Heavy Equipment Costs: Breaking Down Owning and Operating Costs
Heavy equipment costs fall under one of two categories. One category indicates how much it costs to purchase (finance), protect (insure) and legalize (permit and registrar) heavy equipment and machinery. The second category includes the costs associated with operating and maintaining a machine: fuels costs, operator wage/salary, maintenance, etc. As a result, owners and companies divide heavy equipment costs into 1) owning costs and 2) operating cost.
Owning costs accumulate regardless of whether an owner or company uses a piece of heavy equipment, whether it works or it sits in the equipment yard. Operating costs are those that accumulate only as a piece of equipment works.
Another difference between owning and operating costs is how owners and companies fund each.
A portion of the funds for owning costs generally come from either business savings or outside financing. The remainder comes from gross profit. Operating costs, on the other hand — while funding can come from financing, — typically the money comes from gross profit. That is to say, in a normal business model, a portion the payments toward both financing costs and operating cost come out of gross profit. But, a majority of owning costs come from business savings or financing while the majority of operating costs come out of gross profit.
There are formulas for both owning and operating costs. Minimizing owning and operating costs is the means by which an owner or company keeps a heavy equipment operation solvent.
Estimating owning costs is a methodology with a strict formula. There are six variables that pertain to owning costs:
- Delivered price
- Property tax
- Residual price at replacement
- Recoverable net value (work)
Delivered Price Costs
The purchase price of a machine, in addition to the cost of delivery, is the delivered price. Implements and attachments are also part of the delivered price. In the case of heavy equipment, the delivered price can also include the variable, “less the tire replacement costs.”
So, the heavy equipment delivered price costs are the machine, its implements and attachments; and transport costs. And depending on how a business owner or heavy equipment company choose to calculate costs, the delivered price can be the total minus tire replacement. When calculated in that manner, the cost of tire replacement becomes an operating cost.
Financing Interest Costs
Not every heavy equipment company’s owner or heavy equipment company can pay cash for purchases. Commonly, the purchase of heavy equipment requires financing. Financing means borrowing money from a lending institution or private financier. And invariably, financing is associated with an interest payment. In addition to the principal of the loan, the borrower must pay interest on the loan.
There is a simple formula for financing interest. Financing interest is the interest rate divided by the number of payments multiplied by the loan principal: (IR/P) x LP = I.
In addition to the principal of the loan and interest, taking out a loan requires taking on additional costs. Insurance is typically the most costly. Financiers who lend money to owners and companies for the purchase of heavy equipment almost invariably require the borrowers to carry insurance. Lenders require borrowers carry insurance in order to ensure they do not lose their money if something happens to the machine.
Heavy equipment insurance is also known as commercial contractor’s equipment insurance. There are several types of heavy equipment company insurance. “Contractor’s Equipment coverage is meant to fill the gaps in Commercial Property and Business Auto policies,” explains the Graham Co. Commercial property policies generally only cover property that remains in the same location. Business auto policies generally exclude mobile equipment.
Commercial equipment insurance covers heavy equipment, “mobile equipment.” Mobile equipment includes machines like generators, skid steers, backhoes, front-end loaders, mini-excavators and excavators, pavers, cranes, etc.
Typically, heavy equipment insurance covers two types of accidents/incidents: operating risk and third party. “Operating risks relate to any external calamity such as fire, explosion, spontaneous combustion, lightning strike, theft, fraud, or misappropriation-related damage that occurs while the equipment is in operation or being driven on roads. Third-party liability covers claims against a contractor by someone other than the insurance company, i.e. another contractor, a project owner, a developer, or a municipality.”
Delivered price, financing interest, and insurance are all debt costs. But, when calculating owning costs, there are also credits. Two examples of potential cost credits are residual price at replacement and tire replacement costs. While not always a part of owning costs accounting, both are credit options.
Residual Price at Replacement
Similar to the blue book value of a car or pickup, a residual price at replacement is an estimate of the value of a piece of machinery based on the make and model of the machine, the attachments it has, the number of hours on the engine, and a variety of other variables. Residual value setting (RVS) is not merely a guesstimation.
So precise are today’s RVs publications and residual value setting companies with respect to the future value a machine will have at resale, that heavy machinery owners can safely account for residual value when calculating owing costs.
Explains Terese Kramer, vice president, Equipment Management Group, BMO Harris Equipment Finance Company (BHEFC). “We continue to take a holistic common sense approach to RV-setting. We use the fundamentals of appraising to determine values and then consider such factors as lease term and structure, historical customer behavior, return conditions, pending regulatory issues and equipment life cycles.” As a result of the accuracy of RVS estimations, heavy equipment owners and companies can use the variable “residual price at replacement” when estimating annual owning costs.
Not all companies choose to do so, however. Many owners and heavy equipment companies consider heavy equipment a zero-sum factor in their books after payment of the delivered price costs. The reason being, residual value accounts for money that is not yet in the bank. “While many owners prefer to depreciate their equipment to zero value, others recognize the residual resale or trade-in value.”
Tire replacement costs are another variable owners and heavy equipment companies can account for in different ways.
Tire Replacement Costs
The cost of replacing tires can be an operating cost. It is not necessarily an ownership cost. However, in order to make tire replacement operating costs delivered price minus tire replacement must be calculated into ownership costs as a debit.
And doing so — subtracting tire replacement costs from ownership costs — allows for a more accurate calculation of residual price at replacement. “ Since tires are considered a wear item in this method of estimating owning and operating costs, total tire replacement cost is deducted from machine delivered price to arrive at a net figure for depreciation purposes. The outlay for tires is then included as an item in operating costs.”
Hourly tire costs equal the replacement cost of tires divided by the estimated tire life in hours.
To generate income for a heavy equipment company or company owner, a machine must work. The business adage, “you have to spend money to make money,” is particularly relevant in the heavy equipment industry. The two biggest costs in a heavy equipment operation are labor wages/salaries and fuel. But, there are other costs as well.
For example, again, tires are an operating cost.
Tire Lifecycle and Replacement Costs
Tires wear out faster than any other component on a piece of heavy equipment. Heavy equipment with rubber tracks also wears out faster than steel tracks and steel wheels. But, rubber tracks are considered an ownership cost because they last considerably longer than rubber tires.
As an operating cost variable, tires costs have a formula: replacement cost divided by life in hours.
By estimating the replacement costs and the life in hours, each month a company can put aside money for tire replacement costs. Recapping heavy equipment tires, however, are an option for extending the life of tires.
Planned and Preventative Maintenance
Planned maintenance (PM) costs are the most common operating costs associated with heavy equipment aside from wages/salary and fuel. PM costs include things like lube oils, filters, grease, and maintenance labor. The formula for PM is a simple as adding up all PM associated costs.
The cost of the few operating costs heavy equipment companies and company owners can not anticipate. Most repair costs are unknown until they are necessary. Broken lights, worn out cables, broken bucket teeth, etc. are all necessary repairs — in addition to not being foreseen — must be addressed immediately.
With the exception of special wear items — tires for example — the formula for repairs is simply the addition of parts costs and repair labor costs.
There is no operating cost greater than salary and wages. Operator wages are simple to account for — wage rate multiplied by hours worked. There are a large number of variables that determine wage rates including machine type operated and regional wage average.
As of late 2017, the three states with the lowest operator wages were Arkansas, Georgia, and North Carolina. Pennsylvania, Colorado, and Maryland fell in the middle. And the states with the highest operator wages were Illinois, New York, and Hawaii.
The amount of fuel a machine uses over the course of an hour, day, week, month, or year determine fuel use costs. Fuel is the second greatest operating costs, save catastrophic failure repair costs. Diesel fuel prices vary from week to week, month to month, and year to year. Additionally, diesel fuel prices vary from state to state. However, the price of diesel is relatively consistent across the states.
Fuel Costs Per Gallon
The exceptions are Hawaii, California, Alaska, Utah, Washington, and Wyoming. Diesel has been considerably more expensive in those states historically. The states where diesel has historically been the least expensive include Mississippi, Texas, Louisiana, Missouri, and Delaware according to the U.S. Energy Information Administration.
Since 2007, the national high for diesel per gallon occurred in 2008. The price was $4.79 per gallon. The lowest prices for diesel occurred in March of 2009 and February of 2016. Both times the price of diesel dropped to $2.00 per gallon. From March of 2011 until the middle of 2014, the price of diesel remained steady at around $4.00 per gallon as a national average. The price of diesel did not exceed $3.00 per gallon from January of 2015 until May of 2018.
Cutting Fuel Costs
Of all the cost variables associated with a heavy equipment operation, cutting fuel costs is the easiest means of lowering expenses. And, cutting fuel costs also allows for the biggest savings. There are a variety of means of cutting fuel costs. Operators play a large role in the fuel efficiency of a machine. By using best-practices when operating, operators can reduce the fuel consumption of a machine dramatically. Reduced idle time, operating at ideal rpm, and the efficient staging materials to minimize travel distances are examples of best-practices.
Additionally, technologies increase fuel efficiency. Onboard GPS, GPS tracking devices, and pre-combustion fuel catalysts are prime examples. The Rentar Fuel Catalyst, for example, can reduce fuel consumption by between 3 and 12 percent on heavy equipment.
Heavy equipment operating costs are greater than those of almost any other industry. Heavy equipment is expensive to purchase. And, heavy equipment is expensive to maintain. Fueling heavy equipment is expensive. So large are the sums of money spent on each cost that cutting a small percentage from each can mean dramatic savings overall. Getting the best price possible on a machine and getting the best fuel economy are the first two places to begin trimming heavy equipment costs.