Equipment Executive: Myths and Misconceptions

By Mike Vorster, Contributing Editor | July 31, 2012

I have been looking over some recent articles and have come to the conclusion that they were too serious. It is time to have fun. Here are some bumper stickers you can use to dispel some of the myths and misconceptions about equipment, equipment management, and equipment costs.

You do not reduce equipment costs by:

1) Capitalizing Repairs

Yes, you do reduce the repair costs accounted for in a given period. But there is a danger that you lose sight of the impact of capitalized repairs in the mystery and unnecessary confusion that surrounds depreciation and the owning cost calculation.

A cost is a cost. You write the check, and in the fullness of time, you experience the full cost. The danger comes from the fact that you may not recognize significant repairs and rebuilds as repair costs: the costs associated with turning the key and putting the machine to work. Capitalizing repair costs understates operating costs, overstates owning costs, and extends depreciation. All three factors cause you to hold onto the machine for longer than you should. And that can give rise to some very real problems.

Capitalize repairs if you must. But recognize them for what they are: operating costs that have been put on a payment plan to reduce their impact in a particular accounting period. Capitalized rebuilds that extend life and, in many cases, change the function of the machine are a completely different matter.

You do not reduce equipment costs by:

2) Changing the Depreciation Schedule

Yes, extending the depreciation schedule will reduce the charges booked against the machine in a given year. Annual depreciation charges are not true costs. The market sets the actual cost of depreciation when the machine is sold, and the sale price, the auction price, or the trade-in value finally defines the depreciation actually experienced through the life of the machine. The charges set in the depreciation schedule provide for the market depreciation expected to occur as the machine ages, but they are nothing more than interim estimates that will, in the end, be adjusted by the final gain or loss on book value.

An overly aggressive depreciation schedule may leave some profit in the iron, but it produces artificially high estimated owning cost rates and, thereby, noncompetitive bids. A benign depreciation schedule produces artificially low rates and causes you to undercharge for the actual depreciation experienced and be upside down when the machine is sold.

It is a complex balance. Recognize residual values and set depreciation schedules that conservatively but realistically mimic residual market value.

You do not reduce equipment costs by:

3) Deferring Replacement

“We need to save money, so we are going to run our old iron a little longer.” Yes, you are going to defer capital expenditure, eliminate some monthly loan payments, or avoid some lease commitments. But what about higher operating costs, lower reliability, and increased downtime?

There is no such thing as a free lunch. Extending life conserves capital and reduces owning cost, but it also increases operating cost and lowers availability. The economic life or sweet spot, defined as the point where the sum of decreasing hourly owning cost and increasing hourly operating cost reaches a minimum, is a fact of life. Keeping machines beyond their sweet spot life means that every hour you work is more expensive than the average of all the previous hours to date and simply does not make sense. You go up the cost curve, down the availability curve, and round the spiral of doom.

It is not easy. Replacement is where the cold hard facts of business and finance meet the reality of equipment owning and operating costs. If you want to stay in business, you must replace the equipment you use up in the

production of work. This means you absolutely need a long-term fleet-replacement strategy that respects financial constraints and provides the funds needed to keep fleet average age within reasonable limits.

You do not reduce equipment costs by:

4) Underreporting Hours Worked

We need a thousand copies of this bumper sticker on each and every job site. Pulling, or underreporting hours worked, is obviously wrong and obviously counterproductive. Yet it occurs in many organizations. You can most certainly reduce the job level reported cost of digging a trench by underreporting excavator hours. You can also live in the misguided belief that this is a good or heroic thing to do because it helps your cost report show that you have met your budgeted cost. Underreporting hours worked makes the cost of trenching artificially low and the cost of the trencher artificially high. The true cost of trenching to the company is not affected: It is disguised, hidden and contorted.

Incorrectly reporting actual hours creates a cancer that spreads across many parts of the business. The way the cancer eats into the equipment account is minor compared to the damage it causes in job costing, estimating and bidding. If underreported hours cause us to believe that productivity is higher and unit costs lower than they actually are, then job costs, estimates and bids will be dangerously in error. The implications to the company, its information systems, and the facts of life can be fatal.

The solution is simple. There needs to be zero tolerance for falsifying the data the company depends on for its survival. Routine checks should be in place and errors eliminated.

You do not reduce equipment costs by:

5) Reducing the Rate

This is another bumper sticker that is obvious in its simplicity but not understood. Estimators and project managers are constantly looking for ways to reduce the equipment costs at a project level, and they constantly push for lower equipment hourly rates. Lowering the internal hourly rate for a piece of equipment will reduce the “cost” of the equipment as seen by the project that uses the equipment and pays the internal hourly rate. Lowering the hourly rate will not, however, reduce the cost of the equipment as experienced by the company. This is entirely dependent on the money that has gone—or will go—out the door to pay for the actual cost of owning and operating the machine.

Low and competitive rates are a natural product of an efficient operation that utilizes its assets, minimizes impact on equipment, and implements best practices in preventive maintenance, repairs and rebuilds. It works like a funnel. The true costs of owning and operating the machine go in; the rate times hours worked comes out. There are no tricks; the more cost you put into the funnel, the higher you must make the rate.

Utilization and the rate take money out of the funnel. Your operators and preventive maintenance technicians stand shoulder to shoulder as the first line of defense in reducing costs and slowing the rate at which money goes into the funnel. If you focus on them, their training and their ability, then costs will come down and hourly rates will follow.

Bumper stickers can teach us a lot. Use these to better manage equipment finances.

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