From our 2018 Member Newsletter here is an excerpt from the feature article: The Costs of Owning and Operating Machinery by Irwin Post. To get the full article, plus so much, just become a member!
Editor’s Note: This article was originally written for Independent Sawmill and Woodlot Magazine. However, the information is highly applicable for any business or individual that operates equipment. We hope you find it helpful!
The Costs of Owning and Operating Machinery
Machinery is crucial for most timber harvesting, sawmilling, and value-added work with wood. While some tasks can be successfully completed with just a few hand tools, machines can greatly increase productivity and reduce the physical effort required. Chain saws, farm tractors, sawmills, dry kilns, planers, forklifts, skidders, bulldozers, and many other machines can be central to getting tasks done properly and efficiently.
If harvesting trees on your woodlot or milling logs into boards is your hobby, then the machines you own may be dictated by your desires and/or the depth of your pocketbook. If, however, you operate a serious part-time or full-time business, a thorough understanding of the costs of owning and operating machinery is essential to your profitability. An analysis of these costs will help you make good business decisions about buying machines and/or upgrading to more modern and productive ones.
FIXED COSTS
Fixed costs are the costs of ownership—the expenses incurred, whether the machine is parked or used every single day. There are several components to consider when estimating fixed costs; the price of the machine; the amount of time you will own it; its value at the end of this time (called the salvage value); and the cost of money, insurance, and taxes. Sometimes there are other costs that belong in the fixed category as well, such as buildings needed to house the machine, special tools for operation or maintenance, and the expense of a spare-parts inventory. Fixed costs are usually determined on a yearly basis.
Dividing the yearly cost by the number of hours of use per year provides an hourly cost, which is very useful for pricing products or services and for making purchasing decisions.
PRICE, SALVAGE VALUE, and DEPRECIATION
The price of the machine, whether new or used, is the only item in this list that you can know at the outset; all the others need to be estimated. For new equipment, the amount of time you plan to own it is very important, as most machines, like cars and trucks, depreciate significantly in the first few years and then lose value more slowly after that. The salvage value depends on the age and condition of the machine when you part with it, inflation, and the machine’s desirability in the marketplace.
Machines desired by homeowners and part-time users, such as wood planers, smaller farm tractors, and small bulldozers, tend to have high salvage values. In contrast, there is a very limited market for older large and specialized equipment, so salvage values for skidders, industrial woodworking machinery, and large earthmoving equipment tend to be low.
To estimate annual depreciation, subtract the estimated salvage value from the price of the machine and divide the result by the expected number of years of ownership.
THE COSTS OF MONEY
We all know that it costs money to use money. If you borrow money to buy a machine, you will pay interest on the amount of money borrowed. For the down payment (or total amount, if you buy out-of-pocket), you will incur what economists call a “lost-opportunity cost,” which is the return you would get from investing the money, combined with the cost of not having the flexibility to use that money elsewhere (a difficult number for a small business to estimate).
The cost of money is tied to interest rates. At this writing, interest rates are historically quite low, so the cost of using money is also low.
In practice, you can estimate the cost of money by multiplying the amount of money you put down by a lost-opportunity cost and adding the annual interest cost of your loan, if any.
I currently use 5 percent for my lost-opportunity cost. Note that if you keep the machine after a loan is paid off, you will then have a lower money cost and, hence, lower annual fixed costs. There are formulas that adjust for this and depict a constant cost of money or the entire time you will have the machine. Alternatively, you can consider the annual loan payments in your computations to more accurately reflect cash flow and to conservatively plan for the time when the payments will end. The amount of the annual interest payments can then be set aside for increased maintenance costs as the machine ages and for eventual replacement. It can be instructive to do the computations both ways.
That’s just the first 20% of the article. Get the whole article to find out about: Insurance and Taxes; Annual Operating Hours; Variable costs like energy use, consumables, and repair/maintenance; Case studies; rules of thumb, machine life; and more. Gain valuable insight to the total owning and operating costs and the formulas needed to make wise business decisions!