14.1. Economic analysis and cost control
14.2. The methods of economic project analysis
14.3. Cost control in established enterprises
Charcoal producers fall into two groups. The first are subsistence producers who only market charcoal to acquire cash needed to buy goods or pay taxes, etc. Economics and cost control are of little interest to this producer. He needs the cash and selling some of his charcoal is a way to acquire it.
The second group produce and sell charcoal as a business in which the circulation and growth of the capital they have invested in the business is their main concern. Economics and cost control are important for them.
Although the first group is personally not much concerned with economics, government authorities concerned with improving the charcoal industry must study the economics of subsistence charcoal production. An economic analysis must be the basis of any assistance programme to enable these producers to make more and better charcoal. In many countries subsistence produced charcoal is a major part of total charcoal production. Economic analysis is important to define the future of this sector of the industry, reveal its positive and negative features, and its long term viability.
It is difficult to draw a sharp line to divide these two activities. Generally, economic analysis is of direct use in the planning phase of the development of the enterprise to project the cost of constructing and getting it into production. The objective is to demonstrate the economic feasibility of the proposal, then mobilise the investment funds required and lay down how they will be managed and repaid. Cost control, on the other hand, is concerned more with an enterprise which is up and running. It is the management tool which enables the enterprise to remain economically viable.
Production cost control is built around and forms part of the operations of a producing enterprise. It can be carried out with a background knowledge of accountancy or even just bookkeeping. The main requirement is to always use production data and statistics which are measured in the plant itself. On the other hand, economic analysis of projects requires a deeper knowledge of economics and a technical knowledge of the processes which will be used. A large project calls for a team of technicians, some more qualified in economics, others in technology and engineering.
The process of economic analysis of projects is often called a feasibility study but, strictly speaking, this is only one step along the road to setting up a complete project. For large and medium size charcoal projects (3, 22) a team of professionals is required who must cover the fields of economics, forestry, building and civil engineering, technology of the process of production, finance and marketing. The complete study for the charcoal industry has the following aims:
1. To provide that a market or end use of adequate size exists for the charcoal and any by-products and to quantify it in detail.
2. To prove that suitable and adequate wood raw material exists and can be harvested economically for the expected life of the plant or to prove that a suitable raw material resource can be economically generated by forest plantations.
3. To choose the production technology to be used and to design the entire production system from wood harvesting through to packaging and marketing of the finished charcoal.
4. To prepare complete financial projections showing the method of financing, detailed expenditure budgets for land plant, site preparation, infrastructure, construction, start-up and training costs. The financial projections must be carried forward approximately twenty years to a point where debts incurred in construction of the plant have been liquidated and the enterprise is functioning as an established business. For the manufacturing enterprise about twelve to fifteen years projection may be sufficient but, if the enterprise is to establish plantations for wood supply, then it is necessary to extend the financial projection till the plantation has gone through a complete rotation, involving replanting which could be twenty years or more. The financial projections will be in the form of a financial model showing profit and loss, sources and expenditure of funds, taxation and cash flow.
5. To prepare documentation for negotiations with government agencies on questions of forest resources, plant site, power and water supplies and other tax concessions, infrastructural needs, control of pollution, etc.
6. Prepare documentation and negotiate with financing agencies, both national and international, to secure financing for the project.
The list of requirements is formidable and costly and time-consuming to accomplish. Fortunately, more or less routine procedural sequences for accomplishing this work have been worked out by international finance authorities and the process is divided into a number of steps which are designed to test the feasibility of the project before committing funds for a complete technical and financial study. Normally the complete project study is preceded by, at least two steps, called a pre-feasibility and a feasibility study. If the results of these studies are positive, then it is worth committing funds for a full project planning exercise leading to the financing and construction of the enterprise.
The value of the complete study depends, in the long run, on the quality of the basic data on which the study rests. A study based on false premises is useless. Only experience in the field can indicate whether the data base is reasonable or not. As a guide to the effect of errors in basic assumptions, it is usual to test the complete financial model of the project, using varying values of key assumptions such as selling price of charcoal, percentage of fines, charcoal yield during carbonization, cost of wood delivered, growing and harvesting costs, growth rates of plantations, and so on. The degree of risk entailed by variations in principal cost factors then becomes clearer and enables key factors to be more closely scrutinised. Once the financial model has been prepared and programmed on a computer, such studies are relatively simple to carry out. Planning is relatively simple: the difficult task, especially nowadays with high interest costs, is to construct the plant and get it operating profitably within the available financial resources. If there are serious cost overruns or construction delays, a situation can easily arise where the project cannot be completed or can never operate profitably. Hence the need to seek solutions in charcoal making which require minimum capital investment.
14.3.1. The unit operations
14.3.2. Unit costs and budgeting
14.3.3. Supervision and management overheads
Procuring finance for and constructing a large new enterprise for making charcoal nowadays is a difficult and costly proposition. As stated earlier, capital and interest costs are so high that a few construction delays can transform a profitable project into a permanent loss maker. Therefore, more attention needs to be given to improving and developing established charcoal making operations by building on the intrinsic expertise and resources they possess, eliminating or reducing constraints which prevent them from functioning at maximum efficiency. It is usually easier and often more successful financially to expand an existing enterprise than to construct a completely new, large scale one and expect it to operate profitably without difficulties.
Established enterprises and traditional production systems are not all successful or soundly based. Nevertheless there always exists a structure of skill and experience within the system which can often be mobilised to work more effectively by proper cost control.
The first step in cost control is to set down the unit operations of charcoal making and decide on a system of cost centres, usually the same ones as the unit production operations. The following example is taken from operations in the Chaco forests of South America (3) where charcoal is made on a large scale by traditional but well organised methods. The unit operations are shown in figure 14. These unit operations can be used as cost centres and unit costs calculated for each one. As total production cost is the sum of each unit cost, providing they are expressed in a common unit of measurement, e.g. per ton of charcoal at the side of the kiln, the relative importance of each unit operation becomes clear. For example, the unit cost of harvesting wood and delivering it to roadside may be calculated as $5 per stere. This cost must be expressed in dollars per ton of charcoal at side of kiln before its contribution to overall costs can be clearly seen. This cost depends on the yield of subsequent unit process steps. In general, the only significant one is the loss during carbonization. The cost of $5 per stere must be multiplied by the number of steres needed to produce one ton of charcoal free of fines. A typical figure could be 7.3 steres of wood produce one ton of charcoal free of fines. The cost of the wood at side of the road per ton of charcoal is then $5 x 7.3 = $36.50 per ton of finished saleable charcoal at side of kiln. This process must be applied to all unit costs to determine their overall effect on product cost. Technical knowledge of the process as well as cost accounting skill is needed for this and to decide whether efforts to reduce the effect of a particular unit operation on costs could be worthwhile; e.g. yield of wood per hectare could be raised, by gathering more small diameter branchwood. But if this wood mainly produces only fine charcoal in the kiln, the effort could be counterproductive. Tests would be necessary to clear this point. Hence the need to combine the efforts of the technician and the cost accountant to control costs.
Cost targets have to be set up in the budget for cost control. It is easier for each sector if its budgeted costs are set in the unit of measure it uses at that point, e.g. stere of fuelwood, ton of charcoal, ton/kilometre of charcoal, and so on. These figures are combined by management using appropriate conversion indices to check on overall performance in terms of the budget for the whole enterprise. To measure performance for the whole enterprise it is necessary to carry out process inventories on a regular basis, about every one to three months. The physical stock of raw material, semi-finished and finished charcoal, when combined with the input of wood and shipments of charcoal over the inventory period, enable the overall results to be calculated. In addition, records must be kept in each department of the material used, output achieved, number of kiln cycles. Unusual events such as floods, prolonged rainy periods, very dry conditions, labour shortage, equipment breakdowns, and transport delays also need to be noted in the production records of each department. Means to weigh and measure are essential.
Every system of management control and cost budgeting requires staff and costs money. The effort achieved has to be worthwhile. Therefore the costs of management, again divided into sectors, must be calculated and the cost apportioned to the various sectors. Cost analysis for each unit operation may reveal whether some operations could be better carried out by subcontract. This normally requires lees supervision and overhead costs. Transport is a particular case where contractors may well be cheaper than an internally organised system.
Collection and assessment of cost control data normally requires an extra technician who may also be responsible for quality control, etc. The processing of the raw data for management use is then usually carried out by the clerical staff of the office.
Calculated costs of actual unit operations are then compared by management with the budgeted costs set up at the start of the financial year. Action can be taken to reduce cost overruns where they occur and, at the same time, the financial situation of the enterprise is revealed on at least a month by month basis. The actual profit and loss result of the enterprise is not known down to the last cent by this process. The exact financial results come from the normal financial accounts which are kept parallel with the cost accounts. The financial accounts, however, give only a historical picture of results, which may be too late to enable corrective action to be taken.
Fig. 14. Unit operations in charcoal production