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Cost Segregation Analysis for Improved
Investment Return
By: Mike Clemens
Cost justification of projects is a challenge we all
face. Here’s an idea to help in this area: asset cost
segregation. This tax analysis technique legally
squeezes additional tax savings out of facility
investments due to faster write-offs; resulting in
higher net-present-values. You can apply the technique
to both new facility construction and existing buildings
(acquired after 1986). You can use the technique for
both new and existing facilities, but we see it most
often used to help justify new construction. We advocate
utilizing “Cost Segregation Analysis” early in the
facility planning process to improve a projects’ return
on investment.
Cost Segregation Definition. There is a growing industry
trend to utilize this accounting practice that leverages
recent (1997) IRS rulings to speed up depreciation
write-offs for facility investments. This ruling affects
depreciable property on the books after 1986. The
analysis that must be performed to qualify for this tax
benefit is a “Cost Segregation Study”. The essence of
the ruling allows the depreciation expense to be doubled
by utilizing an appropriately faster depreciation
schedule. The results of the cost segregation process
can add several percentage points to an investment’s
total return. The rule of thumb of when to consider
going through the cost segregation effort is when the
expenditures for a structure, including leasehold
improvements are more than $750,000. (This threshold
allows the NPV savings gain to cover the cost of the
analysis and still allow some savings for the project
justification.) A typical Cost Segregation study
involves a detailed review and estimate of construction
costs; including all aspects of a facilities’
construction, equipment, and site-work capital spend.
For each project asset, cost elements are created (e.g.
electrical, mechanical, structural, landscaping) and
classified into specific asset categories. These new
categories serve as the basis for recalculating
depreciation write-offs, resulting in greater tax
savings. Architects and engineers need to examine CAD
files and detailed construction cost information during
the analysis to accurately apply costing values to the
proper asset classifications. On a new facility the
engineering and construction firm can provide cost data
once actual costs are known. For existing facilites,
engineers can calculate the savings after reviewing
construction documents and visiting the site.
Developing an Expansion Plan. Companies usually begin
the process of reinvesting in plant and equipment with a
Strategic Planning project. Objectives may encompass
planning for business expansion (growth plans, new
products, acquisitions), or may focus on cost reductions
(plant closures, relocations, or automation). Since most
companies embark on major capital investment projects on
an infrequent basis, it is very common to engage an
outside firm (like Operations Associates) that has
demonstrated expertise in the development and
implementation of real-world solutions. W often work
with an internal team comprised of senior management,
operations, engineering, marketing, information
technology and human resources. This effort usually
includes a close examination of facility locations and
utilization, transportation costs, inventory positions,
and operating efficiencies. The ensuing plans may
require the relocation or replacement of equipment, the
redeployment and reductions in inventory, new or
expanded facilities and new information technologies to
maintain or improve competitive advantages. Key elements
of this plan will be candidates for cost segregation
analysis. Cost segregation most often comes into play on
the new facility portion of the project, which typically
applies to the majority of the investment capital and
often is the most difficult to cost justify.
Justifying Your Project. The projects that get the
funding are usually the ones with the highest rate of
return or at least meet minimum requirements established
by that company. We all face enormous challenges when
determining ways to cost-justify improvements in our
manufacturing or distribution infrastructure to meet
strategic needs. Typical companies have established
guidelines or “hurdle rates” that need to be met before
an investment option will even be considered for
funding. These rates can be in the neighbor hood of
12-15% and are especially challenging to meet when a
need for new or expanded facility has been identified.
There are common areas to look for investment
justification during the process of developing an
economic justification:
• Sales Growth (Profit increase)
• Transportation Cost Reductions (Savings)
• Inventory Investment Reductions (Savings)
• Operating & Overhead Expense Reductions (Savings)
• Lease Cost Savings (Savings)
• State & Local Relocation Incentives (Savings)
The financial team should quantify benefits to your
project in each of these areas of potential savings. As
a aid to this effort, Cost Segregation can add several %
to an investment’s rate of return. The actual savings
increase with more complex facilities. A typical
warehouse may have up to 10% of its asset value
reclassified; while a specialized manufacturer may
exceed 90%. Net Present Value savings can increase by
16% for each dollar of reclassified assets (assuming a
35% marginal tax rate and a 5% discount rate). Cost
segregation, may provide your new facility project the
boost that is needed to jump that project justification
hurdle.
Please
see the link below to read more about Cost Segregation
from our alliance partner, BDO Seidman's Cost
Segregation Team
BDO Cost Segregation Article
on this topic
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The Consultant as
Knowledge Provider
By:
Mike Rigg, PE
Occasionally companies
are reluctant to hire consultants because they worry
that they won’t be left with any institutional knowledge
when the consultants leave. Sure, by using consultants
they get the task accomplished in a professional manner,
but they worry the consultants will be overly-protective
of their knowledge. The companies usually want to ensure
their people are capable of picking up where the
consulting team leaves off.
At Operations Associates, we plan for knowledge transfer
on most engagements. Training of the internal people is
an important part of our ability to be successful.
Whether it is as a part of a project, or as stand-alone
training, Operations Associates views it as our
obligation to leave the client with sustaining
knowledge. We have a diverse body of training materials
which we use to directly transfer knowledge to our
clients’ teams (either while on a project or as a
stand-alone training course). Our training materials
include such topics as:
• Lean Manufacturing
• Constraint Management (Process “De-bottlenecking”)
• Decision Making & Judgment
• Advanced Project Management
• Quality Improvement
We offer both customized training as well as more
generic courses through other providers, such as the
University of North Carolina, Charlotte.
When selecting a consultant, be sure to ask what they
“leave-behind.” Some consultants will share and others
won’t. We do share even though it means we are less
likely to get a repeat engagement.
We can send you
information on how these courses and bodies of knowledge
can improve your company’s only sustainable competitive
advantage, its people:
Lean Manufacturing
• Develop a culture to identify and reduce cost
• Streamline your processes
• Dramatically increase your profit margin
Decision Making & Judgment
• Understand the pitfalls to making good decisions
• Learn your own personality traits that affect your
decision making positively and negatively
• Learn why only 8-10% of people are good decision
makers and how to improve those odds across your
organization
• Make better decisions
Advanced Project Management
• Run better projects
• Achieve faster implementations
• Reduce project risk
• Reduce project costs
Quality Improvement
• Train staff on the tools of quantitative analysis and
problem resolution
• Reduce your cost of quality
• Develop a culture of continuous improvement
Please contact us for
more information on the courses offered by Operations
Associates: 800.860.4902
Mike Rigg, PE
FREE Offers!
Call us for our free "Best Practices"
booklets:
Ten Mistakes To Avoid In
Distribution Center Planning
Ten Steps to Avoid
Project Failure
Hiring a Consultant: Ten
Lessons From the Trade
also...
OA'S Overview Brochure
For more information
contact:
Mike Rigg, President
MikeRigg@oallp.com
Christi Suchyna, Director
of Sales & Marketing
ChristiSuchyna@oallp.com
800-860-4902
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