SECTION III Service Systems
7.5 Cost Justification Methods
There are a number of ways to justify ergonomic spending. Some of these methods are discussed below.
Benefit/Cost Ratio
This simple method calculates the ratio between the benefits of an ergonomic project and the cost to implement it. The idea is that an ergonomics program that pays for itself is a good investment.
How do you calculate the economic benefit of an ergonomic solution? One way of calculating the economic benefit of an ergonomic program is to look at the cost of injuries associated with ergonomic problems. You make the assumption that implementing the ergonomic program will generate solutions which will prevent future injury. The calculation of the benefits to the cost ratio is shown below:
Example:
An ergonomic injury has occurred once a year on average for a particular material handling job. The injuries have occurred when employees move bundles to and from sewing machine workstations. There are four material handlers in the area, and one injury has occurred in each of the last three years. The average cost of the injuries is $20,000.
The cost of the solution is $5,000. This money will purchase material handling equipment, raise platforms beside the sewing machines, and large work tables to store materials near waist height before they are distributed to the sewing operators.
In other words, the benefits of the ergonomics project are worth four times its cost. This is a sound investment.
Benefit to cost ratio =Value of benefits Cost of changes
Benefit to cost ratio:$20, 000
$5, 000 =4 0.
7-4 Occupational Ergonomics: Design and Management of Work Systems
Payback Period
You can also look at the payback period for an ergonomic improvement. Payback period refers to the length of time it will take to recover the costs of improvements.
First you must determine the costs and benefits associated with the ergonomics improvement. Then you can calculate the time it will take to offset the cost to implement. To calculate the payback period, use the following equation:
Example:
In the previous example, the costs of the injuries that the solution will prevent average $20,000. The improvements cost $5,000. How long does it take to recover the cost of the ergonomics solution?
Another straightforward way of evaluating the benefit of an ergonomics program is to use return-on- investment analysis. Its calculation is shown below:
Example:
Using the data from the cost-to-benefit example, the return is the benefit, or $20,000 for the avoided injury. The investment is the cost of the ergonomics solution or $5, 000 for the material handling changes.
The return on investment is 400%.
As was shown earlier, this is a sound investment.
Losses vs. Goods Sold
You can also evaluate an ergonomic solution by determining the sales volume required to offset an injury.
While the calculations for this method of analysis are relatively easy, you must know the profit margin for the business. The calculation is shown below:
Once the sales volume needed to offset the cost of the ergonomic injuries is determined, then the same effort used to generate this sales volume should be used to correct the ergonomics program.
Example:
A carpal tunnel surgery case has cost your company $18,000 for medical and workers’ compensation costs. The profit margin for your company has been 5% for the past three years.
Payback period in years Costs per year Benefits per year
( )
=Payback period in years = Costs per yr. = $5, 000
Benefits per yr. = $20, 000=0 25. years 3 months
( )
Return on investment =Return to company Investment ×100%
Return on investment =$20, 000
$5, 000 ×100% for a ROI of 400%
Volume of sales required to offset loss =Cost of losses Profit margin
Volume of sales to offset loss =Cost of losses
Profit margin = $ , =
. $ ,
18 000
05 360 000
present costs.
The time value of money assumes that the value of a dollar today will be different a few years from now.
For example, $100 today, when invested at an interest rate of 8% per year, will have a value of $108 in one year. This calculation is known as the future value of present sum. This is sometimes abbreviated as F/P.
Likewise, $100 one year from now is only worth $92.59 invested at 8% interest per year today. This calculation is known as the present value of a future sum (abbreviated as P/F). As you may suspect, they have a reciprocal relationship. The present value of a future sum may be used to express varying future benefits in terms of a present sum. This might be encountered when some years will produce more savings than others.
Often there will be a series of equal benefits over a number of equivalent periods which comprise the economic life of the project. Because these time periods are often, although not necessarily, years, the benefits are described as annuities. In the case of equivalent benefits occurring at equal time periods, two calculations are of use, the present value of an annuity (abbreviated P/A) and the future value of an annuity (abbreviated F/A).
The tables for determining the time value of money can be found in computer spreadsheet programs or in financial or engineering economy books. In order to select the appropriate table, you must know both the interest rate and the economic life of the project. Most companies have an interest rate that is used to evaluate projects in this manner. The tables list multipliers for the appropriate combination of interest rate and year. The cost or benefit is multiplied by the multiplier value given in the table in order to determine the present value.
Once the present values are determined, then the benefit to cost ratio or the return on investment calculation can be made.
Example:
A certain family of jobs has a recurring injury pattern. This is a sewing job, and there are 40 workers on the day and evening shifts. Approximately three lost time injuries have occurred each year. The injuries have required medical treatment and have sometimes resulted in lost workdays. The average cost of the lost time and medical treatment is $1,000 per injury or $3,000 per year.
Minor changes are needed to correct the ergonomics problem. The sewing machine head will be modified with a different guide, and the bundle table will be altered to make room for more asiding.
These changes will cost $500 per sewing machine workstation. The cost of the changes is $500 per workstation times 20 workstations, for a total cost of $10,000. This cost will be incurred immediately, so the present value of the cost is also $10,000.
The value of the benefits is an annual savings of $3,000. Based on outstanding contracts, there is reason to expect that the benefits will continue to accrue for a period of at least five years. Using a computer spreadsheet, we find the appropriate multiplier for an annuity at 8% annual interest for 5 years is approximately 3.993. We multiply this times the average savings of $3,000 per year to obtain the present value of the savings over the five-year economic life of the project and find that it is $11,979.
Determining the benefits to cost ratio is now simple:
Benefit to cost ratio =Benefits
Costs = $11, 979
$10, 000 =1 2.
7-6 Occupational Ergonomics: Design and Management of Work Systems
This is a sound investment as the benefits exceed the costs by 20%.
The return on investment can also be calculated using the present values of the benefits and costs.
The calculations are shown below:
assuming that a family of jobs has experienced only one injury recently and that methods training has been suggested to avoid a similar injury in the future. The injury was a carpal tunnel surgery, and it was a serious compensation claim. The full cost of the injury was $20,000. It is estimated that another injury would occur approximately every five years.
The methods training that has been recommended is relatively short and will only require each worker to spend one hour per year for the training. Since the training is done on the job, a trainer will also be required for each hour of training. The full cost of the training then will be 40 hours total for the 40 workers plus an additional 40 hours for a trainer. The average cost of a worker’s time is $6.50; and there is an additional cost for employee benefits of 25%. The cost of the trainer is $8.00 per hour plus the employee benefit cost of 25%.
The annual cost of the training is:
Item Costs
Workers: 40 workers × 1 h./worker × $6.50/hour × 1.25 $325.00 Trainer: 40 hours × 8.00/hr. × 1.25 $400.00
Annual Training Costs $725.00
The present value of the recurring costs for 5 years at 8% interest is the same as that calculated above.
For a five-year period, it is 3.993 times the annual cost for a total of $725 × 3.993 = $2,894.93.
We assume, for simplicity, that the future benefit of avoiding a carpal tunnel case is a sum that will be realized five years from now. Looking in our reference, we find that the appropriate multiplier for the present value of a future sum (P/F) at 8% interest for five years is 0.6805. Multiplying the future value of $20,000 by 0.6805 we obtain the present value of the benefit.
The cost to benefit ratio is:
This is a sound investment.