Cost Identification and Estimation

1. Cost Identificationand Estimation

2. Introduction to Cost Identification and Estimation [15 minutes]

3. Decision-making factors Today’s focus Technical Project selection Regulatory Financial Organizational

4. The language of business Costs are an important aid in translating environmental needs to business needs. In addition, they already serve as an “official language” in the company. project profitability ROI capital investment profit centre market share cost allocation overhead costs unit price CDO incinerator ban regulatory compliance wastewater energy efficiency dioxin recycling With the cost translation, the business and environmental manager can communicate and co-operate more effectively. Adapted from “Pilot program for the promotion of environmental management in developing countries” (P3U). Environmental Cost Management. GTZ-P3U. Bonn, Germany

5. Financial analysis steps • Cost identification & estimation • Project profitability evaluation We will discuss this now We will discuss these tomorrow

6. Cost identification & estimation • Initial investment costs • e.g., equipment, installation, training • Annual operating costs, savings,and revenues • current operations, before the project • after project implementation • e.g., materials, energy, labour • Need to identify, estimate and allocate all relevant and significant items impacted by the project

7. Small group exercise:Cost Identification at the PLS Company [75 min]

8. The PLS Company • A medium-sized manufacturer of food packaging materials • Major manufacturing steps are Printing, Laminating, and Slitting • Waste management includes incineration and wastewater treatment • Cleaner Production has reduced volume of solid scrap and annual operating costs

9. Manufacturing steps at the PLS company — Materials flow map plastic film, aluminium film, adhesive solvent air emissions solvent air emissions INVENTORY printed laminated film printed film product SLITTING plastic film, ink PRINTING LAMINATION Solid scrap Solid scrap Solid scrap Liquid waste ink to waste management to waste management

10. Waste management at the PLS company — Materials flow map air emissions air emissions wwtp chemicals Cleaner water to a nearby stream fresh water dirty scrubber water fuel and fuel additive WASTEWATER TREATMENT INCINERATOR liquid ink waste from printing step solid scrap from printing, laminating, slitting steps sludge ash OFF-SITE LANDFILL

11. Exercise instructions • Introduction (10 min.), detailed in your handout • Review the written description and flow maps for the PLS Company (10 min.) • Question 1 (15 min.) • Question 2 (15 min.) • Discuss your answers with the other small groups and the instructor (20 min.) • Lessons learned (5 min.)

12. Three broad categoriesof costs • The cost of manufacturing inputs • Materials, energy, labour, capital, etc. • The cost of waste management • Waste handling, regulatory compliance, waste treatment and disposal, etc. • Less tangible costs • Production throughput, product quality, company image, liability, etc.

13. Checklist:“The Investment Decision Cost/Savings Checklist” Refers to the checklist document

14. The cost of wasteat the PLS company • The total Cost of Waste due to the generation of solid scrap during print runs was estimated to be US$213,000 per year, including: • Cost of lost direct manufacturing inputs (e.g, plastic film, ink, energy, labour) • Cost of waste management (e.g., incinerator operation, wastewater treatment plant operation, final waste disposal)

15. Problematic accounting practices—what might make it difficult to estimate costs accurately(Particularly costs related to waste)Let’s Brainstorm! [30 min]

16. Problematic accounting practices? • Various costs at a facility might be... • “Hidden” in the accounting records • Misallocated from overhead accounts • Classified as fixed when they are really variable, or semi-variable • Not found in the accounting records at all • (Can you think of others?)

17. “Hidden” costs of lost raw materials Manufacture of plastic rear panels for automobiles (as a percentage of input materials) Material loss per accounting records Actual material loss Adapted from: Rooney, Charles. “Economics of Pollution Prevention: How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.

18. “Hidden” costs of lost raw materialsat the PLS company • The PLS accounting records show: • The amount of raw materials used • The amount of final product shipped • But the records do not show: • The amount of solid scrap waste generated • The amount of any other lost raw materials

19. Direct vs. Indirect Costs (1) • Direct Costs are costs that can be easily traced to a unit of product • e.g., direct materials, direct labour • Indirect Costs are costs that cannot be traced as easily to a unit of product • e.g., facility energy use, insurance, maintenance, waste treatment • A cost considered “direct” at one firm may be considered “indirect” at another firm

20. Direct vs. Indirect Costs (2) • In general, direct costs within an industrial firm are assigned directly to the process, product, or project responsible for generating the cost • Indirect costs are assigned to facility, division, or company overhead accounts • It can be difficult to find costs “hidden” in overhead accounts

21. Environmental management costs “hidden” in an overhead account Product Manufacturing Cost Statement Variable Costs Raw Materials Intermediates Additives Utilities Direct Labour Packaging Wastewater Treatment $2.27/lb. $0.87/lb. $0.41/lb. $0.96/lb. $11.32/lb. $10.31/lb. $9.14/lb. $0.04/kW-h $0.07/kW-h $27.40/hr $31.43/hr. $0.60/pkg. $0.57/pkg $0.01/gal. • legal expenses • environmentally driven R&D • permitting time and fees • environmental training Fixed costs Supervisor Fixed labour Depreciation Divisional overhead General services & administration Fixed Costs Supervisor Fixed Labour Depreciation Divisional Overhead General Services & Administration $4,600 $57,800 $1,227 $13,662 $1,294 Total Variable Cost Total Fixed Cost Total Manufacturing Cost Total Cost Source: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources Institute. May 1995.

22. Survey of industry accountantsin the US Findings: • Environmental management costs such as waste handling, treatment, and disposal predominantly assigned to overhead accounts • Even energy and water costs (manufacturing inputs) are usually assigned to overhead accounts Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995

23. Cost assignmentat the PLS company • The cost of direct materials, labour, and energy are assigned directly to the manufacturing steps • In contrast, waste treatment and disposal costs are assigned to an overhead account in the Office of the Business Manager

24. Problematic accounting practices? • Various costs at a facility might be... • “Hidden” in the accounting records • Misallocated from overhead accounts • Classified as fixed when they are really variable, or semi-variable • Not found in the accounting records at all • (Can you think of others?)

25. Cost allocation Costs initially assigned to overhead accounts are usually allocated back to processes, products, or projects using an allocation basis such as • Quantity of raw materials used • Production volume • Machine hours • Labour hours • Floor space

26. Solid scrap waste Treatment and disposal costs Cost allocationat the PLS company • How would you • allocate? • On the basis of: • # of set-up runs? • raw materials use? • machine hours? • amount of scrap? • some other basis? Allocated from overhead Printing Laminating Slitting

27. Problematic accounting Practices? • Various costs at a facility might be... • “Hidden” in the accounting records • Misallocated from overhead accounts • Classified as fixed when they are really variable, or semi-variable • Not found in the accounting records at all • (Can you think of others?)

28. Fixed vs. Variable Costs (1) • Fixed Costs are costs that do not vary with production level or other factors • e.g., equipment depreciation, labour • Variable Costs are costs that do (or can) vary with production level or other factors • e.g., raw materials use, energy use • A cost considered “fixed” at one firm may be considered “variable” at another firm

29. Fixed vs. Variable Costs (2) • The goal of Cleaner Production is to reduce variable costs • Therefore, it is important to correctly distinguish between fixed and variable costs when identifying and estimating costs to support CP efforts • If CP efforts will reduce a cost — then it is variable!

30. Fixed vs. Variable Costsat the PLS company • Incinerator operating costs at PLS include: • Fuel, fuel additive • Operating labour • Trucking ash to landfill • Equipment depreciation costs • PLS views these waste treatment costs as essentially fixed costs — do you agree?

31. It is important to remember:Future fixed costsare not fixed yet!Cleaner Production nowcan reduce the size & cost of treatment equipment thatyou may have to purchasein the future

32. Problematic accounting practices? • Various costs at a facility might be... • “Hidden” in the accounting records • Misallocated from overhead accounts • Classified as fixed when they are really variable, or semi-variable • Not found in the accounting records at all • (Can you think of others?)

33. Costs missing fromthe accounting records In general, two types of costs may be entirely missing from the accounting records: • Future costs • Future variable costs, e.g., landfill fees • Future fixed costs, e.g., future depreciation costs of new waste treatment equipment • Less tangible costs • e.g., lost profit from reduced production throughput

34. Costs missing fromthe accounting records at the PLS company • Lost profit from reduced production • Future regulatory costs (e.g., stricter wastewater regulations) • Potential liability • Negative company image • (Can you think of others?)

35. Problematic accounting practices? • Various costs at a facility might be... • “Hidden” in the accounting records • Misallocated from overhead accounts • Classified as fixed when they are really variable, or semi-variable • Not found in the accounting records at all • (Can you think of others?)

36. Ease of identifying and estimating costs Equipment purchase, direct materials, energy, labour In general, as you go down this list, costs are more likely to be hidden or difficult to quantify (but every case is different!) LESS HIDDEN MORE HIDDEN Waste disposal Recycle/rework, treatment, waste handling Regulatory compliance, other indirect costs Less tangible costs

37. Potential Sourcesof Cost DataLet’s Brainstorm! [15 min]

38. Potential sources of cost data • Internal data sources • The accounting system • Original data records in different departments • Colleagues/employees • External data sources • Industry colleagues or trade associations • Vendors and consultants • Business partners (e.g., insurance firm) • Government (e.g., environmental agency) • National Cleaner Production Centre

39. Review of What We have Covered so Far [15 min]

40. Cleaner Production • The cost of waste • Usually underestimated! • Profiting from Cleaner Production • Cleaner Production as waste prevention and on-site recycling • Cleaner Production • Benefits • Implementation steps

41. Cost odentification and estimation • Cost identification • Introduction to PLS company (will see more of PLS tomorrow) • Categories of costs (manufacturing inputs, waste management, less tangible costs) • Problematic accounting practices • Sources of cost data

42. Coming up... • Cost estimation tools • Process mapping, material flows • Project profitability assessment • Cash flows • “Simple Payback” indicator • “Time-value-of-money” concept • “Net Present Value (NPV)” indicator • Other indicators • Other profitability assessment issues

43. Questions or comments?

44. Small group exercise:Cost Estimation at the PLS Company [60 min]

45. Exercise instructions • Introduction (5 min.), detailed in your handbook • Question 1 (20 min.) • Question 2 (15 min.) • Discuss your answers with the other small groups and the instructor (15 min.) • Lessons learned (5 min.)

46. Tools For Data Identification and Estimation [30 min]

47. Tools:Original data records • Purchase order/invoices • Production records • Waste shipment records • Equipment logs • Engineering estimates • Regulatory reports • Staff interviews Source: Northeast Waste Management Officials’ Association

48. Checklist:“Cleaner Production Data Sources”

49. Tools: Materials flow map plastic film, aluminium film, adhesive solvent air emissions solvent air emissions INVENTORY printed laminated film printed film product SLITTING plastic film, ink PRINTING LAMINATION Solid scrap Solid scrap Solid scrap Liquid waste ink to waste management to waste management

50. Tools:The materials balance • Physical analogy to financial balance sheet • Compares all material inputs and outputs • Identifies sources of waste and data gaps • Provides basis for cost evaluation MANUFACTURING PROCESS PRODUCT INPUTS NON-PRODUCT OUTPUT (WASTE)