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close this bookAppropriate Food Packaging (Tool)
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View the document7.1 Summary of how to calculate packaging costs

7.1 Summary of how to calculate packaging costs

In this section the main costs associated with introducing or upgrading packaging, as described above, are grouped together and an explanation of how they are calculated is given for each.

7.1.1 Changes to existing production

The costs involved in these changes include creation of space for storing packaging materials, in some cases for assembly of the container, for storage of the packaged food before distribution and space for quality control checks on both the packaging and the filled product. New processing and packaging equipment, storage racks and insect and rodent proofing for storerooms are additional costs.

The cost of extra space may include moving the processing unit to a new building or construction of an extension to an existing room. This, together with any new equipment and upgrading of facilities, will be a capital cost to the business. It may be necessary to take out a loan to cover these costs and the loan repayments will then need to be included in the business accounts as an additional expense.

Other costs are the extra training required for operators in the changes to the process, use of the packaging and inspection of the packaging materials and final product. There may also be a cost associated with a potential reduction in output while new procedures are being introduced. These costs would normally be treated as a capital cost and included with the cost of new processing equipment or a new building.

7.1.2 Packaging equipment

An indication of the range of likely costs involved in different types of packaging equipment is shown in Table 7-1. However, it should be noted that the cost of packaging equipment depends on similar considerations to the cost of other types of processing equipment (for example type and size of equipment, degree of complexity required, materials of construction, country of origin, etc) and it is not therefore possible to be more specific about the costs of individual equipment. Similarly the expected life of packaging equipment will vary according to the type and method of manufacture, the production rates used, the amount of maintenance given and the working environment. Depreciation costs will therefore also vary widely.


Figure

Ancillary equipment such as washers for bottles and jars, and the costs of spare parts, lubricants, installation of electricity or other services required for packaging should each tee taken into account at this stage.

The costs of equipment and spare parts are capital expenditure and if a loan is required the loan repayments are included in the business accounts.

7.1.3 Working capital

One common problem with the purchase of packaging materials in many countries is the requirement to buy large quantities at a time from the supplier or distributor. This is particularly the case if the materials are to be printed as it is cheaper for the supplier to produce a large number at one time rather than having to reset the printing equipment each time for a number of short production runs. As a result the small-scale processor may have to buy several months supply of packaging materials at the outset. This in turn requires a large working capital and good storage facilities to prevent deterioration to the materials until they are used. If packaging results in an increase in the amount of food being processed there will also be an increase in the working capital required to purchase the larger quantities of raw materials and ingredients.

Working capital is treated as capital expenditure in the business accounts and the above remarks on loan repayment apply equally in this case.

7.1.4 Labour

Costs of introducing or improving packaging include both direct training costs and the opportunity cost of lost production during training and familiarization with the new procedures. In addition trained staff may require higher salaries, particularly those involved in quality control and testing.

Labour costs may be either fixed operating costs if the staff are permanently employed or alternatively the costs can be treated as variable operating costs if staff are employed only when they are needed.

7.1.5 Operating costs

Operating costs may increase as a result of higher production rates, but this should also increase the profitability Or the business. The only likely net increase in operating costs from higher production may therefore be greater loan repayments on the working capital.

Other operating costs that are directly associated with the new or improved packaging may include increased fuel/power consumption (for example for bottle sterilization or heat sealing), the cost of the packaging material itself, and possibly higher transport costs to take advantage of a larger potential market created by the longer shelf life of packaged food.

Operating costs are divided into fixed costs that do not change whether production takes place or not and variable costs that increase as the level of production increases. Examples of fixed operating costs include loan repayments, the rent on a building, a business registration tax or depreciation on equipment. Examples of variable operating costs include packaging materials, food ingredients and fuel.

A summary of the costs associated with producing and packaging foods is shown in Table 7-2.

Capital costs

- Building construction
- Facilities (water, fuel, insect proofing)
- Processing equipment
- Packaging equipment
- Distribution vehicle (for example bicycle or truck cost)
- Working capital

If a loan is used to raise part or all of the capital this will result in repayments to the lending agency which will include the interest that is charged on the loan. These repayments are treated as a fixed operating cost below.

Operating costs - fixed

- Loan repayment
- Labour
- Rent on building
- Business registration tax and licenses
- Equipment depreciation

Operating costs

- variable
- Packaging materials
- Food ingredients
- Labour
- Fuel and power
- Distribution costs

Can be either fixed or variable depending on how workforce is employed - see text.

Table 7-2: Costs associated with producing and packaging foods

To calculate profitability, the total fixed and operating costs over a known period (for example one month) are added to give the total costs. The income over the same period is calculated by multiplying the number of packages sold by the selling price per package. The gross profit is the difference between income and costs. The net profit is the amount remaining after taxes (for example income tax) has been paid and other debts are taken into account.

7.2 The cost of introducing Packaging to a small business

In this section an example of fruit juice production is taken to show how a process is changed when packaging is introduced and where some of the associated costs arise. Initially a street vendor is described who sells fresh orange juice directly from a handcart. The juice is squeezed from a hand-operated fruit press into re-usable cups. The vendor sells 50 cups containing 150 ml juice per day at US$ 5 per cup and he works for 6 days per week. One orange supplies a cupful of juice on average.

The following costs are associated with this business:

Capital costs

US$

Juice press

85

Handcart

50

Cups

15

Total capital cost

150

Working capital required for two weeks production

1500

For simplicity it is assumed that a loan for the capital + working capital (150 + 1500) of US$ 1650 is repaid over two years in equal amounts. The weekly repayment is therefore 1650104 = US$ 15.86 per week as a fixed operating cost.

Operating costs

US$/week

Fixed


Equipment depreciation (over 5 years) 150/260

0.58

Loan repayment (from above)

15.86

Operating costs

Variable


Fruit (50 x 6 oranges/week @ $2.5/orange)

750

Labour (the owner does not pay himself a wage but keeps whatever proms he makes)

0

Total costs

766.44

Income (50x 6x 5)

1500

Gross Prom

733.56

Prom per glass (733.56/300)

2.4

This profit is taken as a wage and amounts on average to nearly US$ 3000 per month. However, any investment in the business is taken from the monthly wage.

The fruit juice seller then wishes to expand the business and sell juice that is pasteurized and filled into returnable glass bottles. He processes juice for six days per week and sells the juice in 110 ml bottles for US$ 5.5 each and he sells 500 bottles per day through retail shops in the neighbouring towns. The following are the main costs associated with the expansion of the business:

Capital costs

US$

Bottle washer

125

Bottle steriliser

130

Juice press

285

Product pasteuriser

240

Filler

135

Capper

245

Total capital cost

1160

Working capital required for


two weeks production

25990

For simplicity it is assumed that a loan for the capital + working capital (1160 + 25990) of US$ 27150 is repaid over 2 years in equal amounts. The weekly repayment is therefore 27150104 = us$ 261.05 per week as fixed operating costs.

Operating costs

US$/week

Fixed


(The owner pays two

540

assistants US$ 25 each per


day and himself $40 per day)


Business tax/registration

12

Depreciation (over 5 years)

4.46

1160/260


Loan repayment (from above)

261.05

Variable


Fruit (500x110/1000 x 6) =

5500

330 litres per week or


330/0.15 = 2200


oranges/week


@ US$ 2.5/orange


Bottles, labels and caps

6600

(3000 + 10% wastage


@ US$ 2 each)


Boxes (24 bottles/box)

187.5

@ US$ 1.5/box


Fuel costs

65

Distribution costs

75

Total operating costs

12995.11

Total expenditure

13256.16

Income (500 x 6 x 5.5)

16500

Gross Profit

3243.84

Profit per bottle

1.08

(3243.84/3000)


The total funds available to the owner as both a wage and profit to invest in the business is therefore US$ 1440 (wage) and US$ 12975.36 (profit per month). In addition the owner is providing employment for two people.

From the above example there are a number of aspects that should be noted:

- Packaging costs are the single highest cost of the bottling business.
- The capital cost of equipment is relatively low because simple hand-operated and locally made equipment designs are available.
- The loan required is much higher for the bottling plant in order to pay for both the equipment and particularly the working capital. This may present difficulties if banks or other lending institutions are unwilling to advance larger amounts without an additional owner's security.
- An average price has been assumed for the fruit. In reality the price would be likely to vary throughout the season and the amount of money required as working capital would be higher.
- It has been assumed that packaging can be bought when it is needed. In practice a minimum order may be necessary which would increase the working capital required.
- The profit per unit of product is more than twice as large for the fresh juice than for the bottled juice. In order for the business to be profitable the owner has to take advantage of the longer shelf-life of the bottled juice to find a larger market and maintain production at the higher production volume. However the opportunities for further expansion of the business are greater using bottled juice because the potential market is greater than that for the fresh juice.