Definitions & Standards

SOCIETY OF COST ENGINEERS – DEFINITION OF TERMS

NOTE: These DEFINITIONS are generally accepted but should be used as GUIDELINES only. The key to any good cost model is not to be rigidly held to these definitions but to understand them and to apply them correctly. To ask a supplier to define each in their terms and make sure they are accounted for correctly.

NOTE: This page is continually being updated. If you have questions, comments or suggestion as to needed definitions or disagreements with the content, please use the CONTACT US page and we will attempt to address these.

Amortization

It is the process of allocating the cost of an asset (equipment or machine) over a period of time. For example, if we purchase a machine worth 100,000 USD, and decide we want to “amortize” it in 5 years, it means we need to recover 100,000 / 5 = 20,000 USD every year during the first 5 years. This amount (20,000 USD) needs to be included in the equipment hourly rate.

Batch

This is the number of parts produced between setups. Not to be confused with LOTS or MOQ.

Cycletime

Sometimes called “Engineered Cycle Time”, is the time it takes the machine or equipment to complete its process, measured “floor to floor” (referred to the part being produced, as if it fell to the floor when the process is completed) also Drop Time. The cycle time is therefore composed of:

  • Load and Unload of the part into the machine or equipment
  • Processing time of the part insider the machine or equipment. This processing time is composed of:
    • Value added time: when there is any transformation performed at the part
    • Non-Value added time: movements and waits that add cycle time but do not add value to the part

Dedicated Equipment

When the equipment will be subject to no change over at all, and will be producing the same part (or family of parts) during the lifetime of a project.

The investment incurred to procure these machines or equipment should be spread over the number of parts produced, in replacement of the equipment depreciation calculated based on a number of years. Used in the calculation of a machine rate. If a machine is fully dedicated then the total cost of the machine should be spread over the number of parts produced.

Example: You have a machine that costs $100,000. You have a 10-year program to produce 10,000 parts per year, or 100,000 parts over the life of the program. This would mean you need to spread the $100,000 over the 100,000 parts for $1.00 per part.

For this reason we have a 3 step test to verify the equipment is truly dedicated:

TEST 1: CAN this machine EVER be reconfigured or retooled to produce any other Parts? Yes = not dedicated.

TEST 2: At the end of the program, will the machine be useless? No = not dedicated

TEST 3: Is there a contractual agreement that NOTHING ELSE CAN NOW OR NEVER be run on this equipment? No = not dedicated

After the agreed depreciation is over (total number of parts produced as agreed), this amortization should be removed from the part price, or recalculated if the equipment needs to go through any refurbishment.

Keep in mind that if it is dedicted, at the end of the life, your company owns this equipment and has the right to pick it up and move to any location if the contract is written properly.

Depreciation

The accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Typically, 7 to 10 but could be al short as 1 to as long as over 30 years.

Short run assembly equipment (mostly manual) 1 to 2 years

Injection Molding press / CNC Machine 7 to 10 years

Heavy Duty Stamping Press up to 30 or more years

Direct Labor

Any worker that runs a machine or operation to the part being produced

Electricity Consumption (for hourly rate calculation)

Average electricity consumption of the equipment in kWh/h. Note that the equipment maximum consumption noted in the equipment specifications is NOT the average consumption. In fact, the average consumption could be well below 50% of the equipment peak consumption.

Equipment or Machine

Device used at any operation to add value to the component being worked.

NOTE: Inspection operations are NON-VALUE operations that add cost to the component

Gas consumption (for hourly rate calculation)

Average gas consumption of the equipment in m3/h. Normally used for furnaces, and can include Natural Gas, Endogas, Hydrogen, etc.

Indirect Costs

These are the costs associated with the facility that do not fall into direct (Fixed or Variable), Labor (Direct or Indirect) or SG&A. The key with these costs is to make sure they are not double counted within one of the other categories.

Indirect Labor

Any worker that performs other jobs in the shop floor supporting several operations during his/her shift, but is not directly involved in the active conversion of the component into the final product. According to the SOCE, these Indirect Labor includes:

  • Setters
  • Shift Leaders
  • Group Leaders
  • Quality staff
  • Logistics or material handling staff
  • Purchasing staff
  • Manufacturing Engineers staff

Indirect Markup

Indirect markup is a percentage or multiple of Manufacturing cost, either Machine Cost, Labor Cost or a combination of both. This is meant to capture and express all the indirect costs associated with the shop floor. This would include the category of Indirect Labor as well as the Indirect Cost.

Inspection

Inspection can be broken down into two separate categories In cycle and Quality Lab Sampling

  • In Cycle refers to the OPERATOR (direct labor) inspection, measurements and verifications, visual or measure, that occur between parts being produced (within the next parts cycletime). In this case this is basically free as you are continuing to pay the Direct Labor for the entire cycle.
  • Quality Lab inspections are periodic samples being sent to the quality lab for approval. These are usually called out on a process control plan. Although every attempt should be made to capture these within a Cost Model, they usually contribute very little to the end price as these charges get spread over the entire LOT.
  • Sometimes there are “quality gates” which are inspection of the parts by a different operator, visually, or with gauges. These are by definition non-value operations, but add cost to the product (i.e. waste) and should be considered in the part cost, especially if they are requested by the customer. If decided to implement by the manufacturer, these should be minimized or eliminated and focus on built-in quality.

Insurance

It’s the cost of insuring the asset we purchase in case it is destroyed by a Force Majeure not covered by the asset warranty. It must also be part of the equipment hourly rate calculation.

Interest

It is the interest we need to pay to the money lender for the money we have borrowed to purchase any equipment. As for the Amortization or Investment, it is an amount that we must recover and that should be part of the equipment hourly rate calculation. This interest rate varies with respect to the country where the money is lent.

  • Excel formula “PMT”: Calculates the payment for a loan based on constant payments and a constant interest rate. SOCE uses this formula to calculate the Amortization and Interest cost/hour of an operation based on its investment.

Location

Region and place in the world where the operations are taking place.

Labor Rate

The total cost of a direct operator per hour, all inclusive. (Labor Rate) x (number of hours per shift) x (working days per year) = Gross Yearly Salary (Total yearly cost of the operator to the Company where he/she works).

Labor Time

This is the chargeable amount of time an operator (direct labor) is performing a given task.

Example 1: An operator is required to manually fastens a screw for 10 second. Labor time is 10 seconds.

Example 2: A Machine operator maintains 4 CNC’s each with a 1-minute cycle time. The labor time is 15 seconds or ¼ a minute.

Lot

The number of products produced within a BATCH for tracking purposes (usually for quality reasons). This dose not equal and therefore should not be confused with BATCH or MOQ

Machine Hourly Rate

The running cost per hour of any equipment or machine. According to the SOCE, it is composed of the sum of Fixed and Variable Machine Rates

  • Fixed Machine Rate: Are those costs that are incurred regardless of the number of parts produced. For example: building rental, equipment amortization, shop floor heating/cooling, Interest, Insurance, Floorspace
  • Variable Machine Rate: Are those costs that are directly proportional to the numbers of parts produced. If we produce 0 parts, the Direct Costs spent should have been 0. Electricity consumption, Gas or other elements consumptions, Maintenance

Machine Time

This is the amount of time the particular parts spends on the machine having value added to it.

Material Overhead

Material Overhead or Inventory carrying cost is the cost of carrying inventory. It is important to understand and determine if you want this to include floorspace and or material schedulers and movers. If so then the Category of SG&A and Indirect Labor may need to be adjusted.

AT SOCE, we recommend to use a fixed “handling fee %” to the material price to cover for all the above plus the other costs related to bringing the raw material to the manufacturing plant.

Minimum Order Quantity (MOQ)

This is the minimum amount of product a supplier with allow you to order at one time. This is not to be confused with Lot, or Batch size. This is usually appearing as the quantity on a set order P.O.

OEE

Overall Equipment Efficiency: It is the ratio of the number of good parts produced over a period of time to the number of parts that could have been produced according to the engineered cycle time. For example, a process has a cycle time of 45 seconds, which means it could produce 80 pcs/hr, but over 8 hours the number of OK parts is 520 pcs. In this case, OEE = 520 / 640 (80 pcs/hr x 8 hours) = 81.25%

There is a lot of debate about how to correctly declare the OEE, for example:

  • Should the set-up time be considered as production time and therefore affect the OEE?
  • If we have 30 minutes per shift to clean the working area, should this time be considered as production time and affect the OEE?

Overhead

It’s part of the SG&A, normally the “G&A” expenses. These are the costs a company must incur to open the doors each day

Payment Terms

The expectations between the buyer and seller so that there won’t be any potential misunderstandings nor disagreements because both parties clearly know what is expected and they are satisfied with the requirements.

  • COD “Cash on Delivery”or “Payable on Receipt,” means that a payment is due at the same time as a product or service is delivered.
  • Net 7, 10, 30, 60, 90 These imply that the net payment is due in either 7, 10, 30, 60, or 90 days after the invoice date. For example, if the invoice was dated June 10 and you used one of the most used payment terms, Net 30, then the payment would be expected before July 9.

Profit

It’s the difference between selling price and product cost including SG&A. Publicly traded companies report this on the year end financials. These year end financials are a great source of information not limited to Profit and SG&A.

Residual Value

It is the value of any machine or equipment for which it could be sold after the amortization period. In SOCE, we typically apply a 10% for standard machines and 5% for custom-made machines, and suggest to rest this residual value in the equipment amortization hourly cost, because this money will be recovered at the end of this period.

Router or Job Ticket

This is the step by step instructions (usually including charge times and accounts) informing the plan on how a product is produced and where the costs should be allocated.

Scrap

It is the material, components and/or parts of the component that can’t be sold as finished products and must be dispose.  Scrap can be broken down into three categories Designed In, Bad Part, Material Usage Scrap (Gross vs Net).

Designed In Scrap is the predicted scrap required to insure a good part is made. For example, 1 out of every 10 welded parts is submitted to the quality lab for pull texting and sectioning. These requirements should be stated on print or quality control plan

Bad part scrap the fallout of mis-produced and ideally should not be paid accounted for in an Theoretical, Ideal, or Benchmark Should Cost Model.

Material Usage (Gross vs Net) is the difference between part gross weight and part net weight. For example, in order to stamp a ring from sheet metal, the inner area of the sheet metal that must be cut-off is wasted, and is scrapped.

Scrap that can be sold or recycled should be taken into account in the Should Cost calculation.

Setup

The down time it takes to convert to your component. It is measured from last good part of Part A to first good part of Part B. The costs covered by this should include: Machine Down Time (opportunity costs lost), Labor to change over the equipment, Indirect Cost for the process (tool maintenance). This cost is spread over the batch size.

Should Cost

Calculated cost of a part or assembly using a determined equipment, cycle time and operator content at any given location. If any of these factors change (equipment, cycle time, number of operators, or location), then Should Cost changes.

Typical types of “Should Cost Include Theoretical Optimal, Ideal, Benchmark, Suppler Specific, and Does Cost

SG&A (Sales, General and Administrative)

These are all the costs not directly tied to making a product or performing a service, including:

  • Sales persons, Marketing, Advertisement, etc.
  • Plant, Engineering, Quality and Logistics Managers, and other High-Level staff salaries
  • Finance Managers and Finance staff
  • IT, Phone, Internet and communications
  • Rentals
  • Travel expenses
  • Office supplies and utilities
  • Bad Part Scrap: During the normal production, a certain minimal number of parts may come out incorrect. Depending on your object for modeling you may want to assume either 0, a benchmark or actual percentages.

Publicly traded companies report this on the year end financials. These yearend financials are a great source of information not limited to Profit and SG&A.

Takt Time

This is the amount of time you need to produce the required parts over the expected production time. Often called the drumbeat. Some times referred to as “As slow as necessary”.

Example: If you have a part that takes 15 seconds to produce but need to make 1 part per year your TAKT time is 1 Year and your CYCLETIME is 15 seconds.

Throughput

Throughput is the number of units that pass through a process during a period of time.  It can be parts per hour, parts per shift, or parts per week. If is a combination of cycle time and OEE

 

 

 

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