ESTIMATES preferable to ACTUAL cost figures To Rely on Current
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Costs in Estimating Rates May be Misleading, Because Important Items May be Overlooked. The Only Satisfactory Solution of the Problem is a Budget of Expenditure THIS is the second of two articles in ahich 1 am relating a conversation I had with an owner of six 2-tonners, who, as I told him, was going a lone way astray in his methods of costing, particularly as be used those cost figures in assessing rates. When I concluded the previous article I was discussing with him the subject of depreciation.
He had been depreciating over three years vehicles running no more than 10,000 miles per annum, and then forgetting about depreciation. 'fire consequence was that his ideas of the rates he should charge were very wide of the mark. When the vehicles were new his rates were excessive, but after three years his charges were insufficient: the period of insufficiency was seven or eight years, as; against the three years when his dharges were excessive. He would, of course. be unable to get work during the period when his rates were high, but would find plenty when they were insufficient.
I had been demonstrating to him that for a haulier. depreciation should be assessed on mileage, for the simple reason that depreciation based on mileage measures the life of the vehicle in the miles it will run. His idea of depreciating over three years came from the counsel of a friend. He did not appreciate that that friend's vehicles were covering mileages about three times greater than his arid doing much harder work, so that whereas a period of three years was probably ample for the other operator's vehicles, 10 or 12 years would cover his own.
Provision for Obsolescence
Another point Which arises out of the calculation i.•)f depreciation by mileage is that, where the mileage is very low, the vehicle is likely to become out of date before it is worn out, and if the business be such that it is unlikely to he profitable for an operator to run obsolescent machines, he will have to make provision for that contingency in his figures for depreciation. In other words, he will have to allow for obsolescence.
"The method of providing for obsolescence.1 said, "in respect of the vehicles of the type you use. on the understanding, of course, that obsolescence is a factor which must be taken into consideration, is to add 5 per cent, to the wear-and-tear allowance, which we have already discussed. for every thousand miles per annum which the vehicle runs Less than 24,000.
"In your case, for example, the annual mileage per vehicle is 10,000. That is 14,000 fewer than 24,000, and to provide for this difficult factor of obsolescence it is necessary to add 14 times 5 per cent., that is 70 per cent., to the lcl. per mile which we have already calculated as being the proper allowance for wear and tear. That brings the figure to 1.7d, per mile."
"Do you mean to tell me," he asked, "that another operator, using the same type of .vehicle as I am using, would have to allow 1.7d, for depreciation. whereas I need allow only Id. per mile? I can't see that."
"I will try to explain it. Look at it in this way. Your allowance of Id. per mile is sufficient to provide for your vehicles running 125,000 miles, which is actually 121 years— this No. 1 machine appears to have been doing rather more than 10,000 miles per annum during its life.
"The othet kind • of operator, who cannot afford to run out-of-date vehicles, sets aside an additional 0.70d. per mile. so that he will have enough money to replace his vehicle when it becomes out of date, although it will not have
become worn out. On the basis of 10,000 miles per annum, he will have provided sufficient to buy a new vehicle in about seven years. Acmally, he will want it before seven years have elapsed, but as the vehicle has not run such a big mileage he will probably get a better price for it. and that will make up the difference.
" Does that apply in every case? " he asked.
Not exactly to that extent," I answered. "The figures depend upon the type of vehicle. Yours is one which 1 would assess as having an average life of 100,000 miles. At least, that is the figure 1 would take to assess depreciation. It might run a greater distance before it was done: on the other hand. I have known many vehicles of that type to crack up at not much more than two-thirds that distance. At any rate, 100.000 miles is the usual basic figure for the assessment of wear and tear on a mileage basis,
240,000 Miles for a "Heavy"
"1 he more substantial types of vehicle, like maximumload four-wheeled oilers, six-wheelers and eight-wheelers, are usually built to last longer. A moderate estimate of the life of a vehicle of that type is 240.000 mites and the assessment of obsolescence would he after a different fashion.
" Let me take an example. Assume the case of a fourw heeled maximum-load oil-engined vehicle costing £2,400. Now remember what I told you about getting at the depreciation value. First of all we take away the cost of a set of tvies, and for the sake of simplicity I will assume that to be £150. That leaves (2.250. Next, assume that on resale. when this vehicle had done 240,000 miles, or according to its condition when it had reached that mileage, the amount was 1:250. .[hat leaves a basic figure of £2,000.
"Asaessing the wear-and-tear allowance, just as we did in the other case, I get exactly 2d. per mile. That 2d. is what 1 call the basic figure for depreciation. and it applies so long as the vehicle covers not less than 48.000 miles per annum. just as in your case I said your figure would apply so long as the vehicle covered not less than 24,000 miles per annum.
A Special Case of Depreciation
In the case of this heavier vehicle, Imaever. the addition
to allow for obsolescence is at the rate of 5 per cent, for every 2,000 miles per annum by which the vehicle mileage is less than 48,000. If, for example. the vehicle does 28,000 instead of 48.000 mites, the difference is 20,000—that 13, 10 times 2.000 miles per annum less than the basic figure— and we must add 10 times 5 per cent., which is 50 per cent., to the basic figure for depreciation, which would thus be 3d, per mile instead of 2d."
" But suppose a vehicle like mine does over 24.000 miles per annum? Do we reduce the allowance for depreciation?" "No," I said, "That figure for depreciation is based caa the vehicle's lasting 100.000 miles, and it is only when the mileage falls below 24,000 per annum that there is any need to make a correction to the Id. per mile which I gave you. If it were doing more than 24,000 miles per annum, the odds are that, when it had run 100,000 or 120,000 mites, it would be worn out and would be replaced."
"Thank you very much." the haulier said. "Now, what about this budgeting. which I didn't quite understand?"
"I think the best way in which I can make you appreciate the importance of budeeting," I said. "is by reference to these very figures which we have in front of us for the cost R13 of operation of these vehicles for a quarter ot a year. You take these out regulaily. every quarter, do you?"
"Yes," he said, "regularly." .
I looked carefully down the figures, then said: "Now look. In this ,particular quarter there are no entries against tyres and only a few insignificant items under the heading of maintenance. Would you regardthat as normal?"
• "Ohl no," he said. "As a matter of fact„I think this is a very good quarter."
"In other words," I said, your costs for that quarter are very much lower than normal, so that if you were to base rates on those figures, you would probably be in trouble next quarter."
"Yes, I might," he said.
To repeat the conversation at length would take up-too much space. The sense of the argument, however, is too good to overlook. The moral is the point made -in the previous article, in the course of the discussion on depreciation, namely, that actual figures for cost of operation are not often as useful as estimated figures, at least in fixing rates.
A Paradox
This may be hard to understand. To most people the idea must seem absurd, because, on the face of it. it would seem that actual costs must be a more certain guide, as a basis of rates assessment, than estimates, which, in many cases, are little removed from guesswork.
Part of the explanation lies in what l have already said about the mistakes which are likely to arise from making entries only of actual expenditure on major accounts, these expenses arising at irregular intervals and thus upsetting, for the time being, the balance of costs. Immediately before such an important entry the costs will seem to be low. Immediately after they will appear unduly high. The advantage of budgeting is that it irons out the valleys and peaks of cost There is, however, more in it than that. Every haulier must know that one year's cost figures differ materially from those of the next or previous year Take the case of a low-priced vehicle engaged on a rough job and covering a fairly high mileage each year. The figures for operating costs during the second year are likely to be double those of the first year. Neither set of figures is, therefore, of any value in assessing rates.
This difficulty occurs in dealing with maintenance. Maintenance. is a two-part item of cost. One part is concerned with routine work, such as washing and polishing, and painting or cellulosing. Whatever the practice of the individual as regards trequency of these operations, the only satisfactory way we have of dealing with the cost is to make provision for it before the work is done. In respect of painting and varnishing alone, a difference will arise on a year's working of anything from 130 to £100. Those are the items referred to in "The Commercial Motor" Tables of Operating Costs as maintenance (d), and it is essential to estimate their cost in advance.
Assessing M41ntenance Costs
The other part of maintenance is even more difficult to assess and more liable to give rise to error. I am referring now to running repairs to the chassis and bodywork, and overhauls—minor or major—to engine, transmission and other components, none of which can be omitted if the vehicle is to continae to give good service. What this business of maintenance can, and ought, to mean in respect of actual work to be performed, and as regards the actual expense of carrying it out, has been discussed time and time again in these articles.
During the first six months of use of a vehicle,expenditure on maintenance in both Of these classes is likely to be low. In the lest six months of a vehicle's life the maintenance costs can be very high. Any attempt to calculate rates on
the basis of actual costs in -either of these. two extreme periods of six months would be absurd. An estimate of what the cost is likely to be during the whole life of the vehicle must be =cit.
That life, expressed in miles, divided into the expected total cost of maintenance during the whole of that period, is the cost per mile. This is the only figure which is of any use as a measure for estimating costs and calculating rates.
At this point I may, with advantage, again refer to the conversation, part of which i have reported.
The haulier said: "How am I to get any idea of what is going to be the total expenditure on maintenance with this new vehicle? "
"From past experience and your own figures for actual costs," I replied "I know we have just said thatyou must not use actual costs, but.what I mean is that you must not use current costs. Your record of costs over the past year or, better still. mier several years, can be used to estimate your future costs. Before it is safe to do that, however, you must be quite sure that the figures which you have in your records are complete and that every halfpenny spent on maintenance has been .entered."
"But suppose I am not sure of that, or suppose that, as in the case of so many hauliers of my acquaintance, there are no actual records of cost of maintenance?"
"In that case you should prepare your estimate by using the figures from 'The Commercial Motor' Tables of Operating Costs. They will be accurate enough for your purpose. At the same time, whilst using these figures as a basis for estimates, you must begin to record your own actual costs, so that you will have the information to check against the figures in the Tables. At the end of a year or so, or perhaps three years, you may find it advisable to revise the figures given in the Tables, either upward or downward, and use the corrected figures in your estimates for subsequent years. Even so, you should still continue to check your actual costs against your estimated costs.
A Common Mistake
"The same thing applies," I continued, "but perhaps not to the same extent, with many operators, as regards tyres. In your case, as i have already noticed by reference to these figures, you can go quite a long while without needing any expenditure on tyres. There are two reasons. The first is your low annual mileage; with the present quality of tyre. you could probably go a couple of years with a new vehicle before you needed to buy a new cover, and if you were to depend on your own recorded figures for cost of tyres you would be sadly out especially if you made the mistake which nine operators out of 10 make. even if they know a lot about costs."
"What is that?" he asked.
"The mistake," I replied, "of not immediately entering in your cost .records. under the heading 'Tyres,' the value of the first set of tyres on the vehicle."
"But why should I do that'? he asked. "I have not spent any money on tyres, apart from what I paid for the vehicle." "That's very easily answered," I said, " and, as a matter of fact, we have already dealt with that point, although you don't seem to have noticed it."
"I certainly haven't," he said. • "Well, just think back a bit," I replied, "and recall how, when we were assessing the figure for depreciation about which we had such a long argument. I said that, in order to get at the figure for depreciation, we first take the cost of a set of tyres from that of the vehicle."
"So we did."
"Well, then," I said, "that means that, having separated the cost of tyres from that of the vehicle, you must reasonably be expected to enter that amount somewhere else, and the proper place to enter it is under the heading of 'Tyres' in your cost records." S.T.R.