7. What are workshop overheads and establishment costs?

12th September 1969, Page 92

12th September 1969

Page 92

Page 93

Page 92, 12th September 1969 — 7. What are workshop overheads and establishment costs?

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Readers who have been following this series of articles should recognize that each step in the system is being explained in advance of the time that the information is required to finalize the vehicle record form R.B.6 (CM August 22). By these means any operator intending to implement the system can install the forms of records as they are required, or if need be extract the relevant information from his existing records, e.g. book-keeping entries or the financial accounts.

Access to the latter source will certainly be required to calculate "overheads" and "establishment costs", particularly for an operator with his own workshop, who will need a breakdown of such expenses as rent, rates, lighting and heating and fitters' earnings as distinct from payments to other salaried employees who are concerned with the transport operation as a whole, as these costs are a general charge on the business as opposed to those affecting any one vehicle. The first principle to observe, therefore, is the need to segregate "workshop overheads" from "establishment costs" as illustrated here.

By definition I regard "workshop overheads" as the ancillary costs which accrue to an operator with these facilities but which cannot be allocated to a particular vehicle. Questioning whether any specific expense is a "workshop" overhead, the simple test to apply is whether the cost would have been incurred without a workshop—if so, is the expense then to be regarded as an establishment cost item? It is in the segregation of these two types of overhead costs that difficulties of interpretation may arise.

For this reason it is important to enlist the co-operation of the accountant in time for him to apportion what were "global" overheads as between "workshop" and "establishment". Agreement should be reached on the definition of each; for example, "establislunent" costs in my book are the "administrative" overheads which are incapable of being allocated to a particular vehicle or to the cost of operating a workshop.

Each schedule has been prepared by the accountant in similar form showing the total quarterly costs of all the relevant expenses iincurred under "workshop" or "establishment" and then the final totals taken from the previous year's accounts. Mine are purely notional totals such as might apply to an operator of, say, six vehicles. At this stage no attempt has been made to provide the quarterly or year-end costs of the individual expenses, as the immediate object is to furnish management or the cost analyst with guide-lines for the completion of Form R.1L.6. Nevertheless, the rising trend indicated each quarter dictates that a provision for increased costs needs to be built-in from the inception of the Flow-Line system. You could, of course, add 10 per cent and hope for the best, but as the format for each schedule is intended to provide the actual quarterly cost of each expense item the accountant would include the prevailing costs of each ingredient so far as they are known at the time and thereafter insert intelligent budgets for each remaining quarter up' to the end of the current financial year.

Where the administrative offices, workshop, parking area and /or garage are subject to an overall rent, a single Local Authority rate, water rate, together with power and lighting off one meter, an equitable yardstick has to be employed to apportion these overheads between "workshop" and "establishment". In these circumstances, I advocate calculating the total square footage of covered space and open areas separately and apportioning the related costs pro rata to the total cost of each area, with due regard to the higher rent, rates, lighting and heating, etc., that the covered space would attract. This may take a little time, particularly if expenses such as printing and stationery and a percentage of clerical time incurred need to be allocated between "workshop" and "establishment" costs. This latter exercise is made easier, of course; if a cost analyst is appointed with the total responsibility to maintain the system and check expenditure; consequently, if this is not a full-time job, his time can be calculated as was previously explained, on the basis of one hour per vehicle /month.

I can assure you that this is not an unnecessary, time-consuming chore. On the contrary, a continuous investigation into overhead costs can reveal a variety of profit eroding elements which might otherwise continue undetected for years. For example, costly covered space used for parking vehicles can be more profitably emploYed in production or processing by a manufacturer or in providing a haulier or private carrier with more adequate vehicle maintenance facilities to support an application for an operator's licence under the 1968 Act.

It is imperative for the haulier to exercise the strictest control over these insidious overheads, as evidenced by the examples illustrated for, say, six vehicles—by no means excessive—and which were estimated at £16 per vehicle/month for "workshop overheads" and £50 per vehicle /month for "establishment costs". If these particular costs continued unchecked at the same annual rate then a haulier with a fleet of 60 vehicles could find this figure to be of the order of £60 per vehicle /month.

In any business the spread of overheads has a marked influence on profitability but with the Welfare State and the Exchequer demanding more and more, managements are apt to resign themselves to the acceptance of the same overhead cost per unit as inevitable, even though the spread may be over a wider range of activities.

To emphasize the need for the segregation of these overheads you need only examine the nature of the items included in each schedule to see that they are standing costs unrelated to miles run; consequently, they will accrue throughout the year irrespective of vehicle utilization. For workshop overheads this raises an interesting point, as vehicle maintenance is invariably regarded as a running cost calculated at X pence per mile and yet here we have a cost ingredient which, when added to fitters' wages, is a substantial standing cost week in and week out. At the appropriate time we will explore this interesting aspect.

Closer examination of the expense items included in both schedules will reveal some with which you will not be concerned, as obviously the scale of the operation will influence the nature and content of the costs incurred. Even so, it is prudent to provide for every possible contingency which could reasonably arise in the future—training levies, M.o.T. tests and Social Security Benefits are typical examples.

Although many of the overhead ingredients in each schedule are identical, I must reiterate that as costing is a means to an end, a cogent example of the need to distinguish between "workshop" and "establishment" lies in the ability to compare the true cost of operating one's own vehicles and/or workshop with the cost and facilities which could be provided by public services, since in many cases it is convenience rather than economics that dictates this decision. At the same time the need to prove that adequate maintenance facilities exist cannot be ignored.

The difference between an own-account operator's acknowledged overheads and those of the haulier will be substantial, as the former's tend to be absorbed in total company costs and consequently "hidden", while the latter's are real in the sense that they exist, although not always recognized. The private carrier may not admit of any establishment costs, contending that whether he operates his own vehicles or not he will still require the same staff. Depending upon circumstances and the scale of the operation, this could be partly true but only to the extent that as a variety of people become involved in different ways their time is unaccountable, including management time diverted from its intended purpose.

The accounts department, for instance, becomes involved in checking invoices for fuel and oil, repairs, tyres, administering licensing, insurance and claims. Somebody else formulates the depreciation policy and someone else the maintenance—all apparently at no cost. So, like the operator who uses only public repair facilities, the private carrier who employs only hired transport can reduce the hidden cost of administrative work by limiting it to the checking of hauliers' accounts. Nevertheless, unless the time thus saved can be more profitably employed, Parkinson's Law may prevail. There is one establishment cost which cannot be overlooked, however, and that is the interest or yield on the capital diverted from the means of production or investment to distribution, and which in a well conducted business would need to be justified.

Apportioning the overheads will be the subject of the next instalment.