Keep Depreciation in Perspective
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Policies Offering Substantial Economies in One Item of Operating Cost Can Prove Ill-Advised if the Effect on Other Expenditure is Ignored
THE total expenditure involved in operating a commercial vehicle can be conveniently segregated into five items of standing costs (licences, wages, rent and rates, insurance and interest), and five running costs (fuel, lubricants, tyres, maintenance and depreciation). As I emphasized last week, hbwever, it must always be remembered that these 10 items remain interrelative. Otherwise disappointment could arise as the result of the experience of effecting economy in one item. only to find subsequent increases in cost elsewhere.
Depreciation and maintenance are two such items which are closely rated to each other, and, to some extent, with interest on the initial capital outlay. Inquiries are often received from readers indicating that they are proposing entering into haulage or passenger operation with a used vehicle which they have purchased—or, more prudently, which they are considering purchasing—at what they consider to be a modest price. Because of this low initial outlay they then make the unfortunate mistake of believing that they would be in a more favourable position, economically, than their competitors operating more modern fleets, to the extent that they would be able to offer customers more attractive rates.
There are two fallacies in this attitude. As already explained. costs are interrelated and experienced operators would be well aware that even if there were a saving by the adoption of this policy in respect of depreciation and interest charges, there would inevitably be a substantial addition to the average cost of maintenance as applied to more modern vehicles.
THE second fallacy is that any apparent saving on depreciation costs would be conditional on unlikely circumstances. When the costing of commercial.vehicle operation is undertaken there is an implied assumption—generally accepted but -seldom stated—that .continuity of the transport undertaking or department is intended. Whilst it is necessary to make estimations of the probable life of a vehicle in terms of mileage or years, it would only be in exceptional circumstances where the life of the undertaking had similarly to be estimated or alternatively was known to be of comparatively short duration. An example of this last situation could be where vehicles are purchased specifically for a short-term civil engineering contract.
In the vast majority of cases this would not apply and it would be the transport operator's responsibility to continue to provide, and possibly expand, whatever services he had organized, It therefore follows that replacement of vehicles is an inherent factor to be taken into consideration when calculating operating costs. The method adopted in this series of articles and in "The Commercial Motor Tables of Operating Costs' for calculating depreciation is on a mileage basis. The mileage chosen for a quantity-produced 7-tonner, for example, is 150,000 as the probable economical fife of this particular type of vehicle In order to obtain the depreciation cost per mile, the cost of the original set of tyres is first deducted from
536 the initial price of the vehicle. A further deduction is ther made in respect of the ultimate residual value and the balanci then divided by 150,000 to give the required cost per mile.
In practice, where an operator did in fact commence wit!' a new 7-former and maintained an accurate costing system, he would transfer at weekly or other regular intervals the appro. priate accumulation of depreciation costs, relative to the mileage run, to a sinking fund. It would follow, therefore, at the halfway stage, namely 75,000 miles, that he would have accumulated in the sinking fund half the balance to be written off.
Consider now the position of a newcomer to haulage who expected to reduce his operating cost by purchasing a used vehicle. Assuming it was just such a 7-tanner which had already run 75,000 miles. It could be that the price he paid would be approximately half the original cost. Superficially it would seem that, by calculating depreciation in a similar manner as before, but commencing with the new and lower initial price, the depreciation cost per mile would be lower.
Two replacement policies would generally be available to this type of operator. If he had no ambition eventually to own and operate a fleet of new vehicles, he could continue to purchase vehicles half-way through their useful life. Where this policy did in fact apply it will be obvious that the baiance to -be written off as -depreciation—albeit a smaller amount than would apply to a new vehicle—would then have to be divided by 75,000 and not 150,000 miles. The resulting depreciation cost per mile would then be similar to that applying to a new vehicle. No advantage, therefore, would be derived by way of a lower depreciation cost per mile through operating a used vehicle purchased at a price lower, relative to mileage run, than the initial cost when new.
Alternatively, if the newcomer purchased a used vehicle initially only as an interim measure until such time as he could afford to obtain a new vehicle, he would be compelled to set aside even larger amounts than the operator of a new vehicle. He would, in fact, have to provide an additional sum equal to the amount which would already have accrued in the sinking fund of the original operator from the time the vehicle was purchased new until it was sold to the newcomer.
It is also significant that the largest operators with experience and costings appropriate to their size not only prefer to operate new and modern fleets but have, of recent years, increasingly adopted policies of even more frequent replacement. Complete and accurate statistics are proving that when such a policy' is applied, not only is there little or no increase in operating costs, )ut there is the positive advantage of greater earning capacity )f the vehicle because of its increased availability for service.
I now -propose to give an example of the effect of alternative nethods of calculating depreciation as applied to a 15-cwt. van, itted with oil engine. The variation will be relative to the adoption of time or mileage as a basis of calculation. • No attempt will be made to adjust the cost of depreciation year by jear, or at other intervals, relative to the decreasing value of the vehicle. Whilst this may be -necessary for purposes Other than 3btaining the operating costs of the vehicle, so as to determine the assets of a business at any .given time, the introduction of this variation can only result in further complication to little or no purpose when applied to the actual operation of a vehicle. It would obviously be unrealistic to quote charges, for example, varying according to the age of the vehicle provided for the ausfolner, quite -apart from the restrictions it would impose on the flexibility of traffic arrangements.
THE first of the five items of standing costs of this 15-cwt. van, namely licences, would amount to £20 per annum, the equivalent of 8s. a week on the basis of a 50-week year. This allows for two weeks a year when the vehicle may be off the road for major repair or driver's holidays. The total cost of wages will be reckoned at £9 14s. 8d. This includes additions to the basic wage applicable to an adult driver in Grade I areas as laid down by the Road Haulage Wage Regulations R.H.(70) to allow for National Healthand voluntary employers' liability insurance contributions. An adjustment has also been made to allow for two weeks' holiday with pay.
Rent and rates in respect of garaging the vehicle are nominally assessed at 7s. 8d., whilst vehicle insurance is reckoned a further 9s. 7d. a week. This latter figure is inclusive of the recent increases in commercial vehicle premiums. With an initial cost of £630, interest charged at a nominal rate of 3 per cent. would cost 7s. 6d. a week, giving a total standing cost of £11 7s. 5d. a week, Where the miles per week run averaged 400 the standing cost per mile would be 6.82d. Correspondingly at 200 miles a week the cost would be 13.64d. and at 100 miles a week 27.29d. per mile.
Although remarkable economies have been reported by operators of 15-cwt. vans fitted with oil engines, it will be assumed that in this instance the average rate of fuel consumption is conservatively estimated at 33 m.p.g. With fuel purchased in bulk at 3s. 101d. per gallon, the resulting fuel cost per mile will be 1.41d. Lubricants add 0.20d. per mile and tyres 0.43d. This latter calculation is made on the basis of an expected mileage life of 20,000 from a set costing £45.
Maintenance is calculated to cost 0.84d. per mile and depreciation 1.64d. A mileage life of 75,000 is assumed for this 15-cwt. van whilst the method of calculating depreciation is as already described. The total for these five items of running costs is thus 4.52d., giving a total operating cost of 11.34d.
In contrast to the corresponding calculation of the standing cost per mile at 100 and 200 miles a week, respectively, it is necessary to make adjustments to the separate costs of maintenance and depreciation before determining the appropriate running cost per mile. Because some of the maintenance tasks, such as washing and greasing, are generally undertaken weekly or at other regular time intervals, the maintenance cost per mile increases at lower oVerage mileages a week. For the sake of simplicity, however, such adjustments are made in "The Commercial Motor Tables of Operating Costs" only within
the limits of the lower ranges of weekly mileage. At 200 miles a week the maintenance cost of this 13-cwt, van is therefore estimated to be 1.20d. increasing to 1.70d. at 100 miles per week. Although, as already explained, depreciation is basically calculated relative to mileage, it is appreciated that when the average mileage is particularly low some allowance must be made for possible obsolescence. The depreciation cost per mile in this instance is therefore adjusted to 1.80d. per mile at 200 miles a week and 1.97d. at 100 miles a week. The addition of these adjustments gives a total running cost per mile of 5.04d. at 200 miles a week and 5.71d. at 100 miles a week. Added to the appropriate standing costs, the total operating cost per mile is thus 18,68d. at 200 miles a week and 33.00d. at 100 miles a week, .compared with 11.34d, per mile as already calculated when averaging 400 miles a week:
In the accompanying table the variation in mileages is, for convenience, set ma alternatively per week; Per 50-week year and per five years. The weekly mileages 'range from ,100 to 500 in steps of 100. The results obtained from'alternative methods of calculating depreciation are then shown, • 0 ..c.m.,•
1.97 1.80 1.64 1.64 1.64
BASED on the estimated mileage life of 75,000 for this -15-cwt. van, the depreciation cost per mile as shoWn in: column A is given without any adjustment. It will' he 'seen that if the original estimate of' 75,000 miles as the vehicle .life is in fact adhered to, then the van will have to be operated for 15 years when the weekly mileage averages only 100. Whilst this may well be achieved in some instances, the attractiveness of the van,' as well as other factors, may make the operation of this vehicle over such a period of time impracticable. As a result some adjustment to the basic calculation of 1.64d. per mile would be advisable when the mileage was exceptionally low. P If, however, depreciation is calculated on a time basis-and in this instance a period of five years is accepted-wide variation in the resulting cost per mile is obtained. Thus at 100 miles a week the cost of depreciation per mile is more than five times the corresponding cost when the vehicle averages 500 miles a week.. At 300 miles a week the cost per mile, when calculated on a time basis, coincides with -the amount obtained when a, similar calculation is made on a mileage basis. This situation arises because the mileage run, when averaging 300 miles a week, over a period of five years happens to be the same as the basic estimated mileage of thevan, namelY 75,000.
The cost shown in column B appropriate to Weekly averages of 400 and 500 miles could only be obtained' if the original basic estimated mileage life of the vehicle (75,000) proved too conservative, since over the chosen five year period 100,000 and 120,000 miles respectively would then have been run.
Some operators prefer to halve the amount to be written off as depreciation and then calculate the depreciation cost per mile equally on both a time and mileage basis. The results obtained from this method are shown in column C. Although the variation in the cost per mile from 3.28d. at-100 miles a week to 1.32d. at 500 miles a week is substantially less than the corresponding variation in column B, there is still a difference of over 100 per cent, between the maximum and minimum costs.
Under exceptional conditions, when either low or high mileages were run, it must be admitted that any one method of calculating depreciation cannot be appropriate under all circumstances. Nevertheless it is important that a major objective in commercial vehicle costing-namely simplicity-must not be lost sight of. It is for this reason that the method by which the results obtained in column D has been adopted in this series of articles and in "The Commercial Motor Tables of Operating Costs." The depreciation cost is 6rst calculated on a mileage basis appropriate to the type of vehicle-75,000 in the case of this 15-cwt. van. An average weekly mileage appropriate to the category of vehicle is then chosen as a standard below which successive additions of 10 per cent, are made for each mileage group. Thus, in this particular example, 300 miles is taken as a standard weekly average, with 10 per cent, added at 200 miles a week and 20 per cent. at 100 miles a week. Whilst it is agreed that this formula will still not meet every set of circumstances, it is considered to be a fair compromise whilst retaining comparative simplicity in
calcul ation. S.B.