July/August 1996
Having a firm grasp on your operating costs is essential to managing your recycling business as efficiently, profitably, and competitively as possible. Here, a few cost-conscious recyclers offer a look at how to keep track of your costs.
By Kent Kiser
Kent Kiser is managing editor of Scrap.
Imagine trying to drive while blindfolded. Sure, you could do it, but it would be imprudent and could get you into serious trouble. And why would you want to do it anyway?
That’s exactly how many recyclers see trying to run a scrap business without a firm grasp on all of your processing and operating costs. Indeed, scrap executives note, there are plenty of reasons for knowing these costs—and none for not knowing them.
One is simply a matter of survival. “The scrap processing business is highly competitive and usually involves bidding for raw material,” says Sidney Metzner, chairman of Conservit Inc. (Hagerstown, Md.). “Without a firm grasp on the costs involved in processing the various grades of scrap, a business probably wouldn’t survive long-term.”
Knowing your processing and operating costs is also a prerequisite to setting your buying prices. “In the scrap business, you make your money on the buy, so you can only control what you pay for material and how you process it,” notes Chris Charlebois, vice president of operations for Luntz Corp. (Canton, Ohio).
Costs can also be used as a yardstick for appraising the performance of supervisors, determining whether various departments are profitable, allocating resources and effort, and cutting expenses during tight times. “A well-designed accounting system will throw a spotlight on troubled areas,” Charlebois says.
Having a firm handle on costs also enables you to compete more effectively, asserts Tom Salome, president of M. Lipsitz & Co. Inc. (Waco, Texas), who notes, “What if your competition ignores their costs and pays more than you’re paying? If you don’t know your costs, you won’t know how to compete intelligently. You have to know where you are.” Or as Charlebois adds succinctly, “If you want to remain competitive, the only way is to know your costs.”
When these recyclers talk about the need to understand your processing costs, they’re referring to the importance of applying up-to-date cost accounting practices to your operations. But while some scrap businesses do take the cost issue this seriously, many still “shoot from the hip,” as Bill Lowery, executive vice president of Annaco Inc. (Akron, Ohio), puts it.
This can be an unwise, if not fatal, business approach. After all, processing scrap is a cost-intensive endeavor, requiring hefty financial outlays in the areas of labor, equipment, maintenance, environmental compliance, and transportation, to name a few. And if you don’t fully understand and keep track of these costs, it’s impossible to get down to the most important numbers of all: your per-pound, per-ton, and per-hour processing costs.
A Look at Costs
When dealing with costs, the first fact to know is that there are two basic types: direct and indirect.
Looking at the second first, indirect costs, also known as semidirect costs, are operating expenses that are not directly attributable to a specific operation, such as general administrative overhead.
Direct costs are those that can be directly attributed to a specific operation or cost center. The electricity consumed by a shredder is an example of a direct cost for the shredding department.
Direct costs can be further broken down into two categories: variable and fixed.
Variable costs are those that vary in direct proportion to production volume and encompass such items as scrap feedstock, gasoline, fuel oil, oxygen, supplies, and repairs/maintenance. The more torching you do, for example, the more torch tips and acetylene you consume and, hence, the more you must buy.
Fixed costs, on the other hand, remain constant regardless of production volume. Thus, these costs include insurance, depreciation, property and equipment taxes, lease and rental expenses, and management salaries—all of which must be paid whether your operation is open or closed.
Some accountants assert that there is also a third category of direct costs called mixed or semivariable costs—that is, those that have both fixed and variable elements. The direct cost of using electricity, for example, often contains a fixed monthly charge or minimum service fee as well as a cost that varies with the amount of electricity consumed in an activity. Mixed costs, however, should be capable of being separated into their fixed and variable parts, and these parts can be combined with other fixed and variable costs.
Far from being set in concrete, the fixed-vs.-variable issue is itself variable. For instance, what one recycler considers fixed, another may deem variable or mixed. Or while a cost may appear to be variable on the surface, it could be fixed for all intents and purposes.
Labor is a perfect example of this. By logic, labor would be considered variable in that the greater the production in an operation, the greater the labor costs associated with that activity. “But even when production is at a low ebb, it usually isn’t practical to reduce the labor force and a month or so later attempt to hire back those experienced people,” Metzner says. Consequently, he continues, “in the short run, even the cost of labor is a fixed cost because it no longer varies with production activities.” Or, as Lowery observes about the cost conundrum, “In the short run, all costs are fixed, whereas in the long run, all costs are theoretically variable. That means nothing is sacred.”
Looking generally at costs in most scrap operations, labor—including wages, benefits, and workers’ compensation insurance—is usually the largest single expense, often accounting for around 50 percent of all costs. Other top cost areas include equipment repairs/maintenance, utilities (especially in heavy machinery-intensive operations), liability insurance, and depreciation. Farther back in the cost hierarchy are taxes, rent, and disposal fees.
Which costs are the largest can vary from operation to operation, of course. In a shredding operation, for instance, electricity and repairs/maintenance are often the top costs, while labor may account for only 20 percent of the total. In torching and nonferrous sorting operations, in contrast, labor is likely to be the top cost.
Setting Up the System
When it comes to establishing a cost accounting system, the truth is that “you can do anything you want,” says Charlebois, meaning there’s no one-size-fits-all approach. As Lowery adds, “Everyone needs numbers. But where they get those numbers and how they use them varies.” Even so, there are some basic cost accounting ground rules that many recyclers have adopted and that you may want to follow as well.
But first a word about cost accounting.
Technically, cost accounting, a close relative of financial accounting, is usually applied to manufacturing operations to determine the cost of producing a product. While the scrap industry doesn’t perfectly fit the cost accounting mold, scrap processing is indeed a manufacturing activity and, hence, more and more recyclers are exploring cost accounting practices—or variations of them—in an effort to achieve more exact cost determinations. And that means pinpointing how much it costs to process—or manufacture—a pound or ton of material or operate a piece of machinery per hour.
There are two types of “actual” cost accounting approaches: job order, which is applied to custom-manufacturing operations such as home building, and process, which is used in operations that manufacture one or more products on a more or less continuous schedule—such as scrap processing.
In process cost accounting, costs are generally assigned to departments, or cost centers, rather than specific jobs. “We’ve found that the best cost accounting approach is to isolate a cost center and track all the costs that go into that center,” says Lowery.
Small recycling firms may have only three or four cost centers—perhaps ferrous, nonferrous, nonmetallics, and retail buyback. Larger operations, however, generally require a more-detailed approach, with some firms having a dozen or more cost centers, encompassing such areas as shredding, shearing, baling, torch cutting, maintenance, cranes, loaders, trucking, and administrative. How many cost centers you establish “depends on how exact a science you want to get down to,” Salome says.
After setting up cost centers, costs are accumulated for each center over a certain period of time, such as a month. Then, the total cost for the period is divided by the number of production units or operating hours to get an average unit cost. If your shredding operation, for instance, processed 6,000 tons last month with total direct costs equaling $150,000, then your direct unit shredding cost was $25 per ton.
This number, however, reflects the operation’s performance based exclusively on direct costs. It’s also important to calculate the operation’s performance incorporating indirect costs, which usually encompass overhead generated by nonproduction departments. But how do you know what proportion of indirect costs to assign to each cost center? As Metzner notes, “Overhead allocation is only an estimate, and there are 101 ways you can do it.”
Perhaps the most common approach is the “contribution” method in which indirect costs are assigned to cost centers based on their contribution to the firm’s sales or production. For instance, if your shredder accounts for 40 percent of your firm’s total earnings or output, then that cost center would be assigned 40 percent of the overhead. The rationale is that the larger and stronger the cost center, the larger share of overhead it can absorb.
Other approaches include spreading indirect costs equally among cost centers or arbitrarily assigning a percentage of overhead to each cost center. These less-precise strategies, however, tend to “create a lot of gnashing of teeth between departments,” Salome says.
In any case, Lowery emphasizes, “All of these costs have to go somewhere. If you don’t allocate them, then you’re fooling yourself.”
A Standard Approach
While actual cost accounting as described above is a common approach to tracking costs, many manufacturers—including some recyclers—have also explored “standard” cost accounting practices, which can be used along with or in place of actual methods.
In standard cost accounting, you determine what it has cost or should cost to produce a specific product, with the result being a standard per-unit cost. A scrap business that has tracked its processing costs over many years, for instance, could determine that its standard shredding cost is, say, $25 per ton. The company then compares the operation’s actual monthly performance against this standard, with the goal being to detect and rectify variances in the process. “All you’re looking at is why the actual figure is higher or lower,” Charlebois says.
Though the standard cost approach may work best in relatively stable manufacturing scenarios, it can be helpful in more volatile and cyclical industries such as scrap recycling in providing yardsticks against which to measure monthly performance. The one caveat, however, is that the greater the uncertainty of the endeavor, the more careful you must be in your interpretation of the resulting variances. If your shredder suffers sizable direct repair costs one month, for instance, its per-ton cost may be significantly greater than the standard, and this variance must be interpreted accordingly.
Assessing Industry Costs
Just as all costs aren’t the same, all recyclers’ costs aren’t the same. How one processor’s costs compare with another’s down the street or across the country depends on a host of variables, including the type of material processed, volume run through the operation, type and amount of processing and upgrading done, productivity of the operation, local labor costs and disposal fees, and more.
In addition, cost accounting—and accounting in general—is less a precise science than a discipline of estimates. After all, cost numbers are, in many respects, soft. As Charlebois asserts, “A common misconception about accounting figures is that the cost of any product or unit of output can be measured with precision.”
Due to these factors, it’s difficult to come up with average processing costs for the scrap industry. Even so, some recyclers and equipment makers have bravely offered the following cost ranges—expressed per gross ton unless otherwise noted—for some principal processing niches: torching, $15 to $40; ferrous baling, $6 to $20; nonferrous baling, $20 to $40 per net ton; stationary shearing, $25 to $50; mobile shearing via attachments, $20 to $40; and shredding, $20 to $35.
While recyclers may differ in their cost estimates, they are more unified in their opinion that knowing your costs in the first place is essential to running a business successfully. The fact is that, given the scrap industry’s growing trend toward professional management practices, it is becoming virtually impossible to be competitive when operating from a shoot-from-the-hip, non-cost-based approach.
Salome, for one, believes in running his business by the numbers and encourages other recyclers to do the same. “I happen to think that knowing your costs is invaluable,” he says, concluding, “It’s better to know than not to know.”
A Cost Quiz
Most recyclers will vouch that knowing your processing costs is imperative to making informed buying and selling decisions. That knowledge, in fact, can mean the difference between making a profit and taking a loss on any given purchase.
To test your cost accounting savvy, here’s a buying quiz devised by Sidney Metzner of Conservit.
The Situation. You are offered 100 gross tons of shreddable scrap at $44.80 per gross ton, delivered to your plant. If you want an additional 100 gross tons of the same material, the cost will be $67.20 per gross ton for the extra material. Figure the dirt loss is 25 percent, and there is no value to the nonferrous residue. Assume the shredded product can be sold for $110 per gross ton, f.o.b. your operation, and the market is expected to remain at that price for the foreseeable future.
You should also figure your indirect costs for the operation are $400,000 a year and the direct costs are $25 per gross ton of finished product.
The Question. Based on this information, what would be the best buying decision—purchase only the first 100 tons, buy the 200 tons, or pass on the deal?
The Solution. First, figure out what your costs would be if you purchased only the first 100 gross tons of material. At $44.80 per gross ton and a 25-percent dirt loss, the real cost of the scrap is $44.80 per 1,680 pounds, or $60 per gross ton. Add the $25-per-gross-ton direct costs, and your total cost is $85 per gross ton. Subtract that from your finished product selling price of $110 per gross ton, and you get a $25-per-ton contribution to overhead and profit, or an overall contribution of $2,500 for the first 100 gross tons.
Second, figure out what your costs would be if you also purchased the second 100 gross tons of material. At $67.20 per gross ton and a 25-percent dirt loss, the real cost of the scrap is $67.20 per 1,680 pounds, or $90 per gross ton. Add the $25-per-gross-ton direct costs, and your total cost is $115 per gross ton. Subtract that from the selling price of $110 per gross ton, and you get a loss of $5 per gross ton, or an overall loss of $500 on the second 100 gross tons.
The best decision, therefore, would be to buy only the first 100 gross tons, as that would give you the largest profit—$2,500 vs. $2,000 if you purchased both loads.•
Editor’s note: This article is intended as an introduction to cost accounting concepts and practices, not as professional advice on implementing a cost accounting system. Readers interested in more detailed information are advised to consult a certified accounting firm or other authoritative sources.
Having a firm grasp on your operating costs is essential to managing your recycling business as efficiently, profitably, and competitively as possible. Here, a few cost-conscious recyclers offer a look at how to keep track of your costs.