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DK5739_CH5 - 5 Estimation of Operating Expenses The...

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5 Estimation of Operating Expenses The estimation of capital requirements has received considerable attention in the open literature as evidenced by the vast number of references. On the other hand, operating expenses are estimated from proprietary company files, and hence there is a meager amount of information in the open literature. References 1–4 provide various viewpoints concerning the estimation of operating expenses. Capital expenditures occur once during the life of a project but operating expenses are recurring expenses and, as such, significantly affect the cash flow and profitability of a venture. Some expenses, such as raw materials and utilities, can be estimated with reasonable accuracies from material and energy balances for a process and from projected price structures. Items such as maintenance and plant indirect expenses are estimated as a percentage of the fixed capital investment. Depreciation is set by the federal government rules. Labor, however, is more difficult to project and this is where practical experience is necessary. Generally, all other items in operating expense estimates are percentages of labor expenses. Errors in the estimation of operating expenses occur as a result of improper use or misinterpretation of reference data. An inexperienced person should seek advice and guidance from experienced manufacturing personnel when preparing an operating expenses estimate. 5.1 TERMINOLOGY Operating expenses in this text will consist of the expense of manufacturing a product as well as the packaging and shipping, selling and distribution, and
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general overhead expenses. The manufacturing expense will be interpreted to mean those expenses required to make a product and to ready it for shipment. Unit cost is the cost of an item based upon either a mass or volume unit, e.g., dollars per pound, dollars per gallon, dollars per barrel, etc. Raw materials, by-products and utility costs are quoted on these bases. Direct expenses are those directly associated with the manufacture of a product, e.g., utilities, supplies, and labor. These expenses vary nearly in direct proportion to the production rate. On a unit-cost basis, they tend to remain constant irrespective of the amount of material produced. Raw materials and by- products are often carried on the manufacturing expense sheet as separate items from direct and indirect expenses, although they tend to vary directly with the production rate. Indirect expenses are those that tend to remain constant with respect to the production rate. Examples are depreciation and plant indirect expenses such as security, fire protection, roads, yards, and docks. On a unit-cost basis, the indirect expenses will tend to decrease with increasing production, since their cost is constant or varies slightly with the production rate.
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