Can Written-off Vehicles Pay?
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IMAKE no apologies for returning once more to the subject of .depreciation. It is most contr@versial and involves wide differences of opinion. Certain aspects of it which have been presented to me during the past week or so are worthy of discussion.
During a week-end a short while ago, I had the pleasure of trying out a new model of a car in the moderate-priced range. Several of my friends were keenly interested and many of them intrigued with the car. One decided to get rid of his own car and buy a new one of the kind I was using. .
"How much do you think I should get for mine in a part-exchange deal? " he asked, referring to a car of which he took delivery less than 12 months ago, at the list price of £800, " AbOut £500 is the market value," I replied.
" That's a tremendous drop," he objected. "It has run only 2,000 miles."
"Depreciation on touring cars," I answered him, "is not qetermined to any great extent by the mileage the car has done but by its date, and the first year's depreciation is about 30 to 35 per cent."
" But why is that?"
Enhanced Price "The reason is portrayed by the very car in which you are so keenly interested," I declared. "It has many new features which are, in effect, improvements on the previous year's model." Most car manufacturers—but not ail— embody improvements annually and many car buyers are thereby made to be dissatisfied with the cars they have and are correspondingly willing to pay the difference involved in the drop in price of the old one."
"Well," he said,." I suppose I am just as much an example of the cause of high depreciation as is the car you are showing me, because I am still determined to make the exchange." Then he asked the question which as much as anything has set me on to the re-discussion of depreciation.
" Is this car reliable? " was his next question, " I cannot afford a new car every year and I therefore want one that will last."
I thought of his 2,000 miles per annum and assured him. "The car will last you a lifetime."
After he had gone, it occurred to me to calculate his car expenditure at least so far as depreciation was concerned. / found that if he sold his car at about the market price of £500, he would have paid 3.6d. per mile, about 3icl. for depreciation alone. Calculating depreciation on the mileage basis, I reckoned his car would have to be
c2,8 run for 40 years before he ought to get rid of it as worn out. The foregoing shows, in an exaggerated form, the distinc. tion between depreciation on a time basis and on a mileage basis. Fortunately for us, the figures are not applicable to commercial vehicles, because the user does not have his values upset annually as the result of innovations in design and construction, at least not to the same extent as in the ease of cars.
I was• discussing the problem of haulage rates with a representative of a prominent commercial-vehicle man ufaeturing concern. He said "If I were in the haulage business. today" . . . (and I should explain that before he joined the staff of this manufacturer he was a haulier) . . . "I would buy good vehicles; "1" would depreciate them over five years and then in the -subsequent two or three years, with no , depreciation account to bother Me, I should cut out my rate-cutting competitors."
Definite Profit
His scheme is obviously wrong in principle, but the fallacy in it is not so clear. The flaw, of course, is that for five years he is going to have to operate under a fairly heavy depreciation account. If he is to be in a position, after that period, to adopt the rate-cutting plan be had in mind, he must make a definite profit in each of the five years, notwithstanding heavy depreciation. If he can do so and obtain the rates which those conditions (heavy depreciation and high profit-making) involve, his rates will have to be . higher than average.
If he can obtain those rates, despite the competition and rate-cutting which may be prevalent, there is no point in his going on with the scheme of cutting out his competitors.
There are other flaws. A haulage contractor, if he is to be successful, depends largely on the goodwill he has established with his customers, If for five years he holds customers at a given rate, somewhat higher than average, and then, suddenly, without any justification that he can divulge, cuts those rates, his customers are not going to be so pleased at the " cut " as might be expected. They are going to wonder why they have for some years been paying what will, in the light of these cuts, seem to have been rates which were excessive.
Again, suppose I make the somewhat absurd assumption that the three years of ruthless rate-cutting achieves the desired objective, that is to say, it eliminates competition. The haulier is then going to raise his rates to the old level. • He must do that, otherwise all his scheming has been of no avail. Yet he will have to succeed in that because he will need new vehicles and will have to make provision for' depreciation again.
What excuse is he going to make to his customers? Why must he raise his tates again after operating for a couple or more years at the cut rates? Is it not to be imagined that customers themselves will not discover what he has been doing arid become even more distrustful of him than ever?
Further, this period of five years for depreciation makes no allowance for difference in annual mileage. If the vehicles under consideration have been covering 40,000 to 50,000 miles per annum, by the end of the five years they will be due for replacement, otherwise the accounts for maintenance during the subsequent years will exceed any book savings in respect of depreciation.
This brings me to my third example, typified in a letter before me. It is from a haulier who appears (he does not state that it is so) to have acquired or come into a business, among the assets of which are three lorries, all of them 5-tonners, petrol-engined and old. His own valuation is £120 for the three.
He asks me to estimate the running cost of these vehicles, and in his letter he points out that as the value is so low he will need to make no provision for depreciation. Indeed, he suggests that he should take, as a basis for his own estimate of operating costs the figures in " ' The Commercial Motor' Tables of Operating Costs," less the amount allowed in those Tables for depreciation.
High Fuel Cost
I went into the figures carefully, bearing in mind the known performance of vehicles of the same type and age. I will cite the case of one of them. It is a 5-ton lorry and, having in mind a probable state of disrepair, and other disabilities inseparable from out-of-date chassis, the running costs will be approximately as follows: fuel, 3.95d. per mile; lubricants, sure to be expensive, 0.30d.; tyres, rather more than the average figure in the Tables because of faulty wheel alignment and backlash of steering gear, 1.80d.; maintenance, entirely an unknown quantity, but likely to be in excess of average, say 245d. The sum of the four items of operating cost is 81c1, per mile. The corresponding figure from the Tables but including depreciation is 9.39d.
Actually, therefore, these old vehicles, notwithstanding the elimination of depreciation, cost nearly as much per mile as a new vehicle including full allowance for depreciation.
I have often pointed out in these articles how easy it is for the haulier to overlook some important item of expenditure and thus make a mistake in his costs with the result that, quite innocently, he cuts rates and operates, if not at a loss at least on terms which fail to show him a profit. Indeed, one of the reasons why I am so insistent upon hauliers following a certain well-defined scheme in calculating their costs is that I believe that only in that way can the risk of error be minimized.
I discovered the other day that there is actually a loophole; that even the careful haulier, who makes a note of all, his items of expenditure broadly on the lines which I am so consistently recommending, is still liable to make a mistake of this kind. I was examining the accounts of a haulier and, secretly, I was inclined to the view that his system was thorough.
Conventional Procedure
On broad lines, the system he was using was that which I recommend. He set out his standing charges and establishment costs which, for the half a dozen vehicles he owned, totalled approximately £2,000 a year. The total of his establishment costs he divided among the vehicles pro rata to their load capacity, which is the conventional procedure. He then totalled the standing charges for each vehicle and, adding to that sum a proportion of establishment costs, obtained a fixed sum per annum for each vehicle.
He kept separate notes of his running costs and wages. The latter could not be included in the standing charges as they varied from week to week, largely as the result of working much overtime. Each week, by adding the proportion of fixed charges to the actual running costs, he obtained the total cost per week for each vehicle. He set beside that result the total earnings of that vehicle and was thus aware week by week how much each vehicle was earning.
This haulier had that system in operation for five or six months. He estimated his establishment costs to start with, but as a check was keeping a careful record of them in a book set apart for that purpose. When I had examined the accounts I expressed myself as being satisfied, having no criticisms to offer.
Then he sprang his mine. "I am anything but satisfied with them," he said. "If you look here you will see that I am £400 out." He turned to the notebook in which he kept note of his establishment costs. "The total here, to date, is £430 13s. 4d. Now, according to the standard to which I am working, I've got £627 2s. 9d. debited as fixed charges."
For a Moment I was puzzled, and then I realized what was happening. "But your total of fixed charges set down against the vehicles is more than just establishment costs," I exclaimed. "It includes, for example, the tax and, in your case, depreciation."
Extra Profit "I see," he replied, "well that's at once a relief and a blow. It's a relief because I thought that there was something wrong with my accounts, and that made me uneasy. It's a blow because I thought I had that extra money to spare—a kind of extra profit—and I had nearly reached the point of making up my mind what I was going to buy with it." And so, with a laugh, the incident terminated.
But it was quite clear to me that if I had not quite providently come upon the scene at that time he would have concluded that it was merely his estimate of establishment costs that was exaggerated and that he really had £200 to spend.
Now, if a man like this who keeps careful records can make a slip, how much more likely is it that a haulier who keeps no accounts is going to make mistakes of a similar order? There is another lesson to be learned from this haulier's experience. I have already remarked upon the fact that he included depreciation among the standing charges. Now, I have often pointed out that there is one hard-and-fast rule as to whether depreciation should be regarded as a standing charge or as a running cost. So long as the haulier makes proper provision for it—and that is essential—it does not matter how he classifies the item. I prefer to regard it as a running cost.
I do so because I have always found this method to be more convenient for the purpose of the haulier, which is to ascertain in a simple manner the actual cost of operation at any time and to be able to arrive at an actual picture of the state of his business.
Slack Period
The wisdom of my method was exemplified in this particular case. There was, in the operations of this particular haulier, a slack Period each year. Checking his accounts for a week when the slack season was present, he found a somewhat sorry state of things: he was not making any real profit. During those times of slackness, the mileage covered by the vehicles was much below the average for the rest of the year.
As, however, according to this man's method of costing,• depreciation was a standing charge, the weekly or monthly records of cost would not differentiate as between the slack periods and the rest of the year. As a result, the profit was almost negligible. Now, if depreciation were treated as a running cost, as in my opinion it should be, the amount would, of course, rise and fall with the weekly mileage so that in a week when the mileage was low, the depreciation item too would be low, and affairs would not seem to be as serious as when this item was a standing charge. S.T.R.