One message floating around the physical-asset management community is that “reliability and maintenance are an income.” It resonates deeply given the fact everyone wants to feel that whatever we do is important to our organizations. Maintenance is clearly an important aspect and extremely relevant to the success of a company. Yet, from an accounting perspective, the practice of maintenance (and, somewhat by extension, “reliability”) will be booked as a cost, whereas things such as capital expenditures (CAPex) are seen as investments that add value.
SOME SIMPLE FACTS
Viewed in the context of modern business and accounting practices, the statement that “reliability and maintenance are an expense,” can be disheartening. That’s because business leadership may look at reducing the cost of maintenance based on where it’s located in business accounts. This is where we need to begin the discussion of how physical-asset management has value within the organization versus the concept of ‘income.” Seen from the income side, we use terms such as “simple payback,” “cost avoidance,” among others, that don’t match anything in a balance sheet. This is the key disconnect in communications between maintenance and management.
What we should do is relate the value of maintenance practices to the objectives of the company and, specifically, show how that value ties to the balance sheet.
For Learn More About This Topic, Click On The Following Links To
Drew Troyer’s Multi-Part Article “Balance Sheet Basics For Asset Managers”
Part 1: Replacement Asset Value (RAV)
When you tie maintenance actions to company values, the activity may be seen as a direct cost, but the value of the actions can be measured. The objective is to reduce the cost of business and impact depreciation of assets. Some of this is measurable through asset-management metrics (reference: Metrics & Guidelines (smrp.org)) and can tied to corporate metrics such as Return on Assets (ROA), which ties to Return on Equity, and Asset Turnover, which also ties to ROA. Among other things, this includes the counter-intuitive concept of reducing maintenance requirements and reactive maintenance practices which, in the end, improve the depreciation of equipment.
Other aspects of reducing direct balance-sheet expenses include the following:
1. Energy Costs. These costs have a direct relationship to reliability and maintenance practices. As we venture from reactive maintenance to precision-maintenance practices, a direct and logarithmic reduction in energy costs occur, such as in the alignment example in the article “Considering The Direct Energy And Environmental Impact Of Misalignment | THE RAM REVIEW.” Other practices have impacts on electrical and other energy sources with resources available to internally measure at Advanced Manufacturing Office | Department of Energy. These activities are tied to operational expenses and is a direct measure affecting profitability.
2. Depreciation. This is a direct relational decision between departments. The company may consider repurposing, disposing, or selling those assets, each of which determines a different maintenance practice. From one perspective, an asset that will be used for a few years and then scrapped, minimal maintenance practices may be performed, reducing maintenance costs. In these cases, condition measurement practices could be used to ensure that the equipment remains available during its life cycle. In cases where the asset will be used and then sold with the intention that there is good value, a more robust program may be applied.
The above details are just two examples of the application of physical-asset management to the balance sheet. This is where an expense is added in the right column of the balance sheet under operational costs, and the value of the asset is adjusted on the left side of the column. On the expense side of the column for energy, the maintenance cost is increased, and the energy costs (liabilities) are decreased with the cash balance on the left column increasing to balance the positive energy balance. There are several other areas that can be covered, as well, which we may do in a future article.
For other expenses, such as insurance, and a financial impact from, say, greenhouse gas (GHG) emissions, there is a slightly different approach. However, both have an impact on the balance sheet for the company.
1. Safety Impact of Maintenance. The National Institute of Standards and Technology (NIST) identified in Economics of Manufacturing Machinery Maintenance: A Survey and Analysis of U.S. Costs and Benefits (nist.gov) a direct relationship, not correlation, between safety incidents and the application of advanced maintenance practices. This impacts your OSHA 300 reportables (in the USA) and, as a direct result, has a measurable impact on the company’s Workmans Compensation and business insurance costs. When tracked with the maintenance program, the direct costs associated with maintenance of safety equipment, in addition to preventive- and predictive-maintenance practices (planned maintenance) will be an expense in operations, but a reduction in insurance liability. This one requires a little more work and calls for a close relationship between a site’s Maintenance and Safety departments.
2. Greenhouse Gas Emissions. There are two angles to this one. The first is that there is a published (and recognized) cost associated per ton of CO2 (as with other emissions) that can be found in Technical Support Document: Social Cost of Carbon, Methane, (whitehouse.gov). Using Table ES-1, and a 3% discount rate, the present cost per ton of CO2 is $52. Consider the 600-hp motor on a VFD example discussed in the article “Considering The Direct Energy And Environmental Impact Of Misalignment | THE RAM REVIEW.” In it, we identified savings of $6,790 in energy cost for a precision alignment, which resulted in an additional asset value of 48 tons * $52/ton = $2,496, or a total of $6,790 energy and $2,496 in indirect emissions reduction for the balance sheet. If the company were located in a state that traded in carbon credits, the value would be based on the market (which is currently averaging $7/ton CO2). For a company, this is a saleable commodity that lands in the Finance portion of the balance sheet and translates as a real dollar value.
The true challenge comes in tying these areas into company accounting, in which the link between balance-sheet cash and assets, and maintenance-balance-sheet costs are often overlooked. While business accounting practice sees maintenance purely as expense and CapEx as investment, connecting the dots involves reliability and maintenance personnel actually understanding the language of business accounting.
Breaking down the silos that exist between finance and physical asset management also means that a better input related to future plans for equipment is communicated. The discussion of how the asset will be utilized, depreciated, and disposed of assists the reliability engineer or maintenance professional in identifying the best practice for maintenance in its life-cycle context. In turn, the link between reliability, maintenance, and safety provides an additional avenue for credit to the maintenance organization. And, of course, the aspect of tying environmental impact lends another dimension to the overall affect reliability and maintenance has on the corporate balance sheet.
THE BOTTOM LINE
It’s time to accept that physical-asset management is an expense. In the financial world, debit, credit, and expense mean very different things than we normally think. We need to show on the balance sheet what the direct result of our reliability and maintenance expenses and CapEx investments is. By doing so, the proper business impact can be applied.TRR
ABOUT THE AUTHOR
Howard Penrose, Ph.D., CMRP, is Founder and President of Motor Doc LLC, Lombard, IL and, among other things, a Past Chair of the Society for Maintenance and Reliability Professionals, Atlanta (smrp.org). Email him at howard@motordoc.com, or info@motordoc.com, and/or visit motordoc.com.
Tags: reliability, availability, maintenance, RAM, energy costs, safety, greenhouse gas emissions, Return on Assets, Return on Equity, Asset Turnover
