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A Fleet Manager's Guide To Building an Internal Rate Structure

Insight - 1010 Min read

July 25, 2023

The automotive industry is quite competitive, and companies must set a reasonable base rate for all their vehicles while still making a profit. And most of the time, the senior management in the company is liable for making sure that all the financial costs are met and all operations run smoothly. Luckily, several calculations make this possible.

In this article, we'll examine what it takes to be a fleet manager and how to build an internal rate structure. The goal is for you to understand what a successful rate looks like and how to develop and improve one.

Role of a Fleet Manager

Automotive companies that employ a large workforce and fleets of vehicles require a fleet manager to oversee what is going on and make vital decisions. This fleet manager is crucial for a company's success, and although they are often overlooked, they significantly impact the company's overall growth. This is especially true for small to medium-sized businesses.

The role of a successful fleet manager includes; making strategic business decisions, ensuring total operation productivity, customer satisfaction, and in this case, fixing rates. A successful fleet manager must have a broad and specialized skill set and the ability to thrive in a fast-paced environment. They also need to be educated on vehicles, types, and maintenance and have some experience working in the automotive industry.

Fleet management in automotive industries also includes managing commercial vehicles to ensure optimal utilization, maintenance, and fuel consumption. It also aims to maximize the efficiency of an organization and monitor the financial gains from the vehicles. Some other qualities and skills that a fleet manager needs to have included the following:

  • Technical knowledge of the automotive industry

  • Knowledge of changes and trends

  • Solid understanding of federal and state regulations for commercial vehicles and drivers

  • Business priorities

  • Solid understanding of vehicle maintenance and safety practices

Financial Role of a Fleet Manager

The fleet in an automotive company is the second largest expenditure after salaries and wages. Financial mismanagement of the fleet resources can lead to the company sinking. This means that the role of a fleet manager in finance is vital; they have to monitor the fleet costs between the manager and the finance department.

They are also responsible for selecting and maintaining the vehicles to keep the deliveries and distributions within the budget and on schedule. Therefore, fleet managers need extensive knowledge of logistics and software programs that monitor the drivers and vehicles in the fleet.

The Function of Finance in Fleet Management

Fleet managers are in charge of making important decisions on the vehicles to be purchased and how many. Some companies prefer buying specific models and making the payments immediately, while some lease vehicles to meet their needs which generally saves on cost.

It's up to the fleet manager to make the best decision in the company's best interest. When the company does not need the vehicle anymore, it's the manager's responsibility to research the market and resell it to get back as much for the company as possible.

A fleet manager must therefore be capable of evaluating risk, calculating depreciation, and knowing the right time to sell. Their primary goal is to minimize as much risk for the company as possible.

What Is the Relationship Between a Fleet Manager and Financial Manager

The company's fleet manager and financial manager need to communicate since they both work in the company's best interest. The financial manager needs access to the fleet manager's list of vehicles to purchase or lease since they control the budget. They also need to have a significant level of trust in the relationship.

In general, the finance manager and finance department are in charge of the company's financial statements and accounts and assist the fleet manager in making sound financial decisions. The fleet and finance managers can improve the company's operations and success. Management can also access the accounting data to make strategic decisions and decide where further attention is required.

The finance department also helps the fleet manager prepare budgets and forecasts for a big company. However, depending on the company's size, the fleet manager can also act in the capacity of the finance manager.

Developing an Internal Rate Structure

One of the critical functions of a fleet manager is creating budgets and reviewing the company's financial performance. They also take part in asset evaluation and procurement processes.

What Is Internal Rate?

A company's internal rate, also known as the internal rate of return, is the estimated equipment cost and the internal revenue used to cover those costs over a certain period. It can also be defined as the discount rate, which produces a net present value of zero when applied to a project's cash flows.

The fleet manager calculates the internal rate as part of their budgeting task and uses various techniques to assist in effective decision-making. It's referred to as internal since it does not consider external factors like inflation.

Calculating the Internal Rate

Computing the internal rate is similar to calculating the Net present value (NPV). The formula is the same since most of the factors remain constant. To derive the internal rate, the manager has to rely on the trial and error method instead of analytical methods. They can also use software such as Microsoft Excel, which gives relatively accurate results.

IR= (Cash flows) -- Initial investment

(1+r) i

Cash flow= cash flow during the period in question

r= discount rate

i= period

The rate at which the cost of investment and the present value of future cash flow are the same is considered the ideal rate of return. Any project that can achieve this is both successful and profitable.

Types of Equipment Costs

Equipment cost is the total cost of the equipment, including all the related costs such as capitalization costs, insurance, cost of buying the equipment, and taxes. The equipment cost can be calculated using a company's balance sheet. There are two types of equipment costs:

  1. Ownership cost

  2. Operation cost

Ownership Costs

The ownership costs in automation refer to the ultimate measurement for determining the cost of operating the vehicles. It also includes the soft costs such as the maintenance, power, and floor space used to store the cars. The ownership cost includes:

  • Acquisition cost

  • Depreciation

  • Interest

  • Insurance

  • Overhead

  • Return on Capital

  • Vehicle administration

  • Property tax

Acquisition Cost

The acquisition cost is the fee you pay when buying or leasing a car or another type of vehicle. It's also referred to as an administration fee or origination fee. It costs a few hundred dollars on average and should be included in your budget when you are planning on getting a car. The acquisition cost of a specific car brand is often the same in most locations and only changes if there is a feature update.

Depreciation

Cars tend to lose their value over time which can affect the total cost of ownership. Vehicles lose around 25% of their value within the first year in a regular market. Over the next five years, the depreciation rate is between 14% and 18%. However, the car market has changed over time, and the depreciation rate is almost nonexistent.

If you want to know how much your car has depreciated over time, you can search for it through a service such as CarMax and compare it to how much you purchased it. Although there are several ways to manage your car's depreciation rate, you need more control over it once you've purchased it.

Formula

Depreciation= (purchase price-salvage value)/ years

Does Depreciation Affect the Internal Rate?

Depreciation does not affect the internal rate since it's calculated in the future period and does not affect the company's current cash flow. It's, therefore, not included in the calculation of the internal rate.

Overheads

The overheads of owning a vehicle include the maintenance and repair costs. If the car is still under warranty, the owner does not incur any repair costs; the warranty is usually three years for most companies. Owners can also buy an extended car warranty.

Standard maintenance costs are $121 on average monthly and include oil changes and tire rotation, usually done thrice a year. If the car is not under warranty, or if the warranty has expired, you need to set aside some money every month for emergencies.

Property Tax

When purchasing a car, there are several taxes and miscellaneous included. To calculate your vehicle's property tax, divide your annual vehicle registration renewal amount by 12, and include other expenses such as parking fees.

Formula

Property tax= (AAV/100). Factor% / 52 weeks

Insurance

The average annual cost of insuring a car in 2021 was $1,771. However, the cost may vary based on where you live, your driving history, the type of coverage, and the insurance company you choose. If you live in an area that may not be secure, your insurance premium will likely be lower and vice versa. The same goes for your driving history; your premium will also be higher if you have a terrible history or a police record.

Safe driving may lower your insurance cost and protect you from extra surcharges. It's also vital that you select the proper coverage. Ensure you talk with an insurance expert to help make the right insurance decisions.

Registration

The registration fee for vehicles varies depending on the state. Some states base their registration cost on the car's age, weight, and horsepower, while some have a flat registration fee for all vehicles. You can check out the registration fee in your state from the National Conference of State Legislatures.

Saving on Car Ownership

Although the ownership costs can be steep, owners can put some measures in place to keep the expenses in check. They include:

Shopping for Cheaper Car Insurance

Some insurance companies offer cheaper premiums than others; it's vital to compare the rates for each type of premium from several providers before picking one. However, the insurance cover should provide maximum coverage and be from a reputable insurance company.

Refinance Your Car Loan

Depending on the type of car loan, it can be refinanced at a lower rate. It's essential to check if there are lower rates, especially if there has been a significant change in the market since you last purchased the car.

Maintain Your Car Often

When saving money on maintenance and repairs, the best option is to maintain your car often instead of waiting for the issues to pile up. Early detection of problems and maintenance may bring the repair costs down significantly. If you have a warranty, the company advises you to take your car for regular maintenance and diagnostic checks.

Consolidate Your Driving Trips

The more your mileage goes up, the faster the vehicle depreciates. It's a great idea to carpool with friends and run all your errands on one trip or take alternative public transportation.

Operation Costs

The cost of running and managing a business fluctuates annually, even by a few percentage points. Operation costs in the automotive industry include fixed costs and variable costs. The fixed cost includes sourcing suppliers, maintaining facilities, and testing the new vehicle prototypes. Variable prices, on the other hand, include the raw labor and the materials.

Raw Materials and Parts

The greatest cost when it comes to manufacturing automobiles is the cost of the raw materials and costs; they typically account for more than 55% of the total cost of manufacturing a vehicle. One of the best rules to keep in mind when sourcing raw materials and car parts is that cheap is often expensive. Most cheap materials and parts are not durable or sturdy and end up lowering the car's market value.

Sales Tax

Sales tax is included in the production cost of every vehicle since all the raw materials and parts are taxed. It also affects the price of the car in the market.

Labor

Once the vehicle manufacturing process is complete, advertising and labor costs are added to the production costs.

How Can Operation Costs Be Reduced?

While operating costs are roughly the same across all automotive industries, there are several ways to reduce operating costs. Some of them include offshore manufacturing, especially in companies located inside the U.S. The manufacturing plants are often set up in the south of the border, such as in Mexico, where labor is cheaper because of the low wages.

Moving manufacturing outside the border provides more access to skilled labor and lower transportation costs. With many manufacturers going to Mexico, it has become one of the main imports in Mexico.

How to Determine the Base Rates

The automotive industry is competitive and requires companies to improve to compete. For example, only a few car buyers remain loyal to the first automotive company they purchase their car from. One of the ways you can retain your clients is by setting a reasonable base rate for buying and leasing costs. This is where KPIs come in.

Knowing what to measure is vital in keeping the company afloat. With so many KPIs to choose from, it may not be easy to pick the best among them. Some of the popular Key Performance Indicators to focus on include:

  • Average downtime

  • Utilization rate

  • Safety incidents per employee

  • Throughput

  • Inventory turns

  • EBITDA

Average Downtime

One of the most significant key indicators an automotive company needs to consider when coming up with its base rate is its downtime. It can be calculated by:

Average Downtime = downtime hours within a specific time period ÷ (total time available to produce vehicles within the same period) × 100

The automotive industry must take action to ensure that downtime is minimized and turned into more productive ventures. It's pricey, and the cost is included in the total price of the cars and lease.

Utilization Rate

The utilization rate can be calculated using the following formula:

Utilization rate= (actual output) ÷ (maximum output) × 100

Utilization rate is the ratio of how many vehicles an automotive company produces over a certain period and how many vehicles it could produce within the same period if the time and labor were used optimally. If a company produces fewer cars, they are likely to be more expensive than a company that produces more cars within the same period.

The output data includes gross production numbers, resource use, and total materials input. It's also vital for automotive companies to calculate their utilization rate to determine how well they are utilizing their money and labor and how they can optimize both.

Safety Incidents per Employee

The overall safety of employees in any industry is vital. Accidents are common in the automotive industry because they include assembling parts and using equipment and machines that can be dangerous. The safety incidents per employee affect the base wages and salaries, indirectly affecting the overall cost of purchasing and leasing the vehicles. The formula for calculating it is as follows:

Safety incidents per employee= (no of safety incidents within a given time period) ÷ (number of employees working during the period).

Throughput

Throughput refers to the average number of vehicles produced over a specific period. It's calculated using the formula below:

Throughput= (no. of units produced) ÷ (time in years or months)

Throughput is one of the best measures of the effectiveness of the production line. Meeting the company's goals depends on the throughput. It also enables them to gauge whether there are any weaknesses in the vehicle production line.

Inventory Turns

Inventory turns= COGs ÷ average inventory

This KPI enables a company to determine the times inventory is sold versus the number of sales. It also gives them an idea of how much time the company requires to sell all the remaining inventory and gauge their competitive advantage.

EBITDA

EBITDA is calculated by adding the net income, interest, taxes, depreciation, and amortization. It's the best metric to measure a company's current cash flow. Companies can also use EBITDA to compare their profitability with other automotive industries. It's also used as a baseline to look at the company's total earnings, which is helpful for comparison purposes. It's important to note that:

  • Interest is not included because the debt incurred when purchasing the business does not matter.

  • Taxes should be removed when comparing operations because they depend on the location of the operations.

  • An analyst should be consulted when comparing facility lease expenses to amortization to ensure that the data is accurate.

  • Consider deducting the expected future expenditure if you add depreciation when calculating the EBITDA.

How Can Salvage Value Affect the Internal Rate?

Salvage value is the total cost of all the damaged goods and parts in the company. The salvage value calculates the depreciation of assets to determine the yearly losses. When there is a change in the salvage value, it results in a new depreciation amount.

Salvage value is treated as positive cash flow in the company at the end of the assets' life because they can be sold. It can be adjusted for the tax before being included in the NPV, considering both the capital gain and loss.

Determining the salvage value requires companies to estimate a salvage value that is neither too high nor too low. The value should be estimated depending on how long the company expects to hold and use the asses and how hard it's used. Usually, most companies set the salvage value to zero when they plan on using the assets for an extended period or if the technology quickly becomes obsolete.

If the salvage value is set too high or too low, it can significantly harm the company. For example, if it's set to a high value, the depreciation would be understated, net income would significantly increase, and the total fixed assets would be inflated on the balance sheet. The opposite would happen when it's set too low; the depreciation is overstated, while the net income would be understated.

How Do You Determine Operational Cost?

Operating costs include the maintenance and administration of a company daily and consist of the cost of the goods, rent, payroll, and other overhead costs. The cost excludes non-operating expenses such as internet costs, interest, investment, and foreign currency translation.

Calculating Operating Costs

By studying the company's financial statement or balance sheet, you can find the information needed to calculate the operating cost. The following formula can be used to accurately calculate the operating costs:

Operating cost= cost of goods sold+ operating expenses

To calculate:

  1. Take the total cost of goods sold from the income statement.

  2. Find the operating expenses, which are also in the income statement, and add them to the cost of goods sold to get the total operating expenses for the particular period.

Types of Operating Costs

There are many types of operating costs in an automotive company. They include:

  • Legal fees

  • Accounting fees

  • Sales and marketing costs

  • Office supply costs

  • Utilities

  • Rent

  • Benefits and wages of the staff

  • Production costs

Should Internal Rates Be Used by Estimators?

Yes. The internal rate is accurate and can be used by estimators to calculate the compound return on investments and the project. In serious budgeting, senior management likes to have an internal rate of return to enable them to compare and rank projects and pick the most promising ones. It is also widely used in analyzing private equity and venture capital investments which involves cash flow at the end of each financial year.

What Other Factors Impact Cost Recovery?

Cost recovery in most automotive companies can be challenging to calculate accurately. However, companies need to understand the cost of recovery bookkeeping to protect themselves from uncertainty regarding revenue recognition.

When calculating the cost recovery, the company has to ignore the profits related to sales until the cash flow is greater than the cost of sales. It does not recognize any profits made until the payments have recovered the sellers' cost, which makes it safer for businesses and companies to use.

Several factors affect cost recovery, they include;

  • Energy

  • Repair

  • Recovery

How Often Are Internal Rates Reviewed and Changed?

Internal rates don't remain the same over the year or several years and can be modified several times in a year based on several factors. The modification and change will impact the attractiveness of the investment.

Special Internal Rates

Some special internal rates include:

  • Lump sum

  • Intermittent usage

  • Contractual standby equipment

Lump Sum

The lump sum is a single large payment made at a particular time instead of smaller frequent payments. For example, an investor might pay all the amount at once instead of paying for a lease in installments.

Intermittent Usage

Intermittent usage of vehicles refers to occasional use instead of continuous use. The intermittent use of vehicles and equipment increases the cash flow in the company because the cars will require minimal maintenance and have a lower depreciation.

Specialized Equipment

Automotive companies need to have specialized equipment, including assembling and repairing equipment. They can decide to either purchase or lease most of the technical equipment depending on the frequency it's used. Some of the necessary equipment in an automotive company include:

Vehicle lift

During vehicle repairs, a mechanic must get under a vehicle lift to inspect the engines and other diagnostics. It's vital equipment for companies that offer regular car repairs; it's also pretty hard to lease one from another company because they are hard to move and are mostly built into the building.

If you decide on purchasing a vehicle room, ensure you buy one that is of high quality and has readily available parts. Lifts are a wise investment since they are built to last and are also crucial in maintenance.

Jack and Jack Stands

Most vehicle repairs temporarily raise the car a little bit above ground level. A strong jack stand can last you for a couple of years, especially if it's high quality. Pole jacks are also helpful in supporting axles and other car components.

Engine Hoist

Engine hoists are fundamental for any automotive company that assembles and repairs vehicles. They are used in rebuilding, repairing, and replacing engines. Ensure you buy one capable of hoisting even the largest and heaviest engine.

Workbench

Working on vehicles will require you to own a workbench. It should be durable, sturdy, and able to withstand heavy-duty work. It also makes it easier to hammer all the separate parts.

Air Compressor

You need a reliable air compressor to operate most of the tools within the workshop, including auto lifts and pneumatic hand tools. When purchasing one, ensure you get one with the highest capacity you can afford to be sure it can power all your needs.

CMMS Program

A computerized maintenance management system (CMMS) is software used in most industries and companies that centralize information and facilitate some processes and maintenance operations. It helps optimize the utilization of physical equipment within the company, such as vehicles and other equipment. It also makes communication and plant infrastructure easier.

The information contained in a CMMS database includes resource and labor management and asset registry, which stores the following information:

  • Location and position

  • Performance

  • Manufacturer, model, serial number, and equipment type

  • Associated documents

  • Measurements and reports

  • Maintenance program

  • Training and reference material

  • Ownership and operating cost tracking

CMMS is also crucial in ensuring preventive maintenance by predicting the required maintenance based on usage, triggered events, and time. It also helps in reporting, analysis, and auditing.

New Trends in the Automotive Industry

A lot has changed since the onset of Covid 19, and several industries have been impacted, including the automotive industry. Some of the significant changes include the green initiative, which has increased the production of electric vehicles. Automotive companies are also working on improving the efficiency of the existing models.

Another trend includes the growing popularity of mobility, which includes ride shares and short-term rental programs. These two trends are bound to increase companies' internal rates and make the respective companies popular with old and new clients.

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