Improving Your Bottom Line at One Watt per Square Foot
By Richard Buzard Most manufacturing and sales based businesses look at improving their profit margin by increasing sales revenues or reducing financing costs. One study showed that increasing their sales 50% increased 71.4% and that by reducing financing costs, their profit margin increased by 21.4%. Cutting costs by 20% would increase their margin by 114.2%. After learning of this, your CFO wants to know if we can get similar results, and asked the operating unit managers (facilities, human resources, information technology, finance and accounting, and purchasing) to show how they could each provide a 20% contribution to the goal. No department may make changes in current staffing levels. The building is a 56,700 square foot Class A office building that is operated (heat, light, and air conditioning) 56 hours per week. Annual operating expenses are $666,225 ($11.75 per square foot) and annual income is $1,516,725 ($26.75 per square foot). The investment horizon is 7 years, capitalization rate is 8.18%, market earnings rate is 5%, and the current S&P 500 P/E ratio is 16.66. A 20% savings in operating costs is $133,245, and the facility manager’s goal is $26,649. The results are impressive. Saving 1 watt per square foot will result in saving $25,440.43 with electricity priced at $0.112 per KwH. The building asset value will increase $311,007.71, and because the company is publicly traded, shareholder value increases $423,387.57. The 227,147 KwH savings results in decreasing greenhouse gas production1 by 160 metric tons per year. What can these energy savings buy? The facility manager (FM) can borrow money at 9%, wants a 5 year loan, and plans to use 80% of the energy savings to pay for improvements. Taken from operating funds, $25,440 in annual savings could finance energy improvement projects equal to $82,000 without increasing today’s operating budgets. Simple payback will be in 3 years, 3 months. Annual financing costs are $20,426 and cash flow is $5,017 during the payback period. The cash flow savings pay for the upgrade and continue for the life of the equipment, in most cases an additional 7 to 13 years. At the end of 11 years, the cumulative cash flow is $203,187 and the net present value is $102,741. The facilities manager needs to find another 5%, or $1,208.57 in annual savings to meet his goal, and can use the cash flow created during payback as funding. 5 years ago, Purchasing bought a paper baler for $7500 with the goal of selling waste paper to a local recycling firm. The baler has an expected service life of 15 years with a zero estimated salvage value. It is being depreciated on a straight line basis and has a book value of $5000. The current market value is $1000. It has never performed to expectations. You found a new unit that while it costs $12000 (including installation), will increase sales from $10,000 to $11,000 per year and will reduce labor, energy, and other annual operating costs from $7000 to $5000. It has an estimated salvage
Believed to be the cause of Global Warming.
value of $2000 at the end of 10 years. The company’s cost of capital is 10%, and it pays 40% on taxes. In making his recommendations to management, the FM uses the concept of life-cycle costing, which considers the entire life-cycle costs of equipment- purchase price, installation costs, utility consumption, maintenance and manpower costs, changes in depreciation, and final residual or disposal costs. The process is completed by evaluating repair or replacement in terms of a net present value cost analysis. Using this process, he finds that annual cash flow from the existing unit is $2000, but replacing it provides a cash flow of $4000 per year. Present value of the existing baler is $12,289.13, and PV of the proposed unit is $24,578.27 – a much better choice. This puts him over his goal of $26,649, and he still has $13,069 available for use. A facilities condition assessment2 done during the prior quarter showed several other areas of improvement with nominal costs and that will result in additional savings and improvements in the work environment and productivity, and presents this information to the CFO. Because using future energy savings to fund current upgrades is a new way of thinking, the CFO asks what would happen if they did not invest in an energy savings project. A discounted cash flow analysis shows that the company would have to invest $65,207.83 now at the market earnings rate so you will have enough money every month to pay for the difference in utility bills. Upon learning this, the CFO gives permission to proceed with the project.3
An expert in facilities management and energy efficiency, Richard has experience in commercial, institutional, and governmental facilities. His LinkedIn profile is at www.linkedin.com/in/richardbuzard, and he can be contacted at (248)935-9097 or at firstname.lastname@example.org.
See “The Facilities Condition Assessment: An Advanced Tool to Create Sustainable Growth and Control Costs” at http://tinyurl.com/cpy3al7. 3 This article does not take into consideration energy rebates and incentives. For more information, please refer to the Database of State Incentives for Renewable Energy at www.dsireusa.org.