Much has been said and written about the stalled U.S. economy. Many blame the reluctance of small businesses to expand and add workers to an uncertain tax and regulatory climate. Others blame the failure of businesses to grow on the often-debunked belief that financing is neither affordable nor available. Regardless of how valid the hurdles are, a snow removal and ice management business may need to replace existing business property, remodel or upgrade the business premises or invest in new equipment for workers in order to survive.
Fortunately, tools are available that can help every snow removal contractor decide whether or not to commit to capital expenditures, particularly those involving the expansion of the business. Best of all, a decision-making process involving a relatively simple analysis usually factors in economic uncertainty and well as other contributing factors, real or imagined.
Even in the best of times it is difficult to decide whether to make capital expenditures. Obviously, there are situations where no formal analysis is required. One of the snow removal operation’s two ice melting systems dies. A rough estimate of the cost to repair is more than the cost of a new matter. Can the operation get along with only one?
Generally, no analysis is needed if:
- Failed equipment is being replaced with the same or similar property and the need for that business asset remains the same.
- Equipment, business property or assets are being added because an employee has been added
- Expensive repairs are needed, a replacement would cost substantially more that the repair and once the repair is completed the replacement property will have a useful life similar to a new unit.
The term “Cost Benefit Analysis” is used in business planning although it has no precise definition beyond the idea that both the positive and the negative impacts of a transaction are going to be summarized and weighed against each other.
The term covers several varieties of analysis, such as: Total Cost of Ownership analysis (TCO), Return on Investment (ROI) analysis, and Financial Justification. All of these approaches to cost benefit analysis attempt to predict the financial impact and other consequences of a particular action.
THE COST OF OWNERSHIP
An analysis of how much it costs to own an asset of the snow removal business, a cost of ownership analysis better known as a TCO Analysis, is specifically designed to find the lifetime costs of acquiring, operating, and changing something. TCO analysis often reveals large differences between the price of something and its long-term cost.
Today, the TCO analysis is used to support acquisition and planning decisions involving a wide range of assets that incur significant maintenance or operating costs over a long usable life. Total cost of ownership is used to support decisions involving equipment, vehicles, buildings and computer systems, to name just a few.
Unfortunately, TCO analysis ignores many business benefits that result from projects or initiatives, such as increased sales revenues, faster information access, improved competitiveness, or improved service quality. When TCO is the primary focus in decision support, it is assumed that such benefits are more or less the same for all options and the choices differ only in cost.
RETURN ON INVESTMENT
Everyone making an investment expects a return at some point. Someone who invests in an education, for example, may be doing so to have a good job in the future. In business, an investor who puts money into a business normally expects a monetary return. A business and/or its owner, usually invests to help the operation grow, expand or, in many cases, merely survive.
The easiest tool for analyzing business investment is a computation of the rate of return on that investment. Return on Investment (ROI) analysis compares the magnitude and timing of investment gains directly with the magnitude and timing of investment costs. A high ROI means that investment gains compare favorably to investment costs.
One serious problem with using ROI as the sole basis for decision making is that ROI by itself says nothing about the likelihood that expected returns and costs will be as predicted. After all, ROI by itself says nothing about the “risk” of an investment. ROI simply shows how returns compare to costs if the action or investment brings the results hoped for. For that reason, proper investment analysis should also measure the probabilities of different ROI outcomes, and wise snow removal contractors’ decision-makers will consider both the ROI magnitude and the risks that go with it.
Financial Justification analyzes whether or not an investment is justified — in financial terms. In other words, Financial Justification helps a contractor decide whether or not to go forward with a proposed action. The results of a financial justification analysis address questions like these:
- Does the proposed acquisition represent the best use of funds?
- Can the proposed new equipment be used to improve the snow removal or ice management operation’s financial position?
- Will the proposed security, legal, accounting or other service "pay for itself"?
Financial Justification is distinguished from other types of analysis only by the special emphasis on financial decision criteria. Just which criteria determine justification in a particular situation depend heavily on the operation’s objectives and the current business situation.
A crucial early step in designing the financial justification of a transaction, therefore, is to determine specifically which financial criteria are important to decision makers in the present situation.
A basic analytic approach, often referred to as “Net Present Value,” asks the question of how and how long it will take for newly acquired equipment, services or property to pay for itself. Quite simply, a factor, equal to the operation’s cost of capital is applied to the expected cash flows from the new equipment, property or asset. Under this approach, early returns from the investment are usually more valuable than later returns.
The net present value approach, or some variation, is generally the best method to analyze an investment. All cash flows are accounted for including any salvage value expected when the newly acquired business asset is eventually disposed of or sold, along with negative cash flows (e.g., high repair costs in later years of the newly acquired property’s useful life).
The payback period method has long been used for a quick, cheap and “dirty” analysis. In today’s current economic climate, it can make sense since it inherently takes into account risk, particularly the risk several years out. A good example would be a piece of equipment that may be obsolete or where a significant upgrade should be available in a couple of years.
Naturally, every contractor will face situations where there is no need for a formal analysis. Generally, the numbers should be run before deciding. Sometimes, particularly with changes in technology, the savings are obvious. However, no business property, equipment or asset should be replaced just because it has failed. After all, it may no longer be needed or the technology has changed.