Equipment Costing: What You Don’t Track Can Hurt You
Logging companies invest literally millions of dollars in processors,
skidders, and other types of equipment to run their operations. From
an economic standpoint, making an investment in such capital equipment only
makes sense if the revenue generated by the equipment exceeds the cost.
All too often, loggers face the specter of bankruptcy as a consequence of
failing to measure their costs correctly. Just ask Ritchie Brothers.
At Caribou Software
, our focus is on making software that helps contractors make more money.
We use the following equipment cost worksheet in our software to help you evaluate the economics of your current jobs
and to help to develop bids for future jobs. Click here
to request more information on how Caribou Software
can help your business.
Calculating your equipment cost is not only important for measuring your
profitability. It is also important because many mills spend a great deal of
time estimating equipment costs in order to set logging rates.
Specifically, they estimate the costs per productive machine hour that a
contractor should be able to achieve for each machine involved in harvesting
a cut block. They then convert the hourly cost to a cost per ton (or cord or MBF), based on an estimated production per hour ratio.
For example, if the hourly cost of a buncher is calculated as $150.00, and
it produces at a rate of 75 Tons/Hr, the cost per ton is calculated at
$2.00/ton. This rate-setting exercise theoretically ensures that the
contractor earns enough to cover his equipment costs and earn a decent
return on his investment.
The question, of course, is how to arrive at this hourly cost figure, and
what exactly it should include. There is no set formula for
calculating the cost of a piece of equipment, but an accounting cost
“build-up” approach is fairly common. Under such an approach, one
identifies all the relevant expenses on an annual basis and then spreads
them over productive hours in order to arrive at an appropriate hourly cost.
This paper explores the types of costs typically included in such a build up
and identifies some of the key issues involved in measuring the costs.
The following equipment cost caclulator allows you to build up to the hourly cost
of operating your equipment. The resulting costs are expressed both on an hourly basis
and on a per ton basis. In order to make the calculator work, just fill in the yellow input
fields and the page will automatically recalculate.
1/ In this worksheet, we focus on production hours, meaning the costs are expressed in cost per production hour.
To the extent that the machine is idle, any costs associated with it being idle are spread across the productive hours.
The obvious implication of this is that you need to earn a higher rate to cover your costs on machines that are not heavily utilized.
2/ We recommend that you exclude the cost of tires. Tires are better treated as an operating expense and should not be included in the cost basis.
The cost of tires is entered below in Sectio IV.
3/ Salvage Value is defined as the price that the equipment can be sold for at the time of its disposal.
Used equipment rates vary widely throughout the world. Many factors affect the future resale or trade-in value, such as the hours worked or the condition of the machine,
the type of jobs and operating conditions under which it worked, and the physical condition of the machine.
Often times up to 40 to 50 percent of the value of the machine will be lost in the first quarter of the machine's life and up to 70 to 75 percent of the value will be lost
by the time the machine reaches its half-life. The salvage value percentage is often estimated as 10 to 20 percent of the initial purchase price.
4/ Annual Average Equipment Value is the average value of the equipment over its lifetime. This value is calculated as: ((P - S)/2) + S, where P is the total purchase cost
of the equipment and S is the salvage value. This formula assumes that economic depreciation is straight-line -- a simplfying assumption that allows us to level out
the machine cost over each year of its life.
Just how much of an effect does our straight line assumption have on the overall equipment costing estimate? Suppose we take a machine that costs
$100,000, lasts 5 years, and has a salvage value of $25,000. The straight line method will yield an annual cost of $15,000, with a present
value of $56,862 (at a 10 percent discount rate). If we use the tax rule of 30 percent declining balance depreciation, the present value over
five years is $67,173 -- a difference of 18 percent. Though using the straight line method is simpler, we must recognize that it tends to
introduce a downward bias in the cost of the machine.
Having noted this difference, it is important to recognize that maintenance expenses actually behave in an offsetting manner to the pattern of economic
depreciation. Maintenance expenses tend to be smaller at first and then grow over a machine’s life. So, if you choose to use the
straight-line approach for depreciation because it is easier, you should also use an ‘average’ level for maintenance and operating expenses (where
the average reflects an expectation of expenses over the life of the equipment), and not just the current year. For example, if you use the
current year expenses for a new machine, this amount will understate the average expenses over the life of the machine unit. The point here is
that if you level out depreciation over the life of the machine, you should also level out the maintenance expenses as well.
5/ A common rule of thumb is that lubricants and grease cost 5 to 10 percent of the cost of fuel. The rate shouild be higher when operating in heavy dust, deep mud, or water.
For machines with complex and high pressure hydraulic systems such as forwarders, processors, and harvesters, where the consumption of hydraulic fluids is highr, the rate should also be bumped up.
6/ The Employee Load Factor should include all employer taxes (payroll taxes) and employer-paid benefits (e.g., health insurance, savings plans).
A load factor of 25.0% is not uncommon.
Other indirect employee costs are somewhat more complicated. There are a variety of business practices amongst logging contractors and
their mills with respect to the treatment of administrative overhead expenses. These expenses are a fact of life for any company, no matter
what industry. They include such items as: the payroll costs of your accounting and clerical staff; office computer & software costs;
the payroll costs of your supervisors when they are managing your operations or training new employees rather than running a piece of harvesting equipment;
the cost of your own company pick-ups used to transport your workers to and from a job site; your office rent and office equipment; the cost of your company Christmas party;
and any other costs incurred to run your business that does not fall into one of the categories above.
Some mills provide an explicit dollar amount per volume harvested to cover administrative costs. If your mill does not provide compensation for
administrative overhead in such an explicit way, you will need to treat these costs as a fifth cost category that should be accounted for when
building up to your hourly equipment cost rates. These costs are as critical a part of running a successful, long-term logging operation as the
repair and maintenance costs associated with your equipment, so make sure that you are compensated for them.
In the worksheet, you can use the "Other costs" input field to account for any other indirect costs (or direct sosts).
7/ The Return on Capital is the return you require in order to make the investment in the machine. A common metric used for this value is
between 10 to 15 percent. For example, if you have a machine whose average value is $400,000 and you require a rate of return of 10.0%, this means that
you must make a profit of at least $40,000/Yr, otherwise you should not make the investment. Including this as a "cost" in the calculator, means that if your
rates are such that you cover your costs in full, you will have also earned your required return.
8/ Maintenance and Repairs includes everything from simple maintenance, such as replacing filters and hoses, to the periodic overhaul of engine, transmission,
clutch, brakes pumps, and other major equipment components, for which wear primarily occurs on a basis proportional to use. Note that the cost here includes not just the parts
required to complete a service, but the fully-loaded labor cost that the work entails.
An owner's experience with similar equipment and cost records under typical working conditions is a valuable source of data for estimating these costs.
If experienced detailed cost records are not available, the hourly maintenance and repair cost can be approximated as a percentage of annual depreciation expense.
The table below provides some rough industry estimates.
|Rubber-tired skidder (cable)
|Rubber-tired skidder (grapple)