Computing a Sinking Fund
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"The Commercial Motor" Costs Expert Describes a Simple Method • by Means of Which a Haulier Can Keep Account of Current Expenses, Including the Charge for Depreciation, and Have a Financial Reserve for Meeting Periodic Items of Expenditure IT has been suggested to me that I should deal with depreciation alnd impress readers with the importance of reckoning it on the basis of the present-day costs Of new vehicles. To reckon old vehicles' depreciation on the basis of their original cost is wrong and liable to lead to loss of profits. Present circumstances make the matter more urgent. A lack of realization of the consequences of assessing depreciation incorrectly, matters more nowadays as big sums may be lost.
The subject is of wide interest. Not only hauliers are concerned, but every industry in the country also. Nearly every company chairman making his annual report refers to it, to the effect that as replacement of wasting assets calls for greater expenditure, a correspondingly increased appor tionment of reserves it needed. .
To come hearer home. On page 462 of the November 30. 1951, issue, there is a report of a judgment in a case dealing with compensation to be paid to a haulier whose business. had been acquired by the Road Haulage Executive. In that judgment it was stated " that the applicant contended that no adjustment should be made to the profits of the company, in which provision had been made for depreciation on the 20 per cent. reducing balance method based upon the purchase price of the vehicles. The Executive proposed a similar rate of depreciation, but based upon the replacement cost of the vehicle on the date of transfer..
• Adjustment to Cost
Section 47 (1) of the Transport Act lays down the method to be adopted when calculating compensation to be paid for goods vehicles. It is necessary first to ascertain what it would cost, at the time of transfer, to replace the vehicle with a new model of a similar type. To that sum the following adjustment must be made: 20 per cent, of the reducing value of a vehicle must be deducted in respect of each complete year that has elapsed since the date when the vehicle was first registered. ,
What that means can be shown by a simple example. Take .a vehicle costing 11,000 to-day but only £800 when it was put into commission in 1946. In assessing compensation, the basis for calculation would be £1,000 and not 1800, and the present-day value of the vehicle would be ascertained by deducting 20 per cent, per annum from the reducing value of the vehicle. For the first year, 20 per cent. of £1,000, £200, is deducted. For the second year. 20 per cent. of £800, £160, is deducted. For the third year the value of the vehicle would be taken to be 1800 less £160, that is £640, and 20 per cent. of that is £128, and so on.
I have always put the matter much more simply than that whenever I have referred to depreciation. I have always pointed out that depreciation is to be calculated as a sum to be set on one side by an operator towards the
purchase of a new vehicle when the present one is worn oui It would be of little use to calculate depreciation on the basis of the initial cost of the vehicle if the cost of the new one is likely to be twice as much.
The same subject in different guise has come to me this week in a letter from a reader. He wants to know if he should make some provision for a sinking fund, that is to say, whether he should regularly lay by something towards the purchase of a new vehicle when his present one is worn out. The amount,-he consider, should appear in the Tables of Operating Costs among the standing charges.
have written to him in reply, pointing out that depreciation is the equivalent of his sinking fund and( that, in my opinion, the proper way to calculate depreciation, especially for the purpose he has in view, is on the basis of the mileage. The amount which appears in the Tables under the depreciation is the amount which may be set aside for each mile run towards the purchase of a new vehicle.
Differentiating Between Expenses
On one occasion, 1 applied this idea of a sinking fund more extensively and it may be of interest if I briefly reintroduce it. It first appeared when rate-cutting was rife and the appreciation of the meaning of costs of operation not so widespread as it. is to-day.
At that time, the difficulty under which small operators laboured, and still do, was in .differentiating between expenses which are current and those which are periodic, and again, of the period expenses which occur at reasonably short periods and which are experienced only rarely. The division of the Tables into running costs and standing charges is not sufficient to that end. It has indeed little to do with the matter, for some of the earliest and the less prominent items of -expense, those which must seem to be "current," are included in the standing charges, whilst • the running costs embody items not recurring for upwards of five years.
When a man buys a vehicle there are two items of expense which have to be met immediately. They are insurance and tax. If he is not going to drive the vehicle himself, he next has to think of the wages he must pay the driver—still an item of standing charges. He may have to find somewhere to keep the vehicle and will have to pay rent, and that is also a standing charge. Of these four items, -two, wages and garage rent, recur frequently.
The operator has to buy fuel and oil, and he has to keep doing so all the time the vehicle is running. There again are two items—this time amongst the running costs—which come readily to mind when the cost of operation is being discussed. There are still four items of expense left of which the new owner knows little. One, among the standing charges, is designated " interest " and refers to the
interest on the first, cost of the vehicle. This is forgotten altogether by most owners; even experienced users have confessed to overlooking it when making their calculations of costs.
Of the four, however, that relating to tyres is the least likely to be overlooked, although there again, its importance in the eyes of the user will depend largely upon the mileage
, that his vehicles are 'doing. Then there is maintenance, which looms more or less prominently according to whether the mileage,is -great or small.
The four items of expense which recur at lengthy periods are, in the order of the frequency of their appearance: tyres and maintenance (equal); .depreciation; and interest on first cost. I have already dealt with the first two. The last one never appears as a positive item of expense. It is a loss, the loss on the intettst which would have been earned by the money spent in the purchase of the vehicle had it been invested.
We are therefore left with depreciation, which is, to all intents and purposes, a measure of a sinking fund. It indicates in pence per mile the amount which the operator must put on one side if he is 10 be able to buy a new vehicle when the old one is scrapped.
I need not discuss how it is calculated: an article on the subject appeared in "The Commercial Motor" dated October 26, 1951.
All the items of expense which do not recur frequently can be dealt with in a sinking fund. I have already pointed out that so .far as wages, rent, petrol and oil are concerned they are items of expense which occur with sufficient frequency to ensure that the operator is not only constantly aware of thetm hut knows how much he has to spend. It is the others, tyres, maintenance, depreciation and, to a lesser extent, licence and insurances, which are apt to be overlooked. If, therefore, 1 regard expenditure on wages, rent. petrol and oil as current expenditure then I can arrange to deal with the others in a sinking fund. Table I 'shows how such a fund would appear in relation to a 5-ton petrolengined vehicle.
As regards a machine of that type and size, the lyre cost approximates to an average of 1.4d. per mile; maintenance [(d) plus (e)j, 2.1d. per mile; depreciation, £1 per week and 0.42d. per mile; licences, 12s. per week; insurance, 15s. per week.
There is no point in working to decimals in building up the sinking fund. The object is to make sure that there is safety put by a sum of money which will enable all these expenses to be•met when they arise. It will be sufficient to take the sinking fund for tyres to be 12s. per 100 miles; for maintenance, 18s.; for depreciation on a mileage basis 3s. 6d, per 100 miles and on a time basis £1 per week.
Table I sets out the savings on account ofsinking fund in relation to the operation of a '5-ton lorry, and it should be easy to understand. It is recommended that the haulier who adopts the scheme should enter the money in a separate banking account. He should also draw up a form on the lines of Table I. If the vehicle he operates be a 5-tonner. the figures given in the Table will apply. If the vehicle be of some other size, then he can quite easily calculate the various amounts himself in the way that I have already described.
Across the top of the Table the various items are enumerated as described above, and as a reminder the actual amounts to be set aside per 100 miles or per week are shown. There is a column for the weekly mileage. one for the total to date and another. a fairly wideone, for the
recording of any expenditure which may duly be debited against the sinking fund. The information needs to be entered .cach
It will be noted that the totals to date for each item are shown in the Table. That is the most useful way of keeping a cheek on the figures. as the operator is then able at any time to see how much is standia6 in the fund for tyres. maintenance, or for depreciation (against the time when a new vehicle is needed), for licence or for insurance. The grand total indicates how much s'hetutd be in the bank for this sinking fund.
Now for a brief description of the method of compiling the Table. In the first week enr1%.1 October 6, 220 miles were covered. The amounts to be deposited are shown item by item in that first line. For 220 miles at 12i. per 100 miles, the amount is it 6s. 5d.: that is the sinking fund for replacement of tyres. At 18s. per 100 miles the amount for 220 miles is £1 19s. 7d.: that goes into the sinking fund on account of maintenance, and so on.
It will be noticed that during the week ended November 10. two new vakes were fitted at the cost of 18s. That stun is deducted front the total of the maintenance fund at that dale. Actually, for the 410 miles in that week the amount at 18s. per 100 miles is £3 13s. 8d., and that in the ordinary way would have been added to the total in the week ended November 3, £13 13s. 8d., making-l7 7s. 4d. to be set down opposite the figure for November 10. The 18s. spent on the valves is deducted from £17 7s. 4d., leaving £16 9s. 4d., to be entered in the appropriate space in that column.
A similar procedure is followed in the next week, when four sparking plugs were purchased at an expenditure of £1. During the week ended November 17, the vehicle ran 550 miles and the cost for maintenance at 18s. per 100 miles was £4 19s. In the ordinary way. that /4 19s. would have been added to the previous total, £16 9s. 4d., giving £21 8s. 4d. The £1 for the sparking plugssis therefore deducted, leaving £20 8s. 4d.
In the-next week. November 24, a new cover costing £24 had to be purchased; this puts our column for tyres in the ." red" and in the week following, the brakes had to be refaced at ru cost of £3 10s., and it is that which keeps the figure for maintenance at approximately the same as it was the week before.
The point to note here, however, is that there is no difficulty in paying the bills for these items, because even when this expenditure is met there is still a balance of £48 14s. 10d. The process continues week by week until the time comes when even a new vehicle can be purchased. By putting this money into a separate account, the haulier avoids any mistaken ideas about the profit he is making. Further, the money is always available to spend on essential maintenance, and that undoubtedly helps to ensure that the vehicle is properly maintained mechanically -and otherwise
kept in good condition. S.T.R.