, the company may enter into a new lease with the leasing company on new equipment for the same dollar amount or more than was financed in the original lease. The lease pricing on the new deal is not subject to negotiation and is almost always higher than on the first lease. d. A final option may be offered to return all and not less than all of the equipment from the original lease to the leasing company. This option is seldom offered without some penalty such as a restocking or return fee. And in addition, option c must be consummated. 2. In-Place In-Use Fair Market Value: Depending on the end of lease purchase option language, the calculation of the purchase price can be quite confusing. Costs may be added to the fair market in-use purchase price even though these costs were not financed in the original lease. The in-place value might include some of the following: a. The price to install replacement equipment. b. The de-installation costs for the original equipment. c. The costs to upgrade software to current standards even if the customer did not need the upgraded features. d. The cost of training employees to use the equipment. e. The electrical connection charges and site preparation costs. 3. Mutually Agreed to Fair Market Value: Usually this end of lease term means the leasing company dictates the fair price. If the customer does not agree to purchase the equipment for that price, the lease automatically renews. Usually the return option is no longer applicable because the customer did not provide the leasing company with the proper written end of lease notification. Thus, the customer lost the penalty-free equipment return option. 4. Fair Market Value Cap: This option means the maximum purchase price is set in the lease documents and will not change. This is a good option from a total customer cost control and cash flow standpoint. Your accountant needs to review this option if they have directed you to find an operating lease for tax or accounting treatment. This option probably will not qualify or comply with the Federal Accounting Standards Board No.13 guideline (FASB-13). 5. Fair Market Value with Appraisals: This is a good option for achieving a win-win purchase price. Two appraisers are selected, one by the customer and one by the leasing company. The purchase price is determined as a result of input from both appraisers that follow the definition of Fair Market Value contained in the lease. The purchase price is usually the average of the two appraisals. Sharing the appraisal cost is better for both the customer and the leasing company if each pays for their own appraisal.

4 Most lease documents state the customer pays for both appraisers. Customers should negotiate the Fair Market Value, the terms related to the appraisal process and the financial responsibility for the appraiser s services and fees. Notification Requirements Add Costs if You Miss Them Leases are packed with notification requirements. Miss one notice and the fees add to the cost of the lease very quickly. The following are just a few of the notification requirements. 1. Notification End of Lease: Every lease contains requirements for when end of lease notices are due. Failure to respond as required will result in automatic lease extensions and possible loss of equipment return or purchase options. a. The end of lease notification requirement means the lease will automatically renew if the customer does not provide the leasing company with proper written notice. Most leasing companies want an end of lease notice 60 days before the end of the lease original term. Sometimes notice must be given as early as nine months before the end of the lease. Miss the notice and the lease term is renewed for periods as short as one month and as long as the original lease term. b. Some of the trickiest notification language is when the lease states that notice must be given no less than 120 days before the end of the lease and no more than 150 days before the end of the lease. Negotiate this language to allow more time in which to give notice. c. We recommend that notice be allowed anytime after the first day of the lease and no less than 60 days before the end of the lease. 2. Corporate Name Change Notification: Leases require written 30-day notice if there is a change in the customer s ownership, name, headquarters or equipment location or corporate structure such as a change from a partnership to a corporation. If notice is not provided as required, the customer is in a technical default of the lease. Leasing companies do not like a default and customers usually have 20 days to correct the default condition. 3. Usage Reporting-Copier Lease Notices: Copier lease notification refers to the usage reports that are provided to the leasing company or a copier service organization in a timely manner. Failure to do so results in estimated billings that may exceed actual usage charges. One common copier usage plan involves a cumulative usage method of accounting over a usage period of a year or more. 4. Tax Notification: Tax notification requirements cover types such as sales, use, property, excise and stamp taxes. The biggest problems arise over who is going to report and pay the taxes initially. The customer is always responsible in the end for tax payment. Avoid double tax filing and reporting by early discussions with the leasing company. Also be aware that some leasing companies charge excessive service fees for reporting and filing with the proper taxing authority. We recommend periodic audits of lease invoices to be sure that tax proper rates are applied. Companies report to us that they most often find errors in the leasing company taxes due to

5 incorrect equipment locations and unusually high assumed equipment values that are reported. Audit Invoices for Bottom Line Impact We advise our workshop participants and clients to monitor and audit the first three months of lease invoices. What are the biggest problems to watch for? 1. Documentation Fees: Is the documentation fee per lease schedule or for the entire lease deal? If the documentation fee is assessed as one document fee for each lease schedule and the customer thought it was a one-time fee billed on only the first schedule, contact the leasing company and attempt to renegotiate the documentation fees. 2. Insurance Billing: Proof of insurance coverage is required for all leased equipment. It is the responsibility of the customer to insure the equipment against loss and damage. The customer must provide the leasing company with this proof, usually before the lease commences. If an insurance premium is billed on the first lease invoice, protest immediately. Send insurance proof to the leasing company in the form of an insurance binder provided by your insurance agent. Stay on top of this and audit all invoices until insurance charges are removed and proper credits are issued. 3. Interim Rent: All leases define interim rent as the daily rental rate charged for the period of time falling between the equipment acceptance date and lease commencement. Interim rent is billed on the first or second invoice unless the interim period stretches for months. Standard lease language provides for interim rent. We recommend that companies use an interest only calculation method for financing the period between equipment delivery and acceptance and lease commencement. 4. Interest Only: If the interim period is billed as interest only, audit the invoice for this billing method. Lease company contract departments manually prepare interim interest rent on a customized invoice. Interest only errors are common. This example shows the difference between interim rent and interest only rent for 30 days on $1,000,000. Using the interest only method, and this customer reduced the cost of interim financing by $22,100 (2% of the total financed).

6 Term: Interim Rent vs. Interest Only Rent 36 months Total financed: $1,000, Lease factor: payment in advance: $28, Daily rental rate: 30 days interim rent $28, $966/day, $28,670/30days Daily interest rate: $219/day if interest is at 8% 365 days 30 days interest only $6, Savings with interest only $22, Documentation, Communication and Tracking A successful lease relationship is built upon great documentation. The following is a list of tips to follow for contract reviews and leasing company relationships. Document all conversations no matter how insignificant they seem to be. Send confirming notes to the leasing company via . Retain a copy for your files regarding the nature of the discussion, assignments or commitments made by either the leasing company or the customer. Use certified mail with return receipt required for every piece of correspondence of serious nature pertaining to the lease. Never depend solely on faxes or . Timely retrieval of essential documents may be necessary to support your case. Do not depend upon the leasing company for document retention. It is the customer s final responsibility. Retain all receipts until the end of the lease, the equipment is returned or purchased, and all property taxes are paid. Ask your accountant for guidance in the proper length of time to retain lease documents. Be aware that leasing company equipment inspection expenses and penalties may straggle in. Receipts will be helpful in reconstructing original equipment selling price, replacement costs and equipment serial numbers. At lease termination, verify that the leasing company processes all UCC lien filings releases. This is an area some leasing companies do not manage well. When leasing companies do not process the lien releases, surprises await for customers. The surprises can come when customers want to sell the equipment, borrow money for a new piece of equipment, refinance the leased assets or even sell real estate in which the equipment had been located.

7 Missing Documents Will Kill Your Budget A complete contract review is standard for most procurement professionals. The trouble comes when the RFP does not require that the leasing company send every document necessary for the financing transaction. We find that many leasing companies standard practice is to send their customers the Master Lease Agreement and few if any of the support documents. These support documents must be reviewed and negotiated prior to lease commencement. Many support documents change the terms in the Master Lease and these documents usually contain a sentence like the following: the following special terms shall apply notwithstanding anything to the contrary contained in the Master Lease Agreement between the Customer and ABC Leasing Company. If all documents are not read in context and comparison to the terms in the Master Lease, customer cost increases are almost a given. We recommend that all companies make a checklist of the possible documents for every transaction. If you do not find them in the leasing company package, require they be sent and reviewed before any determinations are made as to the competitive nature of the leasing companies may be made. The following is a short list of a few of the most often missing documents: Equipment Schedule Stipulated Loss Value Table Exhibit A, which may be the equipment list including the equipment purchase price; eventually it will contain equipment serial numbers Return Provisions Delivery and Acceptance Certificate We believe that the tips we provided will assist supply chain professionals in improved document review and in their tracking processes. During the next two years, everyone will be asked to sharpen technical skills, learn and implement costs savings measures and be proactive in their contract management processes. If this is accomplished we will see a return to a stronger economy and forecasts will again be optimistic. The doom and gloom will not last forever. This too shall pass. Bibliography A portion of this paper was excerpted from: Redmond, Mary A. The LeaseSpeak System: Your Guide to Saving Money on Leases. Bonner Springs, KS: ILR Publishing, 2008 <

8 Rhodes, David, and Daniel Stelter. "Collateral Damage Part 4: Preparing for a Tough Year Ahead: The Outlook, the Crisis, in Perspective, and Lessons from Early Movers." The Boston Consulting Group (Dec ): 40. < pdf>. Statistics from news releases dated December 15, 2008 from American Bankruptcy Institute. < lay.cfm&contentid=55930> The Equipment Leasing & Finance Index as of December <