Know operating costs for a reasonable return

Sept. 1, 2002
Despite opinions from management to the contrary, truckload carriers need a better grasp of their cost accounting, Martin Labbe told the annual meeting

Despite opinions from management to the contrary, truckload carriers need a better grasp of their cost accounting, Martin Labbe told the annual meeting of the Truckload Carriers Association Refrigerated Division. Most carriers make a good attempt to monitor the finances of their companies, but nearly all need to focus their accounting process more carefully to understand the costs associated with providing transportation services.

Labbe is a principal in the firm of Martin Labbe and Associates. The firm provides consulting for individual carriers and for the Truckload Carriers Association. The Refrigerated Division meeting was held July 10 to 12, 2002, in Bernalillo, New Mexico.

A uniform set of accounting procedures would be helpful to the entire truckload carrier industry, Labbe said. With most carriers using the same procedures, modified as necessary to meet specific needs, the industry would have a clearer picture of its financial health and its cost structure. “Better accounting might not help carriers get better rates, but it certainly should point out rates to stay away from,” he said.

Most carriers are familiar with financial accounting. That's the set of rules that carriers use to evaluate their businesses, Labbe said. Financial accounting is inherently historical, looking at what a company has done in the past. The best it can do is to show trends for the future based on past performance. Financial accounting operates according to uniform rules, widely accepted by most business analysts.

Financial accounting is most useful to capital markets, lenders, and investors who need to evaluate a business. Obviously, financial accounting allows a business to file its taxes, Labbe said. Although financial accounting provides a measure of a company's liquidity, it is not an operational tool.

The classifications of data in financial accounting are current and non-current. That's about as detailed as financial accounting gets, Labbe said. It can list current assets, and it can point to current activity or past activity, but it won't indicate whether or not a company is operating in the correct mode, he said.

Measuring goals and objectives

To evaluate business operations, management accounting is more useful, Labbe said. It provides managers with a prospective orientation by looking at individual parts of the company to determine if goals and objectives are being met. An important feature of management accounting is that companies can customize the rules to ensure that performance is evaluated in a meaningful way. Every trucking company does its business in a slightly different way, approaching customers differently, choosing lanes differently, picking freight differently. If businesses are to operate differently, they need to use evaluation tools that look at these special situations in a way that makes sense internally, he said.

For instance, some carriers focus on on-time service while others concentrate on claims-free operation, Labbe said. Whatever the focus of a business, its managers need an accounting system that accurately portrays the cost of that dedication.

Financial and management accounting are both useful, but only when viewed in the appropriate context, Labbe said. For instance, an accounting system that provides information in averages such as average cost per load or average revenue per load does not really provide much information. Averages are not an accurate measure of reasonable rate levels for truckload carriers, he said.

Financial accounting has a number of appropriate uses. Most importantly, it can be used to assess the liquidity of a business, Labbe said. A good financial accounting system will calculate a carrier's return on investment, gross margins, and net income. “Note that all this information covers what the carrier has done, not what it is doing or what it is about to do,” he said.

Using the historical data from financial accounting can determine how a carrier focuses on its business, but it may establish rules for decisions that are not valid, Labbe said. A good example is using financial accounting for customer evaluation. Financial accounting will provide data on total revenue and total loads. It will provide an average cost per mile in an attempt to establish profitability. However, all this information is based on averages, so it may not apply to specific lanes or loads, he said.

Track profits and problems

More useful data would indicate which specific loads from a given customer are profitable, Labbe said. Even better would be an accounting system that shows exactly how much money a carrier makes from each load. That tells a carrier which customer to concentrate on and which loads from that customer to go after with the most energy. Conversely, carriers need to know which customers and loads to avoid. “Truly useful accounting indicates which loads are financial disasters and exactly how bad the disaster is,” he said.

At first glance, a carrier might want to drop all unprofitable business, but if some unprofitable lanes or loads are part of a bid package with an important customer, that is not possible, Labbe said. Some customers are profitable across the entire range of their loads, and those customers require that carriers bid on difficult, potentially unprofitable freight to get access to the lucrative freight. The goal of good accounting in customer evaluation is to know which loads to address in terms of cost reduction to make the entire package more profitable. Financial accounting will not do this, he said.

In fact, using the averages from financial accounting will result in always bidding on the low side for profitable business and bidding on the high side for the unprofitable business, Labbe said. The idea is to know which loads to address to reduce costs and to get the customer support for that effort. In some instances, support from the customer can be generated by detailing the costs of specific loads and showing the cost disadvantages involved, he said.

The key to evaluating a customer is determining the resources used to serve that customer and placing a value on each of those resources. Allocating resources involves more than tractors and trailers. Sales and marketing also costs money, so carriers must decide how much sales and marketing effort should go into securing every load in a system. Determining those costs will take more effort by carrier management. The good news is that the actual work is not difficult to do, Labbe said. Gathering the information and putting a system in place will take time. For most carriers, setting up a detailed management accounting system will probably take three years or more, he said.

Look for alternative operations

Management accounting helps carriers make sense of their business, Labbe said. For instance, should the business run its own maintenance operation? Maybe the company is located in an area where internal maintenance is the only alternative. If alternatives are available, a detailed management accounting system will help evaluate the costs associated with each of those possibilities, he said.

One of the most important features of good management accounting is performance evaluation, Labbe said. It allows managers to compare performance to projections. By identifying the exceptions to the business plan, managers can determine whether or not it makes sense to continue putting resources into a given activity or customer.

In addition, appropriate accounting assigns costs to the correct categories. Carriers cannot simply assign a portion of the president's salary to every activity in the company, Labbe said. Decisions must be made, assigning the costs associated with the president or the vice-president of marketing to specific activities. Place the cost for specific individuals in the departments where they are most involved, putting the cost burden where it belongs rather than trying to average that burden across the entire range of company activity, he said.

Measurement requires classification

Cost measurement begins with classification, placing the costs in the slots where they belong. That is easy to do when the cost applies to operations or maintenance or dispatch. It is more difficult when the cost applies to an administrative department, Labbe said. To assign costs correctly, they must be classified by the job being done and by the activity involved.

An accounting system must assign costs in a way that is useful for economic modeling, planning, and budgeting, Labbe said. Managers have to buy into the system and be able to show that they are, in fact, using the resources that the budget shows them using. For the system to work, they must agree that the costs shown for their department are the costs they actually incur. With accurate assignment of costs, managers can make budgets and plan for future activity, he said. With a good plan, a carrier can compare actual costs to projections and determine quickly if expenditures are out-of-range and why the variance is taking place.

Good planning allows an understanding of the relationship of direct and indirect costs. For instance, direct costs have a high degree of cause and effect with specific activity, Labbe said. Good examples are driver wages or fuel costs. Both are highly variable, based on the amount of activity involved. Conversely, indirect costs are harder to assign to a specific cause and tend to be more fixed such as administrative salaries. Spare parts are another indirect cost, because the price of an individual part and the labor required to install it is hard to assign to a specific load. Indirect costs usually support multiple activities and generally require pooling before being allocated by calendar periods, traffic lanes, or loads, he said.

Direct costs are not always variable. However, the more direct costs can be assigned to specific activities, the better managers will be able to measure company performance, Labbe said. Conversely, indirect costs are not always fixed, but in general offer the best opportunity for allocation to specific activity for strategic reasons. For instance, some carriers want to allocate indirect costs on the basis of loads, and others assign those costs to total fleet mileage, he said.

Judicious use of this information allows a carrier to evaluate customers, determining how much it costs to sustain a relationship with a given shipper, Labbe said. “If we could determine that 10% of the customer base caused 90% of the administrative problems, would it make sense to keep those clients?” he said. “Wouldn't it make more sense to turn those customers over to competitors? If the projected cost for one of these problem customers is $1.96 a mile, but the customer only wants to pay $1.46 a mile, walk away.”

The movement of freight is only one part of the total cost equation. Other costs include administrative and sales effort and possibly extra routing activity to support a given shipper and receiver pair, Labbe said. A good example is the ban in New Jersey on the use of 102-inch trailers off the interstate highway system. Expending extra miles, extra travel time, and increased payment of tolls to serve customers that require travel in or across New Jersey should be allocated specifically to the loads in or crossing the state. “I refer to this as the New Jersey diet plan, because refrigerated carriers delivering food to New Jersey will not purchase fleets of 96-inch trailers specifically for their New Jersey customers,” he said. “Either rates will increase or deliveries will decrease.”

All this comes down to the movement of freight. Truckload carriers generate revenue by moving freight, Labbe said. With the possible exception of brokerage operations, everything else a carrier does is a cost center. Good accounting allows managers to focus on the profitability of individual loads and other activities rather than focusing on the entire business.

Focus on revenue

Trucking is the relevant business activity. It generates the revenue. Trying to charge for other activities simply generates additional costs, Labbe said. Other kinds of services carry administrative burdens and costs that even if charged for still must be covered by the movement of freight to ensure profitability.

Customer evaluation is one side of the accounting coin; internal management is the other side, Labbe said. Simply determining and accepting internal costs is not sufficient. Carriers need to ensure that costs incurred are actually the lowest costs possible. Customers evaluate costs, and if costs at their carriers do not fit projected patterns, shippers will switch carriers, he said.

The key to controlling costs through management accounting is making it happen from the top down, Labbe said. If the president is not committed to making management accounting work, every organization has enough resistant people to torpedo the initiative. With committed executive support, everyone in an organization can be convinced that all costs count. Then the business can begin to operate with measurements against internal standards openly compared with whatever industry standards may be available. Good managers know where the bottlenecks in their operations occur. If the president supports performance management, those bottlenecks can readily be eliminated, and the company can begin to move forward in line with the standards it has set for itself, he said.

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