Improving BSO Services and
SME Performance Through
Cleaner Production
[SPEAKERS NAMES]
[DATE]
Module 5:
The CP process and
tools/techniques for CP
implementation
Module 5:
The CP process and
tools/techniques for CP
implementation
5.1:
Operational inefficiency &
associated costs
 Remember,
CP is a tool for
improving business
efficiency
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5
What is efficiency?
Efficiency=the reduction of waste
? What is waste?
“Waste is any material or
energy leaving the facility. . .”
Proactive
definition
“. . .not as part of the product.”
Less strict
definition
“… without first being used as
efficiently as possible.”
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6
!
Definitions of waste
vary, but ALL
companies generate
waste as part of their
operations.
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7
Many forms & sources of waste
Waste comes in
many forms. . .
WASTES
Air Emissions Heat
Loss
INPUTS
Materials
Products
Energy
By-Products
Water
Hazardous
Waste
Solid
Waste
(trash)
Wastewater
WASTES
. . .and has many
different sources
Allowance  breakage  contaminated solids  core loss  customer returns  damage 
drainings  dust  evaporation  furnace loss  greenhouse loss  hidden losses  leakage 
overfill  non-conforming material  packaging  process loss  rework  second quality 
stock loss  washings 
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8
?
What are the
costs associated
with waste and
energy loss?
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9
The “cost crocodile”
The true cost of
waste can be
like a crocodile,
with only a
small part
visible
See “the cost iceberg” in: Bierma, TJ., F.L. Waterstaraat, and J. Ostrosky. 1998.
“Chapter 13: Shared Savings and Environmental Management Accounting,” from The
Green Bottom Line. Greenleaf Publishing:England.
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10
Costs of waste are often underestimated
 For every $1 of waste cost
measured, another $2 - $3 of cost
are “hidden” in the accounting
records, or are not on the books
at all
 Companies typically
underestimate how much waste
really costs them, sometimes by
several orders of magnitude
 This applies even to big, wellmanaged companies too!
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For example. . .
11
CASE
STUDY
Cost of animals “dead on arrival”
The “Nutrimeat”
abbatoir purchases
animals at the farm
gate and transports
them to the abattoir.
About 1% are “dead
on arrival” (DOA)
from the stress of
transport. These
animals are
incinerated.
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DOAs are waste.
What is the cost?
Farm gate cost
(30kg @ $1/kg)
$30.00
Av. Transport cost
$0.80
Incinerator fuel cost
(30kg @ $0.10/kg)
$3.00
Lost profit
$4.00
Total cost/DOA
$37.80
(vs. cost of disposal alone:
$3.00)
12
CASE
STUDY
Cost of waste ink
Southwire” estimated
the average disposal
cost of a drum of
hazardous waste ink
as US$50
Upon closer
inspection, the true
cost was discovered
to be US$1,300 per
drum:
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!
Unnecessary waste
represents inputs that
were purchased
unnecessarily.
Lost raw materials
(ink, thinner)
$820
Corporate waste
management activities
$350
Disposal
$50
Hazardous waste tax
$20
Internal waste handling
activities
$60
Total cost/drum
$1300
13
Assessing the costs of waste:
an essential part of the CP process
 All waste has a cost—but
the cost of some types of
waste is far more
significant than others.
 Reducing waste saves
these costs—but may also
require initial investment
and effort
 Therefore, assessing the
costs of waste is essential
to:
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or
?
Identify the key
problems
that CP can address
Evaluate whether CP
measures are good
business decisions.
14
?
How do we
best identify
the true costs
of waste?
This is discussed later
in this module. . .
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15
Module 5:
The CP process and
tools/techniques for CP
implementation
5.2:
The Cleaner Production
Process (Overview)
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Getting oriented
The CP process is not an “extra.”
It is just good management.
WHY? The CP process produces…
– Improved information for
management (understanding
of production costs and of the
true cost of waste)
– Prioritization of improvement
opportunities and analysis of
their profitability
– Understanding of technology
options
Which should be
INTEGRATED with the
business planning
process
(more on this in a later section)
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The Cleaner Production Process
Step 1: Getting organized
(setting goals, assembling a team)
Step 2: Identification of opportunities
(review costs, analyse using process
mapping, materials balance, root cause
analysis, options generation techniques)
Our focus
today
Step 3: Prioritization and evaluation
Step 4: Implementation
Step 5: Measurement and review
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18
The CP process is a cycle
Identification of
Opportunities
Getting
Organized
Prioritization
and
Evaluation
Measurement
and Review
Implementation
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19
Getting
1
Organized
First, think
about who
should be
involved in
the CP
process.
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Think first in terms
of functions, not
individuals
Functions are the
same in almost all
organizations, big
or small. . .
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Getting
1
Organized
Get
organized
ID
opportunities
CEO/Manager
Research &
Development
Legal
Basic organizational
functions
Each function may have a
role to play in CP!
Purchasing
Materials Control
Inventory
Operations
Quality Control
Shipping
Maintenance
Engineering
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Implement
Measure,
review
Board/Owner/Partners
Production
Accounting
& Finance

Prioritize
Evaluate
Sales &
Marketing
Environment,
Health, &
Safety
21
Getting
1
Organized
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
In small organizations, single individuals often
perform many functions: (“wear many hats”)
sales
accounting
owners
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manager
Prod’n
Shipping
Handout: “Cleaner
Production Team”
22
Getting
1
Organized
So now. . .
Assemble
your team.
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Set challenging CP goals, ensuring they
are aligned with business objectives
Essential for success:
Identify a leader for the CP process:
Get management support
AND
Identify potential barriers to the CP
process (e.g., institutional) and identify
solutions
Identify external resources
(e.g., CP centers, technical assistance)
Seek input from personnel at all levels
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23
2
Identifying CP
Opportunities
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
OVERVIEW:
1. Assess costs to identify areas for
efficiency improvement
2. Use process mapping as a tool to
understand flow of materials,
energy, and waste
3. If necessary, use Root Cause
Diagnosis to figure out WHY a
problem exists
4. Use option generation techniques
to identify possible CP solutions
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We will learn
about each of
these tools

24
3
Prioritize
& evaluate
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
OVERVIEW
1. Determine the value of each CP
option based on:




Profitability (costs versus savings)
Risk and cash-flow issues
Level of commitment needed
Alignment with business objectives
CP options are
evaluated with the
same criteria as any
business investment
2. For projects needing capital
investment, conduct a project
profitability assessment
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4
Implementation
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
OVERVIEW
1. Establish a concrete yet attainable
schedule with check-in points;
action plan
2. Assign responsibilities
3. Allocate necessary resources
4. Work with employees who will be
affected, getting feedback from
them regarding the initiative
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 CP
implementation
is just like
implementing
any other
change in a
business.
26
5
Measurement
& review
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
OVERVIEW
 Collect data before/after to measure
and document success
 Periodically review your CP
initiatives in conjunction with your
business plan
 Goal: Continuous improvement!
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27
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Module 5:
The CP process and
tools/techniques for CP
implementation
5.3:
Step 2 of the CP Process:
Identification of CP opportunities
FOCUS: cost accounting
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28
WHY COST ACCOUNTING?
 Assessing the costs of
Remember:
waste is essential to
identifying the problems
that CP should address
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29
Cost categories
In any enterprise, there are three broad
categories of costs:
The cost of
production inputs
Materials, energy,
labour, capital,
etc.
The costs of
management of
materials, energy,
& waste
Waste handling,
regulatory
compliance, supply
chain requirements,
waste treatment and
disposal, non-product
losses, etc.
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Less tangible
costs
Production
throughput, product
quality, company
image, liability, etc
Handout: “Costs
checklists”
30
Problematic accounting practices. . .
Waste imposes costs in
all three categories
But problematic
accounting practices
Costs can be. . .
hide its true costs
A. “Hidden” in the
accounting records
B. Misallocated from
overhead accounts
C. Mis-classified as fixed
when they are really
variable, or semi-variable
D. Not found in the
accounting records at all
(Can you think of others?)
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31
CASE
STUDY
Problematic Accounting Practices:
Hidden costs of raw materials
Manufacture of
Plastic Rear Panels for Automobiles
MATERIAL LOSSES (as % of input)
2%
per accounting
records
52%
actual
How did this happen?
Engineering
specification allowed
50% waste;
accounting records
only showed
waste/loss in excess
of specification
Adapted from: Rooney, Charles. “Economics of Pollution Prevention:
How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.
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32
CASE
STUDY
Problematic Accounting Practices:
Hidden costs of raw materials
“PLS” packaging company
(printing and assembly of potato chip bags)

Accounting
records show:
 The amount of raw
materials used
!
 The amount of
final product
shipped
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Accounting records
do NOT show:
 The amount of
solid scrap waste
generated
 The amount of any
other lost raw
materials
We will learn more
about the PLS
company in our
practical exercises
33
EXAMPLE Problematic Accounting Practices:
Misallocation of costs
Consider 2 identical production machines with
different utilization. How should you allocate a total
electricity cost of $100/day between the units?
Unit 1
100 units/hr
2 hours/day
Unit 2
100 units/hr
8 hours/day
!
BAD:
 GOOD:
$50/day
$20/day
$50/day
$80/day
If investing in a more efficient
unit, replace/upgrade unit 2 first!
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34
The
Concept
Problematic Accounting Practices:
Misallocation of costs
In accounting, costs initially
assigned to overhead accounts
(e.g. utilities) are usually
allocated back to processes,
products, or projects using an
allocation basis such as:
Quantity of raw
materials used
Machine hours
Production
volume
Labor hours
Floor space
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As in the previous slide:
!
An incorrect allocation gives
incorrect cost signals!
!
Correct allocation is needed
to accurately target CP
efforts, and support better
internal decision making.
35
Problematic Accounting Practices:
Mis-classification of fixed vs. variable costs
Fixed costs are costs that do
not vary with production
level or other factors
Variable costs are costs that
are costs that do (or can)
vary with production level or
other factors
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Equipment
depreciation
Permanent labor
Rent
Loan Interest
Raw materials
use
Energy use
Casual labor
Water use
36
Problematic Accounting Practices:
Mis-classification of fixed vs. variable costs
The goal of Cleaner
Production is to reduce
variable costs (or prevent
end-of-pipe fixed costs)
“If CP efforts
will reduce a
cost — then it
is variable!”
Therefore,
it is important to correctly
distinguish between fixed
and variable costs when
identifying and estimating
costs to support CP efforts
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37
Problematic Accounting Practices:
Mis-classification of fixed vs. variable costs
!
A cost considered
“fixed” at one firm may
be considered “variable”
at another firm !
!
Future “fixed” costs are
not fixed yet—CP applied
now may reduce the size
and cost of equipment
that you may have to
purchase in future
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38
Problematic Accounting Practices:
Missing costs
In general, two types of costs may be entirely
missing from the accounting records:
Handout:
“Assessing
Contingent
and LessQuantifiable
Costs”
permit and other
environmental
fees
lost sales due to
returned
products
Less tangible
costs
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For example
Future costs
For example
(variable)
(fixed)
Lost
sales due
to failure
to meet
customer
spec
Future
depreciation
costs of new
equipment
Equipment
replacement
lost sales due to
returned
products
Cost to reputation of
product quality
problems
Lost profit from
product quality
problems
Etc.
39
Ease of identifying/estimating costs
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
Equipment purchase,
direct materials, energy, labour
Waste disposal
Recycle/rework, treatment,
waste handling
MORE
HIDDEN
Regulatory compliance,
other indirect costs
Less tangible costs
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40
So, now we know all the problems

of cost accounting.
But how do we actually
get started?
?
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41
The basic “recipe”
for quantifying the cost of waste
First, check
the general
ledger
& production
records to
obtain all
available
information
about costs and
quantities of
inputs and
outputs
1
Production records
contain the volume of
goods produced
Sometimes, they
include information
such as physical
quantities of inputs
used and number of
rejected products.
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The general ledger
contains only external
transactions, not
internal flows between
departments or
production steps. It will
show inputs purchased
and goods sold.
However, physical
quantities (kg, litres,
kwh) of inputs
purchased are often not
recorded.
42
The basic “recipe”
for quantifying the cost of waste
2
Match cost & quantity information
to the process diagram:
 assign costs & quantities to all inputs
 assign quantities to all wastes
3
Process diagrams are
our next topic.
Calculate the total cost of each
waste, which includes
 the cost of purchased inputs
from which the waste is made
This is the hard part—
but doing is easier
than explaining
 the labor expended on these inputs
 costs of managing the waste
(labor, treatment costs, etc.) .

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We will LEARN BY
DOING with practical
exercises.
43
Potential sources of cost data
Often the general ledger and production
records don’t provide all needed information.
So where do you look?
Internal data sources
Original
records in
other
departments
Non-product
outputs/
product
losses*
Employees
Activitybased costs*
*only relatively sophisticated SMEs
will have this information
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External data sources
Industry
colleagues or
trade
associations
Vendors and
consultants
Business
partners
(e.g.,
insurance
firm)
Government
(e.g.
environment
agency)
44
Group exercise–
Cost accounting at the PLS
company [45 minutes]
(see handout)
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45
Basic PLS Process
Printed Plastic
(Interim Product)
Plastic film
STEP 1:
PRINTING
Laminated Sheets
(Interim Product)
Plastic Aluminum
film
film
STEP 2:
LAMINATING
STEP 3:
SLITTING
FINAL
PRODUCT
Scrap
Scrap
Scrap
To incineration
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Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Module 5:
The CP process and
tools/techniques for CP
implementation
5.4:
Step 2 of the CP Process:
Identification of CP opportunities
FOCUS: process mapping
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47
Process mapping
Process maps are:
the schematic depiction of a
production process
They divide a
process into
basic steps
and list
inputs and
outputs for
each step
Sand (new/old),
bentonite*, coal dust,
water, energy
Sand mixing
area
Dust, gases, noise,
reject mixed sand,
surplus sand
Patterns, mold forms,
sand filling, coatings,
energy
Molding
Molding Section
section
Dust, gases, surplus
sand, noise, rejected
molds
liquid metal
Casting area
Energy
Midland Metals
Foundry Process Map
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Shake-out &
Cleaning area
Gases, organic fumes
Dust, gases, mold
forms, used sand
Finished
products
48
Process mapping
Process maps are
constructed in a
particular way:
Product materials:
become part of the product
Material & energy inputs
(product & non-product materials)
Interim product
(from previous
work step)
Work Step
Non-product loss
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Non-product materials:
not incorporated into product
Interim/final product
(to next work step)
Non-product loss
material or energy that is lost
as scrap, waste, or emissions
49
Process mapping
Process maps. . .
 Are a key tool for understanding the
production process

Makes relationships between
operations visible and lead to a
systems view of the business

Can be used to keep track of both
quantities of inputs and outputs
AND costs

Are extremely useful for helping
communicate CP opportunities to
management & all departments
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Making a process
map is therefore an
essential part of the
identifying CP
opportunities.
50
Don’t all facilities already have process maps?
!
NO.
Micro-enterprises rarely
have any process
documentation.
Small enterprises usually
keep separate
documentation by
department or machine.
There is rarely
documentation that makes
connections between all
process steps.
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Sophisticated SMEs
may have information
in the form of Flow
charts, Value stream
maps, Process and
instrumentation
diagrams, Machine
configurations, Arrow
diagrams, Box
diagrams, Floor plans,
etc. All are complex;
none replace a basic
process diagram!
Handout:
“Understanding a
Process with
Process Mapping”
51
CASE
STUDY
“Nutrimeat”
Enterprise Profile:
country
sector
employees
production
market
Philippines
Abattoir
90 (regular &
contract)
300-700
animals/day
Exportquality
products
produced to
high hygiene
standards
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52
CASE
STUDY
fuel
Process mapping: “Nutrimeat”
water
water
Transport
Live
animals
• Animals delivered in
trucks;
• Trucks are washed
Faeces, urine,
contaminated
water
Animals
dead on
arrival
Holding &
Inspection
Live
animals
• Animals are held in pens
& inspected.
• Condemned animals are
separated and killed.
Condemned
animals
Faeces, urine,
contaminated
water
Incineration
Wastewater treatment
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53
CASE
STUDY
Water
Process mapping: “Nutrimeat”
Energy (to sterilize
equipment)
Disinfectant
Stunning
& Bleeding
Animals are first
stunned or killed,
and then bled
Faeces, urine,
contaminated
water
Carcass
Water
Disinfectant
Evisceration & Splitting
Carcass
• Abdomen cut open & viscera removed
• Breastbone split
• Heart/liver/lungs removed;
• Head removed
• Carcass cut into two along the spine
blood • Hide removed
Wastewater
Intestines,
edible organs
Condemned parts
Hides
Inedible offal & Parts
Wastewater treatment
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Incineration
54
CASE
STUDY
Process mapping: “Nutrimeat”
Energy (for
refrigeration)
water
Chilling
Carcasses
refrigerated
overnight
Energy (to sterilize
equipment &
refrigeration)
Carcass
Energy (to sterilize
equipment &
water
refrigeration)
water
Meat
Cutting &
boning
Carcasses are cut
into pieces for
retail, some bones
removed
Packaging
Bones
fat
Leaks of refrigerant fluids (Ammonia, CFCs
wastewater
Wastewater treatment
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55
CASE
STUDY
Process mapping: “Nutrimeat”
Some secondary production processes
Waste treatment
processes
?
?
?
Incineration
Condemned animals
and parts
?
Secondary production
processes
? ?
?
Rendering
Parts and scraps
are rendered for
tallow
?
?
And what other processes?
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56
CASE
STUDY
Result of the Nutrimeat CP assessment
Process mapping + cost
accounting revealed 3
key areas for efficiency
improvement:
1
reducing “dead on
arrival” animals
2
Finding alternatives
to incineration
3
Housekeeping
measures to reduce
water use
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57
Group exercise–
Process mapping at the
PLS company [45 minutes]
(see handout)
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58
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Module 5:
The CP process and
tools/techniques for CP
implementation
5.5:
Step 2 of the CP Process:
Identification of CP opportunities
FOCUS: Root cause analysis &
CP options generation
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59
Causes of inefficiency?
Now, you have
 Gathered cost information
 Made a process map
As a result:
you understand the costs of
waste & have identified key
inefficiencies/ problems.
But: no solution is possible
without understanding the
CAUSE of the problem(s).
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
Sometimes, the cause of
the problems is clear.
!
Sometimes it is not
60
?
If the “root cause” of a problem
is not clear, what do we do?
Root cause
analysis
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61
A tool for Root cause analysis:
The fishbone diagram
A fishbone (causes tree) diagram
is
is a simple tool for
identifying the true causes
of a problem.
it divides all causes into four
categories:
Materials
Machines
People
Methods
Possible causes in each category are
then systematically identified.
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Again, doing
is easier than
explaining
62
CLASS
EXERCISE
Root cause analysis:
The XYZ bakery
A CP analysis of a bakery identifies
BURNED BREAD as the main problem.
Burned bread is a waste with high
costs!





Cost of inputs (flour, yeast, sugar, etc.)
Cost of labor to make the bread
Cost of fuel for the oven
Lost profit
And. . . If the incidence of burned bread is
reduced, the business can expand without
buying a bigger oven!
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Identifying CP
options requires
understanding the
cause of the
burned bread
problem.
63
CLASS
EXERCISE
Root cause analysis:
The XYZ bakery
We start by identifying XYZ’s:
materials
Flour +
machines
Oven + ??
people
Employees
methods
Bread recipes + ??
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64
CLASS
EXERCISE
Root cause analysis:
The XYZ bakery
Now, we draw our “causes tree”. . .
Material
Machines
Door seals poorly so
oven heats unevenly
Pans
Some pans are
blackened
Oven
Burned
bread
People
Methods
. . .and identify possible causes in each category.
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65
Root cause analysis
Sample
causes tree
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66
Root cause analysis:
Once you have identified possible
root causes, how do you know
which one(s) are real?
 In a real situation, those who know the
process best should participate in
making the “causes tree”
 Questions can be resolved by talking to
employees and observing the
production process
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67
Root cause analysis: final notes

Keep in mind the
80/20 rule (20% of
causes account for
80% of problems),
so focus on the big
issues and avoid
dwelling on smaller
items
 Often, people focus
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on the obvious
solution rather than
best solution.
Identifying root
causes helps to
identify solutions
that solve the
problem at the
source.
68
Once we understand the root
cause, we look for a CP option
to address it
the CP
 Sometimes
options are obvious.
!
Sometimes they are not.
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69
?
If the CP options to address a problem
are not clear, what do we do?
Generate CP
options
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70
Generating CP options
Two basic approaches
Internal
External
Generating solutions
internally with internal
expertise & creative
thinking
Looking for outside
solutions via research,
technical assistance
can save effort!
existing alternatives
used elsewhere are
often documented in
case studies or
available through
technical assistance
providers
BUT… don’t be
limited to external
solutions. They may not
be the best for your
situation.
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71
Generating CP Options internally
General idea:
get people with knowledge
of the process to think
creatively about solutions.
Focus on generating a
large number of options
THEN worry about
assessing if they are
feasible or practical
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
Experience shows:
Employing worker
knowledge and a little
creativity can lead to
impressive results.
Your team should feel
confident that they can
generate equally or
more effective
solutions compared to
“external experts.”
72
Generating CP Options internally
Two approaches to encourage creative thinking
“BRAINWRITING” – ask each
member of the group to WRITE
DOWN possible solutions
(Often works because people tend
to write more than they say)
“PROVOCATION” –
Encouraging wild and
outrageous suggestions
Have some provocative
solutions to initiate the session
May trigger an unusual but
effective solution
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73
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Module 5:
The CP process and
tools/techniques for CP
implementation
5.6:
Step 3 of the CP Process:
Prioritization and Evaluation
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74
Review:
Where are we in the CP process?
1
Get
organized

We have assembled our
CP team
2
Identify CP
opportunities

We have identified a number of
CP opportunities
3
Evaluate
&Prioritize
4
Implement
5
Now, we must
EVALUATE & PRIORITIZE
these opportunities
Measure &
review
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Which will we address first?
Second? Which are not
worthwhile? Why?
75
Principles and strategies
for prioritizing CP opportunities
FIRST
THEN
Do financial analysis
= evaluating cash flow and
profitability implications of the CP
options
Prioritize, based on financial
information & business priorities.
!
Remember, even if a CP option does not require
capital, it will require management attention—
this is in limited supply! Therefore, prioritization
must be strategic!
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76
Principles and strategies
for prioritizing CP opportunities
How do you prioritize strategically?
1. Remember the
“Pareto Principle”
(or the “80/20 rule”)
2. DO prioritize both
short-term &
long-term opportunities. . .
3. BUT, implement
“low hanging fruit” FIRST
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Consistently, about 20%
of improvement
opportunities provide
approximately 80% of
cost savings. Look for
this 20%!
LOW-HANGING FRUIT are
CP opportunities that are
easy and low-cost to
implement, and which
provide appreciable cost
savings almost
immediately. Use these
immediate successes to
build support for longerterm CP efforts.
77
Total cost* by source
A typical “pareto” (80/20) result
A & B account for about
80% of the total costs of
non-product loss
Sources of non-product loss
*total cost=purchase, disposal & management costs
of material purchased but disposed of as waste
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78
Overview of the
remainder of this section
In the remainder of this module, we will:
 Introduce basic concepts
of financial analysis

 Cash flow analysis
 Profitability Indicators
 Introduce some decision-making
tools to assist in prioritizing CP
opportunities

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79
Financial analysis:
Getting started
Reminder:
financial analysis =
evaluating the cash
flow and profitability
implications of the CP
options.
The same process is used
for assessing any business
project, especially capital
investments
Characterizing the project’s
impacts on cash flow is
always the first step.
Cash flows are used to
calculate profitability
indicators
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80
Financial analysis:
Getting started
Two basic types of
financial analysis
Stand-alone
Incremental
Considers only the cash
flows of the proposed
project
Compares the cash
flows of the proposed
project to the
“business as usual”
cash flows
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Most projects
require incremental
analysis!
In incremental analysis,
you only need to
estimate the cash flows
that CHANGE compared
to business as usual
81
CASH
FLOWS
Basic concepts
Cash outflows
(COSTS; negative)
+
Cash inflows
(REVENUES & SAVINGS;
positive)
= NET CASH FLOW:
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One-time
Annual
Other
Initial
invesment
cost
Operating
costs &
taxes
Working
capital
Equipment
salvage
value
Operating
revenues
& savings
Working
capital
(Elements of cash flows)
82
CASH
FLOWS
Basic concepts
Definitions of special terms
Working capital
“the total value of goods and money
necessary to maintain project
operations”
includes items
such as:
Raw materials
inventory; Product
inventory; Accounts
payable/receivable;
Cash-on-hand
Salvage value
the resale value of equipment or other
materials at the end of the projects
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83
CASH
FLOWS
Timing
INFLOWS
Project
Start
Working
Salvage
Capital
Value
Annual
Revenues/Savings
Year 1
Initial Investment
&
Working capital
OUTFLOWS
Year 2
Year 3
Project
END
Annual Operating Costs
Annual Tax Payments
Annual Financing
Payments
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84
CASE
STUDY
Cash flow for a
CP Project at the PLS company
We return to the PLS
company. . .
Enterprise Profile:
location
sector
product
size
Southern
Africa
Packaging
Laminated film
for food
packaging
SME
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85
CASE
STUDY
Cash flow for a
CP Project at the PLS company
CP Opportunity:
Quality control camera
 The camera will detect
problems with the
manufacturing process
and stop the process
automatically
 Will reduce the amount of
scrap/rejected product
Costs &
Savings
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Investment cost
$100K
Annual cost savings
(materials)
$40K
One-time savings:
Avoided wastewater
treatment plant upgrade
(year 3)
$55K
Working capital
$0
Salvage value (Camera,
year 3)
$10K
86
CASE
STUDY
Quality control camera
at the PLS company
Outflow
Inflow
Net
cash
flow
Year 0
100K
0
-100K
Year 1
0
40K
-40K
Year 2
0
40K
+40K
0
40K +
55K +
10K
+95K
Year 3
Using the costs and
savings, we can figure
the net cash flow each
year on an incremental
basis. I.e., this is how
cash flow changes
compared to business
as usual
For analysis purposes, we assume the project
ends at year 3 & the salvage value of the
camera is recovered
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87
In our PLS example,
total investment = $100K &
annual savings = $40K
?
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Would you
recommend this
investment?
88
Profitability assessment:
interpreting cash flows over time
!
There is no simple
answer to this
question.
HOWEVER, using
PROFITABILITY
INDICATORS will help
with the decision
A profitability indicator, or
“financial indicator” is a single
number that characterizes
project profitability.
Common profitability indicators:
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Simple
payback
Return on
investment
(ROI)
Net present
value (NPV)
Internal rate of
return (IRR)
89
Profitability indicators:
Simple Payback and Return on Investment
These indicators incorporate
 The initial investment cost
 The first-year cash flow
Simple Payback
=
(in years)
ROI (in %)
=
Initial Investment
Year 1 Cash Flow
Year 1 Cash Flow
Initial Investment
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90
Profitability indicators:
Simple Payback and Return on Investment
How are
ROI and
simple payback
used?
In larger companies, the simple
payback or ROI calculated for a
project are usually compared to
a company rule of thumb called
a “hurdle” rate:
A project must meet the “hurdle
rate” to be considered by
management.
Our company may
rule is that project
payback must be 3
years or less.
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Which means ROI
must be 33% or
MORE.
91
CASE
STUDY
Quality control camera
at the PLS company
In our PLS case, what
is simple payback and
ROI?
PAYBACK=
INVESTMENT/YEAR 1 SAVINGS
= $100K/$40K
= 2.5 yrs
ROI=
YEAR 1 SAVINGS/INVESTMENT
= $40K/$100K
Investment cost
$100K
Annual cost savings
(materials)
$40K
One-time savings:
Avoided wastewater
treatment plant upgrade
(year 3)
$55K
Working capital
$0
Salvage value (Camera,
year 3)
$10K
= 40%
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92
!
ROI & Simple Payback
have a problem.
They do not account for the time
value of money
What do we
mean?
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93
The time value of money
If we were giving away money,
would you rather have:
? $10,000 today?
? $10,000 three years
from now?
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!
94
The time value of money
$10,000 today, thanks
$10,000
today,
thanks!
WHY?
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95
The time value of money
There are 2 reasons for
answering “today”
Inflation
Investment opportunity
Both are the source
of the “time value of
money” (TVM)
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96
The time value of money (TVM)
Inflation
Investment
opportunity
Money loses purchasing
power over time as product/
service prices rise, so:
A dollar today can buy more
than a dollar next year
How much does it cost?
This year
A dollar that you invest
today will give you more
than a dollar next year —
having the dollar now
provides you with an
investment opportunity
$1 today
$1
Next year $1.05
investment
$1.10 a year from now
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97
TVM and profitability assessment
When you invest in a capital
project, you have:
 An initial investment
happening NOW

series of cash inflows IN
 AFUTURE
YEARS, that pay
back the initial investment
over time
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So, it is
important to
take the TVM
into account
when you are
estimating
project
profitability
!
98
TVM: Present value of future cash flows
Typically, we
take TVM into
account by
converting all
FUTURE cash
flows to their
PRESENT
values
The idea is to DEPRECIATE
future cash flows at a particular
annual rate, the discount rate
The calculation is exactly the
opposite of calculating bank
interest
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99
TVM: Present value of future cash flows
The value of the cash
flow in year n
Present Valuen = Future Valuen
(1 + d)n
The value of the cash
flow for year n at “Time
Zero,” i.e., at project
start-up
d = the discount
rate
n = the number of
years after project
start-up
Handout:
“Performing NPV
calculations”
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100
TVM: Present value examples
What is the present value of $1 in the future?
Discount rate (d): 10%
20%
30%
40%
Years into future (n)
1
2
3
4
5
10
20
30
.9091
.8264
.7513
.6830
.6209
.3855
.1486
.0573
.8333
.6944
.5787
.4823
.4019
.1615
.0261
.0042
.7692
.5917
.4552
.3501
.2693
.0725
.0053
.0004
.7142
.5102
.3644
.2603
.1859
.0346
.0012
.0000
Present
value factors*
*Note: present values can be calculated
easily with present value factors
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101
Profitability indicators:
Net Present Value (NPV)
If we:
1
2
figure the present
value of the net cash
flow for each year of
the project.
And then add all
these present values
together,
we obtain the
NET PRESENT
VALUE (NPV)
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NPV is calculated for a
particular project lifetime. It
does not consider cash flow
beyond that time period


If NPV > 0, the
project is profitable
If NPV < 0, the
project is not
102
CASE
STUDY
Quality control camera
at the PLS company
In our PLS case, what
is the NPV?
It depends on the
discount rate!
(and the time period)
Net
cash
flow
Present
Value
(10%)
Present
Value
(15%)
Present
Value
(20%)
Present
Value
(25%)
Present
Value
(30%)
Year 0
-100.0
-100.0
-100.0
-100.0
-100.0
-100.0
Year 1
40.0
36.4
34.8
33.3
32.0
30.8
Year 2
40.0
33.1
30.2
27.8
25.6
23.7
Year 3
95.0
71.4
62.5
55.0
48.6
43.2
40.8
27.5
16.1
6.2
-2.3
NPV
All figures in 1000s of dollars
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103
TVM: choosing discount rates
Discount
rates make a
big
difference to
profitability!
When borrowing money:
the discount rate is AT LEAST the
cost of capital (i.e., bank interest
plus loan fees)
When investing one’s own money:
How do we
choose the
right one?
+
+
=
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inflation
rate of return on alternative
investments
risk premium
discount rate
104
Profitability indicators:
Internal rate of return (IRR)
IRR is
the discount rate for which
NPV = 0, over the project lifetime.
The IRR tells you what
discount rate makes the
project just barely
profitable
IRR is similar to NPV in
that it considers both the
time value of money and all
future year cash flows
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105
CASE
STUDY
Quality control camera
at the PLS company
In our PLS case, what is the IRR?
Net
cash
flow
Present
Value
(25%)
Present
Value
(30%)
Year 0 -100K
-100.0
-100.0
Year 1 +40K
32.0
30.8
Year 2 +40K
25.6
23.7
Year 3 +95K
48.6
43.2
NPV
6.2
-2.3
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By inspection, IRR is
between 25% and 30%
Exact calculation:
IRR=28.6%
IRR must be calculated
iteratively
Financial calculators and
spreadsheets calculate IRR
automatically

106
Comparing profitability indicators
Simple
Payback
& ROI
Advantage
Disadvantage
Easy to Use
Neglect TVM
Neglect out-year costs
Do not indicate project size
NPV
Considers TVM
Needs firm’s discount rate
Does not indicate project size
IRR
Considers TVM
Requires iteration
Does not indicate project size
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107
Do financial indicators tell everything
about financial feasibility?
! NO.
Considering the
individual
circumstances of
the enterprise is
critical!
For example,
considering NPV
or IRR is not
helpful if:
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The firm has no
significant cash reserve
and cannot obtain
financing, OR
Can obtain only a very a
small amount of financing
(NPV and IRR do not
indicate SIZE of project.)
In these cases, improving
cash flow in the short
term is the only option
108
“Experience shows that for the
smallest enterprises, simple
payback of a year or less is a
good rule of thumb.
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109
Prioritizing CP options
Now, we have
evaluated the
potential CP
opportunities from
a financial
perspective.
However, financial
considerations are
only one element of
deciding to
implement a
project
Technical
?
Financial
Regulatory
Organizational
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How do you
weigh all these
considerations?
110
 A number of decision-making aides for
prioritizing CP options exist

!
However:
Decision-making aides can’t make a
decision for you! They can only
facilitate systematic consideration of
the issues involved.
Some examples
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111
Decision-making aides for prioritizing CP options
The Criteria Matrix
The criteria matrix forces a systemic comparison of
options according to specific criteria.
Determine a score for each cell on a 1-5 scale:
1: poor/expensive/difficult
5: excellent/not costly/easy
Complexity
Initial cost NPV
Maintenance
& Reliability
Total
CP
Option 1
CP
Option 2
Criteria are examples only—choose criteria that
reflect the particular circumstances
CP
Option 3
Add the score in each category
to determine “winners”
Improving MSME Performance through Cleaner Production.
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112
Decision-making aides for prioritizing CP options
Forced pair analysis
In forced pair
analysis, options
are compared
systematically in
pairs. The result is
a best to worst
ranking of options.
Let’s say we have
4 CP options, A-D
1
A
C D
2
First, compare A & B
3
Let’s say B is best.
So B moves to the top of
the list
B
4
Improving MSME Performance through Cleaner Production.
Module 5: The CP Process & Tools. Visit www.encapafrica.org.
B
A C D
Now, compare A & C
113
Decision-making aides for prioritizing CP options
Forced pair analysis
5
If C is better than A,
the new order is
B
6
BUT
C A D
Now, compare D to
A
If A is better than C,
the order remains
B
OR
A C D
Compare C to D
In either case, D will move “up the list”
until it loses in comparison to another
option.
Improving MSME Performance through Cleaner Production.
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114
 Remember, implement
“low hanging fruit” FIRST

Improving MSME Performance through Cleaner Production.
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115
Get
organized
ID
opportunities
Prioritize
Evaluate
Implement
Measure,
review
Module 5:
The CP process and
tools/techniques for CP
implementation
5.7:
Step 4 & 5 of the CP Process:
Implementation and
Measurement/Review
Improving MSME Performance through Cleaner Production.
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116
Review:
Where are we in the CP process?
1
Get
organized

We have assembled our
CP team
2
Identify CP
opportunities

We have identified a number of
CP opportunities
3
Evaluate
&Prioritize

We have evaluated and
prioritized these opportunities
4
Implement
5
Measure &
review
Now, we must
IMPLEMENT our CP
priorities and measure
our progress
Improving MSME Performance through Cleaner Production.
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117
Action plans: the basis of implementation
4
Key elements of action plans
Implement
Implementation requires
an ACTION PLAN.
goals
Specify WHAT will be implemented and the
performance improvements that will result
responsibilities
resources
milestones
metrics
Improving MSME Performance through Cleaner Production.
Module 5: The CP Process & Tools. Visit www.encapafrica.org.
Specify BOTH who will coordinate &
who will carry out specific tasks
Identify the resources required for
implementation
Set out specific implementation steps &
WHEN they should be achieved
Specify how goals and
milestones will be measured
118
Action plan matrix
Summarize your action
plan in a matrix:
CP Project:
Goals:
Milestone
Coordinator:
Target date
Responsible
Person
How
measured
Resources
Needed
1.
2.
3.
In larger organizations, the matrix is used to
obtain management sign-off/approval
Improving MSME Performance through Cleaner Production.
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119
Why measure and review?
5
Measure &
review
Measurement and review
has two objectives:
Keep
implementation
on-track
Monitor the MILESTONES in
the action plan. Where
milestones are being missed,
the coordinator must know &
take action!
Monitor
performance
Once the CP project is
implemented, measure its
actual performance against
its goals.
Performance monitoring
should CONTINUE and
become a part of business as
usual.
Improving MSME Performance through Cleaner Production.
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120
Make monitoring of
CP implementation business as usual
Energy is 50% of our production
cost. We implemented good
housekeeping and equipment
modifications to improve energy
efficiency.
Now, the production department
reports kWh of electricity used
per kilogram of product to
management each month.
In fact, we have a continuous
improvement goal of reducing
kWh/kg by 5%/year.
Improving MSME Performance through Cleaner Production.
Module 5: The CP Process & Tools. Visit www.encapafrica.org.

Monitoring
supports
continuous
improvement
121
REVIEW of module 5
Waste is
inefficiency and
imposes many
costs on
businesses. Its
true cost is often
hidden.
Via the CP process, we
identify the true costs
of waste, prioritize
problems and CP
options, and implement
these priorities
systematically.
Improving MSME Performance through Cleaner Production.
Module 5: The CP Process & Tools. Visit www.encapafrica.org.
1
Get
organized
2
Identify CP
opportunities
3
Evaluate
&Prioritize
4
Implement
5
Measure &
review
122