It is no secret in today’s stormy economy… cash flow is tight in businesses and organizations, and energy efficiency at zero upfront cost can appear out of reach. For many, it has been a downward spiral of spending more on operations and being further unable to upgrade systems. However, there are ways to “turn the ship around” and head out of the storm.
Although cash flow constraints delay about a third of good energy management projects from getting implemented, this article describes financing mechanisms that can allow your projects to get implemented…now.
Why Energy Efficiency?
If your company doesn’t have the upfront capital to fund an energy project, you could finance the project (just like your home mortgage) so that the implementation costs are spread out over time and this cost per year is less than your savings cash flow. Financing does not have to be complicated. In fact, financing energy efficiency/green projects can be very similar to your mortgage or car payment with fixed payments for a length of time. The big difference is that your car will not “save” you money like an energy project, which might have a 25% return on investment. Even if you pay 15% interest, you are still saving more money than the finance payments, which means the project becomes “cash flow positive” and does not impact the capital budget! This can allow your CFO to move forward without sacrificing any other budget line item.
Unfortunately, when presented with financing options, a common reaction is to hesitate as people don’t like to enter into long-term contracts or pay an additional financing cost to a lender. However, with many energy management projects, the cost of financing is usually less than the cost of delay. Plus, if you do finance the project, the simple payback is effectively zero!
Table 1 below shows the cash flow for a non-financed project. Assume the project costs $100,000 and saves $28,000 per year for 15 years. This project could get approved IF the client has $100,000 in cash to fund it. The project has a Net Present Value of $ 102,700 and an Internal Rate of Return of 27%.
Now, let’s look at financing the project with a simple loan. Let’s say the client finances the $ 100,000 for 15 years at 10% per year. That means that instead of investing $100,000 upfront (the bank provides these funds), the client pays $13,147 each year to the bank for 15 years. At the end of 15 years, the bank loan is paid off (just like a mortgage or car payment). To keep this simple, ignore interest tax deductions as well as depreciation- which would likely improve the financial benefits even further.
In this case, the project generates $14,853 each year for the client. Because there is no upfront investment required, the IRR value becomes infinity, or you could say that the project’s simple payback is immediate!
Beyond the benefits of financing, there are also ways to get free money for certain types of projects. There are utility rebates, tax refunds, credits, and other sources of free money that will improve a project’s financial return. Here are some useful websites that allow you to see utility and tax benefits in your state:
Let’s walk through a typical project’s approval process. Assume you have developed an energy project that will have a simple payback of 4 years, but the equipment (and savings) will last for 15 years.
The “do nothing” alternative is the most frequent competitor for energy project funding. This phenomenon is totally normal as most bosses will pause before funding a project to be sure that they are getting the best return on investment among all their investment possibilities.
However, many people forget that with energy projects- every moment of “pause” means that more money is being thrown away on unnecessary wasted energy… and you can never recover those wasted funds.
One additional benefit that is often not presented is that many energy management projects, the Internal Rate of Return can be greater than company’s profit margin. In this scenario, you can make a good argument for approving the project, as this will further improve raise the company’s profits.
For further exploration into financing techniques, such as loans, bonds, leases and performance contracting mechanisms, click here to watch a free recorded webinar: http://dl.dropbox.com/u/17735723/Financing-for-Engineers.wmv