Cost covering method - examples

  • Fixed Price
  • Coverage Percentage
  • Ceiling
  • Ceiling on Coverage Percentage
  • Exclusion
  • Own Risk
Fixed Price

Used if:

  • Stable business.
  • No high risks.
  • Predictable risks.

Less useful for:

  • Unpredictable service demand.
  • No experience (knowledge, other country, equipment).

Example

Assume:

  • Calculated service contract sales value: 10,000, advance payment
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 12,000
  • Actual costs spent on service order: 9600

This means:

  • Installment invoice of 10,000 in advance
  • No separate invoices will be sent
  • Loss of sales: 2000 (10,000 -/- 12,000)
  • Loss of costs: 1600 (9600 -/- 8000)
  • P/L account: Sales - Costs: 400 (10,000 -/- 9600) profit
Coverage Percentage

Example

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 8000
  • Actual costs spent on service order: 6400
  • Discount: 10%

This means:

  • Installment invoice of 1000 (10,000 * 10%)
  • Additional invoices of 7200 (8000 -/- 10%)
  • Profit of sales: 200 (1000 -/- 800)
  • Profit of costs: 160 (800 -/-640)
  • P/L account: 1800 (1000 + 7200 -/- 6400) profit
Ceiling

Used if/for:

  • Defining the most basic amount to deliver service (keep resources available), which means the customer has to pay for each following service that will be delivered.
  • In a high risk or unpredictable environment.
  • Customer cannot pay the entire service contract, but this could change over time (season revenues).

As opposed to Coverage Percentage:

  • No shared risk.
  • Risk of service company is limited to ceiling.

Example 1

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 8000
  • Actual costs spent on service order: 6400
  • Ceiling: 5000

This means:

  • Installment invoice of 5000 (= ceiling)
  • Additional invoices of 3000 (8000 -/- 5000)
  • Profit of sales: 0 (ceiling is consumed by customer)
  • Profit of costs: Costs estimation should be related to sales, otherwise only assumptions can be made
  • P/L account: 1600 (8000 -/- 6400) profit

Example 2

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 2000
  • Actual costs spent on service order: 1600
  • Ceiling: 5000

This means:

  • Installment invoice of 5000 (= ceiling)
  • No additional invoices, because ceiling is not reached
  • Profit of Sales: 3000 (5000 - 2000)
  • Profit of Costs: 2400 (4000 - 1600)
  • P/L account: 3400 (5000 -/- 1600) profit
Ceiling on Coverage Percentage

Used if/for:

  • Defining the most basic amount to deliver service (keep resources available), which means that the customer must pay for each next service that will be delivered.
  • In a high risk or unpredictable environment.
  • Customer cannot pay the entire service contract, but this could change over time (season revenues).

As opposed to Ceiling:

  • More risk for the customer.

Example 1

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 8000
  • Actual costs spent on service order: 6400
  • Ceiling: 1000, discount: 10%

This means:

  • Installment invoice of 1000 (= ceiling)
  • Additional invoices of 7200 (8000 -/- 10%, discount < 1000)
  • Profit of sales: 0 (ceiling is consumed by customer)
  • Profit of costs: Costs estimation should be related to sales, otherwise only assumptions can be made
  • P/L account: 1800 (1000 + 7200 -/- 6400) profit

Example 2

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 8000
  • Actual costs spent on service order: 6400
  • Ceiling: 1000, discount: 20%

This means:

  • Installment invoice of 1000 (= ceiling)
  • Additional invoices of 7000 (8000 -/- 20%, discount > 1000 -> 600 added to be invoiced -> (8000 -/- 20% + 600))
  • Profit of Sales: 0 (ceiling is consumed)
  • Profit of Costs: Hard to define
  • P/L account: 1600 (8000 -/- 6400) profit

Example 3

Assume:

  • Calculated service contract sales value: 10,000
  • Calculated service contract costs value: 8000
  • Actual sales spent on service order: 800
  • Actual costs spent on service order: 640
  • Ceiling: 1000, discount: 20%

This means:

  • Installment invoice of 1000 (= Ceiling)
  • No additional invoices, because the ceiling is not reached
  • Profit of sales: 200 (1000 -/- 800)
  • Profit of costs: 160 (800 -/- 640)
  • P/L account: 360 (1000 -/- 640) profit