Do You Really Know Your Costs to Conduct an Inspection?

As I introduce this article, I submit that I am not an accountant and barely made a “B” in accounting principles in college.  Since then I have not had to apply hardly any of the concepts that I wrestled with in Dr. Middleton’s Accounting 102.  Given that I will state that cost accounting is a very obscure area of accounting expertise, and most accountants that work with cost accounting are hired by corporate America to perform private cost analysis and evaluation on the products manufactured by that particular company.  Cost accounting can be helpful, however, if you’re going to have a need to establish prices for your business, or set cost of goods limits in relation to selling price.  In our practice providing a service, we certainly have costs associated with each inspection in much the same way as manufacturing does making a product.  As an exercise in my strategic planning for re-pricing my services in 2008, I set out to determine what exactly is my cost associated with each inspection.

Understanding Cost Accounting:

How do you determine the selling price of your service?  Do you simply add up the cost of all the office supplies and gas for your truck?  Do you know how to accurately factor in equipment costs?  How about the cost of the marketing or insurance, should they be considered?  I’ll bet you didn’t realize there were so many pieces to the cost accounting puzzle.  These aren’t all the pieces, either.  The pieces we’re going to discuss here, are basic cost accounting factors, and will apply to most inspection businesses, across the board.

As a business owner and a cost accountant, it is your responsibility to accurately determine the precise cost of the service your company provides.  In order to determine this cost, you’ll need access to information such as, average miles driven to and from an inspection, marketing costs, equipment purchases, software license fees, professional service expenses, etc.  How do you determine these figures?

For my company, I created a sample inspection order, purely for the purpose of conducting an average cost analysis for a typical inspection.  With figures such as computer equipment and tools, I had to make some assumptions about their life span.  In my scenario I also have to make some other assumptions like the annual number of inspections I will perform in 2008.  My assumption projects 300 inspections to be completed in the next year.  I know that many of you will do more or less than that number.  This number is important as it allows you to make computations about your average insurance cost per inspection, average equipment wear and tear costs, and average marketing costs, etc.

You also have to apply some economies of scale, meaning your cost for some areas is reduced as your number of inspections increases.  For example, your cost per inspection for your website (assuming your have a fixed annual fee) goes down as your number of inspections increases.  Conversely, your fuel and car maintenance costs generally increase proportionately as your inspection counts increase.

My exercise was to create a spreadsheet of costs (see Table).  It was an alarming outcome as my costs in some areas are far higher than I imagined and in other areas are much lower.  This tool should allow me to make better business decisions in all purchasing plans too.  At a glance I know that insurance is a heavy hitting cost area.  If I am looking to cut costs, this is a starting point.

As I mentioned my assumption is based on a 12 month projection of 300 inspections.  In this way I can determine how much I pay in E&O insurance for each inspection by simply taking my annual premium and dividing by 300.  In the next section, with data I have kept on miles driven to and from inspections, I determined the average inspection round trip.  For me that number is 38 miles.  I understand that sometimes we drive two miles to an inspection and other times it’s 60.  But in order to determine an average cost per inspection I considered the average round trip (also considering other business trips traveled like to the bank too).  While the 2007 Federal mileage allowance is 48.5 cents, I calculated that my cost is more realistically about 39 cents per mile.  This was derived from the particular cost of my truck depreciated over seven years, maintenance, fuel, etc.  To no surprise this is an expensive area, but it became more even alarming when it’s broken down.

Continuing through the table you will see other expenses particularly related to my company.  In order to determine the cost per inspection for my laptop, I took the cost of the computer and divided it by an assumed life span of 1000 inspections.  While it may last longer or I might drop it down a flight of stairs next week, it should last about three years or 1000 inspections.  Other expenses you should consider are what I call “buried” costs like banking fees and merchant credit card discounts.  These numbers reduce my bottom line heavily too.  Note that my spreadsheet does not reflect any types of corporate or employment taxes however.

As you begin your goal setting for 2008, you may find it helpful to participate in this exercise too.  You may find ways cut costs and re-price your services so you can bring home a bigger paycheck.