Equipment Costs

By Jim Huston, MBA, CPE

Costs for New vs. Used Equipment: In essence, purchasing new versus old equipment is not a question of operating savings; it?EUR??,,????'???s a question of capital. Can you afford to buy new equipment? Used equipment may be cheaper to purchase, but is usually more expensive to maintain. Therefore, the CPH will tend to remain the same. Even if you plan to buy used equipment, cost it out using the ?EUR??,,????'??new?EUR??,,????'?? purchase price. The CPH will generally be the same for new and used equipment. Another reason for using the new price is because useful life and repair and maintenance costs are easier to determine for new equipment. Using the new purchase price also automatically adjusts our equipment rates for inflation and price increases.

Calculating Equipment Cost Per Hour

There are two reasons for calculating the cost per hour (CPH) for a piece of equipment: 1. To calculate budget projections for direct equipment and G & A overhead vehicle costs. 2. To calculate the amount of direct equipment costs to include in a job in the bidding process.

Our goal is to recover all our company/division equipment costs for the year in the jobs we complete and bill in that year. To do so, we must: Accurately determine costs. Allocate the correct amount of these costs to jobs. Complete and bill enough work/jobs in the field to cover all our equipment costs for the year.

It may help to think of yourself as an equipment rental company, or a car rental firm (such as Hertz or Avis). They, just like you, need to know vehicle/ equipment costs (purchase price, interest rates, repair and maintenance, etc.) to determine appropriate customer rental rates.

These rates are based on an hourly, daily, weekly, etc., cost figure that?EUR??,,????'???s marked up to cover corporate G & A overhead and net profit. If vehicle/equipment costs aren?EUR??,,????'???t identified accurately, subsequent rental rates would be either too high (prompting customers to shop elsewhere) or too low (causing the company to lose money).

I know of construction and maintenance companies, both large and small, that lost customers and hundreds of thousands of dollars because they didn?EUR??,,????'???t bid their equipment costs accurately. Nor did they track their equipment costs (and revenues generated) to cover these costs in jobs completed. They didn?EUR??,,????'???t ensure that they?EUR??,,????'???d at least break even for such costs.

You?EUR??,,????'???ll want to recover the costs of ?EUR??,,????'??light?EUR??,,????'?? cars and trucks (under one ton) in either four years, at 2,080 hours per year (8 hrs/day x 5 days/wk x 52 wks/yr), or, for seasonal companies, in five years (8 hrs/day x 5 days/wk x 42 wks/yr).

How it Works

A contractor in New England, with whom I was consulting, questioned whether he needed to use my pricing methods. He did not have to competitively bid his work. He did the work and then gave his clients a bill. They always paid whatever he charged them because the contractor did good work, and the customers trusted him. As it turned out, his invoices were more than reasonable.

During the course of the day of consulting, the contractor kept complaining how he thought that his sales revenue for the year was about $75,000 short of what it should have been. Sales revenue should have been about $575,000 not the $500,000 that he had charged. Finally, I asked him to explain to me how he had priced his work for the previous year.

His 20 percent markup on material costs was fine. The $35 charge per labor, including general condition time, was accurate. There was nothing wrong with the 15-20 percent markup that he put on subcontractor costs. However, when I asked him how he charged for his equipment, he looked stunned. He replied that he did not think that he should charge for equipment as it was just a cost of doing business.

I responded that he was correct in stating that it was a cost of doing business. However, I wanted to know how he passed this $60,000 cost of doing business for equipment on to his customers. He had not. With a proper markup for net profit and G & A overhead, this $60,000 would have accounted for the missing $75,000.Think of it! Had this contractor written out invoices totaling $575,000 for the year, his clients would have paid it without question. He simply shorted himself $75,000. And it was all profit.

How would you have corrected this flaw in this contractor?EUR??,,????'???s estimating system? Do you have similar flaws in your estimating system?

Renting vs. Owning Equipment: Unless you use and bill for a piece of equipment at least 50 percent of the time (20 hours/week), it?EUR??,,????'???s not financially practical to own it. If, however, a piece of equipment is either not readily available or would be impractical to rent, it usually pays to purchase it. But before purchasing, you should assess the financial feasibility of owning it by comparing projected revenues and operating savings generated to projected costs incurred. Many manufacturers allow you to rent with the option to buy.

Useful Life and Meter Time

We need to make the following distinctions (or assumptions) concerning our method of equipment costing:

A. For cars and trucks under one ton in size and below, this will be 8,320 (2,080 hours per year x 4 years) hours.

We want to recover our costs for these ?EUR??,,????'??light?EUR??,,????'?? vehicles in either four years, at 2,080 hours per year (8 hrs/day x 5 days/wk x 52 wks/yr), or, for seasonal companies, in five years (8 hrs/day x 5 days/wk x 42 wks/yr). Incidentally, in this case, the eight hours per day is not necessarily meter (or engine running) time.

After four or five seasons, these vehicles are usually worn out. If they last longer, great! However, we want to be conservative in recovering our costs. We prefer to recoup our costs sooner than later, in no more than four to five years.

B. The useful life of heavy-duty trucks (larger than one ton), tractors, dozers, trenchers, mowers, etc., consists of projected actual meter time/hours prior to that piece of equipment needing a major overhaul.

We?EUR??,,????'???ll use 10,000 engine running or meter hours for heavy-duty trucks before needing such an overhaul. However, the 10,000 hours may be spread over 10 to 15 years, not just four to five like light-duty trucks.

Useful life meter time/hours for tractors, dozers, trenchers, mowers, etc., will generally be much less than those for heavy-duty trucks. They can, however, also last 10 to 15 years before needing a major overhaul. This equipment is built to last and to endure the wear and tear. If you don?EUR??,,????'???t use it, it won?EUR??,,????'???t wear out (for the most part) in four to five years, as do the lighter trucks and vehicles.

As a general rule, I like to project lifetime hours for gas engines at 100 hours of life per horsepower. Diesel engines I project at 125 hours of life per horsepower. However, I?EUR??,,????'???ll cap lifetime hours for equipment as indicated in Table 9.1.

Bobcat has a Fair Market Value Lease that features low monthly payments for buying its skid-steer loaders over a period of one to two years. You can select either 600 or 800 hours of annual use of the machine. At the end of the lease you can buy the machine at its fair market value or return it to the dealer.

Summary

Some estimating systems put all equipment costs, both field and office related equipment, in G & A overhead. This is a big mistake which can cause you to charge too much for labor intense jobs and too little for equipment intense ones. We calculate a cost per hour (CPH) for each piece of field equipment. This CPH is then multiplied by the amount of hours the piece of equipment is going to be used to do the job. Costs for vehicles used by G & A overhead personnel are included in the G & A overhead budget.

The CPH for a given piece of field equipment is comprised of three items. They are: the acquisition cost; the maintenance cost; and the fuel cost. To maintain fair market value for equipment, the acquisition cost is calculated using the current replacement price for a given truck or piece of field equipment.

To ensure that equipment is paying for itself, many companies will create a separate equipment checking account from which all expenses for equipment are paid. Jobs are charged an intra-company rental rate for using the equipment and these charges are deposited into the equipment checkbook. Larger companies often form a separate equipment division or company, which pays all equipment expenses. These divisions or companies charge a rental rate to the users of the equipment and bill them accordingly.

Construction and maintenance companies lose customers and hundreds of thousands of dollars because they don?EUR??,,????'???t bid their equipment costs accurately, nor track their equipment costs (and revenues generated) to cover these costs. Some contractors don?EUR??,,????'???t even ensure that they at least break even for such costs.

Buy or lease?

Often, the leasing versus buying option is one driven by tax benefits (check with your CPA or accountant), rather than savings for operational costs. Cost out the leased vehicles as you would those you might purchase. Be sure you adjust the ?EUR??,,????'??purchase price column?EUR??,,????'?? so it reflects all lease payments and other appropriate items (i.e., periodic maintenance included in lease agreements, extended warranties, etc.).

If the lease-life for the equipment/vehicle is significantly shorter than the normal expected life (should you purchase), adjust the life expectancy to the shorter term. Adjust maintenance and fuel costs to account for the shorter period, as well.

For example, a leased vehicle that?EUR??,,????'???s to be replaced every two years by a ?EUR??,,????'??new?EUR??,,????'?? leased vehicle should have an adjusted life expectancy of 4,160 hours (2 years x 2,080 hours per year) versus 8,320 lifetime hours. Anticipated maintenance, insurance and fuel costs should cover only the two-year period. Theoretically, there should be little to no anticipated repair or maintenance costs, especially if periodic routine maintenance (replacing worn belts; lube, oil and filters, etc.) is included in the lease.

Finally, compare the lease CPH to the purchase CPH to determine any savings. If there are, adjust your estimating budgets accordingly and weigh the option of using the higher or lower CPH in your bids. While the lower is realistic, the higher would provide a ?EUR??,,????'??contingency?EUR??,,????'?? (or ?EUR??,,????'??fudge?EUR??,,????'??) factor that should translate into a slightly increased net profit margin (you should be able to detect this increased margin in your job-costing reports) for individual projects.

This article was adapted from James Huston?EUR??,,????'???s new book and audio book, How to Price Landscape & Irrigation Projects, released in July 2003 and his previous book, Estimating for Landscape & Irrigation Contractors. The author is president of J.R. Huston Enterprises, Inc., which specializes in construction and services management consulting to the Green Industry. Mr. Huston is a member of the American Society of Professional Estimators and he is one of only two Certified Professional Landscape Estimators in the world. For further information on the products and services offered by J.R. Huston Enterprises, call 1-800-451-5588, e-mail JRHEI at jrhei@jrhuston.biz or visit the J.R. Huston Enterprise web site at www.jrhuston.biz.