Return on steam efficiency investment

Before reading this article refer to a companion article appearing in the January 2004 issue of PLANT ENGINEERING magazine. This article illustrates a hypothetical manufacturer's step-by-step improvement of return on investment (ROI). Each of the consolidated financial statements in sequence (Steps 1, 2, and 3) shows the financial elements that make up ROI.

01/10/2004


Before reading this article refer to a companion article appearing in the January 2004 issue of PLANT ENGINEERING magazine.

This article illustrates a hypothetical manufacturer's step-by-step improvement of return on investment (ROI). Each of the consolidated financial statements in sequence (Steps 1, 2, and 3) shows the financial elements that make up ROI.

Step 1 is a financial snapshot of manufacturing operations before implementation of a steam efficiency initiative. There is nothing remarkable about this model statement. The highlights include a profit margin of 10% (line 22), which means the company earns 10 cents from every dollar of revenue. The revenue generated by these assets is twice the value of the assets (line 18). Together, margin and asset turnover (line 23) yield an ROI of 20% (line 24).

Step 2 shows the company's consolidated financial statement after implementing steam efficiency. The steam plant superintendent spends more on operations and maintenance, labor, and training. In return, the savings in fuel costs, waste reduction, and reduced overtime more than compensate for the increases.

Manufacturing now produces more gross margin (line 9). Savings from reduced emission penalties and hazard insurance (lines 10 and 11) add to income performance (line 15). The profitability of the plant is reflected in the increased margin (line 22), but this is facilitated, in part, by investment in new plant assets (line 16).

Accordingly, asset turnover (line 23) declines relative to Step 1. The magnitude of margin improvement more than compensates and ROI improves to 26.5% (line 24).

Step 3 , the plant decides to capture the full economic value of its improvements. Step 2 generated an additional $456,000 in net income (Step 2, line 15). Since the plant is making money, it makes sense to reinvest this revenue in production.

Production is increased by 533 units. All manufacturing expenses (line 8) increase relative to Step 2, but this is mainly because of the increase in production. Higher salaries for better-trained plant staff (line 3) push overall expenditures even higher. But with margin per unit still at 15% (line 22), the increased production boosts the overall magnitude of net operating income even more (line 15).

Finally, the increased production in Step 3 is generated without increasing the asset base; asset turnover (line 23) improves relative to Step 2. Despite the constant margin, the improvement in asset turnover is enough in Step 3 to increase ROI to 28.8% (line 24).

This analysis omits some additional opportunities. For example, the steam efficiency initiative, as described here, simply increased capacity for making more of the same product. An alternative would be to let capacity serve a new product line. The energy-efficient plant may be able to market its product as a "green" alternative, thus commanding a premium price, which would ultimately drive ROI higher.

Steam efficiency's contribution to manufacturing ROI

Financial metric After implementation After reinvesting additional revenue
RevenuesNo changeIncrease with production volume
Operating expensesNet decrease per unitIncrease with production volume
Net operating incomeIncreases per unit and overallProportional increase greater than expenses
Margin, %Increases as % of revenueNo additional increase as a percentage
AssetsMay increase*No additional increase in magnitude
Asset turnoverMay decrease*Increases with production volume
ROIIncreases with marginIncreases again with asset turnover
*Assets increase only if capital investments are required. Some initiatives require only operational changes. When capital investment is avoided, assets do not increase and asset turnover does not decrease. One study shows about half of steam efficiency opportunities can be obtained without implementing capital projects (Griffin, 2003).


In the final analysis, an investment in steam system optimization provides benefits beyond the boiler room.

  • Plant staff gets training and a boost in pay

  • Steam plant superintendent gets the resources to upgrade steam assets and maintenance

  • Product managers enjoy lower costs per unit

  • Sales and marketing have more negotiating room because the spread between cost and price has widened

  • Corporate officers demonstrate a higher ROI

    • Consolidated Financial Statement
      STEP 1: Financial position prior to any energy efficient implementation

      Units Price Per Unit Financial Result
      Line 1Revenue10,000$1000$10,000,000
      Cost of GoodsCost Per Unit
      Line 2Direct materials10,000$300$3,000,000
      Any waste is reflected in the cost per unit.
      Line 3Direct labor (fully loaded)12,000 hr.$66.67/hr.800,000
      Average fully loaded salary for staff of 6, each working 2000 hr./yr.
      Line 4Overtime (fully loaded)1000 hr.$100/hr.$100,000
      Driven by extra shifts needed to compensate for downtime.
      Line 5Operations & maintenance$700,000
      Includes consumables, service contracts, etc.
      Line 6Boiler fuel purchases400,000 MMBtu$5.00/MMBtu$2,000,000
      Price is averaged across fixed contract and spot market purchases.
      Line 7Other manufacturing expense$400,000
      Overhead and any other manufacturing expenses.
      Line 8Total cost of goods manufactured$7,000,000
      Line 9 Gross margin $3,000,000
      Value generated by manufacturing prior to administrative costs.
      Administrative expenses
      Line 10OSHA & emissions penalties$200,000
      Some companies actually budget for these
      Line 11Hazard insurance$1,000,000
      Line 12All other expenses$800,000
      Includes front office salaries, legal, audit expenses, etc.
      Line 13Total administrative expenses$2,000,000
      Line 14 Total operating expenses $9,000,000
      Line 15 Net operating income $1,000,000
      Assets
      Line 16Plant and equipment$4,000,000
      Line 17All other assets$1,000,000
      Line 18Average operating assets$5,000,000
      Financial metrics
      Line 19Fuel cost per unit of production (total fuel cost÷ units produced)$200
      Line 20All other costs per unit (all other costs÷ units produced)$700
      Line 21Total expense per unit (total expenses÷ units produced)$900
      The plant is like a money machine; put 90 cents in one end to get $1.00 out the other end.
      Line 22Margin (net operating income÷ revenue)10%
      This plant makes 10 cents on the dollar.
      Line 23Asset turnover (revenue÷ average operating assets)2.0
      Assets pay for themselves twice a year in the form of revenue produced.
      Line 24Return on investment20%
      A modest return, more than treasury bills, but it can be better.


      STEP 2: Financial position after implementing steam efficiency initiative

      Units Price Per Unit Financial Result
      Line 1Revenue10,000$1000$10,000,000
      No change
      Cost of Goods Cost Per Unit
      Line 2Direct materials10,000$285$2,850,000
      Optimization of thermal resources reduces waste by $150,000.
      Line 3Direct labor (fully loaded)13,500 hr.$66.67/hr.$900,000
      Optimization requires greater labor input by $100,000.
      Line 4Overtime (fully loaded)500 hr.$100/hr.$50,000
      Optimized performance, reduced downtime, and less overtime saves $50,000.
      Line 5Operations & maintenance$900,000
      Improved monitoring and maintenance increases costs by $200,000.
      Line 6Boiler fuel purchases360,000 MMBtu$4.90/MMBtu$1,764,000
      Reduced fuel consumption and greater use of low priced, fixed contracts saves $236,000.
      Line 7Other manufacturing expense$405,000
      Training expense increases as staff skills are developed by $5000.
      Line 8Total cost of goods manufactured$6,869,000
      Fuel savings and waste minimization outweigh other cost increases by $131,000.
      Line 9 Gross margin $3,131,000
      Gross margin isolates cost/price effectiveness of manufacturing from front office costs.
      Administrative expenses
      Line 10OSHA and emission penalties$25,000
      Optimization enhances safety; emissions drop proportionately with fuel consumption.
      Line 11Hazard insurance$850,000
      Clean log book is leverage for lower cost premiums by $150,000.
      Line 12All other expenses$800,000
      No change
      Line 13Total administrative expenses$1,675,000
      Summary of plant optimization cost benefits that accrue to the front office.
      Line 14 Total operating expenses $8,544,000
      A net improvement in total expenses of $456,000
      Line 15 Net operating income $1,456,000
      Assets
      Line 16Plant and equipment$4,500,000
      Optimization requires investment in new or replacement equipment of $500,000
      Line 17All other assets$1,000,000
      Line 18Average operating assets$5,500,000
      Financial metrics
      Line 19Fuel cost per unit of production (total fuel cost÷ units produced)$176 (was $200)
      Line 20All other costs per unit (all other costs÷ units produced)$678 (was $700)
      Line 21Total expense per unit (total expenses÷ units produced)$854 (was $900)
      Now the money machine only requires 85.4 cents in one end to get $1.00 out the other end.
      Line 22Margin (net operating income÷ revenue)15% (was 10%)
      Margin reflects cost/price business efficiency.
      Line 23Asset turnover (revenue÷ average operating assets)1.8 (was 2.0)
      Line 24 Return on investment (margin x asset turnover)26.5% (was 20%)
      The improved margin more than compensates for decreased asset turnover.


      STEP 3: Financial position after reinvesting savings in production

      Units Price Per Unit Financial Result
      Line 1 Revenue 10,533$1000$10,533,000
      Expense savings from Step 2 are reinvested to produce more goods and revenue.
      Cost of goods Cost Per Unit
      Line 2Direct materialsfor 10,533 units$285$3,001,905
      Cost per unit is unchanged from Step 2 but number of units increases.
      Line 3Direct labor (fully loaded)14,200 hr.$70/hr.$994,000
      Increased production requires more labor hours plus wages reflect value of training.
      Line 4Overtime (fully loaded)500 hr.$100/hr.$50,000
      No change from Step 2.
      Line 5Operations & maintenance$945,000
      This increases proportionately with output.
      Line 6Boiler fuel purchases379,188 MMBtu$4.90/MMBtu$1,858,021
      Fuel expense increases proportionately with production.
      Line 7Other manufacturing expense$426,587
      These increase more or less proportionately with production.
      Line 8Total cost of goods manufactured$7,275,513
      Higher output explains greater total expenditure relative to Step 2.
      Line 9 Gross margin $3,257,487
      Higher production more than compensates for greater expenditures relative to Step 2.
      Administrative expenses
      Line 10OSHA and emission penalties$25,000
      No change from Step 2.
      Line 11Hazard insurance$850,000
      No change from Step 2.
      Line 12All other expenses$800,000
      No change from Step 2.
      Line 13Total administrative expenses$1,675,000
      No change from Step 2.
      Line 14 Total operating expenses $8,950,513
      Higher than Step 2 but lower than Step 1 despite additional level of production.
      Line 15 Net operating income $1,582,487
      Increase in revenue more than compensates for rise in expenses.
      Assets
      Line 16Plant and equipment$4,500,000
      No change from Step 2.
      Line 17All other assets$1,000,000
      No change from Step 2.
      Line 18Average operating assets$5,500,000
      No change from Step 2.
      Financial metrics
      Line 19Fuel cost per unit of production (total fuel cost÷ units produced)$176 (same)
      Line 20All other costs per unit (all other costs÷ units produced$673 (was $678)
      Line 21Total expense per unit (total expenses÷ units produced)$850 (was $855)
      Line 22Margin (net operating income÷ revenue)15% (same)
      Line 23Asset turnover (revenue÷ average operating assets)1.9 (was 1.8)
      Line 24 Return on investment (margin x asset turnover)28.8% (was 26.5%)


      More Info

      If you have any questions about this article call Mr. Russell at 202-530-2225. Article edited by Joseph L. Foszcz, Senior Editor, 630-288-8776, jfoszcz@reedbusiness.com .



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