Not again, Bob thought. The new system that we proposed is not on the approved projects list. This is the second year in a row it hasn;t made the cut. I thought everyone here supported the purchase. It would make the plant run better and sure make our lives a lot easier. I just don;t understand how those in the head office make decisions. I bet they;ve never worked in a plant.
Perhaps Bob;s comments sound familiar to you. Automation specialists often consider new technologies in terms of the opportunities they provide for improved performance. In contrast, plant and corporate management look at business issues and overall plant profitability. This difference in view frequently leads to misunderstanding and confusion.
Every company has a limited amount of capital available for investment and cannot fund all proposed projects. To stand a chance for approval, new technology must provide a suitable financial return. Many articles have revealed the potential economic advantages and return on investment (ROI) from upgrading automation technology at process plants. Unfortunately, the claimed benefits often are unrealistic and unsubstantiated. This leads to significant credibility issues when the forecast results don;t materialize and contributes to management;s skepticism about proposals in this area. To overcome such concerns, you must perform an accurate financial analysis for these technologies. We will explain how. This can help you obtain support for your next automation investment.
Understand plant economics
The first step is to realize that the plant is a financial asset. We may think of plants as a collection of equipment and personnel that converts raw materials into products. From a financial point of view, a plant is an asset that consumes money and produces money -- it should generate more than it uses. Figure 1 details the major monetary components of a project. [To view Figures 1-4, click on the the Download File button at the end of this article.]
By convention, financial inputs are classified either as expense or capital. Expenses include all the ongoing production costs, such as raw materials, net utilities (those used less those produced) and operating and maintenance expenses. Capital has investment and working components. Investment capital refers to the cost of major equipment or system additions that will last for several years and can be depreciated for tax purposes. Working capital is the value of inventory and required short-term financial funding.
To prepare a precise investment evaluation, we must understand the language and objectives of financial managers. We can only provide a quick overview; a more comprehensive review appears in standard financial analysis references, such as Brealey and Myers .
A company;s management strives to increase the long-term financial value of the corporation to its owners. This value can be measured in many ways, most of which, like stock-market valuation, ultimately reflect financial performance. A popular method for evaluating this performance (Figure 2) is return on invested capital (ROIC). This not only is a good internal measure but also correlates with long-term stock-market results. Consulting company McKinsey  recently published results of a study of 130 publicly traded chemical companies in the United States and Europe and their financial and market performance during a 40-year period. Its conclusion: Only returns on invested capital drive market-to-book valuations.
The yearly ROIC equals the profit measured as after-tax net income, cash adjusted (ATCA), divided by the invested capital at the start of the year. Invested capital consists of fixed and working capital, plus other assets. The boxes at the bottom of Figure 2 list the primary manufacturing variables that affect ROIC. These variables represent decisions made by plant personnel that impact financial results, and exclude other costs, such as land taxes, for example, outside the control of staff. ROIC typically is evaluated as an average over several years to smooth yearly fluctuations and give a better long-term measure.
From a financial point of view, a plant aims to maximize long-term ROIC. How can automation and advanced automation affect manufacturing cost and revenue components?
Realize potential benefits
To increase ROIC, a plant must reduce capital or increase profit or, preferably, do both at the same time. The boxes at the bottom of Figure 3 illustrate the primary areas where automation and advanced automation savings are normally found. When considering a project, evaluate all possible savings areas.
Potential capital savings include both fixed and working capital components. For instance, an opportunity often exists to cut costs of the automation project itself in areas such as:
- purchase price;
- installation, configuration, calibration and commissioning; and
- project execution.
Working capital can be reduced by lowering inventories of raw materials, intermediates and products and also by decreasing stocks of equipment spare parts. One Middle Eastern refinery estimated a savings of $11 million per year from reduced inventory carrying charges. Capital deferred also results in savings due to the time value of money. (Longer equipment life from better control or more production from the same equipment, which allows postponement of plant expansion, can lead to deferred capital.)
Operating cost savings can accrue from lowering energy/utilities usage and decreasing raw material costs by increasing yields of desirable products. In special cases, it may be possible to substitute a lower-valued raw material.
Improved automation performance and enhanced monitoring of process equipment can cut the costs of all types of maintenance. Specific savings can include reductions in: