written by | May 11, 2022

What is Life Cycle Costing? Analysis & Importance Explained

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Table of Content


The life cycle costing is an approach to the economic analysis of all costs associated with creating, operating or maintaining an energy conservation (ECM) project for a specified time.

The assumed escalation rate reflects the increase in the cost of uses over time. Future expenses are expressed in modern rupees, using an appropriate discount rate that reflects the value of money. 

One can directly compare expenses and savings and decide after absorbing in-depth information. Now, it's time to check the life cycle costing definition, process, advantages, disadvantages and what can you expect from this process. 

Did You Know?

Maintenance, repair, fuel, interest, depreciation and downtime are just a few life-cycle expenses that impact the value of an asset to a business. LCA considers all these additional costs to identify the most efficient replacement point for fleet managers. It allows them to reduce expenditure, increase profitability and reduce the total cost of ownership.

How Much Does Life-Cycle Insurance Cost?

If we talk about what is life cycle costing, this costing method is used to estimate the one-time and ongoing costs for purchase throughout the life of the product or goods. The concept of one-time costs is quite straightforward because it's the price of an item. In the case of Chauncey, it's the price of the jet in itself. It could also include (depending on the jet's model) the cost of installation.

These will continue to be incurred after purchase, such as operations, maintenance costs and even upgrades. Operations costs are ongoing costs related to the usage of the product. For a corporate jet, it includes fuel, supplies and salaries for crew members.

Costs for maintenance are associated with the maintenance of the item. The corporate jet may eventually require replacement parts. Also, there will be a need for an aircraft mechanic to make repairs.

Disposal costs are the expenses that are incurred when disposing of the product after its use of the product has ended. This could include selling or shipping the aircraft to an auction yard.

Then it is possible to consider residual value. Residual value is the amount of the product when it has reached its useful lifespan. Certain private aircraft are able to last for as long as 30 years.

Also Read: Everything You Need to Know about Inventory Costing Methods

Why are Life Cycle Costs Important?

The following points emphasise LCC's importance. 

The concept of Life Cycle Cost applies to a variety of sectors. The estimation of the life-cycle cost is an important factor in deciding whether to purchase an asset. Management evaluates the cost of operating and maintaining the asset and generally chooses an asset with the least cost. 

The costs that management considers include installation, purchase price and operating costs financing maintenance, depreciation and disposal, as we mentioned up there.

The study of Life Cycle Costs is crucial if the project involves multiple options. The alternatives differ in terms of the costs necessary to complete the project. In this case, the manager chooses the option which will result in the greatest savings. The best option is to reduce the initial cost and the operating expense.

Look over a few of the arguments in-depth about how knowing the asset's total cost can inform your business choices to avail the most of life cycle costing benefits.

Choose from the Two Assets or More

Life cycle costing is a method to help in making purchasing choices. If you just consider the cost at the beginning of the asset, you may be spending more money over the long term. For example, an old model might come with an affordable price tag. However, it will cost you more in repair and utility costs than a brand new model.

Managing life cycle costs depends on your ability to make wise investments. When you're deciding on two or more investments, think about the total cost of each asset instead of just the price before you.

Determine the Asset's Value

How can you determine when to buy an asset? In general, you consider the advantages/disadvantages of the purchase. However, if you solely take into account the initial, immediate expense, you'll be unable to determine whether the asset can benefit your company financially in the long term.

With the help of life costs, it is possible to more accurately determine if an asset's investment return (ROI) is worth the cost. If you solely focus on the current cost of the asset and do not consider the future expenses, you'll underestimate ROI. This wrong estimation can bring adverse effects. It may even disturb the whole business strategy. 

Make Sure You Have a Precise Budget

If you know what an asset's value will be, it is possible to make budgets that reflect your company's actual costs. This way, you don't underestimate your company's expenses.

A budget consists of revenues, expenses and profits. If you underestimate the cost of an asset on your budget, then you have overestimated your earnings.

Inadequately accounting for expenses could result in excess spending or negative cash flow. If you are going to include a partner in your business, your communication skills must be on a top level. It will increase the chances of doing a collaboration with a big company.

Who is the Person Who Uses the Life Cycle Cost?

Companies that employ long-range plans extensively use the concept of life cycle costing. It allows them to maximise their profits over the long term. Businesses that do not think of LCC as crucial may purchase assets at a lower price. However, they do not consider the costs they might have to pay over the asset's lifespan.

What are the Costs to Include?

There are a variety of costs over the lifespan of an asset, product or project. These expenses are typically operational costs, procurement costs and disposal costs. There can be a variety of sub-costs in these costs, including fuel, repair and maintenance, replacement, and much more.

However, we cannot consider all costs in a Life cycle analysis costing. Instead, we should focus on high costs. We count a cost as "important" if it can be dependable in affecting the project's life-cycle cost.

Also Read: Accounting Cycle: Definition and Steps in the Accounting Cycle Process

LCC of Intangible Assets

Intangible Assets are assets that aren't visible or touched, like patents, goodwill and other such assets.

LCC for an intangible asset is the total cost for acquiring and maintaining the asset. For example, you may pay the price for the patent. Additionally, you hire an attorney to handle the paperwork. You must pay annual fees to keep the patent. All of these expenses are considered LCC.

To build goodwill, you'll need to consider all the expenses involved in creating it. Examples can be the price of a logo, advertising campaign, website, etc.

Life Cycle Cost Analysis (LCCA)

This type of analysis can help determine how much the project and the alternatives cost. Following that, the project's management may use it to pick the most appropriate option to reduce the costs of owning without losing the functionality or quality.

One must perform LCCA from the beginning or at the point when the design process begins. Beginning the process right from the stars gives enough time to make adjustments. In turn, it will help reduce the life cycle cost. The first step in LCCA is to assess the effect of the choices available. Then, we have to measure the impact in terms of money.

Conclusion

It is necessary to reduce the cost of future expenses to the present value. This makes it simple to calculate the present value of the life-cycle cost. Also, it's possible to use previous data to calculate the expense value accurately.

To make the process easier, you need to determine the variable costs first. Just like this useful procedure of knowing economic analysis costs, you should try to eliminate the entire calculations of transactions of the business as well. 

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FAQs

Q: What’s the process of conducting a life cycle cost analysis?

Ans:

  • Understand the expense maintaining the status 
  • Identify costs
  • Identify various advantages
  • Assign a monetary value to the expenses and advantages
  • Create a timeline for costs and revenue you expect
  • Compare costs and advantages.

Further, comparing costs and benefits can be touch without considering a few points like:  

  • Inflation
  • Lost return on investment
  • Discount rate
  • Payback period

Q: What types of costs do I need to include in the life cycle costing process?

Ans:

Generally, life cycle costing calculation includes adding six sorts of costs; 

  • Purchase costs
  • Operational costs
  • Maintenance costs
  • Depreciation costs
  • Financing costs
  • End-of-life costs

Q: What are the disadvantages of life cycle costing?

Ans:

Using the life-cycle concept sometimes causes hardship in your business. It may cost you more money than you expected. Following are the most considerable disadvantages of life cycle costing:

  • The early struggle for profitability
  • Drop-in productivity
  • interest charges
  • Changed value of the rupee

Q: What are the life cycle costs’ benefits?

Ans:

There are three primary advantages of life cycle costing:

  • Long-term value
  • Reliable planning and less risk
  • Green building certification credits

Q: What is the life cycle costing?

Ans:

The life cycle costing definition is very simple. It is a technique of adding up each cost of an asset beginning from its initial cost to everything that comes till the end of its life.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.