UC-NRLF $B 260 sm FUNDAMENTAL^*^ COST<7/9 prof™ CALCULATION ^^M DENHAM Digitized by the Internet Archive in 2007 with funding from IVIicrosoft Corporation http://www.archive.org/details/fundamentalsofcoOOdenhrich FUNDAMENTALS OF COST an5 profit CALCULATION By Robert S. Denham Chief Engineer, The Denham Costfinding Co, Cost Engineers, Cleveland, Ohio Author of Practical Cost Engineering, Manual of Cost Engineering and Estimating, The Science of Costfinding^ The A-B-C of Cost Engineering, Etc, Etc, Revised Edition CLEVELAND Cost Engineer Publishing Co. 1919 ',6^^ v^vV-aV^ "^^^ Copyright 1918 Copyright 1919 By ROBERT S. DENHAM International Copyright All Rights Reserved " • * • e c Printed by Gardner Printing Co. Binding by Forest City Bookbinding Co. Cleveland PREFACE Mr. Business Man: This book is written for you. It is in- tended to help you to throw the searchlight of analysis into those recesses of your business heretofore darkened by the cobwebbed tradi- tions and formulas handed down from the age of the tallow candle, the ox cart and the quill pen. The two most vital factors in business are Cost and Profit, but few there are who can, in any transaction, define the point where the elements of Cost cease to accumulate, and Profit becomes a reality. It is extremely important, now more than at any other time in the history of America, that business men know the cost of doing business, the cost of manufacture, the cost of distribution, and the extent of the profits in the business. Thousands of concerns not profitably con- ducted are forced to pay taxes on profits which do not exist, because unthinking and misinformed accountants have established incorrect methods of calculation. For the same reason others who should pay taxes will go free. Every business should be profitably con- ducted. Every business should pay its fair 405503 r »r' " ' ' ' ' '' • * .. ' c 'Preface share into the treasury of the nation and state; but how shall there be certainty as to profitableness when the ancient methods of calculation in common use are misleading? How shall fairness and justice be upheld when costs and profit in modern business are calculated by methods which have been obso- lete for generations? We are confronted today, in a time of seri- ous concern, with the deplorable facts that the accounting profession has clung too long to its ancient formulas; that it has offered no practical solution for many of the more im- portant industrial and commercial problems; and that there is no evidence that it is now engaged in any recognizable effort to meet the needs of the hour. The author offers no apology for breaking away from traditional methods. He is ham- pered by no "professional ethics" which for- bid departure from so-called "standard ac- counting practice," thereby destroying initia- tive and balking progressive development, but discarding precedents, breaking the idols of "authorities" whose theories date back to other times when conditions were simpler than now, he places every problem of Cost under the test of logical analysis. 4 PTeface The crying need is for facts: the facts of cost, the facts of profits, not the camouflage of meaningless, mythical phrases such as cost accounting offers in "prime cost," "factory cost," "labor cost" and "gross profit," nor the Stygian mystery of that cesspool of ignorance "overhead expense." Every element of expense is definite, in amount, in purpose and in benefit. The line between loss and profit in every transaction can be known within a fraction of one per cent. The profit on each sale and on the busi- ness as a whole can be accurately determined, if you know how. But the ancient methods must be dis- carded. The uncertainty of "overhead" and "gross profit" must give way to the definite- ness of practical Cost Engineering. Theories and formulas must be replaced by analysis and reason. There must be coordination be- tween modern business and methods of calcu- lation. It is the purpose of the author to show insofar as the limitations of this popular- priced book will permit, what the elements of cost are, the correct rules for calculation, grouping and distribution of same, the cor- rect methods of determining the cost of pro- 5 Preface duction in factories and the cost of merchan- dising. In view of the fact that practically all school textbooks teach incorrect methods of calculating profits, and not to exceed ten per cent of those whose duties include the making of selling prices know the correct method, a chapter on that subject will be included. The aim will be to make each statement as clear as possible, to back up each recommen- dation with the reason for its presentation, and where truth and justice will be served by digression from the traditional methods in common use, to convince the reader that the difference is not only justifiable but worthy of acceptance. Further, the author hopes to leave in the mind of every reader the impression that the information he has gained is not only worth the expense and time required to obtain it, but that it will in a practical manner serve as a basis for more successful business methods in the future, so that profits may be developed from hitherto unprofitable sources, and per- manent good will established. Sincerely, THE AUTHOR. 6 CONTENTS Preface 3 1. The Philosophy of Cost and Profit 9 2. Direct Expenses 19 3. Indirect Expenses 29 4. Economic Expenses 43 5. Determining Cost 59 6. Selling Prices and Profits 77 7. Making Cost and Profit Statements 95 8. The Terminology of Cost Engineering.. 105 Index of Terminology 116 General Index 117 ^^One of the first things that a man has to learn in business is how little he can do by himself. When he finds that out he be- gins to look around for people to do what he can't!' — Henry Ford. CHAPTER ONE THE PHILOSOPHY OF COST AND PROFIT What is Cost? Wc grow so accustomed to the use of com- mon words that we rarely stop to consider their definitions. In fact we consult the dic- tionary, as a rule, only when we encounter some word that is new, or that is used in an unfamiliar sense. As a matter of fact there are many words in common use by persons who should know better, that are used with- out thought of their true meaning. One of these is "cost." We hear the merchant speak of his "cost" when he has reference to the amount charged him in the invoice for the item, without re- gard to the other expenses which have been involved in carriage, warehousing, protecting and handling the goods. We hear the manufacturer use the term "actual cost" when he has in mind only the elements of material and wages paid the workers who are directly engaged in the pro- duction of the item under consideration. Fundamentals of Cost and Profit Calculation We hear the accountant glibly talk of "prime cost" when he has in mind the same elements, and of "overhead cost" when he refers to the other expenses involved in the operation of the factory and the distribution of its product. It is possible to convey information clearly and definitely from one mind to another only when each speaks the same language and understands the meaning or definitions of the words used, therefore the author requests the reader to follow carefully the definitions pre- sented herewith, that he may fully understand the viewpoints and methods presented. The cost of an item of product is the sum of the expenses involved in its production and distribution up to the moment at which cost is determined. This is the first fundamental principle of Cost Engineering. Cost is the sum of certain expenses. Being a sum it must be a definite amount. Two methods, therefore, which produce different results in the effort to determine cost, cannot both be correct. Both may be wrong, or one may be right and the other wrong. Expenses are the elements of cost. Part 10 The Philosophy of Cost and Profit of the expenses cannot be cost. Cost is noth- ing less than the sum of all of its elements. If a cent is omitted, or a cent included that is not involved in the production of the item under consideration, cost has not been determined correctly. The expenses of a business, or of the operation of a factory, are definite, and lim- ited. It is possible to so analyze these ele- ments that each may be exactly known. The total is then easily ascertainable. When the items of product of the factory differ in size or character it is necessary to know definitely the cost of each lot of like items produced. If one lot or item has been charged with expense which belongs on other product, an overcharge exists, not only de- stroying the accuracy of the result in connec- tion with the item under consideration, but preventing correct determination of cost on the items which should have borne the amount thus overcharged. The sum of the costs on individual lots of product for a given period should equal the total of the expenses involved for the same period. The problem presented by a factory which manufactures a single commodity, as cement, beer, etc., is simple compared with 11 Fundamentals of Cost and Profit Calculation the problem of cost determination in a factory where every lot is different from every other lot, as is the case in factories making goods to order upon specifications provided by the cus- tomers, as in the manufacture of metal parts, stampings, printing, etc. Every individual expense item is definite (i) in amount, or it could not be recorded; (2) in purpose, otherwise it would not be au- thorized; and (3) in benefit, for it is to pro- cure some definite thing, either a commodity or service, more desirable than the amount of money involved, that the expenditure is made. Expenses may be classified into two pri- mary groups: Direct expenses and Indirect expenses. Expense items which have but one bene- ficiary, to which they are chargeable in total, without distribution, are direct expenses. Expense items which have two or more beneficiaries, requiring distribution, are indi- rect expenses. These divisions have long bfeen recognized by cost accountants, but someone, generations ago, thoughtlessly assumed that more or less of the direct expenses might safely be used as a basis for charging the indirect expenses, and 12 The Philosophy of Cost and Profit later generations of accountants have, with- out question, accepted the formulae as au- thoritative. The slightest effort in the direc- tion of analysis will prove that no expense is basic, and that such methods have no founda- tion in fact. No accountant would think of adding to- gether the direct items of material and direct wages on a hundred orders and distributing the total to the individual orders upon some arbitrary and unrelated basis, because, being direct expenses, he can make the charge to each without necessity for distribution. Yet, for many decades, since the introduction of labor-saving and automatic machinery, the standard practice of cost accounting has been to mass the unrelated indirect expenses into an "overhead" or "general expense" account and distribute the total upon a purely arbitrary and unrelated basis, as for example the direct labor expense, or the total of material and direct labor expenses. As no expense item is basic, and no group of expenses is basic, such methods are purely arbitrary and have no relation to facts. That men who are otherwise intelligent will advocate and follow such practices is prima facie evidence that the principle of ex- 13 Fundamentals of Cost and Profit Calculation pense distribution is unknown to them. Further, it is proof of the power of precedent to so enthrall its devotees that they will fol- low established routine long after progressive changes ih correlated factors have made such methods ridiculous. As the result of analysis it is found that every element of cost is related directly to certain definite processes or functions of the business; that where division of benefits re- quire distribution of the expense item, the divided parts can be measured and propor- tions determined, so that in every case the charge can be made in such a manner that the proportions of expense charged will be identical with the proportions of benefits con- ferred. Cost accounting recognizes no principle of expense distribution, but depends upon purely arbitrary methods. It uses the only method possible where an overhead expense account is created. The creation of such a mass of unrelated expenses in itself defeats the possibility of correct distribution because it combines elements requiring different kinds of units for expressing volume, whereas the practical distribution provided in cost engi- neering requires that all of the factors of a 14 The Philosophy of Cost and Profit group should be measurable by a common unit Correct expense distribution, then, is ac- complished by considering each element in relation to the benefit conferred, combining the elements in groups only when the factors of the group consist of items providing iden- tical proportions of benefits, all of which are measurable by a common unit. In succeeding chapters the various classi- fications of expenses will be considered, the principle of expense distribution presented and explained, and methods of determining the cost of articles or items outlined. Hazy as is the definition of cost to the average man, it is little if any less understood than the word ^Trofit." Profit is that part of the ^^price'^ for which an article is sold which remains after the cost has been deducted. Percentages of profit are correctly ex- pressed only when they relate to the selling price as the base, or ioo%. The profits of a period are expressed in relation to the total of sales. Statements, frequently seen in the public prints, which assert that ioo% or 200% 15 Fundamentals of Cost and Profit Calculation profit, or other percentages above loo, were or can be made on the sale of goods, simply display the ignorance of the person responsi- ble for the statement. If an article costing one cent is sold for one dollar the profit percentage would be 99. It is inconceivable that 100% profit could be made on a transaction, for such a condition would exist only in case the goods sold cost nothing, and no expense, even that of time, was involved in the conduct of the business. A very common but erroneous method of calculation is to compare the profits with the investment, expressing the relation by per- centage. Such errors and the consequent confusion are due to the fact that the accounting pro- fession has no definite terminology. An effort to establish a correct terminology in connec- tion with the science of Cost Engineering was made by the author several years ago in "A Catechism of Costfinding" now practically out of print. A similar effort is included in this book under "The Terminology of Cost Engineering." No scheme of figuring profits can be con- sidered practical which does not include in 16 The Philosophy of Cost and Profit cost every element chargeable either immedi- ately or eventually as an expense item. Profit is always the net increase in tangi- ble assets due to the active transactions, or sales, of business. It has no relation to invest- ment. Interest on investment is not profit, but is the wage of financial energy. It is a form of fixed expense that has no relation to activity or the transactions of business. « Increased value of merchandise, due to fluctuations in price, is not a part of profits. The actual sale of the goods at a higher price, because of the market fluctuation, will un- doubtedly yield a larger margin of profit, but the profit cannot exist until the sale is actually made. The anticipation of profits, because of market changes or the carrying of goods in a warehouse at a valuation which is higher than their cost, and thereby anticipating profits, is never justifiable. No profit exists until the transaction has been carried forward at least to the point where the recorded charge for the item sold exceeds the total of the outlay for the item and the expenses of conducting the business. 17 Fundamentals of Cost and Profit Calculation Gross profit is a myth. The term was origi- nated and is used to designate a percentage applied to part of the elements of cost for the purpose of arriving at a<supposedly profitable selling price in which neither the cost nor the amount of profit is definitely known. It is a makeshift term, practicable only as a means of avoiding an admission of ignorance of true cost. Further discussion of "Profits" will be in- cluded in the chapter entitled "Selling Prices and Profits." 18 CHAPTER TWO DIRECT EXPENSES Direct Expenses are few in number, com- pared to Indirect Expenses, and present prac- tically no problem to either the accountant or the Cost Engineer. A direct expense item is one expended for the benefit of but one beneficiary. It may be chargeable to an individual fac- tory order, an individual manufacturing process, a class of product, or, in the case of an office or store, it may be chargeable to an order, a department or a class of merchandise. A direct expense item is always charge- able in total to a single account or beneficiary. It never presents a problem in expense dis- tribution because its benefit is never divided. The major direct expense items are the material chargeable to a factory order and the amount of wages paid to workers engaged in production on individual factory orders. The minor direct expenses are, repairs to machinery, which should be charged directly to the process for which the machine is re- quired; the supplies required for processes; 19 Fundamentals of Cost and Profit Calculation indirect wages for service in connection with an individual process; the cost of replacing spoiled material or ^product; expense for sharpening tools, or replacing points and knives worn out or destroyed in the operation of processes; freight or cartage on shipments which require such expense in excess of the usual cost of delivery; advertising used in connection with special lines of product, etc. Many items which are direct in relation to a process are indirect in relation to the fac- tory order. In determining classifications the relationship must be considered. Early in the history of the race each in- dividual or family existed upon the product of its own energy, but when the advantages of specialization became apparent, men began specializing in the things that they could do best, and serving their neighbors, who in turn selected other special work, so that exchange of product took place, and there was devel- oped what we now call ^^trade." One man made shoes, another clothes, an- other built houses, thus originated the shoe- makers, the tailors and the building trades. As the demand became greater than the indi- vidual worker could supply he took on as 20 Direct Expenses helpers other individuals to whom he taught the "trade," and thus he became an employer. Rivalry sprang up between the workmen, each striving to do his work more skillfully than his fellows. Since the quality of the out- put and speed of production depended largely upon the condition of the tools used, the care- ful workmen found it most practical to pro- vide their own equipment, thus avoiding exchanges with careless workmen which might occur if the tools were owned by the employer, and the rights of usage common between them. In those days there were no power-driven machine tools requiring heavy investment on the part of the employer. Neither power, repairs nor machine supplies were necessary. Consequently, the major items of expense were for materials and the wages of the work- men. Product was comparatively uniform in character. No such factory organizations existed as are common today. It was both pos- sible and practicable for the employer to de- termine a selling price by calculating the amount of the outlay for material and wages applying a percentage margin sufficient to 21 Fundamentals of Cost and Profit Calculation cover his few other factory expenses, his liv- ing, and a fair profit. To make the employer's problem easier, the absence of transportation facilities in those days limited competition to his imme- diate locality. No salesmen were calling on his customers with similar goods at lower prices as is the case today. In fact, if his was the only shop in the neighborhood engaged in his particular line he had a virtual mo- nopoly, and the price obtainable was limited only by the keenness of the demand and the ability of his customers to pay. Changes in methods took place gradually. Labor-saving machines were introduced, mak- ing it possible for one man to produce many times as much product in a given time as for- merly. Wage rates remained practically the same per day as before, and the employer as- sumed that he was getting several times as much product as previously with the same expense. Expenses for power, repairs, supplies, etc., were charged to general expense, or overhead. Little or no consideration was given to depre- ciation, or interest on investment. Everything except material and direct wages was charged to overhead, the total of which was distrib- 22 Direct Expenses uted to orders or lots on the basis of '^prime cost," the total of material and direct wages involved. Gradually manufacturers learned that the expenses of processes had no relation to the cost of the materials; that it cost no more to cut or sew goods costing $6.00 per yard than to do the same work with goods that cost half as much. The cost of operating a stamping press was the same whether the material being formed was iron or brass. By many manu- facturers, material was dropped from con- sideration as a basic item, and direct wages alone adopted as the basis of distribution. The automatic machine has all but elim- inated the wage factor on many processes. In many factories the variety of processes ranges from hand work, done in the original way with bench and hand tools, through varying processes involving high wage rates and small investments, low wage rates and large invest- ment, to the extreme where one individual attends several machines. Yet the traditional practice of assuming that wages are basic re- mains the most commonly used method of distributing the indirectexpenses. In hundreds of instances throughout the country, both material and wages are so con- 23 Fundamentals of Cost and Profit Calculation sidered. Ridiculous though they are, prac- tically all schools of post accounting still teach these methods. Leading "authorities" on cost accounting, in current publications, cite them as having certain advantages, giving simplicity precedence over accuracy. Let us test their merit: The most important of the indirect ex- penses are for housing, or rent for the space used; equipment, involving depreciation, taxes, insurance, etc. ; power, and administra- tion. Suppose that in a given factory two men are employed, one at a wage of 25 cents, and the other at 50 cents per hour. If there is a relation between the amount of wages paid to the workman,, and the other expenses, the amount of space used by the 50- cent man must be double that used by the 25- cent man. The same proportion should exist in the equipment investment, in the amount of power used, and it should require twice as much effort to supervise, and keep the records of the 50-cent man's time, as to do the same work for the 25-cent man. The facts are, that as between the wages paid to the workers and the indirect expenses, 24 f Direct Expenses no such relation exists. Careful analyses made by competent and experienced cost engineers of the individual expense items involved in the operation of over six hundred factories have failed to disclose a single instance where any other expense was in the same proportion, or had any discernible relation to the amount of direct wages paid to the workers. In fact it has been thoroughly demon- strated that there is no single expense item nor group of items which is ba^sic, or that can be safely used as a basis for the distribution of another expense item, or group of expenses. The author has been told many times by manufacturers that they had no problem of costfinding because they paid their workers by the "piece." Experience proves that the piecework wage system complicates, rather than simplifies, the work of the cost engineer. The assumption of the majority of manu- facturers who pay wages by pieces, is that because the material cost is the same, and the wages per piece the same, all like pieces cost the same, regardless of the speed or skill of the workers. Let us see. Suppose two workers are engaged on the same kind of process, using the same equip- 25 Fundamentals of Cost and Profit Calculation ment, supplies, power, etc., and supervised by the same foreman. Ohe, however, pro- duces loo pieces per day and receives as pay therefor $1.50. The other produces 200 pieces per day and receives as pay $3.00. Such cases are common in actual experience. Assume also that the overhead percentage as determined by the cost accountant is 100% (a rate in common use regardless of the true proportion of the "overhead burden" to the total of the direct payroll). Adding 100% to the wages paid we find that the result makes it appear that the lOO-piece lot cost $3.00, the 200-piece lot cost $6.00, and the per piece cost is the same in both lots. What are the facts? The worker who earned $1.50 required the same equipment investment as the other, used the same amount of space, the same amount of power, the same supervision. In fact all the elements were identical, except the wages ; so that the actual difference in cost of the two lots was not $3.00, as the ac- countant figured, but $1.50. Assuming now that the total of the indirect expenses applied was correct, an equal division would show $2.25 applicable to each. The cost of the loo-piece lot is now found to be $3.75, and the 200-piece lot cost $5.25, or $2.62^ per hun- 26 Direct Expenses dred. The product of the low wages is found to be the most expensive, while that of the employe receiving higher wages because of greater efficiency is nearly one-third less ex- pensive per piece. Experience and analysis prove that no ex- pense is basic, that all efforts to use direct wages or other direct expenses as a means of apportioning the indirect expenses are mis- leading. We find that while methods of manufac- ture have been constantly improved until me- chanical processes have almost universally displaced manual methods, the accounting profession has failed to keep pace with the improvements. Its ^^authorities" are still ad- vocating and teaching methods rendered obsolete by the introduction of the first labor- saving machine tool, and are becoming more and more inadequate and ridiculous with every progressive step in mechanical processes of production. It is time that manufacturers everywhere learned to think for themselves, to discard obsolete and misleading methods, and demand others which, in the light of modern scientific analysis, can be depended upon to show the 27 Fundamentals of Cost and Profit Calculation true relation between cost and selling price in every transaction. Direct expenses are not basic cost factors. They are simply expense factors which, hav- ing but a single beneficiary, require no act of distribution. 28 CHAPTER THREE INDIRECT EXPENSES In all the history of trade, commerce, and manufacture the indirect expenses of business present the problem hardest of solution. A brief statement of the early history of this subject was included in the preceding chapter. Only that phase of the subject was covered, however, relating to the use of direct expenses as a basis of distribution. In a comparatively few instances, an effort has been made in plants having a number of departments doing different kinds of work, to treat each department as though it were a separate factory. Thus in a factory manu- facturing agricultural implements depart- mental divisions would be formed for foun- dry, forging, machine shop, woodwork, paint- ing, etc. An effort was made thereby to charge directly to the department as far as the ac- countant was able, such expenses as seemed to belong to each. The general expenses of the business were then charged throughout either upon the basis of the direct wage pay- roll of departments or as in a few cases, in the ratio of the totals of the expenses directly charged. The total of these so called "depart- 29 Fundamentals of Cost and Profit Calculation 4. mental overheads" was distributed over the factory orders in proportion to the direct wages involved, or in proportion to the man hours of the workmen engaged directly upon the orders. In simple factories, corresponding to the individual departments of the composite fac- tory, the man hour basis is sometimes used by accountants. Another method of distributing the in- direct expenses in factories employing a vari- ety of labor, as well as a wide range of invest- ment in machinery for different processes, is the "machine hour rate" plan. This plan takes into consideration more or less crudely the expenses involved on account of the different amounts of investment, the varying rates of depreciation, the power required, the floor area occupied, etc., and divides the total by the number of hours that the management estimates the machine should be operated normally during a given period, usually a year. The rate, thus determined, is added to the direct wages of the workers on each process, and to the sum of them is added the expenses of administration on some arbitrary basis, usually the total of the "prime cost" of the order. 30 Indirect Expenses Early in the present century Mr. A. Ham- ilton Church, an engineer, in his book ^^Dis- tribution of the Expense Burden," offered a progressive step by suggesting that a factory be divided into units, each of which per- formed a single type of operation. Each of these divisions was to be treated as though it was a separate factory, although under the same roof, and no dividing partitions existed. Under his plan every division should be charged with its rent upon the basis of floor area. Depreciation, insurance on equipment, and taxes, should be charged upon the basis of investment, while power was to be charged on the basis of horsepower hours. An hourly rate was then determined by dividing the total by the actual productive hours. This imme- diately appealed to practical men as being a sound and logical method of handling these expenses. Thus far Church solved the problem of expense distribution satisfactorily, but his work was incomplete, for in the same book he admitted that the problem of distributing the administration expense or, as he termed them, the ^'general establishment charges," baffled him. He vigorously attacked the traditional method of charging them on the basis of direct wages, and doubted the practicability of pro- 31 Fundamentals of Cost and Profit Calculation ductive hours as a universal basis, therefore admitting that he could offer no satisfactory rule for their distribution, he put the problem up to the reader, advising him to use his own judgment as to the method most practical for any individual case. Church's effort should have recognition as the first radical step away from the tra- ditional formulas of cost accounting, and in the direction of what is today known as Cost Engineering. All the definite suggestions made by him conform to the fundamental principle of ex- pense distribution, the very foundation of Cost Engineering. Had he gone a little farther, and analyzed his own methods, he would have found that in each case the expense was charged in proportion to the advantage it con- ferred on the benefited divisions, and that those proportions were always expressed in the term of measure denoting the relative vol- ume of the units. For example, the item of rent being expended to secure usable floor area benefited each division in the proportion of the floor area used. Floor area is logically measured by using the square foot as a unit; therefore the relative number of square feet of area used indicated the relative amount of expense chargeable. 32 Indirect Expenses In like manner, since it is the dollars of investment which must be protected against loss through depreciation of machinery; and against fire by insurance; and against which taxes are levied; the dollars of investment in the various divisions indicate the proportions of depreciation, insurance and tax expenses chargeable to each. In 1908, when the author developed and formulated the fundamental principle of ex- pense distribution he had not heard of Mr. Church, nor of his book, but he had come into contact with the methods which he advocated, and they seemed so logical that he immedi- ately analyzed them to determine the princi- ple behind them. Through long experience, and by careful analysis, it has been found that the principle, as formulated, applies to every known indi- rect expense, and is therefore accepted as fundamental. This principle and its method of application will be presented at length as the author proceeds. An indirect expense item is one which, having two or more beneficiaries, requires distribution. The reason that distribution of indirect ex- penses has baffled the accounting profession so long is that in the absence of knowledge of the 33 Fundamentals of Cost and Profit Calculation fundamental principles of expense, they per- sisted in grouping unrelated expenses into masses, thereby destroying the possibility of correct distribution. Every expense item is originally definite in amount, purpose or object, and benefit. The difference between direct and indirect expenses is that whereas the direct expense item has a single beneficiary to which it may be charged in total, the indirect expense has two or more beneficiaries between which it must be distributed, or charged, in propor- tion to the benefits conferred. The human mind cannot conceive of a divisible thing that cannot be measured by some unit of weight, measure or count. Therefore it follows that if the benefit con- ferred by a certain expense item is divisible, it is also measurable. Being measurable, the relative proportions are easily expressed and may be used as a guide for charging the money expended. One of the weaknesses of the accountants' efforts seems to be a penchant for expressing all proportions in percentages. In the dis- tribution of expenses of manufacture, percent- ages are not only unnecessary but cumber- some. Proportions and not percentages are important. 34 Indirect Expenses While individual indirect expense items are easily distributed, economy of time and effort is desirable. Therefore it is advisable to group expenses for simultaneous distribu- tion wherever such grouping is practicable. Indirect expenses may be grouped for simultaneous distribution only when their benefits are measurable by a common unit, and their beneficiaries participate in identical ratios. The inclusion of two or more unrelated in- direct expense items in a single account or group, as "overhead," "burden," or "general expense," obscures the purposes of the ex- penditures and renders correct distribution impossible. Lacking knowledge of the principles of expense grouping, accountants and others have charged part of the expenses individually ac- cording to the best information which they had, and combined the remainder in an over- head expense account for distribution upon some more or less arbitrary basis. Thus it will be seen that the extent of the overhead or burden account in any cost sys- tem reveals the extent to which the account- ant is ignorant of the principles of expense grouping and expense distribution. Where these principles are understood and 35 Fundamentals of Cost and Profit Calculation intelligently applied, it will be found that there is not left a single undistributed item to apply arbitrarily. In fact, if there were a single instance in experience where the prin- ciple did not apply clearly, it would be posi- tive proof that the statement of the principle was wrong. Then we would immediately have to search again for the fundamental truth which would cover every requirement. For ten years the author has discussed this subject with thousands of manufacturers and supervised the application of these principles in hundreds of factories. Not a single instance has he found where these principles, and the others, which all together form the funda- mental principles of Cost Engineering, did not fully measure up to all requirements. This experience, and the excellent results attained through it, must convince the most skeptical that Cost Engineering actually ac- complishes all that cost accounting aimed to do but failed; that Cost Engineering is a prac- tical science, and that its principles are as fundamental, teachable and universal in appli- cation as the axioms of mathematics. Fundamental principles are invariable. Rules may be made for applying the princi- ples, but whenever the facts in any case are such that the strict application of the rule 36 Indirect Expenses will conflict with the principle, the principle must govern and the rule be changed to meet the condition. For example: In a factory occupying a building by itself, or a part of a building where the type of con- struction is uniform throughout, the arrange- ment of equipment purely arbitrary with the management, and uniform temperature re- quired throughout, the elements of rent and heat can be combined. The total of this group may then be distributed to the factory divi- sions upon the basis of floor area. But if certain processes require a special type of construction, different from the rest, so that the arrangement is dependent upon such construction, or if the atmosphere of cer- tain rooms must be maintained at different temperatures because of the requirements of the processes performed therein, then they cannot be combined. Such conditions cause the rule to conflict with the principle that the beneficiaries must participate in identical ratios. Under such conditions the items of rent and heat should be distributed separately in order that due consideration may be given to the variation in requirements, and each divi- sion be charged with these elements in the exact ratio of benefits conferred. 37 Fundamentals of Cost and Profit Calculation Indirect expenses are of two types and may be classified as ^^mmediate," and "ultimate," or economic. Immediate indirect expenses are items usually appearing on the books, as a matter of record, immediately upon their being in- curred. These are represented by the following by no means complete list: Rent, fuel, current or gas for lighting, power, insurance, supplies, salaries, repairs, taxes, telephone, telegraph, postage, wages, compensation insurance, etc. Ultimate indirect expenses are items that are not usually considered and recorded at the time that they are incurred, but are very generally left for consideration at the end of the fiscal year, if at all. Some managers hold that consideration of these items is optional with them, and they are all too frequently left entirely out of state- ments. Some accountants, fearful that they will incur the displeasure of the client if they show that the business is not profitable, omit at least a part of the items, creating the impression that the business is more profitable than is really the case. Indirect Expenses Some managers, especially those who have no interest in a business beyond their "jobs," insist that important items be omitted, in order that the business may show a profitable result when no real profit exists. Some accountants and many managers for selfish reasons assume that the inclusion of in- terest on investment is a mooted question, and argue against it because it is to their personal interest to do so. The accounting profession as a rule holds out against the inclusion of interest except that paid for borrowed money. Within recent years, however, the number of accountants who admit the justice of interest charges on all of the investment has been on the increase. One unfortunate phase of the situation is that the profession has made no noticeable effort to reach a just and final conclusion in this matter. If it was taken up for formal consideration, it is not likely that even though convinced of the justice of including interest charges, any considerable number of those who have held out against it would admit a change of viewpoint. A typical instance of the attitude of the older generation of accountants is shown in the following incident in which the author was a principal participant: A manufacturer 39 Fundamentals of Cost and Profit Calculation who had given an order for the installation of a cost accounting system to an old friend who was a C. P. A. called upon the author to clear up some interesting points of difference be- tween cost accounting and cost engineering methods. The C. P. A. was present, and ad- mitted the soundness of every contention made, but would not yield the point that Cost Enginering as a whole was more practical and accurate than the so-called "standard account- ing practice" represented in his system. He gave as his reason his belief that he could not afford to brave the criticisms of the profession should it become known that he had made a concession. Such is the power of established precedent to hinder progressive development. The manufacturer, keenly appreciating the value of the differences brought out in the dis- cussion, and the narrowness of the account- ant's viewpoint, placed his order at once for the installation of a Cost Engineering System to replace that only recently installed by the C. P. A. A discussion of the author's reasons for ad- vocating the inclusion of interest on all invest- ment, and other "ultimate expenses," will be covered in the succeeding chapter, entitled "Economic Expenses." 40 CHAPTER FOUR ECONOMIC EXPENSES Comparatively few manufacturers and merchants realize as they should the impor- tant truth that assets naturally tend to shrink, while liabilities always tend to increase under indifference or neglect. Wealth is not created by accident. It is created by the expenditure of energy. Some men may seem to, and a few actually do, grow rich without expending personal energy, but somewhere in the background unseen forces are at work involving the application of a form of energy. Energy in industry is of three kinds: the personal energy of the individual or the or- ganization; the mechanical energy or power applied to the mechanical equipment; and the financial energy, without which the personal energy and mechanical energy would be com- paratively weak. Finances are the lubricant of industry. Without them the wheels of trade and com- merce must cease to turn. The proof of this is seen in the thousands of failures credited to "lack of capital." It is demonstrated on a large 41 Fundamentals of Cost and Profit Calculation scale in the deep valleys of trade charts mark- ing periods of financial panic. When the purse strings of the nation tighten, business slows down. At the points where the greatest strain occurs it stops, and failures occur in large numbers. These three kinds of energy may be lik- ened to the supports of a three-legged stool. Remove either the personal, the mechanical or the financial energy, and the structure of in- dustry topples. The expenses of personal energy are met in salaries and wages paid to workers. The expenses of mechanical energy are met in the expenditures for power equipment and opera- tion, but the expenses of financial energy, the economic or "ultimate" expenses, being less understood, and slower in exacting the penalty for negligence, are most often neglected. Economic expenses are the charges, or elements, of cost which must be included to preserve the economic balance, or equilibrium, of capital. They counterbalance deprecia- tion, waste, shrinkage, and other losses due to the conditions and contingencies of business. If they are neglected, no creditor persist- ently requests their payment and no attorney 42 Economic Expenses calls attention to the fact that they are over- due, demanding immediate settlement, yet in the end they must be paid. Because they are not payable with the cur- rent bills they are easily, and all too fre- quently, omitted entirely from the books and financial statements. Some men call them "intangible expenses." Others jest about them, while still others act on the assumption that their recognition is purely optional and that they may be consid- ered in prosperous years, and omitted in the lean years of business. They are sometimes looked upon in the same light as voluntary contributions to char- ity. Reference to them is almost entirely omitted from the curriculums of commercial schools. Even the accounting profession has no "standard practice" with reference to them. They, however, have been brought into their proper important position in Cost Engi- neering. For it is the business of the Cost Engineer to analyze and present the facts of business as they exist, not as the client would like to have them appear, or as expediency demands, in order that a financial statement may reflect credit upon the management. 43 Fundamentals of Cost and Profit Calculation Accounts payable to other creditors may be defaulted and no legal action follow; business may seem to prosper in spite of the neglect of these elements, but ultimate pay- ment cannot be sidestepped. Time is the in- exorable creditor, exacting payment in full or foreclosing. Just as surely as the natural laws govern- ing health cannot be infringed without the penalty of illness, violation of the natural law of compensation in finance will result in loss, if not in absolute failure. Depreciation is not an expense. Notwithstanding the fact that the account- ing profession has generally advocated "charging off" at the end of the year "for de- preciation" a certain amount from the assets of the business, depreciation is not an expense. Depreciation is a contingency. The custom in times past has been, and still is, to think of depreciation in relation to "wear and tear," the physical condition only being considered in calculations as to the life of equipment. There are many causes of depreciation, but three appear more prominently than others. 44 Economic Expenses They are obsolescence, inutility, and wear and tear. The least of these is wear and tear. A machine may be in first-class physical condition and be actually a liability because it is out of date and its operation so unprofit- able in competition with modern equipment as to create a loss. A machine may be in perfect physical con- dition, and up to date, but if the demand for its product has ceased, so that it cannot be profitably utilized, it becomes a liability rather than an asset. If the machine is actually worn out in service, and its product has been intelligently priced and sold, a reserve has been provided thereby for its replacement, and neither loss nor liability is created. Depreciation is a contingency which the intelligent manager will foresee and provide for by creating a reserve for replacement (not by the makeshift of a depreciation account) . Replacement reserve is provided to take care of the probability that it will be neces- sary at the end of an estimated period to pur- chase a new machine to replace the old. Even though no machine is actually purchased, the reserve should be provided that the stockhold- 45 Fundamentals of Cost and Profit Calculation ers may have their money returned to them at the end of the term of usefulness of the machine. Capital must be protected against loss if financial equilibrium is to be main- tained. "Charging off" for depreciation is an im- practical plan. It creates a constantly reduc- ing basis for the charge, with the result of lengthening the period during which the charge must be continued to balance the orig- inal investment. Calculations show that a ten per cent per annum depreciation charge from reduced bases will actually require ninety- seven years to approximately balance the in- vestment. A ten per cent replacement reserve ^^ charge on!' included in the expenses of operation will provide the funds for replacement in ten years. The "charge on" is the correct method. The term of years or period established as the probable efficient life of a machine is prac- tically the only arbitrary factor in Cost Engi- neering. Reference has been made here only to de- preciation of the machinery values. Prac- tically all assets depreciate, and provision must be made for maintaining economic equi- 46 Economic Expenses librium to avoid losses. The more important items are: Depreciation of buildings. Depreciation of equipment. Depreciation of raw material stocks. Depreciation of merchandise and finished product stocks. Waste from cutting materials. Spoilage due to the hazard of operations, and inefficiency of workmen. Losses from bad accounts and the expenses of collections. Depreciation of good will. In cases where good will has been purchased outright, a reserve should be provided which will balance the investment within the period where the influence of the pur- chased good will is likely to be ex- hausted. Patents should be carefully appraised, and provision made for royalties to be charged against product, which will yield their value, in addition to normal profits, within the period of protection. Interest on Investment is a subject on which there has been almost endless discussion 47 Fundamentals of Cost and Profit Calculation for want of proper consideration of funda- mental principles. Interest on investment is a form of wages for energy employed by the business and must be provided for before profit exists. The expenses of fuel, supplies, and main- tenance, pay for the mechanical energy em- ployed by the business. The wages and salaries paid to individuals pay for the personal energy of workers em- ployed by the business. Interest on investment is simply the wages of the money employed by the business. Just as there can be no profit until after the expenses of operation, and of personal service, have been paid, there can be no profit until after the wages of the invested capital are paid. There are many valid arguments in favor of interest on investment being charged as an element of operating cost, rather than consid- ering it as a part of profits. For example: Assume that a man has $50,000 invested in safe securities yielding the usual legal rate of interest (or wage) of six cents per dollar per year. This man is holding a good salaried posi- tion which pays $5,000 per year for his per- 48 Economic Expenses sonal energy, and has in addition the annual income of $3,000 earned by his investment. He decides to engage in business that his money may earn for him a larger return under his personal management. He draws his money from the security of investment and reinvests it in a business enter- prise solely in the hope of increasing his in- come. He fixes his salary at the old figure of $5,000 for his personal service, and does his best. At the end of the year he finds that the net earnings of the business amount to only $1,500 or three per cent of his investment. Has he made a profit of $1,500? He has not. His business venture has cre- ated a net loss of half of the normal and legal wages of his financial energy. He has lost $1,500 as surely as though in his old position he had been unable to draw more than $3,500 of his $5,000 salary. Suppose that during the next year he does $100,000 in business and his net earnings aside from his salary amount to $4,000. What profit has he made? He has made a profit of one per cent. The legal wages of the money invested is six per 49 Fundamentals of Cost and Profit Calculation cent, or $3,000. His profit this year from his business venture amounts to $1,000 on a turn- over of $100,000, which is one per cent. Interest and profit should never be con- fused, because interest is considered in rela- tion to investment, while profit is properly considered only in relation to sales or turn- over. Accountants sometimes contend that if it is desirable to consider interest on investment separately from profits, it may be done at the end of the year, by setting aside from the profits an amount equal to the legal interest, calling the remainder "net profit." In view of the fact that the majority of modern factories make up goods to the speci- fications of the customer, with a price quoted in advance of making, it is necessary to make estimates. No estimate is complete that does not take into consideration every element of expense that will immediately or eventually be con- sidered in the cost. Otherwise, how could the manufacturer regulate the matter of profit? He must include in his quotations, in addition to the estimated cost, an amount which will provide for the anticipated percentage of profit. 50 Economic Expenses Profit is related to turnover, and not to investment; while interest is related to invest- ment and not turnover, the two items cannot be included in a single percentage. Much of the confusion of thought in these matters is due to the fact that neither public nor commercial schools teach practical meth- ods of calculating cost and profit. Before leaving this subject, let us take an- other example in which we will use the same individual and the same capital as in the preceding illustrations. In this instance the investor requires the use of $100,000, while his personal capital is but $50,000. He borrows $50,000 at six per cent, which he invests jointly with his own. (Those of our accountant friends who deny the man who uses his own capital the right to charge interest on it as a part of the cost of doing business, never question the pay- ment of interest on borrowed money as a legitimate expense.) At the end of the year the business shows a good margin of profit, after paying the in- terest on the borrowed money. Is there any difference in the status of the borrowed money employed in the business, 51 Fundamentals of Cost and Profit Calculation and the money which is owned by the man- ager? Absolutely not. If he succeeds in earning enough to pay back the borrowed money should he then fur- nish the product or goods to his customers cheaper because it is his money that is in- vested, rather than borrowed money? Such a theory is as ridiculous as the claim occasion- ally advanced that a concern has no rental expense because it owns the building it occu- pies. Fundamentally, all industrial activities are conducted with private capital. Every enterprise, corporate, public or private, must secure its financial energy from private sav- ings, the result of ability, energy and thrift on the part of individuals. Stocks, bonds and notes are simply forms of loans. The actual ownership of the capi- tal does not change. The bond or stock cer- tificate is simply evidence that the individual owns a certain amount of money that is used in the enterprise which has arranged for the issuance of the form of document received as evidence of the loan. That rate of wages (interest) is lower as the form of security advances. Government 52 Economic Expenses bonds, the safest form of loans, pay the low- est rate, because the risk is smallest. Commercial loans command a higher rate because the risk involved is greater. Com- mercial paper is practically guaranteed by the common stockholders of the concern issu- ing it, to the extent of the stock investment. The holders of common stock in an enter- prise take the greatest risk, because all other forms of loans come first. Therefore, since they take the greater risk of loss in unprofit- able years they are entitled to the larger re- turn of the profitable years. The chief difference between a common stock certificate and a bond or note is that the former provides no specified rate of wage or term of contract. However, cost, the point between loss and profit, must in justice be determined by a method of calculation which will place every dollar employed in the business upon an equal footing. Cost must include interest on the invested capital at the normal rate, the rate that the business must pay for loans made by those who do not assume the same risk that the stockholder takes. Bookkeepers and accountants are accus- tomed to charging as expense only the inter- 53 Fundamentals of Cost and Profit Calculation est paid on borrowed money. The Cost En- gineer holds that interest should be charged on every dollar employed in the business, re- gardless of ownership. The ordinary classifications on which in- terest should be charged include the invest- ment in : Real estate used for the business. Buildings used for the business. Equipment, factory, office, store, etc. Raw stocks carried to facilitate economi- cal production. Investment in work in process. Merchandise carried to facilitate quick service to customers. Finished product or merchandise carried for customers' accounts. Accounts receivable. Cash in bank for use of the business. These items cannot be added together and a blanket charge made of the mass. Each must be considered in relation to its employ- ment in service to the customers, so that the man who buys the product of hand tools will not pay the interest on investment in expen- sive machine equipment. 54 Economic Expenses Good Will is another item that seems, heretofore, to have escaped the consideration of thinking men. The term, as commonly used, seems to refer to the force of habit in causing people with purchasing power to con- tinue to patronize a concern after it has changed ownership. This type of so-called "good will" is of doubtful value. Notwithstanding the fact that the man who has a store or other business for sale dilates largely on the value of the good will that is included in the offer, it is rare in- deed that the new owner profits much by rea- son of "force of habit." Genuine good will is rarely transferable in total. The man who gains by it is the man who joins an organization which has already established a valuable good will. Complete change of ownership, publicly announced, carries with it little good will. The term is sometimes applied to a legiti- mate form of intangible investment, and in such cases has real value if the business is to be continued under the new management with- out radical changes in character or policy. Practically no business can be established without going through an unprofitable period. Often it requires a year or more to get the 55 Fundamentals of Cost and Profit Calculation business up to a point where its tangible assets equal the amount of investment. The time of the persons who promote the organization, arrange for the preparation of the building, and manage the affairs prior to the date when business actually begins, re- quires a form of investment that does not show in the inventories. The expense of advertis- ing, printed supplies, and other unsalable ne- cessities adds to this investment. These items should all be a matter of rec- ord, and provision made for refunding to the treasury all such items before profit is con- sidered. If the business changes hands before such refunding takes place, due consideration should be given to such of these amounts as have not been refunded. Genuine good will, however, is another matter. It is the very foundation of perma- nent business. Not one man in ten can de- fine it. Good will is the margin of service deliv- ered to the customers beyond what they are asked to pay for. If you sell an article to a customer at a price which leaves him with the impression that he paid all or more than it was worth you 56 Economic Expenses create no good will. But if you deliver an article to a customer at the moment that he needs it, and it is made so well that he never has reason to make a complaint about it, and the price is such that he feels that he got a square deal, you have delivered a margin of service which will come back to you in future business and recommendations of your service to others. Good will is transitory in its nature. Bad management can destroy it. Neglect of the interests of the customers causes it to dissolve like vapor. Where good will is actually purchased a reasonable estimate of the "period of influ- ence" should be made and a reserve provided for and established, that within the estimated period will refund to the treasury the amount paid for it. In the chapter on "Determining Cost" an outline will be submitted to cover as far as is practicable all the items of "Economic or Ul- timate" expenses and the methods by which they are to be included in cost. 57 Round numbers are the cloak of ignorance; definite figures form the basis of action. Two and two make four — au- thorities do not differ. Mathe- matics do not compromise. A few cents in a cost figure^ in a job estimate^ in a profit percentage, mark the line between solvency and bankruptcy — success and failure. Build your system and your facts to give you not the approximate, the probable, the perhaps — but the pre- cise, the actual, the definite. Be exact. — ^^System." 58 CHAPTER FIVE DETERMINING COST There was a time in the history of Ameri- can industries when exact information about cost of production was of very little impor- tance. That day has long since passed and will never return. At the moment when this is written the American business man is confronted with conditions and requirements, made acute by war, demanding immediate and accurate facts about the vital elements of his business. Unfortunately, the opportunities, the am- pleness of time, and the normal conditions of business, which were his in the past, and which afforded the most practicable basis for gaining information, were neglected. He stands today as unprepared from the economic standpoint as was our country, from the mili- tary standpoint, the day the Lusitania was tor- pedoed. He has no choice but to get into action. He must meet the needs of the hour. Every helpful idea serves to lessen the weakness of his position and hasten, the time when he can adequately fulfill the demands made upon him. S9 Fundamentals of Cost and Profit Calculation Business in times past has been conducted in a wasteful manner by rule of thumb meth- ods. American business men have presented the most remarkable examples of rapid for- tune building, but the methods have been hazardous. While some have climbed the ladders of riches quickly, thousands have fallen by the wayside, until statistics show in normal times a greater percentage of commer- cial and industrial failures in this country than in any other country in the world. The American business man is a lover of the game. He is apparently always ready to take a chance. But the time has come when he can no longer take chances. The require- ments of the nation are such that he must have at his finger tips, for immediate reference, more complete and accurate records than he ever dreamed that he would need. He may, in the past, have been willing to plunge, and for a time conduct his business without profit. Today he needs profit that he may not only survive but assist in the sup- port of his Government in its fight for the lib- erty without which his life and the lives of those he loves would be blighted. One of the greatest hindrances with which he has to contend in his effort to meet the 60 Determining Cost emergency of the hour, is the deplorable fact that the terminology of business is cluttered with meaningless terms and phrases. Def- inite information is difficult of conveyance be- cause each individual places his own interpre- tation upon the words that he hears or reads. There is no established terminology. Another hindrance is that methods of pro- cedure are as chaotic and uncertain as the words and phrases by which the effort of transmitting information is rendered inef- fective. The business man is not the only one who is embarrassed and baffled by the fact that business has neither terminology, principles nor practical outlines of procedure, to deter- mine the cost or profit in any transaction of business. The Government officials upon whom has been placed the task of collecting and analyz- ing the essential information are in little, if any, better position. The crying need of the time is for definite statements of the principles of cost and profit, for practical methods of applying those prin- ciples to business so that the problems may be solved within the least possible time and in such a nianner that there shall remain no op- 61 Fundamentals of Cost and Profit Calculation portunity for misunderstanding or contro- versy. Definiteness is the keynote of Cost Engi- neering. Every expense element is definite. It is definite in amount or it could not be recorded. It is definite in purpose or it would not be au- thorized. Its purpose is always the procure- ment of a definite service or commodity more advantageous than the amount of money in- volved, otherwise the exchange would not be made. The advantage gained by the expen- diture imparts a definite degree of benefit wherever the purchased item is utilized. Correct distribution of an expense item demands that the charge shall always be made against the product benefited, and if more than one item or process be benefited the charges must be in the ratio of benefit or ad- vantage conferred. In manufacture, product always consists of definite materials, to which have been ?iip- plitd definite amounts of the time of definite formative processes. Materials are measurable. The expenses involved in the purchase, transportation, storage, and handling of ma- terials can be definitely determined. 62 Determining Cost With definite specifications for materials, definite information as to expenses involved, there should be no question about the possi- bility of determining the cost of materials re- quired for any given lot of product. Processes are definite. A capable engineer can in a short time make a complete list of the processes which any given factory is equipped to perform. The expenses required for the operation of processes are definite. The purposes for which the expenditures are made are definite. None of the operating expenses have any relation to, or are involved in, the ratio of wages paid to workmen. Practically every expense involved in the operation of manufacturing processes has a definite relation to the element of time. Rent is paid on a time basis, or if the building is owned the items of depreciation and insurance on the building, and interest and taxes on the investment in building and land, are calculated on a time basis. As between the processing divisions of a factory the expenses of providing the housing facilities are calculated by the use of the fac- tors of area and time. 63 Fundamentals of Cost and Profit Calculation The expenses incident to the equipment investment, e. g. depreciation, insurance, in- terest and taxes, are all related to time. The amount of investment and the element of time are the important factors. The expenses of the power plant, or for purchased mechanical energy, are related to time. Horsepower required for operating the machines and the time of operation pro- viding the means of determining the propor- tions of power expense chargeable to process- ing divisions. The superintendent supervises the active time of productive processes, while the fore- men supervise the time of the individual em- ployes whether classed as productive or non- productive. Water, soap, towels, and toilet facilities are required for the convenience of every in- dividual, during the time that he is in the fac- tory or office. These items are related to per- sonal time. Supplies consumed in the operation of the processes are required practically in propor- tion to the active operating time. Records of the activities of manufactur- ing processes and individuals require the use of supplies relatively in the proportions of 64 Determining Cost the active time of the processes. Activity, not idleness, creates the necessity for the expenses of such supplies and the services of time- recording and cost-computing clerks. The normal unit of time measurement is the hour. The logical unit of process measurement is the process hour. The cost of process hours w^ill vary with the expense elements involved and the num- ber of process hours over which the process expenses must be averaged to get the average cost of the process hour. The cost of a process hour is a complete cost. Every element involved in the process having been included, there is nothing to add or subtract. The total of the expenses involved in a given process during a given period of time, divided by the chargeable (revenue produc- ing) hours of that process actually charged against the production orders during the same period, determines the rate at which such hours must be charged to determine the cost of that process as applied to the order. It follows that the total charges against all production orders during a given period must practically balance with the total of the ex- 65 Fundamentals of Cost and Profit Calculation penditures of the same period. (These totals are almost invariably within one-quarter of one per cent of an exact balance.) Wages may or may not be included in the process hour cost rate, at the choice of the en- gineer. Wages comprise simply one element in cost. Wages have no relation to the total of the process hour cost. Wages are always related to time. They are computed on the basis of time worked or pieces processed or assembled. Piecework rates are set on a time basis. Where no special reason exists for a sepa- rate consideration of wages they should al- ways be included as one of the elements of the process hour cost. Inclusion within the hour rate materially reduces the clerical ef- fort required for the operation of the cost system. As a result of many years' study of the problems of Cost Engineering the author has formulated a schedule of fundamental prin- ciples of the science of Cost Engineering which he presents herewith. These principles and the rules of appli- cation covered in the various phases of the 66 Determining Cost subject, as discussed in this book, together with the effort at establishing a definite term- inology of Cost and Profit calculation, are of- fered in all seriousness as a nucleus upon which may be builded a recognized science of Industrial and Commercial Procedure. In presenting the following schedule of fundamental principles of Cost Engineering (Denham Methods) each formal statement of principle is accompanied by a brief ex- planatory statement which it is hoped will make the principle more readily understood. /. The cost of an item of product is the sum of the expenses involved in its produc- tion and distribution up to the moment at which cost is determined. (Cost is the price at which the item may be sold without either loss or gain to the seller.) 2. Every cost element (expense item) is definite in amount and purpose, or object, and anticipates a beneficial equivalent in service or commodity. (Expenses having a single beneficiary are ^^direct" expenses; those having two or more beneficiaries are "indirect," and require dis- tribution.) J. Indirect expenses may be grouped for 67 Fundamentals of Cost and Profit Calculation simultaneous distribution only when their benefits are measurable by a common unit, and their beneficiaries participate in identical ratios. (The inclusion of two or more unrelated indirect expense items in a single account or group, as "overhead," "burden," or "general expense," obscures the purposes of the ex- penditures and renders correct distribution impossible.) 4. In the distribution of indirect ex- penses, singly or grouped, the proportions of benefit conferred indicate the proportions of the expense, or expense group total, charge- able to beneficiaries. (Rules may be established for the distribu- tion of certain common indirect expenses, as e. g. Rent, on the basis of used floor area, but exceptions to the rules may be found in every factory. Whenever a rule and its principle are in conflict the principle must govern.) 5. Operating units, or machines, may be grouped and the cost per hour averaged only when their principal expense factors are in approximately uniform ratios, and the output of such character that the work may be inter- changed between the units, or machines, of the group. 68 Determining Cost (Although two or more machines have practically uniform proportions of the chief expense elements, as rent, investment, power, wages and supervision, if the character of the output differs so that work is not interchange- able, one may be operated continuously and the other spasniodically. Under such condi- tions injustice would result from averaging cost of productive hours.) 6. Contingent expenses, such as repairs, shrinkage, normal waste and loss on by-prod- ucts, constitute legitimate charges against pro- duction, (The causes of such expenses and losses serve to indicate the objectives of the indivi- dual charges.) The foregoing principles have been in practical use for the past ten years by an or- ganization of Cost Engineers, and have been tested in hundreds of instances, so that the reader need not feel that he is offered anything experimental. Cost Engineering is a practical science. It is as simple and direct as mathematics. However, it cannot be learned in a moment as a formula may be. It requires conscientious effort to study it until one can become profi- cient in its application. 69 Fundamentals of Cost and Profit Calculation The author does not wish to convey the impression that the reader of this book can immediately install a Cost Engineering sys- tem in his factory or store upon the informa- tion contained herein. The subject is too deep for that. Treatises on various subjects broaden our horizon, and give us a better grasp on the art of living. Study of the principles of chemis- try gives us a better understanding of chemi- cal actions and reactions, but only the few who specialize in the subject and take meas- ures to get actual experience become chemists. Not every man who studies Cost Engineer- ing will become a Cost Engineer, but all who will try to assimilate the principles and rules of practice will be better business men because of the information that the effort provides. Few manufacturers realize the number or variety of the expenses of their business. No list that could be published would be either complete or cover exactly the conditions of any factory. The following list of the more common items of expense is offered simply as sugges- tive of the various kinds of expenses and ex- pense groups which must be considered in any effort to determine cost of production, or the cost of doing business. 70 Determining Cost Advertising Advertising Postage Automobile Expense Bad Accounts Belt Lacing Belting Bookkeeping Clerical Help Costkeeping Deductions for Errors, etc. Discounts to Customers Donations Drivers' Wages Dues, Business Organizations Electric Current for Lighting Electric Current for Power Errand Boys Express Charges Foreladies' Wages Foremen's Wages Freight Fuel Gas for Lights Gas for Heating Helpers' Wages Insurance on Buildings Inventory Clerk 71 Fundamentals of Cost and Profit Calculation Insurance on Equipment Insurance on Finished Stock Insurance on Raw Stock Insurance on Work in Process Insurance, Boiler Insurance Liability Interest on Accounts Receivable Interest on Building Investment Interest on Cash in Bank Interest on Equipment Investment Interest on Finished Stocks Interest on Raw Stock Interest on Real Estate Investment Interest on Work in Process Lubricating Oil Manager's Salary Officers' Traveling Expenses Other Officers' Salaries Porters' Wages Postage — Commercial Rent Repairs to Building Repairs to Equipment Replacement Reserve for Building Replacement Reserve for Equipment Salesmen's Commissions Salesmen's Salaries 72 Determining Cost Salesmen's Traveling Expenses Shrinkage of Merchandise Stocks Signs Soap Spoiled Work Superintendent's Salary Stenographers Stockkeepers' Wages Storage Supplies for Commercial OfBce Supplies for Factory Operations Supplies for Factory Office Supplies for Sales Office Taxes, Corporation Taxes, Income Taxes, Personal Property Taxes, Realty Taxes on Profits Telegrams Telephones, City Telephones, Interior Telephones, Long Distance Messages Towels Waste, Cotton Waste Paper Baling Watchman Watchman's Clock Supplies Water Rent Workmen's Wages 73 Fundamentals of Cost and Profit Calculation Modern Business is complicated, and to be successfully conducted requires system. System is the carefully planned and finished highway upon which management may speed to the goal of profitable endeavor. Smart alecks are fond of making a jest of system, but successful men know that they are essential to economy of operation. A few are unable to draw a distinction between system and red tape. System requires routine, but red tape is the extreme in which the effort of systematizing has shot over the mark and adopted or created routine that is either without purpose or is unprofitable. The author of the routine, working from formula rather than guided by fundamental principles, is unable to eliminate nonessentials, and establishes useless opera- tions, thereby defeating the purpose for which he is striving. Men of narrow vision, assum- ing that the application of these formulas rep- resents system, condemn all efforts of estab- lishing systems except those of their own de- vising. Practical systems must be built upon 74 Determining Cost sound fundamentals. Neither theories, for- mulas, nor personal opinions will suffice. It is not the purpose of this book to offer any special form of system, but rather to pre- sent the fundamentals of Cost and Profit cal- culation in such a manner that the reader may work out his own problems with a better un- derstanding because of the information herein offered. In establishing any cost system it is essen- tial that an effort must be made to simplify the work as far as possible, keeping in mind the factors of accuracy, comprehensiveness and practicability. It is a rule in Cost Engineering practice to place accuracy in the first place among the requisites of a system. However, there is a de- gree of accuracy beyond which it is not prac- tical to go. The limit is watched by keeping in mind the further rule that ^When the cost of the effort approximates the value of the re- sult it is unprofitable to go further." In other words, all effort. must yield a profit to be de- sirable. "Practical accuracy" is defined as a degree of accuracy to go beyond which affects neither 75 Fundamentals of Cost and Profit Calculation the selling price of the product nor the profits. Anything not affecting the profits is neutral and may be done or omitted according to the judgment of the Engineer as to the im- portance of the result. Simplicity is facilitated by grouping ex- penses for distribution. The simplest possible form of grouping is that which conforms to the third principle in the schedule. The indirect expenses in the following list have been grouped as nearly as possible according to that principle. How- ever, in any factory the conditions may re- quire changes from the plan presented here- with. \j Building Expenses: Rent, or. Replacement reserve and insur- ance on building, and interest and taxes on investment in building and realty. Heat Janitor Service Building Repairs Equipment Expenses: Replacement Reserve 76 Determining Cost Interest on Investment Insurance on Equipment Taxes on Equipment Power Expenses: Total of Equipment Expense on power equipment Total of Building Expense chargeable to power Repairs Wages, Supplies, etc., for power depart- ment, including fuel Current (if purchased from central sta- tion) Light and Toilet Expenses: Current or Gas for Lighting Lamps, Cords, Tips, Globes, etc. Water for Lavatories, Soap, Towels, etc. Factory Administration Expenses: General Superintendent Factory Clerks Factory Office Expenses Factory Phones, Telegraph and Postage Factory Stationery and Office Supplies Porters and Elevator Operators 77 Fundamentals of Cost and Profit Calculation Commercial Administration Expenses: Executive Salaries Office Salaries, except factory and sales Telephones and Postage Stationery and Office Supplies Bad Accounts and Collection Expenses Discounts and Deduction to Customers Federal and Corporation Taxes Interest on Work in Process Interest on Accounts Receivable Insurance on Work in Process Craft Organization Dues and Traveling Expenses Selling Expenses: Sales Manager Sales Office Salaries Salesmen's Salaries and Commissions Sales Traveling Expense Sales Phones and Telegraph Stationery and Supplies Advertising and Postage Samples and Sample-making Donations Local Organization Dues, etc. Finished Stockroom Expense (condi- tional) 78 Determining Cost Packing and Local Delivery: Rent, Packing and Shipping Dept Equipment Expense, P. & S. Dept. Supplies, P. & S. Dept. Trucks, Stables, etc. Wages Stock or Merchandise Departments: (Raw and Finished should be considered sepa- rately) Rent Equipment Expense Insurance on Mdse. Carried Interest on Investment in Stocks Taxes Shrinkage Light, etc. Commercial (purchasing, etc.) Transportation Supplies Selling Expenses Wages When attempting to distribute expenses the reader should keep in mind the fact that each division is chargeable only with such ex- penses or proportion of expenses as have actually been involved in the production of the output of the division so charged. 79 Fundamentals of Cost and Profit Calculation The common bases of distribution follow: Building Expenses — Area of used space Equipment Expenses — Replacement value of equipment Power Expenses — Horsepower hours Light and Toilet Expenses — Personal hours, or payroll hours Factory Administration Expenses — Chargeable hours Commercial Administration Expenses — Extended values at cost Selling Expenses — Extended values at cost, when sold Packing and Local Delivery — ^To be determined by circumstances Raw Stock Expenses — Frequently ap- plied on basis of cost of material but requires special attention Finished Stock Expenses — Applied by percentage to stock carried for custom- ers, or through selling expense, accord- ing to conditions Foremen's Wages — Payroll hours of divisions supervised by each 80 Determining Cost Generally speaking, the use of the thing purchased will indicate the proportions chargeable to divisions. This is not always just. When all the expenses of the factory and its business departments have been properly analyzed, grouped and distributed in propor- tion to the benefit conferred by each, the cost per hour of each process is determined. This is done by dividing the total of the divisional expense by the number of chargeable or rev- enue producing hours that have been charged to the factory orders during the period cov- ered by the expenses considered. All product of factories consists of com- binations of materials and the time of the nec- essary formative processes. Materials are to be charged to factory orders at cost, which includes not only the purchase price as shown on the invoices, but all expenses of warehousing, protecting and handling, not omitting interest on invest- ment. The cost of materials plus the cost of proc- esses as determined by Cost Engineering con- stitutes the cost of the order. All expenses being included in the process hour rates, noth- ing is to be added except net profit. 81 Fundamentals of Cost and Profit Calculation In factories where product is made for stock, and sold later, the selling expense should not be included in the process hour rates, but should be applied to the order when sold. In such instances the expenses of ware- housing the finished product should be ap- plied with the selling expenses. CHAPTER SIX SELLING PRICES AND PROFITS The object of all commercial and indus- trial activity is profit. In fact it might be said that the object of all human effort is profit. The first statement refers to the reward of in- dustry, money; while the second refers to various types of reward, such as the comforts of life, the good will and friendship of neigh- bors, and self-respect as well as financial re- ward. This chapter deals with the reward of industry and commerce — profit, as expressed in terms of money. The legitimate reward of business is profit. In fact, commercial activity that is un- profitable is not business ; it is folly. The man who is responsible for unprofitable conditions of business is a menace to the community and to the state. He places in jeopardy the capital and income of the stockholder who has en- trusted to him the profitable use of his money; he destroys the basis of credit and adds to the risk of the creditor whose confidence he abuses ; he injures the business of his competi- tor who is striving to conduct his business on sound principles; he weakens the support of 83 Fundamentals of Cost and Profit Calculation the family that loves and depends upon him ; he injures his Government by curtailing its sources of revenue and nullifying its efforts for welfare and prosperity of its people; but most of all, he injures himself. The fabric of humanity is so closely and delicately interwoven that the failure of one individual to recognize his responsibilities af- fects adversely the welfare of hundreds and often thousands of his fellows. Business must yield profits or failures will result. All business is buying and selling. The merchant buys goods and resells them in the same form, but because he adds an ele- ment of service he is entitled to a profit. The manufacturer buys materials in one form, changes them to another which his cus- tomers desire, adding also the element of serv- ice, and is entitled to profit. Neither would put forth the effort to serve his fellows were it not for his anticipation of the reward, or profit. Profit is the amount by which the selling price of a sold item exceeds its cost. This definition of profit covers several im- portant points : (a) the determination of cost, 84 Selling Prices and Profits SO that there may be certainty that the selling price is higher; (b) determination of a selling price that will at once yield a profit and not be so high that prospective customers will refuse to buy; (c) the fact that the item must be sold before there can be a profit. It is an unfortunate fact that nine-tenths of the men engaged in business do not know how to determine correctly either the cost or the selling price of the goods they sell. The reader may doubt this but his skepticism will not change the facts. He may be one of those who are using wrong methods without know- ing it. The author has stated elsewhere that neither the public schools nor the commercial schools, generally, teach these subjects cor- rectly. Fortunately, there are a few excep- tions. If this book shall have the effect of waking up a few more it will have accom- plished enough to warrant its authorship and publication. The best dictionaries offer definitions of cost and profit which are in accord with tra- ditional methods but not practical for modern business. In thus antagonizing the so-called authori- ties of schools and reference books the author 85 Fundamentals of Cost and Profit Calculation does not wish to be understood as setting him- self up as a higher authority. He presents his claims to the confidence of his readers solely upon the basis of their practicability for use with modern business methods. These are not matters in which a common agreement can govern. The school teachers, college professors and compilers of dictionaries may be eminently capable from the standpoint of classical edu- cation, but the author and the business men of the day are dealing in the facts of trade as they are, and as they are unknown to the eminent authorities who prepare textbooks and dic- tionaries. When the compiler of the dictionary pre- sents the definition of cost as "the price paid for an item" it is evident that he has in mind as the price the consumer pays for the article, the price he paid for his last suit of clothes or for a book. When the educator refers to the diction- ary and finds the definition just quoted, his mind instantly accepts the statement as true because his own experience is identical with that of the lexicographer who wrote the defi- nition. 86 Selling Prices and Profits However, when the merchant or the manufacturer has occasion to use the term "cost" it means something entirely different. It means, not the purchase price alone, but the purchase price plus all of the expenses in- volved in manufacture and distribution up to the moment at which the cost is determined. Much has been said in previous chapters about determining the cost of production in a practical manner, and the weakness of the old methods or traditions of cost accounting. This chapter is intended to cover those ele- ments of business having to do with the dis- tribution of the product after it is made and the cost of manufacture determined — ^with "Selling Prices and Profits." Merchandising, like manufacturing, is a simple proposition if but one class of mer- chandise is handled, but in the department store where each class of goods is separated from other classes by the limitations of de- partments there is large opportunity for the profitable application of Cost Engineering. Sales are the source of revenue of business. In merchandising, as in manufacturing. Cost of Selling must necessarily be a charge against sales. No expense can be charged against in- 87 Fundamentals of Cost and Profit Calculation active stocks of goods. Every expense must be provided for from revenue. Goods that do not move are a liability. In the simple store, selling a single class of goods, the cost of selling absorbs a part of the margin, the remainder of which consti- tutes profit. Margin is the difference between the pur- chase price and the selling price and consists of the cost of selling and the profit. Margin is sometimes erroneously miscalled ^^gross profit," but since the nature of profit is such that it is always net, the latter term is mis- leading. Under the textbook theory a margin, or "gross profit," can be added to the purchase price of the item to determine the price at which it must be sold to yield a profit of the desired percentage. The same textbooks that teach that profit is a percentage in addition to cost (the as- sumption being that purchase price repre- sents the base or cost) , teach that commission paid for making the sale (a part of the selling expense) is to be considered as a percentage of the selling price. 88 Selling Prices and Profits These teachings are inconsistent and im- practical, not only from the standpoint of modern methods, but there never was a time when they were practical. The effect of mod- ern conditions has not increased their imprac- ticability, but it has greatly increased the dan- ger to the welfare of business men of continu- ing their use. The accountants long ago should have in- sisted upon their correction. The only reason apparent for their not doing so is the fact that the nature of accounting, being purely rou- tine, does not develop the reasoning faculties and deadens the creative faculties. The ac- countant must have no imagination. His busi- ness is to record history. Standard practices of accounting have the same relation to the transactions of business that the crafts of undertaking and monument erecting have to the human race — they bury them and preserve their memory by records. Accounting might be quickened into a thing which would serve to create profits if the devotees were not so bound to traditional ^^standard practices" and used their mentali- ties instead of leaning upon the so-called au- thorities. 89 Fundamentals of Cost and Profit Calculation Modern business is done on narrow mar- gins. The facts of Cost and Profit must be known. Traditional theories at variance with the facts are dangerous and will not serve. The modern store, of the better class, is a complicated affair. It involves the sale of many kinds of merchandise, each having a different rate or percentage of turnover. Each requires a different amount of space, special equipment, and, in many lines, spe- cially trained and experienced salesmen. Payment for the service of salesmen may be made either by salary or commission, some- times both. In some instances the employer pays the expenses of the salesman. In other instances the salesman must pay his expenses out of his earnings. The departmental clerk within the store may have no item correspond- ing to the traveling expense of the outside salesman, but he may receive, as part of his compensation, a bonus calculated upon any one of numerous bases recently devised and inaugurated. In addition to the compensation of indi- viduals the expenses of rental, fixtures, sup- plies and administration correspond very nearly to those of the manufacturer. 90 Selling Prices and Profits With margins narrowed by either the keenness of intelligent competition, or the blunders of ignorant competitors, the im- portance of extra cost knowledge enlarges to serious proportions. The future of trade and commerce de- mands that efforts be made at the earliest mo- ment to get into practice a code of procedure and a terminology easily comprehended and practical in use. As little change from present usages as is necessary in such a movement to attain the re- sult is desirable. This may be accomplished if interest can be aroused to the extent neces- sary to accelerate action. It may take a decade to attain the result but the longer the start is postponed the farther into the future is pushed the time of attainment. How shall it be done? Contrary to traditional formula and prac- tice. Cost Engineering proves that the opera- tion of the department store and the composite factory are identical in principle. The costs of each department or division are determined by very similar processes. When the cost is known it remains to de- termine the selling prices and the amount of profit desired or obtained. 91 Fundamentals of Cost and Profit Calculation First — All percentages used in connection with the handling and sale of product and merchandise should relate to the same base. The only logical base developed by analysis of the facts is the selling price in the individ- ual sale, and the total of sales, in the period- ical calculation. Selling price, the base, is always repre- sented by loo per cent. The following items must be recognized as related to selling price, or sales, as the base: Expenses of selling of every nature must be calculated as percentages of the base — selling price, not purchase price. Profit must always be calculated as a per- centage of the base — selling price, not pur- chase price. The more intelligent and advanced busi- ness men are doing this at present, but their number is less than ten per cent of the whole. Many concerns have adopted a fixed per- centage which they add to the purchase price of goods to be sold, as a means of determining the price at which they are to be sold, re- gardless of classification of the items or the amount of the turnover developed. They take a chance on profits and do not know what rate 92 Selling Prices and Profits of profit is made on the whole of the turnover until the end of the period or year. They never know the rate of profit actually made on the individual item or classification. Notwithstanding that calculations for the purpose of making selling prices of individual items are usually made with the purchase price as the base, the profits of a definite period are almost universally based upon the volume of sales. For example: A concern having sales amounting to $100,000 for the year, finding that they had developed net profits amounting to $10,000, would unhesi- tatingly aver that they had made a profit of ten per cent. As an example of the confusion of bases on the part of business men the author will cite an actual incident that came under his personal observation: While discussing this subject with a de- partment manager in a store consisting of sev- eral departments the statement was made that it cost twenty-eight cents of expense on every dollar of goods sold during the previous year. The manager was asked how he deter- mined the selling price on an article. He re- plied that he took the purchase price and added twenty-eight per cent to it to get the 93 Fundamentals of Cost and Profit Calculation cost, and then added an additional percentage to the total for profit. He was then requested to determine at what price he would sell an article, the invoice price of which was $6.20, if the desired profit was ten per cent. His calculation showed the following : Purchase price of item $ 6.20 Expense of doing business 28% of $6.20 1.74 Total cost, including ex- penses 7.94 Add 10% of total for profit 80 Selling price $ 8.74 The author knew, and called attention to the fact, that the store was being operated un- der a receivership, prima facie evidence that there was something wrong with its busi- ness methods. He then briefly demonstrated to the man- ager the correct method of determining the cost and selling price that will yield a certain profit on the sale, as follows: 94 Selling Prices and Profits Selling price represented by ioo% Expense of doing business 28% Profit percentage desired 10%, Total of percentage other than purchase price 38% Percentage representing pur- chase price 62% The invoice price of the item was $6.20. This amount divided by 62 gives one per cent of the selling price, or $10, which multiplied by 100 produces 100 per cent, or the selling price, in this instance $10.00. In practice the selling price is found by moving the decimal point two spaces to the right, thus changing $.10 to $10. 28 per cent of $10.00 allows $2.80 for ex- penses. The profit being 10 per cent is $1.00. The cost of sale is $9.00. According to the old plan the price was incorrectly determined and the article sold for less than cost. This in itself accounts for the receivership. Round figures were used for purposes of illustration. Had the invoice or purchase price been $7.53, that amount divided by 62 95 Fundamentals of Cost and Profit Calculation would have yielded $.1215, or a selling price of $12.15. The result in any case may be proven by calculating the given percentages of the total. With the principles of Cost Engineering applied to determine the amount of expenses chargeable to each class of sales, it w^ill be found that when the expenses of the depart- ment are considered in relation to the amount of turnover of that class of sales, a different percentage of cost will be found for each. The rate of profit should differ on differ- ent classes of goods. It is ridiculous to assume that one rate of expense and profit will be practical for a great variety of lines of goods. In any case, the percentage of expense and the percentage of profit added together and deducted from 100 will show the precentage of the selling price represented by the pur- chase price. The purchase price divided by the number per cent which represents it will yield one per cent of the selling price. This multiplied by icmd determines the selling price. When the departmental or "line" percent- age has been established for a period, all that is necessary in determining the selling price of 96 Selling Prices and Profits any item is to divide its purchase price by the percentage and set the decimal two points to the right. There have been published from time to time schedules of percentages which could be added to cost to produce certain percentages of profit on the sales. For example: To make a profit of 25 per cent add 33-1/3 per cent to cost. To make a profit of 20 per cent add 25 per cent to cost. To make a profit of 16-2/3 P^^ ^^^t add 20 per cent to cost. Although the basic principle of this type of schedule is correct because the percentage of profit is related to the selling price, it makes no provision for the expense of doing busi- ness, is necessarily limited to the percentages included, and uses the cost, frequently an un- known quantity, as a basis. The following incident will serve to show the result of using diflferent bases for percent- ages and the confusion likely to occur where correct methods are not understood. One of the principals in this business spent several years serving as bookkeeper for an- other concern which had "failed for lack of capital." 97 Fundamentals of Cost and Profit Calculation The author was told that the business was one of the most profitable in the industry which it represented. In fact they boasted a 25 per cent profit, which was extremely un- usual for that class of manufacture. To prove that this was true they stated that they had paid a 25 per cent dividend a month previous to the date of the interview. In discussion the author was given the fol- lowing data in connection with the business : Capital Stock $100,000 Sales 360,000 Material used 99j590 Profits 27,280 Their plan of making prices was as fol- lows: Compute the cost of material used and add 33-1/3 per cent. Compute the cost of manufacturing pro- cesses and add 33-1/3 per cent. The total of these two items was the selling price, and should yield a profit of 25 per cent on the sale. The fact that they were able to pay a 25 per cent dividend satisfied them that they had succeeded in making 25 per cent profit for the year. It had not been noticed that while they 98 Selling Prices and Profits calculated 25 per cent on sales they had suc- ceeded in making only 25 per cent on the cap- italization. They confused the percentage of dividends on capital with the profits on sales. When asked if they had included depre- ciation in their calculations they stated that they had charged off their customary 5 per cent. Interest on investment had not en- tered into their calculations of cost or income. They admitted the justice of an 8 per cent re- serve for replacement, to offset the deprecia- tion on plant. Taking an additional 3 per cent for depreciation, and allowing 6 per cent of total investment as interest expense, their prof- its dwindled to $18,940, or slightly over 5 per cent of the sales. It was easily shown that the addition of one-third to the cost of the $99,590 of mate- rials used should have yielded $33,177 net profit on materials alone. The actual net profit being $18,940, it was evident that the factory had been operated at a loss absorbing $14,237 of the profit which should have ac- crued on the materials. In closing this chapter it is advisable to present a resume of the more salient points of the relationship of the various financial items encountered in connection with the cal- culation of Costs, Selling Prices and Profits. 99 Fundamentals of Cost and Profit Calculation (a) Manufacturing Expenses: On ac- count of the extreme variation in the amounts of various items required by the different pro- cesses, no distribution by percentage is possi- ble. Each item must be charged proportion- ately to its use, or its benefit to the individual process, as expressed in units by which the item itself, or its use, is measured. (b) Merchandising Expenses: Advertis- ing, selling commissions, rent of storerooms, and all other expenses in connection with the sale of the manufactured goods, or materials, or articles bought for resale, may be charged by percentage of selling price, it being under- stood that where the proportions of such ex- penses differ to any considerable degree on different classes of merchandise, each class shall be charged with such rate as will cause the sales of that class to carry their just pro- portion of the expenses involved. (c) Interest and earnings always to be considered at a rate per cent per annum of the amount invested. (d) Dividends are to be considered at a rate per cent of capital stock entitled to parti- cipate. (e) Profits are always to be considered at a rate per cent of the amount of sales. 100 CHAPTER SEVEN MAKING COST AND PROFIT STATEMENTS The Cost and Profit Statement is the pulse of the business, the index of its vitality. The executives of the healthy business have no difficulty in the preparation, and no em- barrassment to anticipate in the presentation, of such statements. The business that is weak at the heart is the one in which the making of Cost and Profit Statements gives cause for uneasiness and fear. Statements are required for three pur- poses: (a) that the management may be kept in touch with the vital factors of the business; (b) as a basis of credit; and (c) for purposes of taxation. Unfortunately, there are people who fail to realize that nothing is ultimately profitable except the truth. They are sorely puzzled in their efforts to make one statement serve all purposes with results to their liking. If the profits do not show up well, the statement reflects upon the ability of the man- agement. If they show up in the statement 101 Funjajnmta h of Cost and Profit Calculation better than the facts warrant, it means that the concern will be likely to both deplete its work- ing capital by declaring excessive dividends and pay taxes to the Government of fictitious earnings. If camouflage is used with the banker he may, and likely will, see through it to the detriment of credits. The honest manager will not try to fool either himself or his directors, because if the profits are not what they should be their best interests are served by knowing it so that the conditions may be corrected. The Government wishes to be fair, and will demand only its share, but will punish efforts to evade just taxation wherever it finds them. The banker is inclined to be more generous with the man who presents an honest state- ment showing small assets than with him whose statement, although showing large as- sets, bears the earmarks of "doctoring." In the long run statements at different times can be and frequently are compared. Dishonesty cannot long be consistent. It is a misfortune that there are managers, boards of directors, and even accountants who will stoop to dishonesty in making statements. 102 Making Cost and Profit Statements Corporations have been known to pay div- idends regularly up to the period wherein a receiver took charge of their affairs to secure the interests of the creditors. Such conditions indicate that there is something fundamentally wrong with meth- ods of preparing statements. It should not be possible for men to present information in forms seemingly truthful, while as a matter of fact they are widely at variance with the truth. The author would be unfair if he created the impression that all erroneous statements were dishonest. Many of them are made by men who sin- cerely wish to present the truth about their business, but they do not know how. They either have been taught or have simply ab- sorbed traditional methods. Many statements made up by public ac- countants are seriously erroneous, because the accountant either does not know the facts, does not know how to get the facts, or does not know how to present the facts. Another thing responsible for erroneous statements where honest effort has been made to present correct information is the uncertain terminology of business. 103 Fundamentals of Cost and Profit Calculation How shall a man, be he accountant, busi- ness man, or law maker, present information correctly when he must do so in words that are commonly used without knowledge of their true meaning? Take the word "capital" for example. The average business man uses it in at least two senses. Unless he qualifies it the hearer can- not tell whether he uses it in the sense of cap- ital stock, a liability, or capital investment, an asset. How many of the readers of this book can correctly define "earnings," "income" and "profits?" These words are commonly used interchangeably, yet each has a distinct mean- ing and should never be used in the same sense. The author has yet to find a man who can tell positively whether the new war tax on "profits" is actually levied against "earnings," "income" or "profits." It is evident that the men who framed the law did not understand the terminology of business. At the present moment there is reason to be generous in our criticisms. When the ac- counting profession has no definite terminol- ogy whereby the various factors of business can be designated, how shall we blame either the business man or the law maker? Our 104 Making Cost and Profit Statements generosity, however, should not extend beyond the immediate present. There will be little excuse for ignorance a year hence. The mutual interests of both the Govern- ment and business will be served by a better understanding of commercial and industrial terminology, and a more careful usage of the terms. Whether or not the terminology suggested in the last chapter of this book is adopted is of no moment, if a better suggestion can be of- fered and accepted. A personal element should not be permitted to appear in the matter. The welfare of the country is being hamp- ered today by innumerable discussions, misun- derstandings, and differences of opinion as to the interpretations of certain laws and rulings. The need for better terminology is also appar- ent in the confusion found in conventions and other meetings of business men, because they do not speak the same language of business. The need of better terminology and defi- nite fundamentals was recognized by, and evi- dent in, the earnest effort of Mr. Edward N. Hurley, while chairman of the Federal Trade Commission, to persuade Associations of Manufacturers to adopt uniform systems of Cost Calculation. His efforts were intended 105 Fundamentals of Cost and Profit Calculation to promote an understandable language of business, but his use of the word "system" was interpreted by many as referring to some specific form of records. This misunder- standing nullified much of his effort. What Mr. Hurley desired was not uniformity of mechanism but uniformity in principles of calculation and presentation, so that the busi- ness men of the country and the Government could all understand each other and present confusion be eliminated. The fundamentals required for making Cost and Profit Statements are: 1. Definite knowledge of what is cost, and how it is determined. 2. Definite knowledge of receipts. 3. Definite knowledge of what constitutes income. 4. Definite knowledge of what constitutes earnings. 5. Definite knowledge of what is profit, and how it is determined. 6. Definite knowledge of what constitutes assets. 7. Definite knowledge of what are liquid assets. 8. Definite knowledge of liabilities. 106 Making Cost and Profit Statements 9. Appreciation of the necessity for re- serves to take care of replacements, shrinkage, etc., as a means of protecting ' the invested capital. Any man not fully informed on these sub- jects, or that does not know how to obtain the information, is not competent to make up a Cost and Profit Statement. The fact that practically all the present in- formation is based upon the use of traditional theories, impractical for application to mod- ern conditions, renders the problem of making Cost and Profit Statements very difficult. Competent Cost Engineers, having many years' experience in the installation of Cost Engineering Systems, are unanimous in their statement that of the hundreds of factory or- ganizations they have served, not one had, in their accounting systems, provided for all items of expense. That being the case, it is safe to assume that because of the traditions of accounting practice, and not through any intent to mis- represent facts, practically every financial statement is more or less incorrect. But a small percentage of factories have cost systems designed upon modern analytical 107 Fundamentals of Cost and Profit Calculation or Cost Engineering principles. The remain- der either have no cost system, or use what purports to be a cost system, based upon the impractical formulas discussed in the earlier chapters of this book. Such systems fre- quently vary from accuracy as much as twenty and sometimes thirty per cent. How shall a man be able to develop a practical or true statement of earnings or profits if he does not know how to correctly determine the cost of production or the cost of doing business? How shall he render true statements if he does not know how to distinguish between re- ceipts and income? Or if he confuses the terms "income," "earnings," and "profits?" Nine-tenths of the men in business do not know how to determine a selling price that will yield a certain percentage of profit after providing for the cost of doing business. How then shall they be able to make correct state- ments covering thousands of transactions with varying proportions of cost and profit? Bankers are familiar with the fact that a large percentage of business men are ignorant as to what constitutes the assets and liabilities of a business. Nor can they readily distin- guish the characteristics, important to the 108 Making Cost and Profit Statements banker, which cause some assets to be classed as "liquid." To a large majority of manufacturers the idea that reserves should be set up in cash seems unimportant. They have been accus- tomed to handling depreciation, if at all, through the profit and loss account. In a few instances a reserve account is carried, but the actual money it represents is used in the busi- ness as working capital. Rarely is it possible for concerns using their reserves to avail themselves of the cash to purchase new equipment to replace the old. Where cash reserves are actually carried there is a feeling of confidence engendered similar to that of the man who realizes that he has a good bank account, as contrasted to the example of the man who is continually work- ing on his last dollar. He is free to make plans for betterments knowing that he will not have to worry about the financial side of the problem. His desire to hold that feeling of independence keeps him at the same time from foolishly overequipping his plant. Doing business on a sound basis gives a man confidence in himself, gives him a clear head for progressive plans, makes it unneces- sary for him to resort to misrepresentations 109 Fundamentals of Cost and Profit Calculation and subterfuges in his Cost and Profit Re- ports. The live business man of the hour will study modern methods, discard traditions, do business on a basis of known cost and profit, study the elements of business so that he can have intelligible records for his own use in directing his own affairs, to furnish the banker with the requisite information to sustain his credit, and to give the Government a frank but correct statement of his earnings. He will attain such a degree of prosperity that he will gladly pay his share of the burden of tax and still have enough for his own re- quirements. Ignorance spells weakness. Knowledge is power. 110 CHAPTER EIGHT THE TERMINOLOGY OF COST ENGINEERING The reader has found in the preceding chapters a number of references to the deplor- able fact that Commerce and Industry have no definite and recognized terminology. Several words are frequently used in the same sense, while again the same word is used in several senses. The result is a confusion of terms not only preventing practical transfer of .information between individuals who should understand each other but unquestion- ably causing a serious loss of money. The term "Profit," for example, is fre- quently confused with earnings, income, mar- gin, and dividends, yet each of these words has a different meaning. An effort has been made in preparing this suggested terminology to apply to each word the definition that seems best adapted to con- vey the information desired. Practicability has been given preference over the common definitions of the dictionaries. For example the word "profit" is defined by the Century Dictionary as the difference between the first 111 Fundamentals of Cost and Profit Calculation cost or purchase price and the price for which the article is resold. No account is taken of the expenses of selling, therefore such a defini- tion, while meeting the popular conception of profit, is not practical for use in the light of modern analysis. At the moment of writing, the business men of the United States are laboring with a serious condition due to confusion of terms. Taxes on incomes and profits make it im- portant that the persons affected by the taxa- tion understand fully just what the laws mean. The amount of discussion and the differ- ences of opinion expressed, makes it very evi- dent that grave misunderstandings exist, and demonstrates the imperative need of a definite terminology. The words and phrases are not arranged alphabetically in the appended list but so that the definitions of those generally confused with each other may be the more readily com- pared. The list is not offered as a complete terminology but contains the words most com- monly misused. The author anticipates a more exhaustive treatment of this subject at some future time. Receipts — The total of money or negoti- able items representing money received dur- 112 The Terminology of Cost Engineering ing a period, without regard to either ex- penses, earnings or profit. Income — The remaining: receipts after de- ducting the cost of sales and all other expenses and reserves required by the business. It may be in the form of profits, interest on invest- ments, royalties, rentals, investments made within the period, etc. In the case of an in- dividual it may also include salary, commis- sions, dividends, etc. Income should not in- clude estimated increase in value of property or increase in the market value of goods held in stock. It relates only to receipts and may include items received which were the earn- ings or profits of previous periods. Earnings — ^Total increase of assets due to the activities and investments of the business or individual whether received or not. Earn- ings become a part of income only when the money or its negotiable equivalent is actually received. Earnings are related to investment. Profit of Time Period — The amount by which the total sales of the period exceed the total cost (not purchase price) of the items sold. Profit is always net, the percentage be- ing correctly expressed only when it relates to the total sales of the period as the base, or one hundred per cent. 113 Fundamentals of Cost and Profit Calculation Profit on Transactions — The amount by which the selling price of a sold item exceeds its cost. Percentage of profits is correctly ex- pressed only when it relates to the selling price as the base, or one hundred per cent. Profit differs from margin in that it is all net gain. Margin — The percentage by which the selling price exceeds the purchase price with- out relation to either the cost of doing busi- ness or the percentage of profit in the item. It is expressed properly when the purchase price is used as the base or one hundred per cent. Never should it be added to the pur- chase price as a means of determining the sell- ing price. Erroneously called ^^gross profit." .Gross Profit — A term used where neither the cost nor the percentage of profit is known, to designate the margin between purchase price and selling price of merchandise. It is frequently employed by persons ignorant of correct methods, as a means of determining a selling price. Such usage is frequently pro- ductive of losses where profits were intended. Selling Price — ^The price which a cus- tomer is expected to pay or does pay for an item sold. In all calculations of profit per- centages the selling price represents the base or one hundred per cent. 114 The Terminology of Ct)st Engineering Turnover — The total of the sales of a des- ignated period, usually a year. Used princi- pally for the purpose of expressing the rela- tion of the total sales of a period to the invest- ment used in the business. When the sales of the period are equal to the investment, the turnover is said to be loo per cent. If they are five times the investment, the turnover is 500 per cent, etc. Investment — The amount of money em- ployed in a business without relation either to the assets or the ownership of the money. It includes investment in realty and buildings used, in equipment, merchandise stocks, work in process, if a factory; accounts receivable, reserves, and cash in bank for normal require- ments of the business. Interest on Investment — The wages of the money employed in the business. It is a part of income but not profit. Being included in cost of production, and a part of the selling price of product, it must be deducted from re- ceipts before profit can be ascertained. As a part of income it must be included in income statements. Capital Stock — The amount of the issued certificates of stock of a corporation calculated 115 Fundamentals of Cost and Profit Calculation at par. Capital stock has no relation to invest- ment. Net Worth — The remainder after deduct- ing all liabilities from the total of assets. Has no relation to investment. Assets — The property of a person or cor- poration representing investment immediately or eventually convertible into money for the purpose of meeting liabilities. Liquid Assets — Items of assets readily con- vertible into cash, such as securities, accounts receivable, etc. Surplus — ^The undivided profits of the business. Surplus is sometimes employed in the business as capital, and sometimes carried as a safeguard against embarrassment because of losses at unprofitable seasons. Dividends — ^The payment made to stock- holders in disbursing the earnings of the busi- ness or such part of the earnings as the direc- tors of the corporation decide is to be used for dividends. They are paid to stockholders in the ratios of stock held by them. Wages — The remuneration of employes whose pay is calculated at a rate per hour, day or week. Wage earners forfeit pay for time absent or not used in the service of the em- ployer, but are paid for overtime. 116 The Terminology of Cost Engineering Salary — The remuneration of employes whose pay is calculated per month or year. Salaried employes do not forfeit pay for holi- days, or other absences, including vacations, but are not paid for overtime. Salaried em- ployes are sometimes paid by the week. In cases of willful absence purely for the bene- fit of the employe, the employer may elect whether any or no payment is to be made for the period of absence. Commissions — The remuneration of sales- men, when they are compensated in the ratio of sales of goods or product. Cost — The sum of the expenses involved in the production and distribution of an item up to the moment at which cost is ascertained. Invoice Price — The price shown on the invoice without regard to discounts, or ex- penses of handling and selling, which must be included in ascertaining cost. Expense — Any element of cost. The term is sometimes misused as the title of an account. Properly used it should always be preceded by a descriptive title, as building expense, wage expense. Direct Expense — An element of cost hav- ing but one beneficiary to which alone it is chargeable in total. 117 Fundamentals of Cost and Profit Calculation Indirect Expense — An element of cost having two or more beneficiaries among which it must be distributed. Major Direct Expenses — Usually the items of material and wages which may be charged directly to a factory order. Minor Direct Expenses — Direct expense items, such as repairs, supplies, etc. Immediate Expense — An item which be- comes a recognized liability as soon as in- curred and paid in the regular course of busi- ness, as rent, insurance, etc. Ultimate Expense — An item of expense necessarily considered in cost because it must ultimately be paid although there is not likely to be an insistent demand at a definite date, as replacement reserve to counterbalance de- preciation, interest on investment, etc. Economic Expense — Items or charges made to cover the normal losses of business that the equilibrium of capital may be main- tained, such as charges required to cover shrinkage of stocks, waste in cutting, spoilage, depreciation of equipment, good will, bad debts, etc. Expense Distribution — The act of deter- mining the amount of benefit obtained from 118 The Terminology of Cost Engineering an indirect expenditure, by the several bene- ficiaries, and charging each with that propor- tion of the expense item represented by its proportion of benefit derived. Process Cost — The result found by divid- ing the total of expenses involved in a process, over a given period, by the number of salable units produced. Usually expressed as Process Hour Rate. Cost of Production — The cost of making an item of product without consideration of the expenses of distribution or sale. Cost of production is the total of Material Cost and Process Costs involved. Estimate — An opinion or guess as to the cost or probable cost of an item already man- ufactured or to be manufactured. Usually made by some authorized person presumed to be informed as to processes and their cost and competent to make the estimate. Quotation — ^The amount of an ofTer or bid to furnish specified items at a specified price. Selling Expense — All items of expense in- curred for the purpose of making or increas- ing the sales of goods or product. Cost of Sales — The total cost of the mer- chandise or product sold in a designated per- 119 Fundamentals of Cost and Profit Calculation iod, including all expense elements in connec- tion therewith. The total of all item costs for the period. Replacement Reserve — A cash reserve provided by including in the cost of produc- tion of all items a charge calculated to equal the depreciation of equipment. Included in the charge for product it becomes a part of receipts, when payment is received, and should be deducted before profit is calculated. Depreciation — Deterioration or shrinkage in values for any reason. Commonly used with reference to wear and tear on machinery or other equipment. All assets except cash are subject to more or less depreciation. The chief causes of depreciation are obsolescence, inutility, wear and tear, neglect, etc. Shrinkage — Commonly used with refer- ence to the losses or depreciation in merchan- dise stocks, caused by the elements, handling, theft and carelessness. Principle — A principle is a fundamental truth — a comprehensive law or doctrine from which others are derived, or on which others are founded. A general truth — an elementary proposition. There can be no exceptions to the application of a fundamental principle. 120 The Terminology of Cost Engineering Rule — A rule is a law supposedly but not necessarily having as its basis a principle. A rule, unlike a principle, is subject to change under certain conditions. Unit — A unit is one of the parts of a divis- ible thing and may be expressed by any term denoting weight, measure, or count, according to the nature of the thing to which it is ap- plied. Good Will — A trade-attracting influence in favor of a concern resulting from the pol- icy of delivering to each customer or client, in addition to the requirements of his order, an element of unexpected courtesy or service which has the effect of not only causing a de- sire to patronize the concern again but to tell others about it. System — A plan or routine intended for the purpose of, and actually having the effect of, economizing effort. Red Tape — A plan or system, or part of a plan or system, requiring for its operation either unnecessary effort, or unprofitable ef- fort. If the cost of the effort equals or exceeds the value of the result it is unprofitable and consequently *^red tape.'' 121 INDEX OF TERMINOLOGY Assets 116 Assets, Liquid 116 Capital Stock 115 Commissions 117 Cost ....117 Cost of Production 119 Cost of Sales ^ 119 Cost, Process 119 Depreciation 120 Direct Expense 117 Direct Elxpense, Major 118 Direct Expense, Minor 118 Distribution of Expense... .118 Dividends ^ 116 Earnings 113 Economic Expense 118 Estimate 1 19 Expense ....117 Expense, Direct 117 Expense, Distribution 118 Expense, Economic 118 Expense, Immediate 118 Expense, Indirect 118 Expense, Major Direct...ll8 Expense, Minor Direct.... 118 Expense, Selling 119 Expense, Ultimate 118 Good Will 121 Gross Profit 114 Income 113 Immediate Expense 118 Indirect Expense 117 Interest on Investment — 115 Investment 115 Investment, Interest on 115 Invoice Price 117 Liquid Assets .....116 Margin 114 Net Worth 116 Price, Selling 114 Price, Invoice ^ 117 Principle 120 Process Cost 119 Production, Cost of ..119 Profit, Gross 114 Profit of Time Period 113 Profit on Transactions 114 Quotation ....1 19 Receipts 1 12 Red Tape ^ 121 Replacement Reserve 120 Reserve, Replacement 120 Rule 121 Salary 117 Sales, Cost of...., 119 Selling Expense 119 Selling Price 114 Shrinkage! 120 Surplus 1 16 System 121 Tape, Red 121 Turnover 115 Ultimate Expense 118 Unit 121 Wages , 1 16 122 GENERAL INDEX PAGES Accuracy, Practical, defined 75 Accuracy, prime requisite in cost system. 75 Assets, tendency to shrinkage 41 Bases of Expense Distribution ~ ...^ 79 Capital, source of 52 Contents 7 Contingent Expense, fundamental principle of 69 Cost, defined 10 Cost, erroneous usage of term 9 Cost, fundamental principle of 67 Cost Accounting, origin of - 29 Cost Engineering, proof of practicability 36 Cost Engineering, a practical science ^ 69 Cost and Profit Statements, fundamentals required.... 106 Definiteness the keynote of Cost Engineering 62 Depreciation, causes of „ - 44 Depreciation, "charging off'* impractical ~ 46 Depreciation, items for consideration 47 Dictionaries, some definitions impractical 85 Direct Expense, defined 19 Economic Expenses, definition 42 Effort, the rewards for „ - 83 Energy, three kinds in industries 41 Estimate, when complete , SO Expense, Contingent, principle of ^... 69 Expense, fundamental principle of 67 Expense Distribution, Bases of ~ 80 Expense Distribution, Church methods 31 Expense Distribution, fundamental principle of 68 Expense Distribution, makeshift methods of 30 Expense Grouping, examples of -. 76 Expense Grouping, fundamental principle of 67 Expenses, Definite and Limited ,. ^ 11 Expenses, Economic, defined 42 Elxpenses, Immediate, examples of 38 Expenses, list of 71 Expenses, primary grouping of 12 Expenses, related to Functions of Business 14 Expenses, Ultimate, examples of 3S Expenses, when possible to group 15 Factory and Store identical in principle 91 Finances, importance to industries.... 41 Good Will, defined. _... 56 123 Fundamentals of Cost and Profit Calculation PAGES Good Will, depreciation of « .„ 47 Good Will, discussion of ~ 55 Gross Profit, a myth ^ , 18 Immediate Expenses, examples of -. 38 Indirect Expense, defined 33 Interest on Investment, arguments for 48 Interest on Investment, defined ^ 48 Interest on Investment not part of profit 17 Interest Rates, related to risk. 52 Investment, classification of 54 Labor-saving Machines, confusion caused by ^ 22 Margin, definition of ^ 88 Material Cost, what is included 81 Material Expense not related to Operating 23 Overhead accoimt defeats correct efforts 14 Overhead Account, measure of ignorance 35 Patents, Royalty on 47 Philosophy of Cost and Profit, the 9 Piecework Wages, not an aid to Costfinding 25 Preface 3 Principle, invariable 36 Process Grouping, fundamental principle of 68 Process Hour Rate, how found 81 Profit, anticipation not justifiable 17 Profit, confused with Dividends ^ 98 Profit, defined — .. 15 Profit, related to Turnover 15 Red Tape, contrasted with system 74 Reserves, importance of 109 Rules, limitation of application ^ 36 Schools, impractical teachings of 51 Selling Price, Basis of Profit and Selling Expense.. 92 Selling Prices, right method of making „... 95 Selling Prices, wrong method of making 93 Selling Prices and Profits 83 Statements, Cost and Profit, purposes of 101 Statements, Financial, frequently wrong - ....107 Stocks and Bonds, relation to capital 52 System and Red Tape contrasted 74 Terminology of Business, uncertainty of - 60 Ultimate Expenses, examples of 38 Wages, not basic expense ~— 24 War Taxes, basis of levy ~ ....104 Wealth, the source of ^ 41 124 BOOKS BY ROBERT S, DENHAM MANUAL OF COST ENGINEERING AND ESTIMATING FOR PAPER BOX MANUFACTURERS With Addenda by Joint Cost Committee of the National Federation of Paper Box Manufacturers Assns Publication authorized by the Federated Paper Box Manufac- turers Associations of United States and Canada Buckram, 316 pages - - - - $10.00 per copy FUNDAMENTALS OF COST AND PROFIT CALCULATION REVISED EDITION A vigorous discussion of the vital elements of business A book every man engaged in active business in any capacity can read with interest and profit Cloth, 128 pages $1.00 per copy PRACTICAL COST ENGINEERING Covers the philosophy of Cost Engineering with detailed exposition of the application of the Principles and Rules of Cost Engineering Practice. A book for the manufacturer or student Cloth, about 300 pages .... $10.00 per copy COST ENGINEER PUBLISHING CO., Cleveland, O. 125 COST ENGINEERING SERVICE THE DENHAM COSTFINDING CO. CLEVELAND, OHIO Provides Cost Engineering Service for the planning and installation of Cost Engineering Systems in factories Six hundred users in over one hun- dred cities of the United States and Canada attest the practicability and profitableness of the service SEND FOR LITERATURE OR REPRESENTATIVE THE A-B-C OF COST ENGINEERING— 104 pages, Cloth By Robert S. Denham THE DENHAM COSTFINDER FOR GENERAL MANAGERS A periodical publication The above will be sent free on request of General Managers or Corporation Officers of Manufacturing concerns. Will not be sent to accountants or clerks. Address THE DENHAM COSTFINDING CO., Cleveland 126 ?«■■ THIS BOOK IS DUE ON THF, LAST DATE STAMPED BELOW AN INITIAL FINE OP 25 CENTS WILL BE ASSESSED FOR FAILURE TO RETURN THIS BOOK ON THE DATE DUE. THE PENALTY WILL INCREASE TO 50 CENTS ON THE FOURTH DAY AND TO $1.00 ON THE SEVENTH DAY OVERDUE. «4ffp^ \ 1^ tcMH 1939 ^«i«t'6lW^ f'^'-.. U> LD MAn '-i icuT-^ mnti '*fc Jd&c LD 21-95w-7,*37 YB 1852 UNIVERSITY OF CALIFORNIA LIBRARY