Published: September 01, 2019
New lease accounting standards have shone a spotlight on Lease versus Buy decision-making, as well as the effective management of leases. As such, now is the perfect time to consider ways to maximise the benefits of leasing for your organisation – from better supporting liquidity planning to garnering significant cost savings at the inception of a lease.
The transition from IAS 17 to IFRS 16, the new lease accounting standard, has been widely documented in the European trade press. Likewise, across the Atlantic, where ASC 842 has superseded ASC 840 in US GAAP. Under these new standards, virtually all leases must now appear on the balance sheet.
Despite the challenges of meeting the immediate, and indeed ongoing, compliance requirements, this new dawn for lease accounting also presents a number of strategic opportunities for the finance function, and treasurers in particular. The first is to gain greater visibility over leases, which can, in turn, lead to improved cash forecasting.
A well-run leasing model, whereby leases are visible in a global, cloud-based platform, can free up working capital to be invested in other parts of the business that might have better returns such as expansion, marketing or R&D. Another benefit of leasing is the predictability of payments. Monthly expenses are known in advance enabling treasury organisations to better forecast and plan for cash needs.
Having central visibility over all the company’s leases – across the globe – can ensure that the business is realising the expected economic benefits. For example, many companies do not have processes in place to prevent leases from going ‘evergreen’. This is when companies continue to pay monthly fees beyond the end of a lease term. Overpayment is surprisingly common and can erode the savings expected from leasing. Many leasing companies may not be forthcoming in flagging the error or returning any excess monies.
Organisations should establish processes to alert treasury in advance of leases expiring and allow them time to prevent any overpayments and to thoroughly consider whether the lease should be renewed, or perhaps whether it would be better to buy the asset. This ‘Lease versus Buy’ analysis is another potential area of strategic opportunity for treasurers in the wake of IFRS 16 transition.
With numerous – and often large – operating leases coming onto the corporate balance sheet for the first time, questions will naturally be asked around the benefits of leasing. Why was leasing chosen rather than buying the asset outright? What are the financial implications of leasing? Is leasing the best option for the organisation? And are we getting the best deal on our leases?
As such, finance functions need to be able to justify why the decision was made to lease rather than buy. This requires a documented process that is digitally captured from start-to-finish.
In truth, many organisations do not currently have such a formalised decision-making process. In some organisations, these discussions are simply that – conversations with no rigorous framework. In others, leases are awarded on the basis of good relationships with the lessor. And in the worst-case scenario, leases are renewed out of habit, rather than analysis of the potential benefits.
Even those corporates which do conduct a formal Lease versus Buy analysis will often do so using Excel. While spreadsheets can be an effective tool, manual workflows mean they are also prone to error. Common problems include using outdated financial variables or incorrect formulae in the analysis. These both result in incorrect comparisons that lead to costly financing decisions. This is especially common when ownership of the spreadsheet sits outside of treasury. As such, Lease versus Buy decisions based on these spreadsheets are not necessarily robust – and are not in a format that can be easily shared with management or auditors.
Human intervention in these workflows can also mean that bias may come into decision-making, whether consciously or unconsciously. One lessor may be favoured over another due to pre-existing relationships. Or leasing may seem like the tried-and-tested option, but that does not necessarily make it the optimal solution for the company at this point in time.
One strategy for companies to avoid making incorrect decisions is to adopt an automated and standardised Lease versus Buy application. An automated tool such as this should store all financial variables centrally with regular updates permitted by corporate treasury. Such a tool will also provide assurance that all Lease versus Buy calculations for cash flows and net present values (NPVs) are accurate. And it will ensure that all analyses are consistently prepared in accordance with company policy – across all jurisdictions.
Automating these workflows also removes the emotional and unreliable element from the Lease versus Buy decision. The right software will analyse the cash flow, tax impacts, and present value of leasing versus buying in an unbiased way, as well as determining the optimal lease structure.
Some software can also assist with pricing. Shockingly, companies waste millions of pounds annually under-negotiating savings at the inception of a lease. To optimise rates, companies should utilise best practices in sourcing to select the financing source for a lease. Procurement organisations utilise strategies such as spend consolidation, supplier tenders, and competitive bidding to obtain the best possible price for the machinery, equipment, and vehicle assets they acquire. These same techniques should be applied to source the capital for leases. A request for proposal (RFP) should be developed with the key requirements for the lease then distributed to multiple leasing companies for competitive bidding.
New electronic marketplaces are emerging that are specifically designed to enable corporates to source capital for equipment leasing. Corporates can issue a single RFP to multiple lessors at the click of a button and wait for prices to be offered in return. Experience has shown that using this type of lessor ‘marketplace’ can deliver 6-8% direct savings on the cost of a lease. On a £1m lease, that’s a significant benefit, and given that companies often have hundreds of leases, the return on investment (ROI) for the software is compelling.
Although slightly more difficult to quantify, time savings through automation must also be factored into the ROI discussion. Experienced MBAs will no longer be required to manually perform Lease versus Buy analysis. Moreover, monitoring of leases can be done automatically, rather than by hand.
As with most corporate finance and treasury processes these days, digitisation of the processes with the right technology will be critical to success. With the correct software in place, organisations can ensure the optimal use of capital with consistent Lease versus Buy analysis and competitive bidding as well as ensure ongoing compliance with the new lease accounting standard (see LeaseAccelerator’s article in Issue 269 of TMI for more information on consistently clearing the lease accounting hurdle).
Lease accounting processes can also be smoothed out across the month or quarter, rather than squeezed in at times when the finance team is already overrun with work. For global organisations, the software should have the proper functionality to cover the various international accounting standards, meaning that team members no longer have to focus their energies on ensuring varying compliance standards are met.
As well as offering the potential to streamline headcount where necessary, therefore, the software also frees up finance teams to be more strategic as resources can be reallocated to more analytical, value-added tasks. IT resource can be minimised with a plug-and-play cloud-based solution that requires lower implementation and support effort by internal staff.
A cloud-based solution also means an end to unhelpful siloes around the ownership of lease management spreadsheets. Global users, including those in shared service centres or outside business process outsourcing firms, can be permissioned to access the software, at the relevant points in the workflow – so that they can use their expertise to help make the optimal leasing decision. As a result of correct permissioning of users, treasury will likely become more involved in the leasing process, which plays to the treasurer’s growing strategic role within the organisation as a business partner and growth enabler.
Another critical requirement is user permissions and data security. Organisations should have complete visibility over who is able to access sensitive leasing contracts, pricing, and accounting details. Strong user permissions also enable finance departments to implement effective controls such as segregation of duties which reduce the likelihood of fraud.
Given that the spotlight is still on lease accounting, now is an opportune moment for finance teams to fully realise the economic rewards of their organisation’s leasing programmes – through improved execution. As we have seen, this will require greater visibility over leases, proper management of those leases, and a thorough Lease versus Buy analysis that is fully documented, robust and unbiased.
With the right software in place, finance teams can not only achieve these goals, but also release capital for treasury to put to use more strategically. So, next time lease accounting software comes up in conversation, why not take a moment to consider how the potential benefits could cascade down beyond regulatory compliance? Leasing can – and arguably should – be a strategic tool in every modern treasurer’s armoury.
Joshua May FCCA has worked in finance for more than 20 years. In 2015 he moved into consultancy having seen the benefits that software as a service (SaaS) and automation can bring to the finance function. Initially at BlackLine and more recently in his current position with LeaseAccelerator, Joshua has played a key role in driving business across Europe, the Middle East and Africa. |
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