I/EC
Costs
Glossary of Cost Estimating Terms (Part II) These terms w h e n properly used can help you understand the l a n g u a g e of cost and profitability estimation by James B. Weaver, •HEADERS are reminded that the authors need their help in arriving at true definitions for the terms used in cost estimating and profitability estimating work. In last month's column, a special "Call for Assistance" noted the importance of defining these terms. When this project has been completed the revised glossary will be published in the revised edition of Perry's "Chemical Engineer's Handbook."
Feasibility Study. Investigation of all phases of an investment or research proposal in as much detail as is necessary to justify dropping it or continuing the expenses through the next stage. Field Expense. During the construction of a plant or process unit, any indirect costs of the contractor building the plant. Financing. See Capital, Sources of. Firm Estimate. An estimate of fixed investment such as would be made by a lump sum contractor for bid from final drawings, specifications, and site surveys. Confidence limits ± 2 1 / 2 % . Fixed Capital. See Capital, Fixed. Fixed Costs. The costs which continue at a plant once it is constructed, whether it is operated or not. Essentially fixed in dollars per year independent of the production level in the plant. Include property taxes, insurance, some maintenance, and depreciation (a noncash expense) in all cases. Some labor may also be considered a fixed cost for many purposes, particularly in continuous processes, as long as the plant does not shut down largely or completely. Contrasted with Variable Costs. Force-Majeure. A clause in all construction contracts, making the contractor free from any obligations imposed on him due to strikes, floods, catastrophies, national emergencies, etc. Forecast. Any Estimate of future conditions.
Atlas Powder
Co., and H. Carl Bauman, American
Freight, Chemicals. The transportation charge to the buyer for delivery of chemicals to the plant site. Depending on the chemical pricing basis, may vary from zero to the entire freight cost from the source of supply. Included in Ingredients cost. Also, the freight on finished products which must be prepaid by the supplier. Again, practice varies widely on the portion paid by the supplier. Freight, Equipment. The delivery charge to bring completed equipment to the plant site for construction. Fringe Benefits. The employee welfare benefits; expenses of employment not paid directly to the employee, such as holidays, sick leave, etc. General Expense. See Administrative Expense. Graphical Methods. Use of charts, etc., to show relationships among variables—e.g., nomographs. Grass-Roots Plant. A complete plant erected on a virgin site. Investment includes all costs of site preparation, battery limits facilities, and auxiliary facilities. Guaranteed-Maximum Contract. A type of contract in which contractor agrees to furnish material, construction equipment, and labor to erect a complete facility at cost plus a fixed fee, guaranteeing, however, that the total cost to the owner will not exceed a stipulated maximum figure. "Guesstimates." Quick, order-ofmagnitude estimates which are generally used in deciding whether or not to spend further time on analysis of a new idea. See Feasibility Study, Order-ofMagnitude Estimate, Turnover Ratio. Income. See Profit. May also be used to refer to profit before income taxes, or to gross income from sales before deduction of costs. Income Statement. The statement of earnings of the firm, as approximated by accounting prac-
Cyanamid
Co.
tices, and as required by the Federal Government. Usually covers a period of one year. Also called Profit and Loss Statement. Incremental Approach (also called Out-of-Pocket Approach). The cost-estimating philosophy based on changes in cash flows which can actually be foreseen as occurring, rather than using accounting conventions to approximate overheads, etc. Requires comparison of two Alternatives or sets of conditions—Proposed Case and Base Case. Incremental Cost. See Marginal Cost, Incremental Approach. Indirect Expense. Fixed investment, engineering construction expense, taxes and insurance, startup costs, and contractor's fees which cannot be charged to endcode process items. At job closeout, all indirect expenses are allocated on some reasonable basis to direct code items. Manufacturing costs, continuing expenses associated with manufacture but not directly assignable to cost centers or products. Includes plant overheads, and also certain items which may be charged directly (such as materials handling and maintenance charges) by the preparation of special records. Inflation Index. Historical time scries maintained by the Government and others which approximate the change (usually loss) in value of the dollar in a particular segment of the economy, usually based on an index of 100 for a base period of time. Cost Indexes. Ingredients. The chemical raw materials ; part or all of the chemical components of these end up in the final product. Catalysts and other chemicals which are used in the manufacture, but no part of which remains as a part of the final product, are often considered separately, as operatingsupplies, etc. Valued at delivered cost to the buyer. VOL. 52, NO. 7
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COSTS Installation. Putting in place pieces of equipment by means of erection of foundation, connecting lines to utilities and other process units, etc. An important cost clement to be added to the purchase price of most equipment. Instantaneous Compounding. See Continuous Interest. Insurance, Property. The cost of obtaining financial protection to replace the value of equipment, etc., in case of loss. Intangibles. Elements which have an effect on the forecasts or project under consideration, but are not readily measurable in dollars and therefore can only be described in noneconomic terms. Interest, Compound. The mathematical expression of the assumption that money can be used to earn more money, and therefore that values be assumed to grow at a constant percentage. The rate (expressed as per cent or decimal) at which a dollar increases over each interval of time, usually based on one year. See Continuous Interest. Interest Rate of Return. The rate of compound interest at which the company's average outstanding investment is repaid by proceeds of the project. Also, the evaluation technique which judges the profitability of a proposed investment by this calculation. Also called Investor's Method, Profitability Index (PI), internal rate of return. Inventory. The supply of raw materials, products in process, and finished products required for plant operation and to supply sales requirements. Also, other supplies—i.e., for maintenance, catalyst, chemicals, spare parts. Investor's Method. See Interest Rate of Return. Job Ledger. Book of accounts for the project wherein the accountant makes entries of equipment, labor, freight, and tax costs. Labor, Operating. That portion of the labor crew in processing areas which can be definitely assigned to one product or process area or cost center. Usually excludes labor for maintenance, materials handling, and packaging. Lease vs. Buy. Investment choice between renting or purchasing equivalent facilities on a longterm basis. Leasing Equipment. A method of obtaining equipment through con54 A
tract rental which does not require a fixed investment and does not entail ownership of the equipment. Tax treatment depends on the detailed contractual arrangements, such as options to purchase, etc. Load Factor. See Time Efficiency. Lump-Sum Contract. Type of contract in which contractor agrees to furnish a completely erected facility at a single price. Variations of this type may include a Turn-Key arrangement including quality, quantity, and yield guarantees. Maintenance. The expense, both for labor and materials, required to keep equipment or other installations in suitably operable conditions. Maintenance docs not usually include those items which cannot be expended within the year purchased and must be considered fixed capital. Make vs. Buy. The option which faces many manufacturing organizations of purchasing the raw materials they use, as compared to investing in facilities to manufacture the raw materials themselves. Manufacturing Costs. In the process industries, the total of opcrating costs chargeable to manufacture of a given product, usually expressed in cents or dollars per unit of production. Includes direct expenses such as ingredients, labor, utilities, and also such fixed or allocated charges as maintenance, depreciation (a noncash expense), insurance, and property taxes. Overheads within the plant are usually considered within manufacturing costs; sales, administrative and research overheads, and freight are usually not included. Marginal Cost. The added or incremental costs of making one additional unit of product without additional investment in facilities. Minimum Acceptable Rate of Return. The return on investment level, above the cost of capital, chosen as acceptable for discounting or cut-off purposes. Minimum Unit Cost. Unit cost at that operating level of an existing facility which produces the lowest average manufacturing cost per unit of output. Noncash Expense. A manufacturing or overhead expense for accounting purposes which does not require outlay of funds of the
INDUSTRIAL AND ENGINEERING CHEMISTRY
same amount in the same year but which may result in a tax savings—e.g., depreciation (tax deductible), amortization of good will (not deductible). Nonprocess Equipment. The part of Auxiliary Facilities to which the word equipment can be applied. Includes utilities, shops, equipment storage when not merely buildings—e.g., tanks. Obsolescence. The occurrence of decreasing value of physical equipment due to technological advance rather than physical deterioration. Off-Site Facilities. See Auxiliary Facilities. Operating Costs. Usually a synonym for Manufacturing Costs defined above. This term is more often used for cost expressed as dollars per year than as dollars or cents per pound. Opportunity Costs. The estimate of values which are foregone by undertaking one alternative instead of another one. Usually, the value of the less attractive alternative. Order-of-Magnitude Estimate. A quick estimate of fixed investment obtained without flow sheet or detailed equipment analysis by applying factors, ratios, and escalation to published data or previous installation considered to be similar or by applying Turnover Ratio concepts. The least accurate of the estimate types, on which no order of confidence limits can safely be applied. Out-of-Pocket Costs. See Incremental Costs. Overhead. Those costs in a manufacturing company which are not directly attributable to any one product or processing unit and therefore must be allocated on some arbitrary basis believed to be equitable, or handled as a business expense independent of the volume of production. Overhead, Operating or Plant. Those overheads within a plant area which are directly related to operation of the plant but are not otherwise variable with output. Payables. See Accounts Payable. Pay-Out Time (Pay-off period, payback period). A rough measure of profitability, defined as the time required to recover the original investment in depreciable facilities from profit and depreciation. Usually, but not always, taken after taxes.
COSTS Physical Life. The period which a plant could be or has been operated before shutdown due to physical deterioration. Plant Location Study. The operation by which tangible and intangible factors at various possible plant locations are compared in order to determine the most suitable site. Plant Overhead. See Overhead, Operating. Preconstruction Expenses. All those expenses, including engineering design, drafting, plant location, and even research and development, which precede the actual construction work on a proposed facility. Preliminary Estimate. See StudyEstimate. Present Worth (present value). Current value of cash flow(s) as obtained by discounting. Also, the investment evaluation procedure which involves discounting at a known interest rate (representing a cost of capital or a minimum acceptable rate of return) in order to choose the alternative having the highest present value. Price, Sales. The revenues received for a unit of product. Gross sales price is the total amount paid. Suppliers net sales are obtained by subtracting returns, discounts, freight, and allowances from gross sales. Plant netbacks are obtained by subtracting sales, and administrative and research expenses from net sales. Pricing, Intracompany. Determining at what price a manufactured material from one part of the company should be transferred for use as a raw material in another part of the company. Probability. The statistical concept which takes into account the possible variations among a large number of occurrences or estimates; may be used to improve decisions. Absolute certainty has a probability of 1.0, and an impossibility has a probabilitv of 0.0. Process Equipment. All equipment and appurtenances included in the actual manufacturing process. Usually, the equipment which lies within the Battery Limits. Profit. The accounting approximation of the earnings of a manufacturing concern, after taxes, cash expenses, and certain tax-
deductible noncash expenses such as depreciation. Profit and Loss. See Income Statement. Profitability. A general term for the amount of profit achieved from a given situation. For a proposed investment, generally considered to be related to return on investment. Profitability Index. See Interest Rate of Return. Project. The combination of related investments proposed for approval in a single evaluation. Project Control Estimate. An estimate of fixed investment prepared from completely specified equipment lists, finished engineering flow sheets, frozen plot plans, and general arrangements, together with reasonably complete site and auxiliary facilities information. Such estimates should have confidence limits of ± 5 % and are in sufficient detail to be the basis for sound job cost control. Project Life. See Economic Life. Property Records. Coded records kept by the company of installed cost of all plant property. Proposed Case. The course of action which involves an investment now under consideration, or the series of forecasts which quantify that course. Ranking. The determination of order of preference of a series of investments by some measure of profitability. Investments must not be mutually exclusive and are "ranked" to determine which are to be undertaken. Rate of Return. Abbreviation for rate of return on investment. Rate of Return on Investment. The efficiency ratio relating profit or cash flow incomes to investments. See also Return on Original Investment, Pay-Out Time, Interest Rate of Return, Present Worth, etc. Raw Materials. See Ingredients. Receivables. See Accounts Receivable. Reinvestment. A problem facing those using profitability methods involving compound interest, related to the disposal of those funds potentially earned, in turn, by the funds generated by the investment being considered. Rental Equipment. Fixed investment, equipment which is rented during the construction period to supplement labor in the erection and installation of the project
—i.e., cranes, welders, earth-moving machinery, etc. Replacement. A facility proposed to take the place of an existing facility, without increasing its capacity. A replacement which adds to capacity is called an expansion. Replacements are caused either by obsolescence or physical deterioration. Research. An item of overhead expense incurred in searching for new and improved products and processes. Return on Investment. Abbreviation for Rate of Return on Investment. Return on Average Investment. The ratio of average annual profits over the earning life to the average book value of investment, with or without working capital. Return on Original Investment. The ratio of average annual profits over the earning life to the original or total value of investment, usually including working capital. Return on Sales. The ratio of annual profits to total sales. Not generally considered a relevant criterion of profitability. Risk. The element, largely intangible, representing the likelihood that a project will not achieve the estimates made for it. Salvage Value. The value which can be recovered from equipment or other facilities when taken out of processing use and sold to an outside party. Usually assumed as net of removal costs. Sales Expense or Selling Expense. Merchandising cost ; the expense of getting the product purchased by and delivered to a customer, including processing of orders. Freight and other delivery costs are sometimes considered a selling expense, as may be technical service or product development expenses. (Cost of sales is a confusing phrase, usually a synonym for total manufacturing costs plus selling expense as used here). Scaling Factors. See Six-Tenths Factor. Service Facilities. See Auxiliary Facilities. Service Life, Useful. See Economic Life. Shared Facilities. Productive facilities which are shared by varVOL. 5 2 , N O . 7
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JULY 1960
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