The total cost of ownership (TCO) is an estimation that helps buyers and sellers of any asset determine its purchasing price. The method is widely used to evaluate purchasing support or investment lifetime costs. Individuals can find unique ways to save money and invest in their future by calculating the TCO.

However, studying, determining, and calculating the total cost of ownership can be difficult. That’s why we have devised this step-by-step guide for calculating TCO. One thing to keep in mind here is that you must discuss your assumptions and estimates with experienced colleagues or experts. The effects of uncertainties can be estimated with sensitivity analyses – by calculating the total cost of ownership using different assumptions and cost sizes. Collect arguments, facts, and data for your analysis. Also, make all assumptions and estimates transparent.

This way, you can make the right decision based on both an economic viewpoint and a financial future in a cost-effective manner. Get all important information about the cost types and their amount from the suppliers and providers. In some cases, they have already performed a TCO analysis for their offer. You can use that as a basis and check whether the provider’s assumptions are correct for your application. So, now let’s talk about how you can do this.

The Process of Calculating the Total Cost of Ownership

Step 1: Identify Relevant Cost Types

Based on the description of the products, alternatives, and process, you can determine which types of costs can arise during the acquisition, introduction, use, operation, and disposal.

These types of costs always depend on the service purchased, the internal operating conditions, the process of use, and other factors. They can be better determined if the methods in step 2 were described precisely enough beforehand.

Step 2: Calculate Or Estimate The Relevant Costs

Once the cost types have been determined, the respective cost amount must be calculated or estimated over the entire service life. You will receive the necessary information either from the product provider or from your internal cost and performance accounting department. The following aspects can be considered:

• Costs for materials and preliminary work that you obtain from external suppliers: purchase price, costs for advice, training, operating materials, and use of space or energy.
• Personnel costs incurred within your company: time spent using the product to achieve the desired purpose, time spent on maintenance and repair, or time spent on training or assisting users.
• Disposal costs are incurred when the product is no longer needed, replaced, taken out of service, or disposed of.

Personnel costs are determined by the processes and the duration of individual processes that you described in step 2. For instance, the number of employees who attend a training course and the duration of the training course. Therefore, process-oriented analysis is a great method to calculate the total costs associated with the use and operation of the product. Furthermore, it also offers you a chance to explore different options cost-effectively.

Step 3: Determine the Value of the Total Cost of Ownership

Suppose the amount of the individual cost types has been calculated or estimated over the entire service life for each possible solution and decision alternative. In that case, these costs must be aggregated into a key figure. That is the value for the total cost of ownership. In the simplest case, this is done by adding up the individual costs.

Strictly speaking, however, it must be considered that costs that arise earlier weigh more than costs that arise later. Therefore, as is known from the investment calculation and the determination of the present value, the costs are discounted in relation to the time they are incurred. For this purpose, an appropriate internal calculation interest has to be set.

The value of the total cost of ownership calculated in this way serves as a basis for decision-making. In order to make the alternatives easier to compare, additional key figures can be generated, for example, the total cost of ownership per employee, per hour worked, per year, or per unit area (of a building).

Step 4: Calculate or Estimate the Relevant Costs

Once the cost types have been determined, the respective cost amount must be calculated or estimated over the entire service life. You will receive necessary information either from the provider of the product or from your internal cost and performance accounting. One can differentiate:

• Costs for materials and preliminary work that you obtain from external suppliers: purchase price, costs for advice, training, operating materials, use of space or energy.
• Personnel costs incurred within your company: time spent using the product to achieve the desired purpose, time spent on maintenance and repair, or time spent on training or assisting users.
• Disposal costs incurred when the product is no longer needed, replaced, taken out of service, or disposed of.

Personnel costs are determined by the processes and the duration of individual processes that you described in step 2. For instance, the number of employees who go to a training course and the duration of the training course. The process-oriented analysis of costs includes the total costs associated with the use and operation of the product.

Step 5: Perform Sensitivity Analysis

Before the decision is made, the analysis and calculation should be checked again. After all, numerous assumptions and estimates have been included that are uncertain. So, the best way to ensure that is to perform sensitivity analysis. With sensitivity analysis, you question the results and calculate different variants. The following questions should be examined:

• Which types of costs determine the total cost of ownership?
• What are the cost drivers there?
• What factors determine the amount of these costs?
• How reliable are the estimates (or measurements) of these factors?
• How does the overall result change if these factors change 10 percent or 50 percent up or down?
• Would this lead to a fundamentally different decision?

Step 6: Make A Decision And Ensure Implementation

After these analyses, you can decide on the best alternative solution. That is your investment decision. This decision must be made and should be represented on the basis of the total cost of ownership and its results. You have now determined the key arguments for this from a cost perspective.

In addition, other arguments and criteria for this decision can play a role that you did not consider with the TCO analysis. These are strategic factors such as:

• Importance of the supplier
• Delivery security
• Risk of failure
• Supplier’s reputation
• Suitability as a reference case

Summing Up

These factors and decision criteria complement results from total cost of ownership analysis before finally create your decision. In order for it to be the right decision, in the end, you must ensure that your assumptions are adhered to and taken into account in the implementation. In this respect, you should think about the implementation before making a decision.

Another way to go about it is to hire a service provider who can help you calculate the total cost of ownership. Perfect Timing Financial Group offers customers a chance to make cost-effective decisions at the right time.