The smartest investment you can make

June 1, 2002 By    

Don’t you wish your stockbroker could guarantee you a 30 percent or better return on your money year after year? If that were the case, you’d be crazy not to invest!

What if you could use your propane operation to create a 30 percent or better return on an investment? Wouldn’t you strive to make that business decision part of your daily operations?

Actually, your propane operation has a solid way to create a 30 percent or better return on your investment, but not everyone is aware of it. Once you understand it, you can make an enormous difference on the profitability of your business.

What is the greatest value creation process in your business? What daily recurring business activity creates a 30 to 50 percent annualized return for you on an investment that pays into deep into the future? The answer-I hope you know-is setting new customer tanks.

Do the math

How do I you arrive at 30 to 50 percent return? For a simple example, let’s focus on the setting of a new residential tank, with a 500-gallon capacity and 900 annual gallon usage in normal weather.

Assuming no debt, this creates a $750 investment in the tank, regulator and some piping. Assume a 50-cent-per-gallon gross margin, a 25-cent-per-gallon operating expense (excluding depreciation and amortization) for a 25-cent-per-gallon annual cash flow, or EBITDA*. Therefore, in an average year this 900-gallon customer will generate $225 annual cash flow return. (900 gallons times $0.25 per gallon EBITDA). This generates a 30 percent annualized return in invested capital, assuming no debt is applied.

Now, before you start whittling away at my example with incremental labor costs, principle repayment, gallons off due to weather, or principle repayment, ask yourself-do you know of anywhere else you can get a 30 percent return on your investment? Does your broker or investment advisor have any ideas that compare? I think you know the answer to that question.

Chart A: Annual Return on Investment
Chart A: Annual Return on Investment

Chart A shows the various returns as gallons and EBITDA per gallon vary. Apply a little financial leverage… and “Wow!”

Let’s look again at the same investment. This time, however, consider borrowing one third of the investment at 10 percent simple annual interest. Your investment of capital is reduced to $500 ($750 less the $250 bank loan) and your annual cash flow is reduced to $200 (the $225 cash flow above less $25 annual interest costs). Your return leaps to 40 percent!

Chart B: Rate of Return - Financial Leverage Applied
Chart B: Rate of Return – Financial Leverage Applied

If you were able to borrow 50 percent of the invested capital your annualized return on your invested dollars becomes 50 percent! Chart B shows the returns on various investment situations from no debt to 75 percent borrowed funds.

Your best bet

If you were to list the most valuable activities involved in running your business, do any come close to these returns? If we are correct about the financial impact of setting a tank, under what circumstances would you ever restrict the activity?

At a 30 to 50 percent annualized return, isn’t this a financial investment that everyone in the organization should actively support?

* Earnings before interest income taxes, depreciation and amortization

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