This article explains the two cost groups and how to derive the final calculation. Believe it or not, there are some tricks to this that you should understand so as not to miscalculate the final number.
I’ll start out by explaining the two groupings of costs and the many different components. Then I’ll explain how to properly apply the formula to your situation.
I have written an article about Fixed Costs if you desire to gain an in-depth understanding of this term. For the cost per mile formula, fixed costs are those costs incurred either one time or regular ongoing costs that you must pay whether the vehicle leaves the lot or not. The following is a short list of the most common fixed costs from the most expensive to the least expensive and a short description of each:
- Purchase Price of Vehicle – this is the initial cost of the vehicle. This is really a sunk cost in the cost accounting world, but for the purposes of analyzing the cost per mile for business operation, this particular outlay is considered a fixed cost. You should include any modifications to the vehicle to get it ready for your business. Look at the truck photo above. This cube truck costs around $37,000 new without any amenities. If you decide to add some extras such as A/C, bucket seats etc., you are looking at a $39,500 vehicle. Modifications can include custom paint work for your company’s logo, phone number etc. Throw in a drop down ramp, dolly set, interior rails, clip controls with boards to control the load and you can be looking at another $3,300. So for this article, the initial cost of the vehicle is $42,800.
- Monthly Interest – since work trucks can be easily financed, most small businesses finance the purchase. The financing component includes interest and some principle repayment. The principle payment component is paying for the initial purchase price. On a monthly basis, only the interest is a true cost to the business. There is one issue with this interest payment; it decreases as the loan matures. So each month, this value will change. However, it is not a variable cost as you may think, it is fixed because you must make the note payment whether you drive the truck or not.
- Insurance – rarely do businesses find an insurance policy that is strictly based on the number of miles you drive. Most policies provide an allowance for the number of miles. The policies are generally for one year and range from $2,000 to as much as $4,000 depending on the mileage allowance you signed up for in the contract. There a lot of other variables such as good drivers, proper training, governors on the gas flow, and more. For this article, I am going to price the insurance at $3,100 per year for up to 20,000 miles.
- Licenses, Taxes & Compliance – I love to hate this one. I’ve never understood how the government can tax the initial purchase price of the vehicle and then tax it again each year as personal property. In effect, you are renting your vehicle from the government. But I digress. Each year your vehicle requires a license and registration decal to travel on the roads. In addition, your county or city government taxes the property as personal or business property. Finally, there is the compliance component which is the safety inspection each year. For a work truck like the one above, a typical business will pay around $680 per year for licenses, taxes and compliance. As the unit ages, the property tax component will decrease due to the value change, but overall you should expect to pay approximately this amount annually.
Now that we have the fixed costs groups, let’s analyze how to calculate the respective cost per mile associated with the respected fixed cost.
The purchase price is simple. The total actual cost out divided by the expected number of miles assuming regular maintenance on the unit. Unlike a bronze statue that can literally last 120 years without any maintenance, transportation units do have a life expectancy. What drives the (no pun intended) structural integrity lower is the stress from constant moving of the metal. Metal fatigue sets in and the structural integrity of the undercarriage, the engine, the transmission and so on wear out. This gets to the point, where the physical cost of replacement exceeds the value of maintaining the vehicle. Therefore, transportation vehicles do have a reasonable life expectancy. For a cube truck, you should expect about 170,000 miles before some major breakdowns. At that point, it would be cost effective to replace the unit with a new one. This is approximately 9 years assuming 18,000 miles per year of driving. So here is our number:
Monthly interest will change each month as the note principle decreases, there will be less and less interest per month as the note is extinguished. Remember, this is a fixed cost as we have to pay this interest each month no matter how much we drive the unit. The physical cost will vary (not to be confused as a variable cost) from month to month and year to year. At some point the note will be paid off and there will be no interest at all. For the sake of the calculation, I’m assuming a 65% loan on the original purchase price of $37,000, or $24,050 initial loan principle. The interest in the first year will approximate $1,856. The key is to assume a reasonable number of miles the truck will be used in the accounting period (one year). For the purpose of this article, I am assuming 18,000 per year. So the cost per mile associated with interest is:
It is important to remember, I did not include the principle portion of the debt in the formula. The principle portion was included in the original purchase price as identified above. Its cost per mile was calculated using the formula in item number one.
Finally, this value per mile will decrease in each of the accounting years as you pay off the note. So, if you are thinking the cost per mile changes, yes is the answer. It changes from one accounting period to the next; however, it does stay within a relevant range over the course of time. Also, I stated above that I would list the most expensive to the least expensive. In this calculation, I used a reasonable interest rate but a very small balance on the principle for the note. Most small business owners get their smaller trade-able vehicles financed at almost 100% of the purchase price. In effect, very little down payment. Thus the interest rate cost per mile is significantly higher than 10.31 cents per mile.
Insurance is a bit different than the others. Insurance is a package purchase and can include some maintenance protection. You can purchase extended warranties etc. at the time of purchase. You can also purchase towing options in your annual premium. Furthermore, many business policies stipulate to a maximum number of miles allowed under your plan. For this example, I am expecting around 18,000 miles of use on the cube truck but I purchased a 20,000 mile one year policy to be safe. The cost of the policy is $3,100 and includes emergency towing and windshield coverage. The cost per mile is calculated as follows:
Notice I divided the cost of insurance by the expected number of miles and not the maximum allowed under the policy. Fixed costs are based on the estimated number of miles driven. In this situation, I am estimating the cost for the upcoming accounting period and therefore I have to estimate the expected number of miles.
Licenses, taxes and compliance costs change from year to year. Most notably, the property tax generally decreases as the asset ages and the asset’s value decreases. So this cost varies from year to year yet you have to pay the dollar amount no matter how many miles driven! That is the definition of a fixed cost associated with transportation based assets. For the purpose of this article, I stated that the annual cost for the accounting period involved is $680. The cost per mile is ($680/18,000) 3.78 cents per mile.
Total fixed costs for this cube truck during the accounting period equates to the following:
Fixed costs for a cube truck are approximately 56.49 cents per mile. This is normal for a working truck of this size. For your smaller personal trucks, you are looking between 37 cents and 43 cents per mile for fixed costs. Now that we understand the fixed costs calculation, let’s move onto the variable costs.
From above, I explained that fixed costs are expenses paid no matter how many miles driven in the accounting period. Variable costs are directly associated with the actual number of miles driven. The most common variable cost is fuel. This section explains variable costs and the methods to turn these costs into cost per mile to use the vehicle. The following is a short list of the most common variable costs:
- Fuel – simple and straight forward, total cash out for the fill-ups divided by the actual number of miles driven.
- Long-Term Maintenance – many of the truck operations require ongoing maintenance to keep it safe to operate and efficient in its operation. These items are similar to what you and I pay for our personal vehicles and include:
- Regular Maintenance – oil changes, air filters, lubricants, wiper blades, light bulbs and the regular wash and wax to protect the vehicle is required. For this article, I am assuming an oil/filter system change every 6,000 miles. Wash and waxes occur every 1,500 miles.
- Tires – expect about 50,000 for a set; notice the cube truck above has four in the back and two upfront. You can extend the tire usage to 70,000 miles but for the purpose of this article, I’m going to use 50,000 miles.
- Brakes – these are dependent on several variables, types of tires, type of terrain you drive (city, highway, flat land, mountains), driver behavior and believe it not, disk, drum or air brakes.
- Suspension issues – a typical car and light truck will go over 100,000 miles before the owner has to replace ball joints, tie rods, mounting supports and the struts.
- Exhaust system replacement – often a function of road conditions and the quality of the system installed. Most systems will last about 75,000 miles before the muffler, tail, and exhaust pipe are rusted out. The catalytic converter usually lasts around 120,000 miles. Often these systems can last longer if the environmental conditions are dryer and the roads traveled are smooth with very little rock debris to damage the undercarriage area.
- Tolls – for those of you in the Northeastern part of our nation, tolls are quite common. For those in the Midwest and in the South, not as common to have tolls. So the cost of tolls will vary from one business to another and from one geographical territory to another. For this article, I will assume some tolls, but it will be on the lighter side of the cost spectrum to operate the truck.
The variable costs can easily distort the cost per mile from one accounting period to another. How so? Well, imagine having the tires replaced; all six. This will run around $900. If you limit your accounting period to just one month, and drove around 1500 miles, the cost per mile to drive during this period increases by 60 cents per mile ($900/1500 miles driven). If you extend this over the 18,000 miles associated with the annual accounting period the cost per mile is 5 cents for this one item. So the key is to spread this cost over the entire mileage expected for this item. WAIT, this seems to be a fixed cost, doesn’t it? The answer is no. It is still a variable cost because you will only incur this cost if you drive the vehicle. In the write-up on Long-Term Maintenance above, I identified 50,000 miles as the point to purchase new tires. So for the purpose of the tire element of Long-Term Maintenance, the cost per mile is 1.8 cents. Note how I estimated this cost and it is not the actual cost per mile. You could change out the tires at 52,000 miles and the cost decreases to 1.73 cents per mile.
OK, with this in mind, let’s compute the variable costs part of the formula.
Fuel will be the most expensive variable cost in the formula. Many variables affect this cost. Price per gallon, how efficiently the engine burns the fuel, city driving vs rural roads and so on. For the sake of expediency in this article, I am going to use $3.32 (2016 prices are in the $2.25 range) per gallon (OK, $3.319 cents like the sign says on the road) and the truck gets around 14.4 miles to the gallon. So the cost per mile is 23.048 cents per mile for fuel [((18,000 miles/14.4 miles to a gallon)*$3.319 per gallon)/18,000 miles of travel in the year].
To give you an idea of value, if the actual number of miles per gallon were to rise to 14.9, the cost per mile would drop to 22.275 cents per mile. That is a savings of .77 of a penny per mile. Extrapolate that number out over 170,000 miles and you get a value differential of $1,314. So tune-ups can be cost effective.
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Notice how Long-Term Maintenance has several sub-elements? I illustrated the tire cost above, so the following schedule costs out all the other elements in addition to tires:
Regular maintenance costs will change often due to the frequency of this maintenance schedule. Assuming something reasonable such as oil and air filter changes every 6,000 miles, replacing the wiper blades once a year, washing and waxing monthly and replacing a few burnt bulbs every year, you are looking at around $363 yearly. Cost per mile at 18,000 miles: 2.02 cents per mile.
Tolls – I am going to use $195 annually over 18,000 miles for a cost of 1.08 cents per mile.
Total variable costs per mile equals:
In the beginning of this article I stated that the cost per mile is a two part formula. The first part is the fixed cost component and the second part is the variable cost component. You add these two together. For this example, the cost per mile to run the cube truck as shown in the image is fixed ($.5649) plus variable ($.31382) or $.87872 per mile. That’s 87.872 cents per mile.
For this example, I used estimated number of miles to calculate fixed costs and actual number of miles to calculate variable costs. To keep it simple, both estimated and actual were exactly the same. This will not be the case for you. You need to be reasonable in your estimated miles of travel per year, if you under estimate, the actual cost per mile (once the accounting period is over) will be less than expected and if you over estimate, the actual cost per mile will be greater than your projection.
The key is the fixed costs section. You don’t really know the actual number of miles you will drive until the accounting period is complete. Most folks use this formula based on the actual number of miles driven, which works. But often, you use this formula to estimate your costs of transportation so you may price your service fee structure appropriately. The key is to be reasonable in your estimates so that the total cost per mile estimated is going to be close to your actual cost per mile at the end of the accounting period.
In reality, you will not know the real cost per mile until you stop using the truck at the end of its useful life (in our example, nine years). Once there, you add up all the costs and divide by the total number of miles driven and you will have the actual real cost per mile to drive that truck. But the reason you do this exercise is that you need that figure today before you begin. This helps you to price your delivery costs and service fee structure appropriately. You can’t wait for nine years to pass to figure it out.
Some transportation services use an adjustment factor in their invoicing format to offset some unexpected cost. The most common form is a fuel surcharge to cover the increase in fuel costs. I’ve seen this in airline travel, large delivery services such as interstate commerce or even the local materials delivery service. I’ve even seen it in waste removal (debris removal) services to offset the costs of fuel for the trash trucks.
Earlier I stated that you need to be reasonable in the overall use of the formula. This calculation was for a cube truck, a lower level personal use truck like an F150 or a Dodge 1500 will run in the 45 to 55 cents per mile range. Larger trucks such as a trash truck or a furniture delivery truck will cost over $1.25 per mile. If your formula gives you a calculation of less than 35 cents per mile, then something is wrong. The only way for this to happen is if you purchased a used vehicle or you misestimated the expected number of miles to use the vehicle in the accounting period. Naturally the larger the vehicle; the greater the cost is per mile due to fuel costs and the initial purchase price. Note how fuel and the initial purchase price are the two most significant cost drivers for calculating the cost per mile.
Some side notes of interest:
- The Internal Revenue Service mileage rate deduction is 53.5 cents per mile (2017 rate). Naturally, if you are using a vehicle that is new and meets the level of a work truck, your best bet is to use actual costs as the deduction on your return.
- Track your costs in your accounting software and maintain the vehicle’s history of costs and maintenance issues in a spreadsheet program.
- Communicate with your insurance company about how to keep the cost low, notice how insurance is the third most significant driver of overall costs to operate a vehicle.
- If you happen to have any questions, contact me via the ‘My Services’ page in the footer below and I’ll be glad to help.
Cost per mile to operate a vehicle is calculated using a two-step procedure. The first step is to determine the fixed costs (those costs you will incur no matter how many miles you will use the vehicle). Divide these fixed costs by an estimated number of miles you will use the vehicle in the upcoming accounting period. Typical fixed costs include the initial purchase price of the vehicle, interest on the debt for purchasing the vehicle, insurance, and licensing, taxes and compliance costs. Determine the cost per mile for each individual fixed cost. Then add up the individual costs to calculate the final fixed costs component.
Variable costs are those costs incurred based on the number of miles driven. These costs include fuel, long and short term maintenance, and tolls. As in fixed costs, determine the cost per mile individually as a single line item and then add them together for total variable costs per mile.
Once the fixed costs per mile and the variable costs per mile have been calculated, you can add these two summed costs together to obtain the total cost per mile to operate the vehicle. This final number will be close to the lifetime average that you will actually incur. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.
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