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A SIMPLE RECIPE FOR COSTING
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by Reg P Block TAKE any number of mixed vehicles, list and measure weekly or monthly those cost ingredients which continue all the time, e.g. excise tax, insurance and overheads, and list separately the costs incurred when the vehicles are running, such as fuel, tyres and maintenance. Repeat this process for a year, compiling "standing" and "running" costs separately for the fleet. Why wait a year for the results to come to the boil? Because for a few vehicles it requires that time to produce a cost pattern that will iron out the peaks and troughs of expenditure which arise monthly, and then only if the vehicles you were operating at the end of the "accounting year" were the same in type and number as those you started out with.
For example, if a new vehicle is added or an existing one replaced it can be assumed that there will be very little expenditure on repairs and possibly nothing on tyres in the first year. But what about future years? It is for this and other reasons that you need to budget for all expenditure likely to be incurred over the life of the vehicle(s).
We shall be looking at budgets and budgetary control later in this series, but first it is imperative to check that all the recognized cost ingredients have been taken into account. The following checklists cover the main factors, and I have added some comments on the less familiar costs.
STANDING COSTS RUNNING COSTS Road tax Fuel Operator's licence Lubricating oil (where applicable) Tyres Motor insurance Depreciation Drivers' wages (including bonuses, overtime, subsistence and social security payments) Inspections and maintenance Establishment costs Depreciation There are two schools of thought on depreciation; one says it should be regarded as a cost per mile (running cost), calculated by dividing the estimated mileage life of each vehicle into its purchase price mid so arriving at a cost per mile. This is acceptable when mileage is consistent, but if there should be a change in the nature of the operation, resulting in fluctuating mileages, then the cost per mile needs to be adjusted accordingly. This creates problems when you want to compare like with like, annually. The other school contends that depreciation is influenced by vehicle time on the road and its age when it comes to selling, as on the one hand stop/start work in and around towns and suburbs is more exacting than journey work, although time on the road may be similar, while on the other hand a dealer's offer for a trade-in has more regard to age than mileage. After all, the former is readily ascertainable from the log book while the latter may or may not be right. For my book, I spread depreciation equally over the expected economic life of the vehicle, as a standing cost.
Establishment Costs At the outset the operator needs to appreciate that establishment costs are those expenses which cannot be identified with any particular vehicle. Some examples are rent, rates, 'phone, stationery, salaries, including perhaps part-time help of wife, company car costs, lighting and heating, professional fees, bank charges, HP interest and, for the owner-driver who has not registered under VAT voluntarily because he estimates his year's turnover will be less than £5000, the "inputs" of many of his purchases.
These are administrative costs — as opposed to for example, workshop over heads, which will be dealt with later. As all these operating costs have got to be recovered in a haulier's charges, with the exception of the private use element of the car costs, one can appreciate the importance of maintaining a close watch on each and every such item.
In the own-account field the majority of operators do not recognize that this cost exists in their own companies, as their transport is ancillary to the main purpose of the business, which may be manufacturing, processing or a service industry such as laundries.
Depending on the size of the business and the transport requirement there will be one or more people directly concerned with the day to day running of the department, for instance the transport or traffic manager and possibly a clerk and typist. There will also be others who are partly involved, i.e. the accountant and his staff and possibly the production or sales manager. The basic test to apply in deciding whether those involved, either fully or partially, should be regarded as an acceptable part of the transport cost is: would they become redundant if the company decided to dispense with its own transport and employ a contractor instead. With the possible exception of the drivers the answer is invariably "no", as the only effects would be a little less work for the accounts department, while the transport administration would still be required to allocate the loads and route the contractor's vehicles as they are already doing with their own, There are exceptions, such as the contractor providing his own dispatch office staff, but the occasions are few.
So much for the staff being disregarded as an establishment cost, but what of the financial implications? In the vast majority of businesses a company does not have to operate its own vehicles, so what of the capital employed? Could this be put to better use in the business such as in the purchase of new plant or extensions to buildings, the result of which would increase profits? If the return required on the capital is normally 15 per cent, what does the company's transport contribute to this? In my view very little, as apart from good service to customers — which a contractor could give equally well — the cost of transport adds nothing to the value of the product. I suggest that the least a company should charge its transport department therefore is an amount equal to the interest it could obtain if the capital were invested on the open market. This return then becomes an establishment cost.
Workshop overheads In my checklists, workshop overheads are included as a standing cost — as part of "inspections and maintenance". Why segregate these overheads from establishment costs? So that — with the aid of costing you can decide if your workshop is an economic proposition or a convenient but expensive facility, in spite of operator's licence conditions.
In other words, would it be feasible to contract your maintenance out, particularly if the workshop is mainly used to service management and reps' cars? Obviously if you don't operate a workshop then you are not concerned with this particular cost; but if you do, and you cannot share the cost by servicing internal transport or plant — fork-lifts, cranes and so on, then you need to calculate the overhead costs involved in precisely the same manner as that employed in totting up establishment costs.
The kind of expenses which spring to mind are rent, rates, lighting, power, heating, depreciation on workshop plant, service vans, stock losses and obsolescence. Add to these direct labour, such as fitters, and any indirect labour — supervision and apprentices — and you will recognize that you have a large percentage of fixed costs irrespective of the miles run by your vehicles.
Traditionally, vehicle maintenance has been regarded as a running cost per mile, but since the introduction of compulsory annual testing more experience has been gained of the annual cost of maintaining vehicles to conform to Ministry standards whether one operates a workshop or not. Consequently I now regard maintenance as budgeted standing cost for almost the same reason as that propounded for depreciation. After all, one of the objectives when setting up a costing system should be to minimize the imponderables — those costs which are bound to vary according to mileage.
In order to help an operator set up a costing system which is intended to be a worthwhile exercise I felt it was important to explain the less obvious ingredients. The views I have expressed are my own but they are there — in some detail — for operators to think about and I hope will serve a useful purpose when we become a little more sophisticated.
Costing or accounting?
In the meantime, let us revert to our simple recipe and what it has produced at the year's end. Whether you are an own-account operator or haulier you should then have a progressive weekly or monthly list of standing costs and running costs and a year-end total of each for the fleet. Many operators use this oversimplified method in the mistaken belief that they are "costing", whereas in fact they are merely listing expenditure as it occurs, often without segregating standing and running costs; consequently they are duplicating the work of the accountant.
Another pitfall to avoid is the use of mixed fleet totals as opposed to individual vehicle costs that enable you to detect the bad apples in the barrel. But transcending all such aspects is the need to make costing work for you. To accomplish this you need to have access to vehicle/driver iperformance; that is utilization of time and +ehicle capacity — for example in days worked, units delivered/collected, miles run and, for the haulier, profit/loss per vehicle and for the own-account operator the element of cost to be absorbed in the product or service price.
In the light of the Government's squeeze on profit margins, accurate cost accounting is now more important than ever, so you have to ensure that every ingredient has been accounted for and then be able to question why this or that cost was either lower or higher than expected and why certain vehicles were not gainfully employed on particular days. Finally, what action is necessary and how soon can it be taken to remedy any shortcomings revealed by the system employed?
Simplicity must be the keynote for the newcomer and small operator alike, but to achieve this it is essential to prepare the groundwork carefully. Next week I shall introduce a typical vehicle record, enabling an operator to see the performance and cost per vehicle at monthly intervals.