I. ASSESSMENT OF COSTS

In general, a simple estimate of production costs may be made by assessing those costs which are fixed each year and those which are variable according to the level of throughput. The tables below indicate how these can be built up and related to annual production. In order to estimate fixed costs on an annual basis, investment costs (i.e. such items as land, buildings, plant and equipment) should first be calculated and the ‘life’ of the major items ascertained.

Annual fixed costs are equal to the sum of the following cost items:

(i) Depreciation costs: Depreciation based on life of buildings, equipment and plant, etc. Thus a piece of equipment with a 10 year life would be depreciated at the rate of 10% a year of cost.

(ii) Interest on capital: Estimated as a percentage of investment costs.

(iii) Maintenance and repair costs: Estimated as a percentage of investment costs. This may vary for different items.

(iv) Insurance costs: Estimated as a percentage of investment costs for items which need to be covered by insurance.

(v) Interest on working capital: Based on working capital needed to cover stocks of raw material and finished product, and other operating costs.

(vi) Permanent labour: Salaried staff, e.g. management, supervisory staff, etc.

(vii) Other overheads: Other expenses non itemised above, e.g. office expenses.

(viii) Contingencies: Estimated figure. Say 10% of fixed costs.

Variables costs may be estimated on a daily basis and aggregated according to the number of days worked a year. Table V.1 shows how the various cost items may be estimated in order to obtain the total daily and annual variable costs.

Using such pro-forma schedules, it is possible to compare alternative scales and techniques. The cost per tonne of finished product need not be worked out on the basis of total annual production costs only. It would, for example, be possible to compare labour costs/tonne, raw material costs/tonne, depreciation costs/tonne, etc. In this manner, it is possible to make a simple first stage comparison between alternative processes and a preliminary assessment of the effect of improvements. Thus, for example, a new method may reduce raw material costs by improving yield but increase depreciation costs because of higher investment costs. The effect of variations in annual throughput can also be assessed. Where a significant difference arises in the quality of finished product, then the assessment must take into account alternative sale prices and the likely demand for a better quality, but possibly more costly, product.

Table V.1.
Estimation of variable costs

The total annual production costs and the total cost per tonne of output can then be estimated as follows:

Since this method of analysis takes no account of revenue, it does not indicate whether a process is profitable or not and cannot be used to compare the relative profitability of different processes. An alternative method of evaluation is the discounted cash flow technique. This method takes into account the flow of costs (including replacement costs) and receipts over time. These are discounted to calculate a project’s net present value (NPV) or the internal rate of return (IRR) and thus enable a comparison to be made between alternative projects.

In the following sections, an analysis is made of cost structures for some of the alternative processing techniques described in earlier chapters. These cost structures have been derived from various sources and must be regarded only as approximations. Their main purpose is to provide illustrative rather than definitive statements of the actual costs at present incurred in processing. The costs will differ between locations but, as far as possible, they have been presented on a comparable basis. These illustrative examples will also help a better understanding of the accounting framework described in this section.