Wednesday, April 22, 2009

Getting the Most from an Energy Audit: Five Tips

1. As tempting as it may seem, think carefully about “free” energy audits. If the auditor is not working for you, then they are working for someone else. That MAY work to your disadvantage. Don’t be surprised if a window installer’s free energy audit concludes that your first priority is to install new windows! Decisions that shape your energy bills for the next 10-15 years should be free of commercial bias.

2. Have an agenda for your energy audit. That agenda is shaped by the questions you ask. For example:
• How much can I save on utility bills without spending money?
• How can energy-saving features be incorporated in my procurement criteria for vendors and suppliers?
• What energy saving opportunities are directly linked to tax incentives or utility rebates?
• How can a re-classification of energy-related assets improve my overall depreciation performance?
• What energy-saving opportunities will directly contribute to my ability to market “green” products and services?
• What impacts will energy efficiency have on safety, productivity, or material waste?

3. Prepare your key staff for the energy audit. Surprises make people get defensive. Organize stakeholders ahead of time to plan the scope and expectations of an energy audit. Be prepared to explain what’s in it for them (see point 2). Invite staff participation in the audit itself—this helps to make the experience transparent to all who care to observe.

4. Seek a draft report for review before it becomes final. Review this draft with key managers to ensure the technical and “political” validity of the recommendations.

5. Make sure the final report has an executive summary that is in plain English—keep it free of jargon and acronyms. Use compelling financial performance measures. Are you showing simple payback? That's great. What about the cost of doing nothing? Or the cost to buy vs. save a unit of energy? Or, how much revenue would have to be generated to compensate for a dollar lost to energy waste?

Feel free to add your own comments… after all, this is a blog.

Tuesday, April 07, 2009

Cost Segregation: Recapturing Energy-Related Cash Flow

"Cost segregation" is a business exercise for recovering wealth. The idea is to properly reclassify assets from a tax depreciation perspective that allows the owner to legally reduce tax liabilities and increase cash flows.

Here's how it works. A hybrid engineering/accounting exercise seeks to reclassify the assets that make up a subject property. All too often, an earlier accounting treatment of a property has assigned all features to a 39-year asset class for depreciation purposes. This includes the "bricks, sticks, and mortar" as well as the mechanical systems that condition the building's interior. Boilers, furnaces, air handlers, air conditioning systems, domestic water heating, and the like, are tossed into that same 39 year category. The mistake is that many of these systems have a much shorter functional life-- such as 15, seven, or even five years.

With all else being equal, it is advantageous to accelerate asset depreciation. Cost segregation analyses provide an inventory of systems that can be isolated from the building itself (a 39-year asset). This effectively increases near- to medium-term cash flows to the business. Income taxes avoided this way are added directly to annual cash flow. But here lies the one contradiction: if depreciation is accelerated, then annual expenses are increased. This is a good thing in that it reduces tax liabilities (and improves cash flow). However, this is bad from an operating margin perspective. What looks good from a cash flow perspective can actually make an operations manager look bad, because operating expenses increase directly with depreciation, reducing net operating (pre-tax) income.

To make a win-win situation, the organization’s finance and engineering leadership will obviously need to collaborate. Politically, it should be easy to do: you don't have to buy new machinery or force machine operators to change their habits. You don't take up people's time with awareness training. Everyone can "do it the way we've always done it" ...if in fact that's what you want.

But you can and should do better. The cash flows provided by cost segregation can be used to fund the first round of a solid business plan for continuous energy improvement. Such a plan would:
• start with a cost segregation analysis that identifies opportunities for accelerated depreciation;
• use the cash flow derived from this depreciation exercise to invest in energy-related assets that (1) sustain current production levels with less energy input, and (2) provide new investment tax credits or deductions; and
• reap the operating expense savings that the new energy investments provide.

What's it worth? To illustrate the financial impact of cost segregation, consider this: Each $100,000 in assets reclassified from a 39-year recovery period to a five-year recovery period results in approximately $16,000 in net-present-value savings, assuming a 5% discount rate and a 35% marginal tax rate.


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