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What are the differences between life cycle costing and traditional budgeting?

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If you are involved in energy management projects, you might have heard of life cycle costing (LCC) and traditional budgeting. These are two different methods of evaluating the costs and benefits of an investment over time. But what are the main differences between them and how can they affect your decision making? In this article, we will explain the basics of LCC and traditional budgeting, compare their advantages and disadvantages, and give you some tips on how to choose the best method for your project.

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Leonard Teo

Technical Specialist | Driving Energy and Water Usage Reduction | Certified Energy Manager (SCEM) | Energy Transition |…

1 What is life cycle costing?

Life cycle costing is a method of calculating the total cost of owning and operating an asset or a system over its entire life span. It includes not only the initial purchase and installation costs, but also the ongoing operating, maintenance, repair, and replacement costs, as well as the residual or disposal value at the end of the life cycle. LCC helps you to compare different alternatives based on their long-term performance and value, rather than their initial costs.

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Leonard Teo

Technical Specialist | Driving Energy and Water Usage Reduction | Certified Energy Manager (SCEM) | Energy Transition | Decarbonisation | Water Circularity | Sustainability Strategy
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Life cycle costing look for the entire lifecycle of the project and include costs that are not so apparent when conceptualising project. For example, a project when implemented may have an asset life of 20 years. However, the asset may require minor maintenance every year which diminishes the saving by 2 months each year while incurring additional cost. The project may also require major maintenance at year 10 which require 6 months downtime. Suddenly, the analysis of the entire cost over lifecycle will reduce the benefit of the project but will give a more realistic estimation of the costs in the years to come.

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2 What is traditional budgeting?

Traditional budgeting is a method of allocating funds for a project based on the expected revenues and expenses for a specific period, usually one year. It focuses on the short-term financial impact of an investment, rather than its long-term consequences. Traditional budgeting helps you to control your spending and monitor your cash flow, but it does not account for the future costs and benefits of an asset or a system over its life span.

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Leonard Teo

Technical Specialist | Driving Energy and Water Usage Reduction | Certified Energy Manager (SCEM) | Energy Transition | Decarbonisation | Water Circularity | Sustainability Strategy
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Traditional budgeting would be to cost the project on its capital and basic operating costs. The benefits is analysed with the cost and the payback period is determined to see whether the project is financially feasible.

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3 How do they differ?

The main difference between LCC and traditional budgeting is the time horizon they use to evaluate an investment. LCC considers the whole life cycle of an asset or a system, while traditional budgeting only considers the initial or annual costs. For example, if you want to buy a new boiler for your building, LCC will compare the costs and benefits of different types of boilers over their expected life span, while traditional budgeting will only compare the purchase and installation costs of the boilers.

Another difference is the way they deal with uncertainty and risk. LCC uses discount rates to reflect the time value of money and the risk of future cash flows, while traditional budgeting uses historical or current data to project future revenues and expenses. For example, if you want to install solar panels on your roof, LCC will discount the future savings from lower electricity bills and higher resale value, while traditional budgeting will use the current electricity prices and market conditions to estimate the payback period.

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Leonard Teo

Technical Specialist | Driving Energy and Water Usage Reduction | Certified Energy Manager (SCEM) | Energy Transition | Decarbonisation | Water Circularity | Sustainability Strategy
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Long term planning of operation and maintenance through LCC will give asset owners a view of the cost incurred by the project over the lifecycle. Hence, they would be able to link the project with the actual bill reduction and budget sufficient funds to ensure the sustainability of projects. Projects that do not use LCC may erode the trust of stakeholders due to the "pain" in maintenance and may diminish the credibility of future sustainability projects.

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4 What are the pros and cons?

Both LCC and traditional budgeting have their advantages and disadvantages, depending on your objectives and preferences. For example, LCC can help you optimize your investment based on the long-term performance and value of an asset or system, as well as align your investment with sustainability objectives. However, it requires more data and analysis than traditional budgeting, which can be time-consuming and complex. On the other hand, traditional budgeting helps you manage your budget and cash flow more effectively, as well as track and measure financial performance. Yet it may lead to missing out on opportunities or making suboptimal decisions due to ignoring long-term costs and benefits of an investment. Ultimately, both budgeting methods can be beneficial if used correctly according to your goals.

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5 How to choose the best method?

When it comes to deciding which method is best for your project, it depends on your objectives, scope, scale, and context. Factors to consider include the life span of the asset or system, the uncertainty and risk of the future cash flows, the availability and quality of data, and the organizational culture and budgeting process. For example, if the asset or system has a long life span, Life Cycle Costing (LCC) may be more suitable as it will capture significant costs and benefits that occur over time. On the other hand, if you have limited or unreliable data to estimate the life cycle costs and benefits of the asset or system, traditional budgeting may be more suitable. Additionally, if your organization values short-term results and cash flow, traditional budgeting may be more suitable as it will conform to your budgeting process and expectations.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What are the differences between life cycle costing and traditional budgeting?

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1 What is life cycle costing?

2 What is traditional budgeting?

3 How do they differ?

4 What are the pros and cons?

5 How to choose the best method?

6 Here’s what else to consider

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