Profitability analysis

The first stage in evaluating the profitability of a proposed new product is to compare the total cost of the product (for example, per tonne produced) with the current market price. It is also necessary to estimate future demand for the product, and to determine the trend in the selling price over several previous years. It is also necessary to estimate the number of years that the product can be sold at a satisfactory profit, this is more useful than estimating the possible operating life of a plant Backhurst and Harker (1973 p.47) make the following observation  

Two other measures that can be used to evaluate the profitability of a product are the return on investment and the payback period. The return on investment (ROZ) is the expected profit divided by the total capital invested, expressed as a percentage return. It must be clearly stated whether the profit is based on pre-tax or after-tax earnings. The after-tax ROI is compared with the earnings that could be achieved by an alternative investment, e.g. capital bonds. An after-tax ROI of at least 15-20% is usually expected (or 30-40% pre-tax ROI), assuming that the project is not particularly risky  

The payback period(or payout time) is the number of years from plant start-up required to recover all expenses involved in a project, if all the pre-tax profits were used for this purpose. Depreciation charges are not included in the operating costs. Expenses not incurred directly in the design and construction of the plant are excluded, the analysis is intended to demonstrate the best means of allocating the present and future resources of a company. A payback period of less than five years is usually required for a project to proceed. However, the payback period does not consider the timing of the payments or the profits earned by the plant after the payback period. 

For more detailed discussion of plant economics and profitability analysis, the reader should refer to a specific textbook such as Peters and Timmerhaus. The following quotation from Backhurst and Harker (1973 p.47) provides an interesting summary  

Action Perform a detailed economic analysis of the project including Capital cost estimates (by different methods) 

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Classical process synthesis consists of the synthesis of the alternatives, their analysis and final evaluation. Hurme and Jarvelainen (1995) have presented a combined process synthesis and simulation system consisting of an interactive rule-based system which is used for generating process alternatives (Fig. 10). The process alternatives are simulated, costed and evaluated through profitability analysis. The developed system concept combines process synthesis, simulation and costing with uncertainty estimation. 

This chapter includes a discussion of how to formulate objective functions involved in economic analysis, an explanation of the important concept of the time value of money, and an examination of the various ways of carrying out a profitability analysis. In Appendix B we cover, in more detail, ways of estimating the capital and operating costs in the process industries, components that are included in the objective function. For examples of objective functions other than economic ones, refer to the applications of optimization in Chapters 11 to 16. 

The ability to understand and apply the concepts of cost analysis, profitability analysis, budgets, income-and-expense statements, and balance sheets are key skills that may be valuable. This section treats two major components of economic... 

Griest (1979) has discussed the effects of inflation on profitability analysis and has pointed out that the percentage change in profits after income taxes rarely increases at the rate of inflation, largely due to the effects of taxation. Assumptions about inflation can change the relative ranking of project alternatives based on net present value special techniques based on probability may be required because inflation is difficult to predict. 

Multivariate curve resolution, 6 54—56 Multivariate linear regression, 6 32—35 Multivariate optical elements (MOE), 6 68 Multiwalled carbon nanotubes (MWCNTs), 77 48, 49 22 720 26 737. See also Carbon nanotubes (CNTs) Multiwall nanotubes (MWNTs) synthesis of, 26 806 Multiwall fullerenes, 12 231 Multiwall nanotubes (MWNTs), 12 232 Multiwall paper bags, 78 11 Multiway analysis, 6 57-63 Multiyear profitability analysis, 9 535-537 Multiyear venture analysis, 0 537-544 sample, 9 542-S44 Mummification, 5 749 Mumps vaccine, 25 490 491 Mumps virus, 3 137 Municipal biosolids, as biomass, 3 684 Municipal distribution, potential for saline water use in, 26 55-56 Municipal effluents, disposal of, 26 54 Municipal landfill leachate, chemicals found in, 25 876t... 

EBIT and EBITDA are common indicators used in company-internal decision making supporting operative profitability analysis as basis for... 

Value management concepts focus on total profit analysis with given demand and supply... 

Mulhern, F. J. 1999. Customer profitability analysis measurement, concentration, and research directions. Journal of Interactive Marketing, 13(1) 25-40. 

Finally, tools need to be in place to track the margin contribution for all products and systematically eliminate those which do not meet the required threshold. Internal transfer price systems are typically detached from market dynamics and distort profitability analysis on the level of a single production plant. Such analysis only produces accurate conclusions when performed on the level of products or franchises. 

The next section will explain in more detail the content of different levels. The approach will be applied throughout the whole book, although not in a repetitive manner. Actually, each case study will emphasize only generic conceptual elements. The case study regarding the manufacturing of cyclohexanone by phenol hydrogenation is a kind of leading example. Since the book focuses on technical aspects, there is no place for cost evaluation and profitability analysis. 

Therefore, the economic potential at the I/O level could be seen merely as a tool for selecting the chemical route, and at the same time for setting targets when purchasing raw materials. As a rule of thumb, the ratio of selling prices of products to the purchasing prices of raw materials should be a minimum of two when the payback time of the total capital investment is greater than five years. Preferably, this ratio should be about three for a payback time of three years [3]. More accurate calculations may be carried out easily by means of profitability analysis tools. 

Design data and other process information are obtained during the development stage. This information is used as the basis for carrying out the additional phases of the design project. A complete market analysis is made, and samples of the final product are sent to prospective customers to determine if the product is satisfactory and if there is a reasonable sales potential. Capital-cost estimates for the proposed plant are made. Probable returns on the required investment are determined, and a complete cost-and-profit analysis of the process is developed. 

Methods for including the cost of capital in economic analyses have been discussed in Chap. 7. Although the management and stockholders of each company must establish the company s characteristic cost of capital, the simplest approach is to assume that investment of capital is made at a hypothetical cost or rate of return equivalent to the total profit or rate of return over the full expected life of the particular project. This method has the advantage of putting the profitability analysis of all alternative investments on an equal basis, thereby permitting a clear comparison of risk factors. This method is particularly useful for preliminary estimates, but it may need to be refined further to take care of income-tax effects for final evaluation. 

The basic aim of a profitability analysis is to give a measure of the attractiveness of the project for comparison to other possible courses of action. It is, therefore, veiy important to consider the exact purpose of a profitability analysis before f c standard reference or base case is chosen. If the purpose is merely to present the total profitability of a given project, a simple statement of total profit per year or annual rate of return may be satisfactoiy. On the other hand, if the purpose is to permit comparison of several different projects in which capital might be invested, the method of analysis should be such that all cases are on the same basis so that direct comparison can be made among the appropriate alternatives. 

Under some conditions, such as a profitability analysis based on a small component of an overall operation, the return on investment can be based on the fixed-capital investment instead of the total investment. 

The capitalized-cost profitability concept is useful for comparing alternatives which exist as possible investment choices within a single overall project. For example, if a decision based on profitability analysis were to be made as to whether stainless steel or mild steel should be used in a chemical reactor as one part of a chemical plant, capitalized-cost comparison would be a useful and appropriate approach. This particular case is illustrated in Example 9 of Chap. 7. 

Example 5 Comparison of alternative investments by different profitability methods. A company has three alternative investments which are being considered. Because all three investments are for the same type of unit and yield the same service, only one of the investments can be accepted. The risk factors are the same for all three cases. Company policies, based on the current economic situation, dictate that a minimum annual return on the original investment of 15 percent after taxes must be predicted for any unnecessary investment with interest on investment not included as a cost. (This may be assumed to mean that other equally sound investments yielding a 15 percent return after taxes are available.) Company policies also dictate that, where applicable, straight-line depreciation is used and, for time-value of money interpretations, end-of-year cost and profit analysis is used. Land value and prestartup costs can be ignored. 

With the simple relations described above, you can analyse and understand quite a lot of the operation of a firm. You should, however, be aware of the limitations of this kind of analysis. Our Cost-Sales-Profit analysis assumes that a firm is working at a steady state... 

W. C. Lawler, Cost-Volume-Profit Analysis in J. L. Livingstone and T. Grossman (eds.) The Portable MBA in Finance and Accounting, Wiley, New York, 2002, pp. 102-124... 

Consequently, investment decisions require capital budgeting. This plant profitability analysis is the evaluation and the selection of the best investments from a set of alternatives. Methods for evaluating investments include NPV and rate of return, among others, for private companies and benefit-cost ratio for public works projects. All these come under the purview of plant profitability analysis. 

Allocation of all direct and indirect costs (highlighting environmental, safety and health costs) to a product or product line for the purposes of inventory valuation, profitability analysis and pricing decisions... 

Profitability- Analysis A document supplying information on the profit potential of the final plant. Several standard methods such as return on investment, venture profit, payback period, and annualized cost are used to calculate the expected profitability [957]. 

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