Life Cycle CostingExplained & Defined

Lisa Borga

When it comes to managing your business, every cost matters, you need to know what costs your business is facing now and those yet to come.

This is where life cycle costing comes in.

Life cycle costing, also known as whole life costing, is an approach to managing business costs that takes into account all of the costs associated with an asset from its initial acquisition and ownership to its final disposal.

This knowledge of all of the costs associated with an asset throughout its entire life can offer significant benefits in determining impacts on future budgeting requirements and optimal product pricing.

This methodology also offers an ideal tool for analysis when comparing multiple alternative projects.

Life Cycle Costing Explained

Every company requires assets, and in most cases, business owners have a tendency to purchase those that offer the lowest upfront costs.

However, over time this can be a poor financial decision.

Virtually every asset has associated costs involved in its ownership, and over time recurring costs, such as maintenance and operation, can add up.

In time an asset with a lower initial outlay can easily become more expensive than an option with a higher initial outlay.

Understanding the total costs involved in owning an asset can help business owners to make decisions based on the total costs involved in acquiring an asset, not just the initial expense.

Though the process of determining these costs can be challenging, it can allow for a far more educated decision for managing costs when choosing between multiple possible alternatives.

How to Perform Life Cycle Costing

In order to perform a life cycle costing analysis, all of the costs involved in the ownership of an asset must be totaled.

Determining these costs can be more or less challenging depending upon the asset.

However, it is important to ensure that none are left out in order to perform an accurate analysis.

Often these costs will fall into the following categories:

  • Acquisition Costs: This includes initial purchase costs as well as the costs of construction, if required, in order to acquire the asset. In many cases, assets such as production machinery may also require installation, which should be considered as well in addition to its purchase price.
  • Operating and Maintenance Costs: Operational expenses such as energy, water, and other utilities can encompass a significant component of an asset’s total cost of ownership. Though these costs may be difficult to predict precisely, they should be estimated. Additionally, maintenance and repair costs should be estimated as well. In some cases, an asset may require much more extensive maintenance than its alternatives or may come with a far higher price for replacement parts.
  • Financing Costs: If financing is required for the acquisition of an asset, what fees or interest will be incurred?
  • Depreciation Costs: Virtually all assets will decline in value or usefulness with time. This may occur at significantly different rates depending upon the particular asset, and the cost that this will pose should be accounted for.
  • Disposal Costs: Eventually, most assets will need to be disposed of, and often this will pose a significant expense. Whether it is demolition, disassembly, or hauling away, these costs must be accounted for.

life cycle costing

All of the costs in the lifecycle should be added together in order to find the total cost for the asset.

In many cases, historical data can provide a significant amount of information for devising an accurate estimate of costs.

Often it is easiest to begin with the fixed costs of ownership, which are the costs that cannot be affected, and then estimate variable expenses, which will change depending upon usage.

Life Cycle Costing Analysis for Intangible Assets

All businesses possess intangible assets, and in many cases, these may comprise the majority of a company’s value.

Intangible assets refer to the assets you cannot see and touch, such as patents, copyrights, trademarks, or your business’s reputation.

In many cases, the costs of acquiring and maintaining these non-physical assets can be more difficult than tangible ones, but they are still significant.

For example, in many cases acquiring a patent may cost thousands, not just in purchase costs alone, but consider a lawyer you may have to pay to come up with the paperwork and any fees you may pay along the way.

Even once acquired, often, these assets require additional fees periodically for renewal.

Another prime example is the costs involved in creating and maintaining a brand.

This often includes creating a logo, registering trademarks, developing a business website, and often far more on marketing.

Example of Life Cycle Costing

As an example of life cycle costing, assume that ABC Golf Club Manufacturers require new production machinery to produce their products.

However, before they purchase a new machine, they want to know how much it would cost throughout its lifecycle.

They prepared the following life cycle costing analysis to find out.

Acquisition Costs$7,500
Operating and Maintenance Costs$2,000
Financing Costs$900
Depreciation Costs$3,000
Disposal Costs$1,250
Life Cycle Costing$14,650

ABC estimates that it will spend $7,500 in purchasing and installing the machinery, and based on its previous experience with this type of equipment, they expect to spend $2,000 over the course of the machine’s life on operation and maintenance.

ABC intends to purchase the equipment on credit and pay it off in one year, and at an annual interest rate of 12%, this will cost $900 in interest.

ABC expects the machine to depreciate by $3,000 before it disposes of the equipment at the cost of $1,250 to have it removed.

By determining all of the expenses associated with the equipment over its life rather than just the initial outlay, ABC can establish a far better estimate for how much this equipment will cost.

As a result, it can improve its budgeting and consider if there are any alternatives that would achieve greater cost savings.

Importance of Life Cycle Costing

Life cycle costing is a valuable tool for estimating how much an asset will cost not just initially but throughout its entire life.

This powerful analysis can offer a considerable amount of information for guiding business decisions.

This includes:

  • Deciding Between Multiple Alternatives: Life cycle costing can assist in making purchasing decisions. Integrating life cycle costing into the decision-making process instead of just the initial cost can help to save costs over time. A cheaper equivalent of the same product may require greater maintenance or incur more operating costs. By using life cycle costing to compare multiple options, it is possible to choose the one that offers greater long-term savings.
  • Weighing the Pros and Cons of an Asset: When considering whether or not to purchase an asset, it often comes down to a measurement of the costs and benefits. Simply comparing the initial outlay is not enough to determine if an asset will provide a net positive return over the course of its life cycle. By using life cycle analysis, it is possible to determine its total cost and weigh this against its returns to decide if it provides a sufficient return on investment.
  • Creating Budgets: In order to create accurate budgets, it is critical to forecast future expenses and revenues. Otherwise, shortfalls will inevitably result. Life cycle costing helps to create budgets that represent your business’s total costs.

Key Takeaways

  • Life cycle costing is a methodology for analyzing and estimating the cost of owning an asset over the course of its entire time of ownership.
  • Life cycle costing helps to analyze not just the initial outlay involved in acquiring an asset but all costs involved in acquiring, owning, and disposing of an asset.
  • Life cycle costing makes it possible when comparing multiple possible alternatives to determine what option will result in the lowest possible cost.

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  1. University of New Mexico "Life Cycle Costing" Page 1 . August 11, 2022

  2. Harvard University "Life Cycle Costing" Page 1 . August 11, 2022