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Chapter 4 Cost Control and Budgeting

Chapter 4 Cost 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.

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Chapter 4 Cost Control and Budgeting

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  1. Chapter 4Cost Control and Budgeting

  2. 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.

  3. 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. 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.

  5. 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.

  6. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ Function of doing costing: • Costing for the purpose of profit calculation • Costing 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

  7. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ 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

  8. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ 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

  9. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ • 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

  10. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ Why costing is so important: • 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.

  11. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ Why costing is so important cont’: • Transport managers need to justify the financial performance of their business when seeking capital loans from banks. • Operators need to justify rate increases to customers, with sound and detailed reasons.

  12. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ Why costing is so important cont’: • 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) • Operators must continually determine whether scarce economic resources (land, labour, capital) are used effectively.

  13. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ 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.

  14. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ 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

  15. 4.1.1 THE IMPORTANCE OF VEHICLE FLEET COSTING cont’ • 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.

  16. 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.

  17. 4.1.2 PRICE CALCULATION cont’ • 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.

  18. 4.1.2 PRICE CALCULATION cont’ Cost knowledge is important in price-setting, both for the: • operator so that he at least knows to what extent his rates differ from his costs, • and for the transport user so that he can judge the rates quoted to him.

  19. 4.1.3 VEHICLE REPLACEMENT Issues: • Replacing vehicle too early: • Vehicle still has usable life • Replacing too late: • Vehicle has become very costly

  20. 4.1.3 VEHICLE REPLACEMENT cont’ • 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.

  21. 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,

  22. 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.

  23. 4.1.4 COST COMPARISONS cont’ • 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.

  24. 4.1.5 FACTORS AFFECTING VEHICLE COSTS Factors affecting vehicle costs include the following: • 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.

  25. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ • 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.

  26. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ • Operational Characteristics • Fuel consumption and vehicle wear and tear are affected by the topography (mountainous terrain) and types of roads (gravel, tar, cement) traversed.

  27. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ • 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. • 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.)

  28. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ • 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.

  29. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ • 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

  30. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ 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.

  31. 4.1.5 FACTORS AFFECTING VEHICLE COSTS cont’ 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. • Vehicle selection • Important that the correct vehicle is selected for the job that is to be undertaken.

  32. 4.1.6 PLANNING A COSTING SYSTEM The step-by-step sequence for the establishment of a vehicle costing system is as follows: • Preparation • Define the objectives • Design the system • Implement the system • Maintain the system

  33. 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.

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

  35. 4.2.1 FIXED COSTS cont’ The most important elements of fixed costs are: • Licence fees • This is a fixed cost as it is usually a fixed amount paid annually whether the vehicle is used or not. • 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.

  36. 4.2.1 FIXED COSTS cont’ • 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.

  37. 4.2.1 FIXED COSTS cont’ 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: • Divided by the total number of vehicles • In proportion to the size of the vehicle

  38. 4.2.1 FIXED COSTS cont’ 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.

  39. 4.2.1 FIXED COSTS cont’ 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.

  40. 4.2.1 FIXED COSTS cont’ • 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.

  41. 4.2.1 FIXED COSTS cont’ • 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.

  42. 4.2.1 FIXED COSTS cont’ • The straight line depreciation method divides the cost by the life.  • SL = (Cost – price of tyres – residual value) / Life

  43. 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.

  44. 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.

  45. 4.2.2. VARIABLE COSTS (RUNNING COSTS OF VEHICLES) cont’ • Elements for variable costs are: • Fuel cost • There are different reasons for keeping fuel records: • It is a high individual cost item costs of a vehicle. • It can easily be stolen. • High fuel consumption can be an indication of other problems:

  46. 4.2.2. VARIABLE COSTS (RUNNING COSTS OF VEHICLES) cont’ Engine problems: • Problems with the engine efficiency • Drivers who fiddle with the pump to get more power and higher speed • Drivers choosing wrong routes, which are not as direct as could be • Poor driving techniques

  47. 4.2.2. VARIABLE COSTS (RUNNING COSTS OF VEHICLES) cont’ (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

  48. 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.

  49. 4.2.3 OVERHEAD COSTS (ESTABLISHMENT COSTS) cont’ The following are categories of overhead costs: • Management costs (e.g. salary of the transport manager) • Administration • Workshops and stores • Branch offices • Sales and publicity

  50. 4.2.3 OVERHEAD COSTS (ESTABLISHMENT COSTS) cont’ categories of overhead costs cont’: • Auxiliary fleet • Professional services • Telephone/telex/fax • Rent and rates • Business cars, travelling and accommodation expenses • Training, journals, conferences, etc. • Advertising

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