Chapter 4 Cost Control and Budgeting

Chapter 4Cost Control and Budgeting

STUDY OBJECTIVES

At the end of this chapter students will be expected to:

Explain the importance of vehicle/fleet costing.

Understand the factors which affect vehicle costs.

Have insight into the different types of costs.

Be able to identify the costs to be considered when charging for transport.

Understand the principles and types of budgets.

Become well-acquainted with the importance and role of managing fuel, oil and tyres with regard to vehicle costs.

4.1 INTRODUCTION

4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING• Profit is only part of the revenue received by

carriers; • Rest of the income (revenue) must cover the

costs.• Income is the charge to users for providing the

transport service. • The charge (price) is the freight rate or the cost of

the ticket to a passenger.

4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’

• Costing is a facility which provides essential information upon which transport management can base operating decisions.

• In order to have efficient and profitable operations, such decisions must be based on factual information rather than guesstimates.

• The value of the transport service to the user, however, is largely a subjective concept.

Function of doing costing:Costing for the purpose of profit calculationCosting with a view to tariff-setting or tendering

(what rates to charge, and indications on how rates may be altered in the case of strong competition)

Costing in order to arrive at certain norms or standards with which the efficiency of a transport operation can be measured


Function of doing costing cont’:Costing with a view to providing operators with

industry averages which can be compared with their own cost figures

Costing for the purpose of checking the performance of individual vehicles or groups of vehicles

Costing to help with decisions regarding which vehicles to purchase, based on vehicle cost performance


Function of doing costing cont’:

Costing aimed at anticipating the end of a vehicle’s economic life (when it becomes prohibitive from a cost point of view to operate the vehicle and it should be replaced)

Costing in order to obtain an indication of the suitability of the vehicle and of its components and parts


• Intermodal competition refers to provision of the same transport service by different modes (truck, rail, ship, pipe, plane).

• E.G. competition between a truck company and a railway company to transport ferrochrome

• Intramodal competition refers to competition among the same mode (e.g. trucks) in the provision of the same transport service.

• E.G . Competition between two trucking companies to transport logs for Mondi


Why costing is so important: 1) Owing to high rates of inflation affecting

input costs such as fuel, oil, tyres, maintenance, labour, etc., operators must critically examine their expenditure in comparison with their revenue and budget.


Why costing is so important cont’:

2) Transport managers need to justify the financial performance of their business when seeking capital loans from banks.

3) Operators need to justify rate increases to customers, with sound and detailed reasons.


Why costing is so important cont’: 4) Benchmarking - It is necessary for operators to

compare their own transport costs with those of other operators (intramodal comparison) or other modes of transport (intermodal- rail, sea, air)

5) Operators must continually determine whether scarce economic resources (land, labour, capital) are used effectively.


DEF:• Costing of vehicles is the process of identifying,

calculating and recording every item of expenditure incurred in the purchasing, maintenance, operation, supporting, administrative and management functions - necessary to control their use.

• Total operating costs are then analysed per unit of load, e.g. ton, m^3, passengers, etc.


Financial Reporting (Accounting) vs Costing• Financial Reporting (Accounting)– Income Statement– Balance Sheet– Cash Flow Statement– Historical (takes place after events occur)– Strict Accounting procedures– Done by Auditors and Accountants


• The Costing system – Provides accurate and uncomplicated info on how

each part of the operation performs. – There is no prescribed format.– Includes all the relevant cost items to obtain a

clear and accurate picture of vehicle/fleet costs.– Categorise the costs into fixed, variable and

overhead costs. – This simplifies cost analysis and assists in tariff-

selling.


4.1.2 PRICE CALCULATION

• Costing for the purpose of price calculation• Demand and other market factors often

dictate a transport rate which does not reflect the costs of producing the transport service.

• It is justifiable to base the rate on marginal costing when transport equipment is under-utilised.

• The carrier may, because of actual tactical business considerations, decide to accept consignments at a tariff that does not fully cover the total costs, but covers all the costs associated with undertaking the service (direct operating costs).

• This method of minimum-limit tariff quoting is known as marginal cost coverage.

4.1.2 PRICE CALCULATION cont’

Cost knowledge is important in price-setting, both for the:

1. operator so that he at least knows to what extent his rates differ from his costs,

2. and for the transport user so that he can judge the rates quoted to him.

4.1.2 PRICE CALCULATION cont’

4.1.3 VEHICLE REPLACEMENT

Issues:1. Replacing vehicle too early:– Vehicle still has usable life

2. Replacing too late:– Vehicle has become very costly

• Proper knowledge of a vehicle’s maintenance costs it is possible to predict the time when a vehicle will be nearing the end of its economic life.

4.1.3 VEHICLE REPLACEMENT cont’

Factors to take into considerations when deciding to replace vehicle:

availability of finance, cost of a new vehicle, cost and availability of spares and cost and availability of workshop labour, cost and availability of future work of the

vehicle,

4.1.3 VEHICLE REPLACEMENT cont’

4.1.4 COST COMPARISONS

• Compare Actual Cost to Standard Cost

• Standard Cost indicates what cost and performance should be under normal, not ideal, conditions.

• The difference between the Actual Cost and the Standard Cost will give the Variance

(Actual Cost - Standard Cost = Variance)

• When the difference or variance is abnormally big then steps will have to be taken to decrease it.

4.1.4 COST COMPARISONS cont’

4.1.5 FACTORS AFFECTING VEHICLE COSTS

Factors affecting vehicle costs include the following:

A. The Driver• Correct recruiting and training• If the driver handles vehicle badly, potential fuel

saving will not be realised.• Driver must operate engine in optimum range

(where the relation between: road speed, engine speed and fuel consumption is at a optimum)

• Driving technique also influences the fuel usage, maintenance costs and lifespan of the vehicle.

4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’

B. Accidents and Insurance Claims– Accidents affect the availability of a vehicle

(making vehicles unavailable)– Other vehicles will have to stand in for the laid-up

vehicle (by means of rental and the use of spare capacity or overtime).

– This increases operational costs– also affect vehicle and product insurance as well

as excess payments.

C. Operational Characteristics– Fuel consumption and vehicle wear and tear are

affected by the topography (mountainous terrain) and types of roads (gravel, tar, cement) traversed.


D. Vehicle/Fleet Utilisation (load, distance, time)– strive to have a full load on the vehicle (mass or

volume), for most of the distance and for as many hours as possible in a day.

E. Packaging– Good packaging techniques could result in fewer

incidences of theft and breakages and claims.– E.g. shrink wrapping of packets of sugar etc.,

containerisation, strapping down of loads, etc.)


F. Warehouse Location• E.G.• A warehouse situated 8km from the ‘optimum

point” (in relation to customers) involving 30 delivery vehicles, would result in an additional R432 000 (30 vehicles x 16km per vehicle per day x 225 working days x R4 per km) per annum to operate the fleet.


G. Standardisation (of vehicle)– reduces parts inventory, – Reduces diverse training needs of mechanics and

drivers, – Reduces maintenance problems, etc. – Standardisation thus leads to lower transport

costs in the longer term.

• ENDEND


H. Strikes and labour unrest– Good labour relations normally result in a

motivated workforce where absenteeism is low, and productivity is high.

I. Lead times– This term refers to the time lapse between

receiving an order, and the execution thereof.


U. Management proficiency– The better the decisions the lower the costs, and

vice versa– Important that managers are well-educated and

well-informed about their jobs and that their performances are monitored on a regular basis.

K. Vehicle selection– Important that the correct vehicle is selected for

the job that is to be undertaken.


4.1.6 PLANNING A COSTING SYSTEM

The step-by-step sequence for the establishment of a vehicle costing system is as follows:

(a) Preparation(b) Define the objectives(c) Design the system(d) Implement the system(e) Maintain the system

4.2 COSTS

4.2.1 FIXED COSTS

There are certain constantly present cost elements in road transportation undertakings for the lifespan of a vehicle, independent of the amount of work it has done.

These costs have to be paid even when the vehicle is not used.

• All the fixed-cost elements put together indicate the total costs of owning a vehicle (not using it) for a specific period.

4.2.1 FIXED COSTS cont’

The most important elements of fixed costs are:a) Licence fees– This is a fixed cost as it is usually a fixed amount

paid annually whether the vehicle is used or not.b) Insurance– This is usually a fixed amount paid annually. – This includes only the insurance of the vehicle(s). – Goods-in-transit insurance for loads carried is

included under overheads.

c) Salaries/wages of drivers– This is a fixed amount paid to a driver whether the

vehicle is running or not. – This amount includes his salary plus all other fixed

extras such as housing subsidy, medical aid holiday bonus, etc.


d) Rent and tax en premises• In order to allocate the cost of premises to the

vehicles, the part of the premises allotted to parking has to be determined.

• This is then incorporated in the total amount for rent and tax to determine the amount per vehicle.

• This can be done in one of two ways:i. Divided by the total number of vehiclesii. In proportion to the size of the vehicle


e) RETURN ON CAPITAL (opportunity cost)• It must be kept in mind that when money is borrowed

to purchase a vehicle, interest will have to be paid on that loan;

• Therefore, in this instance, the cost of the capital is the interest paid on the loan.

• When a vehicle is purchased with cash, it must be kept in mind that the amount could have been invested and interest received thereon.

• This interest (opportunity cost of capital) must also be included; in this instance, as the cost of this capital.


f) DEPRECIATION• Depreciation - a certain amount of the income

of the present vehicle is kept separate with the aim of making provision for the new vehicle.

• The operator has to decide in terms of depreciation, the period for which he is going to use the vehicle, or what the life expectancy is in terms of years or kilometres.


• If the life expectancy of the vehicle is, for example, five years, the fleet manager must know where the money to purchase a new vehicle in five years’ time will come from.

• A method is therefore needed which will ensure that at the end of the five-year life of the vehicle, sufficient funds have been accumulated to pay for its replacement.


• If sufficient provision has not been made the operator will have to dip into his own capital or seek financial assistance.

• The original cost of the vehicle plus all the extras, minus the cost of a new set of tyres (these are included under variable costs) minus the resale value of the vehicle, will determine the amount for depreciation.


• The straight line depreciation method divides the cost by the life.

• SL = (Cost – price of tyres – residual value) / Life


Depreciation Example

• A delivery van is purchased for R250 000. The expected life is 5 years. The tyres are valued at R10 000 and the expected repurchase price (second hand value) after 5 years is R90 000. Calculate the annual depreciation as follows:

• (R250 000 – R10 000 – R90 000) / 5 years = R30 000 per year

• Each year for 5 years R30 000 would be expensed.

4.2.2. VARIABLE COSTS (RUNNING COSTS OF VEHICLES)

• Variable or running costs are those costs which are incurred solely when a vehicle is operating.

• These costs have nothing to do with owning the vehicle, or the expenses involved in running the business as a whole.

4.2.2. VARIABLE COSTS (RUNNING COSTS OF VEHICLES) cont’

• Elements for variable costs are: (a) Fuel cost– There are different reasons for keeping fuel

records:1. It is a high individual cost item costs of a vehicle.2. It can easily be stolen.3. High fuel consumption can be an indication of

other problems:

Engine problems:Problems with the engine efficiency Drivers who fiddle with the pump to get more

power and higher speedDrivers choosing wrong routes, which are not

as direct as could be Poor driving techniques


(b) Tyre cost(c) Maintenance cost– These costs can be subdivided into material costs

and labour costs.(d) Oil and lubrication

These costs are not included in maintenance costs and are separately included in the costing system.

(e) Overtime


4.2.3 OVERHEAD COSTS (ESTABLISHMENT COSTS)

• Overhead costs collectively describe all those expenses incurred in running a transport business which cannot be directly attributed to any individual vehicle.

• Management’s salaries, the rental of the premises, electricity accounts, telephone bills, etc. have to be paid whether or not vehicles are idle, for example due to lack of work or mechanical failure.

4.2.3 OVERHEAD COSTS (ESTABLISHMENT COSTS) cont’

The following are categories of overhead costs:Management costs (e.g. salary of the

transport manager)AdministrationWorkshops and storesBranch officesSales and publicity

categories of overhead costs cont’:Auxiliary fleetProfessional servicesTelephone/telex/faxRent and ratesBusiness cars, travelling and accommodation

expensesTraining, journals, conferences, etc.Advertising


Insurance, excluding specific vehicle insurance, forms an important part of general overheads, e.g.:

• Building insurance• Content insurance• Goods-in-transit insurance• Public liability cover• Life cover• All-risks insurance


Two methods of apportioning overheads are available:

1. A direct and equal division of costs between the total number of vehicles in the fleet.

2. A division of the total overhead cost between the total tonnage cubic capacity, revenue-earning potential, etc. is more feasible


4.2.4 TOTAL OPERATIONAL COST OF VEHICLES

• Fixed costs, variable costs plus overhead costs, together make up the total operational cost of vehicles.

Total operational cost of vehicles = Fixed costs + variable costs + overhead costs

• 4 x 2 rigid commercial vehicle– Total number of wheels = 4– No. of driving wheels = 2– Note that a pair of dual wheelsis classified as one wheel

4.2.4 TOTAL OPERATIONAL COST OF VEHICLES cont’

• Increasing revenue trends (especially in inflationary) are not sufficient evidence that the operator is performing well, because additional revenue is of no value unless it is sufficient to cover the extra costs incurred in earning that revenue, and also to provide for a reasonable (predetermined) profit margin.

• Costing enables the operator to determine whether work carried out for particular customers is providing sufficient revenue to cover the total cost of providing that work.

The use of costing information can also determine:Whether the fuel consumption is what it should

be.Whether the amount being spent on

maintenance and repairs is excessive/adequate.


Whether the vehicle is performing according to the planned availability, and if not, why not?

Ratios of labour costs versus output (kilometres, tons, etc.)

Whether tyre costs are acceptable, etc.


4.3 CHARGING FOR TRANSPORT

• 4.3.3 CALCULATING CHARGE-OUT RATES

• Note: As actual costs cannot be known at the time of setting the charge-out rates, budgeted costs have to be used.

4.4 BUDGETING

4.4.1 INTRODUCTION• A budget sets the objectives for the business

and has as a final aim: the forecasting of profit.

4.4.3 TYPES OF BUDGETS

a) Operating budget– the actual running costs of a department

b) Capital budget– which contains the plans for the acquisition of

additional capital equipment to meet the requirements for the expansion of the company,

– as well as the approved programme for the replacement of existing capital assets

4.4.3 TYPES OF BUDGETS cont’

(a) Operating budget• The operating budget is the budget which will

be prepared to determine the day-to-day costs of a department for the next financial year

• It would include all costs in order to give the required level of mobility to company personnel and to ensure an efficient customer delivery service

• The following cost areas should be identified in the operating budget:

(i) Personnel - headcounts and costs including salaries, wages, pensions and medical aid contributions.

(ii) Land and buildings - floorspace, rent lighting, water, telephones, etc.

4.4.3 TYPES OF BUDGETS cont’(a) Operating budget cont’

(iii) Company-owned transport - depreciation, licences, insurance, tyres, repairs and maintenance costs, drivers’ costs, fuel, etc.

(iv) Internal transport - including maintenance costs for internal transport such as works trucks, materials handling equipment and loading facilities.


v) Vehicle hiring - including the hiring of trucks, cars and delivery vans to supplement the company-owned fleet.

vi) Freight - the cost of shipping goods by air, rail, road and sea transport, and also mail.


(vii) Administration - clerical services, stationery, office requisites, copying machines, etc.

(viii) Materials and supplies - the cost of packaging materials, cases, pallets, etc.


(b) Capital budget• A capital budget should clearly indicate the

equipment to be replaced during the period as well as the additional equipment which will be required to meet – the needs of the company because of expansions or – the development of new products

• which require different methods of handling and distribution.

• THE END

4.4.3 TYPES OF BUDGETS cont’

Documents

Chapter 4 Cost Control and Budgeting