Life cycle costing

Life cycle costing is the process of compiling all costs that the owner or producer of an asset will incur over its lifespan. The concept applies to several decision areas. In capital budgeting, the total cost of ownership is compiled and then reduced to its present value in order to determine the expected return on investment (ROI) and net cash flows. This information is a key part of the decision to acquire an asset. In the procurement area, the purchasing staff seeks to examine the total cost of ownership of an asset in order to place orders for those items that are the least expensive, in aggregate, to install, operate, maintain, and dispose of. In the engineering and production areas, life cycle costing is used to develop and manufacture goods that will have the least cost to the customer to install, operate, maintain, and dispose of. In the customer service and field service areas, life cycle costing is focused on minimizing the amount of warranty, replacement, and field service work that must be performed on products over their useful lives.

Life cycle costing is more heavily used by businesses that place an emphasis on long-range planning, so that their multi-year profits are maximized. An organization that does not pay attention to life cycle costing is more likely to develop goods and acquire assets for the lowest immediate cost, not paying attention to the heightened servicing costs of these items later in their useful lives.

Related Courses

Capital Budgeting 
Financial Analysis 
Purchasing Guidebook