How to calculate the whole life cost of cars

Motivated by factors such as tax changes and the potential savings on offer, employers are increasingly moving towards calculating the whole life cost of vehicles within their fleet, says Laverne Hadaway

As the economic downturn continues, knowing precisely how much items cost is more important than ever, both for employers and employees. So when it comes to company car schemes, it is perhaps not surprising that some employers are looking at calculating the whole life cost of their vehicles when buying or leasing.

This has been partly driven by the government’s emphasis on linking taxation to the damage that cars’ CO2 emissions do to the environment. Chris Chandler, senior consultant at Lex Momentum Consultancy Services, says: “So much tax is focused on a vehicle’s CO2 emissions that the list price of a £20,000 car does not give any indication of how much it will cost to run.”

Calculating the whole life cost of a car is a complicated process. Online software can help employers to do the calculations but many of these tools have yet to incorporate tax changes coming into play from April 2009 which will affect the calculation, says Mark Sinclair, director of Alphabet.

Some key factors to take into account include a car’s depreciation, meaning the difference between the purchase price and the residual value of the vehicle at the end of the contract, insurance, maintenance in terms of scheduled and predictable servicing costs, the cost of incidental repairs such as broken windscreens and wing mirrors, fuel costs, and taxation including vehicle tax and employees’ benefit-in-kind liability.

Company cars also attract a writing-down allowance which allows employers to offset the depreciation of cars against tax. The writing-down allowance is currently 20%, but limited to £3,000 per year per vehicle. However, from 1 April 2009, if a vehicle produces more than 160g of CO2 per kilometre (km) it can be written down at only 10% per year. If it is below that 160g/km threshold it can be written down at 20% per year. Factors such as this will have to be taken into account.

In addition, the whole life cost of a car should include employers’ class 1A national insurance contributions (NICs), which are based on the manufacturer’s recommended retail price and take no account of any discounts the company may have obtained.

Where a vehicle is leased rather than bought, residual value and maintenance are included in the rental costs. Until April next year, the finance element of the rental cost of a vehicle can be reclaimed as a business expense. However, there is a disallowance system which reduces the amount allowable against tax for vehicles valued at more than £12,000. The more expensive the car, the higher the disallowance.

From next year, the system changes to one based on CO2 emissions. For cars over the 160g/km threshold, employers can reclaim only up to 85% of the finance element of the lease while there will be no disallowance for those below the 160g/km threshold.

Fuel consumption should also be taken into account. “The increase in fuel costs in the past 18 months has pushed fuel efficiency to the forefront and had a big impact on costs. There is money to be saved by making the right choices,” says Sinclair.

For example, two cars may cost the same but one may have lower maintenance costs, a better residual value, better fuel consumption and lower CO2 emissions. Andrew Cope, chief executive of Zenith, says: “One car could be significantly cheaper to run than the other, say by 10% or 20%. If [employers] have a fleet of 500 cars, that [will] make a big difference [over time].”

Providing more fuel-efficient cars may also be increasingly economical in the long term, as employees claim less back in fuel costs. It can also support an organisation’s corporate social responsibility policy by boosting fuel efficiency and encouraging staff to select more environmentally-friendly models.

Taking all these factors into account, the most obvious models don’t always come out as the cheapest. “For example, BMWs look expensive, but some do well from an environmental point of view and they have a good residual value. Employers need to take account of all costs,” says Cope.

Calculating the whole life cost of cars can also help HR to pre-empt any queries staff may have. Many in the industry feel employees do not need to know the technical details about the cost of their cars, but Chandler says employers should make it clear how much cars will cost staff in benefit-in-kind tax and fuel. “If [employers] are not using whole of life costs, they are not understanding the cost to their business,” he adds.

If you read nothing else read this…

  • The list price is no indication of the whole life cost of running a company car.
  • Key components needed to calculate a car’s whole life cost include its purchase or rental cost, residual value, maintenance costs, fuel costs, fuel consumption and taxation.
  • It is possible for two cars with the same list price to have completely different whole of life costs.
  • Employers can use cars’ whole of life costs in order to incentivise employees to choose greener and more fuel-efficient vehicles.