Profitability indicators

In Section 13.2, a number of economic indicators were derived from the annual cash flow the most useful being the economic life of the project, determined when the annual cashflow becomes permanently negative. 

The cumulative cashflow was used to derive ultimate cash surplus - the final value of the cumulative cashflow maximum exposure - the maximum value of the cash deficit payout time - the time until cumulative cashflow becomes positive. 

The shortcoming of the maximum exposure and payout time is that they say nothing about what happens after the cashflow becomes positive (i.e. the investment is recouped). Neither do they give information about the return on the investment in terms of a ratio, which is useful in comparing projects. 

A common ratio which indicates the profitability of a project is the 

This may be more useful if the cashflow items are discounted e.g. 10% NPV 

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Keywords economic model, shareholder s profit, project cashflow, gross revenue, discounted cashflow, opex, capex, technical cost, tax, royalty, oil price, marker crude, capital allowance, discount rate, profitability indicators, net present value, rate of return, screening, ranking, expected monetary value, exploration decision making. 

Another useful profitability indicator is the internal rate of return (IRR), already introduced in the last section. This shows what discount rate would be required to reduce the NPV to zero. The higher the IRR, the more robust the project is, i.e. the more risk it can withstand before the IRR is reduced to the screening value of discount rate. Screening values are discussed below. 

Value-oriented management concepts evolved from cost and profit controlling towards value based management concepts. Transparency on profitability of invested capital for the company and its shareholders is an objective of value-based management. Profitability indicators are related to capital indicators. Common indicators are Return on Assets (ROA), Return on Capital Employed (ROCE) and Economic Value Added (EVA ) as presented in table 3 (Hostettler 2002 Revsine et al. 2004). 

EVA NOPAT - (NOA WACC)1 Profit indicator deducting capital costs from net operating profit after taxes excluding interests consideration of financing structure of the company... 

The project concludes with a synthesis of the main results, as material and energy consumption, capital-investment, profitability indices and sustainability measures. The critical analysis should review the main requirements and possible improvements. 

As an illustration of the above concepts we will examine the selling price that ensures a profitable operation. If the product price cannot be found from reliable market data, or when the product is new, then making use of simply profitability indicators, as Return On Investment ROI), allows a quick estimation. 

The last two columns show how to determine DCFRR. By trial-and error it is found DCFRR of 32.1%. This is the maximum interest rate that this project could deliver, a rather high figure that predicts that the project would be very profitable, namely because of the high profit in the early years. The profitability indices are ... 

Profitability indicators capable of incorporating the time value of money, long-term costs, and savings are used. 

Table 7.1 displays five potential value-adding projects with positive NPVs and profitability indices. However, the cash needed to undertake all five projects is higher than the cash available. 

From an overall economic viewpoint, any investment proposal may be considered as an activity which initially absorbs funds and later generates money. The funds may be raised from loan capital or from shareholders capital, and the net (after tax and costs) money generated may be used to repay interest on loans and loan capital, with the balance being due to the shareholders. The shareholders profit can either be paid out as dividends, or reinvested in the company to fund the existing venture or new ventures. The following diagram indicates the overall flow of funds for a proposed project. The detailed cash movements are contained within the box labelled the project . 

The point at which the cumulative cash flow turns positive indicates the payout time (or payback time). This is the length of time required to receive accumulated net revenues equal to the investment. This indicator says nothing about the cash flow after the payback time and does not consider the total profitability of the investment opportunity. 

A similar form of indicator is the Profitability Index (PI), where the denominator is the maximum exposure of the project, and is applicable where the company is sensitive to the maximum exposure e.g. 

Nippon Zeon estimated that the break-even cost of its tire pyrolysis pilot plant was 0.25 per tire (29,30). One study indicates that pyrolysis of tires and other polymers should be considered as a means for disposing of scrap within environmental constraints. A plant processing 81,000 t/yr of scrap could be profitable, based on sales of reclaimed products (31). 

In the United States, Europe, and Japan, DCPD streams of 70—95 wt% purity are available. Estimates of recoverable DCPD production capacity in the United States for 1990 for all grades of DCPD is >127, 000 metric tons (39) and in Europe is 48,000 metric tons (40). The vast majority of this production is from hydrocarbon steam-cracking operations. Based on the total operations, more CPD is produced than indicated above, but because of the relatively small quantities available at a single location, much of the cyclopentadiene caimot be recovered profitably. Important producers in the U.S. are Dow, Exxon, LyondeU, SheU, and Texm ark in Europe, Dow and SheU and in Japan, Nippon Zeon (40). 

Fig. 5. Effect of lifetime on profitability. Venture F has a shorter operating lifetime than Venture A, but the same investment and IRR (see Table 4) the NPV is the same at the 10% discount rate. The diagram indicates that the profitabiUty of Venture F is higher than that of Venture A at all discount rates the shorter lifetime leads to a higher annual net return rate (NRR). The IRR rate does not indicate this difference in profitabiUty.

The profit of 10 percent, indicated by ratio 3 in Table 9-26, will be reduced by any dividend due to preferred stockholders, because such payments are not part of fixed-debt expenses the residue is shared among the ordinaiy stockholders. If all the long-term debts were in redeemable 6 percent preferred shares, then (from ratio 3) the net annual profit (aftertax) is Av.vp = 0.10(0.40 A ), or 0.04 A. Interest due on preferred shares is 0.06(0.12 As), or 0.0072 As- Therefore, the earnings for the ordinaiy shares are... 

Total overall performance effectiveness indicates PTPM s pursuit of economic efficiency or profitability. 

The cost of equipment determines the capital investment for a process operation. However, there is no direct relationship to profits. That is, more expensive equipment may mean better quality, more durability and, hence, longer service and maintenance factors. These characteristics can produce higher operating efficiencies, fewer consumption coefficients and operational expenses and, thus, fewer net production costs. The net cost of production characterizes the perfection rate of the total technological process and reflects the influences of design indices. Therefore, it is possible to compare different pieces of equipment when they are used in the manufacture of these same products. 

These latter curves are particularly important when they are obtained experimentally because they are less time consuming and require less specimen preparation than creep curves. Isochronous graphs at several time intervals can also be used to build up creep curves and indicate areas where the main experimental creep programme could be most profitably concentrated. They are also popular as evaluations of deformational behaviour because the data presentation is similar to the conventional tensile test data referred to in Section 2.3. It is interesting to note that the isochronous test method only differs from that of a conventional incremental loading tensile test in that (a) the presence of creep is recognised, and (b) the memory which the material has for its stress history is accounted for by the recovery periods. 

There are various indicators to determine the measure of profit for a process. In the following, we describe two of these indicators return on investment and payout period. The rate of return on investment (ROI) may be calculated as follows ... 

The fact that these systems exist and have been given considerable support by companies and regulators in the CPI, must be taken as a positive indication of an increasing realization of the importance of human performance in ensuring safe and profitable operation of chemical facilities. 

In the above equation, r can indicate the internal rate of return on an investment. Suppose that an investment in an energy-saving technology cost 100 and reduces energy costs by 20 per year indefinitely. The reduction in costs is comparable to net revenues received. The above equation can be modified as follows I equals R/r, where the values of I and R are specified and the value of r is computed. Hence 100 equals 20/r, and r equals 0.20, or 20 percent. The internal rate of return on the 100 investment is 20 percent per year. An investment is generally profitable when its internal rate of return exceeds the (interest rate) cost of obtaining credit. The investment is attractive when its internal rate of return exceeds the investor s hurdle rate, which may vary depending on the riskiness of the investment, and on the rate that can be earned from alternative uses of the investment funds. 

This is a specific sum included in the bid documents. It indicates to the bidder that it is contemplated that the particular work referred to will be carried out, but that, at present, no firm plans have been made as to cost, and usually the work has not been detailed either. The contractor is not entitled to profit or on-cost, unless the works go ahead. An example of this would be a general intention by the client to provide special ventilation to a laboratory, which is part of a larger scheme, but that no firm plans as to the full requirements have been drawn up at the time of inviting bidder. 

Recent surveys of maintenance management effectiveness indicate that one-third, 33 cents out of every dollar, of all maintenance costs is wasted as the result of unnecessary or improperly carried out maintenance. When you consider that US industry spends more than 200 billion dollars each year on maintenance of plant equipment and facilities, the impact on productivity and profit that is represented by the maintenance operation become clear. 

A survey of 500 plants that have implemented predictive maintenance methods indicates substantial improvements in reliability, availability and operating costs. The successful programs included in the survey include a cross-section of industries and provide an overview of the types of improvements that can be expected. Based on the survey results, major improvements can be achieved in maintenance costs, unscheduled machine failures, repair downtime, spare parts inventory, and both direct and in-direct overtime premiums. In addition, the survey indicated a dramatic improvement in machine life, production, operator safety, product quality and overall profitability. 

Ratios well below 1 may indicate financial problems ahead while those substantially greater than 1 may point to poor credit control or under-utilization of cash. This ratio is sometimes known as the acid test . The principal profitability ratio in use is the net profit before interest and tax (NPBIT) to net assets or return on capital employed. 

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