In this example the value of the data you can gather directly corresponds to the quality of the analysis you are able to undertake. Better data will give you better analysis and more control over the pricing and valuation of future contracts.
To build a lifecycle cost you will need to be able to estimate costs, make projections and to conduct analysis over time. Below we outline an example of life cycle costing using multiple contracts.
Estimation
The first part of any life cycle costing analysis requires an understanding of what to include in the costing analysis. Your goal is to be able to ascertain the total cost of purchasing and running an asset, so that you can compare the cost of making different choices. For instance, if you are costing the life cycle of a vehicle, you may wish to include the cost of fuel or you may decide that this cost is relatively constant regardless of the type of vehicle being purchased and exclude it.
The life cycle costing for a car might include the following:
- Original purchase price
- Cost of servicing
- Cost of parts
- Cost of fuel
- Road tax
- Insurance
Before you purchase a vehicle you may not have a list of payments for running an equivalent vehicle, so you can use estimates based on estimates.
Year one costs
Initial price = €60,000
Service costs = €2,000
Parts = €500
Fuel = €6,000
Road tax = €2,500
Insurance = €3,000
Estimated year one costs = €74,000This basic calculation will give you an estimate of the cost for running the vehicle for the first year of ownership, to understand future years you need to create a projected cost.
Projection
To project the cost of an asset into the future, you have to estimate what costs you will experience in subsequent years and consider the economic factors that will change those costs, including inflation.
Year two costs
Service costs = €2,500
Parts = €600
Fuel = €6,000
Road tax = €2,500
Insurance = €3,000
Inflation = 10%
Estimated year two costs without inflation = €14,600
Estimated year two costs including inflation = €16,060Note that we have estimated an increase in servicing costs and parts that is over and above the cost of inflation. This is because we anticipate that the cost of servicing and parts will increase as the vehicle gets older and more work is required to maintain it.
Measuring over time
Finally we consider the combined yearly costs to establish a full life cycle cost. So if we estimate that the car will cost a further €16,580 to run in the third year we can quickly establish a life cycle cost for the vehicle if we were to own it for three years.
Three year costings
Year one = €74,000
Year two = €16,060
Year three = €16,580
Total cost = €106,640
Resale value = €40,000
Total spent = €66,640Here we also consider that the vehicle has a resale value of €40,000 which then returns a cost of €66,640. Having determined this cost, we can look at other options for supplying a vehicle, for instance a lease agreement might cost €3,000 per month for the same 36 month period, which would cost €108,000 but once we add road tax and insurance, the price is less attractive.
The power of a life cycle costing is that it can be used to compare different asset choices, but also to budget for an asset.