10 Ways to Become a Depreciation Management Pro
In North America, depreciation is generally the largest operating expense for a vehicle fleet. Fleet managers must know what depreciation is, how it is applied, and how a corporate fleet program influences this key cost driver.
At a Glance:
Ten aspects of depreciation fleet managers must know are:
- Net depreciation and capitalized costs.
- Best acquisition approach.
- Vehicle purpose.
- Vehicle incentives.
- Timing purchases.
Fleet managers must know all the facts about depreciation. Focus on the following 10 areas:
1 Know the Lingo
Knowing depreciation terms and definitions makes fleet managers more
fluent in this important business issue.
- Capitalized cost: Amount paid for the vehicle after incentives, discounts, delivery fees, and upfitting.
- Reserve rate: Client-controlled monthly payment that determines the book value.
- Market value: Value the resale market places on a vehicle at any given point in time - varies based on model demand, market conditions, vehicle age, odometer, and condition.
- Book value: Remaining "balance sheet" value of the vehicle.
- Residual value: Vehicle's perceived market value when it comes off lease.
2 Know the Math
Net depreciation is the difference between the amount paid for the vehicle at the time it was acquired and the amount it's worth when sold. This is represented by a basic calculation:
Capitalized costs - residual value = net depreciation
To determine the effective monthly depreciation, divide the net depreciation by the number of months the vehicle was in service. To determine the effective monthly reserve rate, divide the monthly depreciation by the capitalized cost.
3 Know the Process
Every vehicle's residual value continually declines. Two ways a fleet manager may account for this according to the vehicle's reserve rate are:
- Flat depreciation rate: Uses the same reserve rate each month for the life of the vehicle, or until the vehicle has a zero-dollar book value.
Flat rate depreciation uses the same reserve rate each month for the life of the vehicle, or until the vehicle has a zero-dollar book value.
- Declining rate: Sets a higher reserve rate in year one and decreases each subsequent year the vehicle is in service, which helps the vehicle keep its book value closer to market value over time. This is valuable for fleets with a high monthly mileage, and also decreases the risk of a large debit disposal adjustment (which occurs if ending book value is greater than residual value).
4 Know the Cost
When evaluating total vehicle cost, consider net depreciation costs in addition to capitalized cost. This helps set reserve rates that align with the expected net depreciation rates and are reflected accurately throughout the vehicle lifecycle.
The ideal goal is to be within $500 of the market rate at the end of the vehicle life. Depreciating a vehicle more quickly than the market rate reduces cash flow (larger payment on the vehicle), while under-depreciating a vehicle results in large single payments upon disposal (since book value will be higher than residual value).
As a vehicle ages, it requires more repairs and maintenance, leading to increased repair, rental costs, and vehicle downtime. While these do not typically outweigh the cost of a new vehicle, the cost impact of driver downtime should not be undervalued.
5 Know the Deal
From an acquisition standpoint, utilizing factory-ordered vehicles can control depreciation costs. Factory orders typically provide incentives and discounts and allow control over custom vehicle options. Certain manufacturers, as well as fleet management companies, also offer "pools" of popular fleet models from which vehicles may be ordered. These offer a cost-effective option for immediate vehicle needs.
When traditional acquisition options are impractical, out-of-stock acquisitions can be used; however, they often entail additional fees and unwanted options. Avoiding unnecessary dealer stock purchases can typically save at least $2,000 on the capitalized cost.