Fixed and variable costs

The main fixed cost of the injection moulding process is，of course，the capital cost of the equipment, but other fixed costs—rent of property，rates，etc.— must not be lost sight of. In the world of the entrepreneur—and such people started many companies in the field of injection moulding.Machine capital cost has not seemed so important in the past. Starting operations with one or two small secondhand machines，the minimum of ancillary equipment，and often poor or even inadequate premises, it has been possible by meeting a local need，perhaps in a specialized field，to make a very reasonable profit. This may have been achieved by hard work and vigilance on the part of the owner of the company, but it has enabled many small companies to grow and invest in newer and better equipment in the knowledge that any new capital expenditure has been met out of profit. It is probably fair to say that，of some 1500 companies in the United Kingdom engaged in injection moulding, perhaps half of them have operated，and many still do operate, in this way.

The owner-manager of such a company does not need to consider the servicing of his capital at，say，15 per cent per annum. He only considers the loss of interest，less tax，on his capital which may，ultimately，be no more than 5 or 6 percent. In such a situation，quoted prices tend to be lower than the general market prices. The owner-manager can afford to be selective in his business，avoiding projects that present difficulties，and is not needing to bother unduly if machines are idle，as long as any paid operative can be fully and gainfully employed. Often，such a company will have little, if any，rent to pay and the small premises will not attract large rates.

The full impact of high capital costs is felt when machines are acquired on borrowed finance，when full labour costs for all operatives have to be paid out of cash flow，and when premises are large，adequate，and of good standard. If， in such circumstances, the management cannot afford to be selective in their choice of work and have to tackle the difficult，time-consuming jobs，as well as the less critical ones，cost savings of whatever type and magnitude are important.

There are various ways of financing the purchase of injection moulding equipment.but, at a time when borrowing is expensive，an allowance of about 15 per cent per annum for servicing the capital involved would appear to be prudent In times of financial stringency. such as have been experienced in the United Kingdom since 1970~and to some extent ever since the end of the Second World War一a company is fortunate indeed which has sufficient new capital accruing from profits to finance the purchase of new machines in order to expand a business. It would also seem that，although charges for amortisation of equipment are included in all company costings，for some reason or another the capital is never available to replace a worn-out or written-ofT machine. Frequently，accumulated capital that should have been set aside for buying new machines has to be spent on repairs to keep a worn- out machine operating so that a contract may be fulfilled.

If capital is not directly available for the purchase of equipment，either from accrued profits or from the issue of shares，medium-term finance may be obtained by means of bank loans, mortgages, sale and lease-back of property， hire-purchase contracts, or equipment leasing.

Bank loans for periods over 12 months are now more readily available than in the past，and will be secured by a direct charge upon the company’s assets. Such loans, known as ‘term loans’, are better than taking up overdraft facilities as there is no danger of their being prematurely recalled. Loan charges vary according to the state of the money market but will be 2-5 percent above the bank’s minimum lending rate.

Mortgages may be available from various sources，such as insurance companies, investment companies，or public and private trust funds. Terms may vary from 5 to 20 years, and the money is secured by a charge on the company’s assets. Generally，mortgages prove to be expensive- High rates of interest may be charged, and in the event of default the mortgagor may take possession of the asset.

The sale and lease-back of the property is a useful method of obtaining additional finance for purchasing additional equipment. Property such as land or buildings is sold to a property investment company under an agreement which allows the property to be leased back to the business for a fixed term with a written-in option for renewal. It has to be borne in mind that the fixed charge for rent will have to be met, irrespective of whether profits are high or low. Property investment companies are not likely to relinquish possession once the sale has been made and this method of financing has that disadvantage. This compares unfavourably with taking out a mortgage, where it is possible to pay back extra capital in good years and so reduce the term of the loan. Sale and lease-back has the advantage that it only reduces the value of the fixed assets by the difference between the value of the property before sale and the value of the lease. This could show capital appreciation in times of inflation or of increasing property values.

Procuring equipment by hire purchase has the advantage of enabling the hirer to use the proceeds of operating the equipment to pay the hire-purchase charges. With injection moulding equipment，for which an amortization period of five years should be allowed，the hirer would be wise to take out his hire purchase over three years so that the written-down value of the equipment will always be greater than the amount of debt outstanding. Hire purchase is expensive because a flat rate of interest is charged for the full amount of debt over the whole of the period, and this virtually doubles the nominal rate of interest which appears to have been charged. The goods purchased under a hire-purchase agreement remain the property of the vendor until the last instalment has been paid，and in most cases maintenance or repairs are the vendor’s responsibility. The amount of debt outstanding will appear as a liability on the hiring company’s balance sheet-

Credit sales are not subjected to the same legal formalities as hire-purchase agreements and the equipment purchased becomes the property of the purchaser at the time of sale. However, real interest rates are likely to be considerably higher than the nominal rates charged.

Equipment leasing is similar to the leasing of property and is becoming more widely used in the United Kingdom，although it has been in use elsewhere for many years. Equipment is bought by a finance company— sometimes by a bank—and leased for a fixed term to the business. The equipment will always remain the property of the lessor，who will probably base the lease charge on a three-year term. For example, for an injection moulding machine costing £20 000，the annual leasing charge would probably be about £7000. By leasing equipment, a business is able to function with limited capital resources, but the equipment must be capable of earning considerably more than the lease charge. An advantage of the system is that at the end of the lease term the equipment can be replaced by brand new equipment on similar terms and without capital expenditure by the lessee.

Compared with financing by direct loan，equipment leasing is rather more expensive. Thus, for the injection moulding machine leased over three years， the cost would be £21 000. If a bank loan serviced at 15 per cent were used to buy the same machine，allowing 20 per cent per annum for writing down the value of the asset, the cost over a three-year period would be: Development Corporation. The last is more concerned with financing new developments rather than supplying funds for an established process.

Having dealt at some length with the most important item of fixed cost，that is, the servicing and obtaining of capital，consideration should be given to the other cost items in running an injection moulding business. It is convenient to categorize these into three groups:

• (1)    Costs that tend to be constant，irrespective of whether output is high，low， or non-existent
• (2)    Costs that vary directly with output.
• (3)    Costs that occur on a variable basis，but are not directly related to output.

Among the items in the first group to be considered，other than the servicing of capital，are:

• (1)    Rent of property，rates，water rate (if fixed)，and allowances for repairs， painting, decorating, etc.
• (2)    Heating，cleaning, and lighting, and the maintenance of services.
• (3)    Maintenance of stores of raw materials，components, moulds, and spare parts，and for bought-in items，such as inserts.
• (4)    Fixed allowances for the repair of machines，moulds，and services on a planned maintenance basis.
• (5)    Telephones, Telex services，timekeeping equipment，fire alarm and prevention services.
• (6)    Office overheads; allowances for stationery, typewriters, photocopiers and other office equipment.
• (7)  Indirect labour, such as management, accountants，secretaries， draughtsmen， storekeepers, etc,， and toolroom personnel， if employed.
• (8)    Allowances for sundries, such as canteen, restroom，first-aid kits, beverage vending equipment, etc.

Of the fixed costs listed (which may be by no means exhaustive) item (1)， together with the servicing charges for capital，will be dealt with separately in working out costings. The other items will normally be lumped together under the general umbrella of overheads. However, anomalies may arise if this is done, as will be seen below when discussing the true cost of material.

The main variable costs，that is，those costs that vary directly with output, are the cost of raw material, allowances for mould amortization，and the cost of packaging material for the dispatch of finished components. In determining these costs，it is important to make some adjustments unless a costing system is used which already does so. These include:

• (1)    Raw material cost is not the price of the material as paid to the supplier， but the supplier’s price plus the cost of storage, the cost of labour and machinery used in storing the material，the loss of interest on capital, and the cost of servicing the capital used in paying for the material. Thus, if a supplier allows six weeks credit in settling the account, but a three months stock level must be maintained，the cost of financing for six/seven weeks and the cost of storage for three months must be added to the basic price. If a labourer is used for moving material in and out of stores，allowances must be made for his wages and overheads. Allowance must also be made for the effects of inflation on the cost of raw materials.
• (2)    Mould amortization can be justifiably considered as a variable cost， because the mould cost per item depends on the length of run and the time over which amortization is to be made. Some moulds need more servicing than others (for example，fast cycling moulds) and estimated costs for servicing must be included under this heading.
• (3)    The cost of packaging material for the dispatch of finished mouldings also varies with output and should be dealt with as a variable cost item. Some injection moulding companies have run into financial difficulties over contracts because they have failed to add realistic amounts for this item. Adding a fixed percentage to a quoted price to cover the cost of despatch may result in either too high or too low a quotation.

Some of the semivariable costs, that is, those costs that vary from time to time but in a manner not directly related to output，include:

• (1)    Cost of electrical power. A certain amount of electricity is used in the factory irrespective of whether or not the full productive capacity is being maintained.
• (2)    Cost of some labour such as casual labour or outworkers recruited during periods of high output.
• (3)    Sales costs such as salespersons’ salaries and commissions, travelling allowances，and the cost of samples and advertising.

Costs of this type may be difficult to determine accurately in respect of any given job and are generally treated as an item of overheads- Provision should， however，be made for including this type of overhead into job estimating on a variable percentage basis to avoid either over- or under-charging.

One further item of variable or semivariable costing which should be mentioned is the cost of reclaiming scrap material. As with some other items，it is all too easy to overlook this item in the belief that any material reclaimed effects a saving of the full price of the raw material. This is not so. Even if an operator has a small granulator by the side of the machine，used for grinding sprues and runners as they are made，there is still a significant amount of labour involved. In addition，there is the capital cost of the granulator to be serviced, the cost of its maintenance, and the cost of the electricity consumed to be added—not to mention the cost of additional cleaning necessary. At best，these may add up to one-tenth of a man-week per tonne of material reclaimed，but if a man is employed full time on reclamation work, depending on the size of the granulator，the cost of the reclaimed material may be from 5 to man-week in terms of wages (at 1978 prices, £20-£80 per tonne).

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