This document discusses the importance of financial modeling and lifecycle planning for asset management decision making. It emphasizes talking to senior management about value in terms of outcomes rather than specific assets or initiatives. The document outlines how to understand and express value, asset valuation using cash flows, financial modeling, lifecycle costing, and discounted cash flow analysis. It provides an example comparing two options using metrics like net present value, internal rate of return, and cash flow ratio to determine which option provides the best value.

1. Institute of Asset Management.
The roles of financial modelling
and lifecycle planning in value-
based decision-making.

2. “People often challenge me about how they can convince their senior
management about asset management. To me the key is to talk their
language. For years, I have suggested that engineers learn and talk
money – the language of business…

3. Essentially I am talking about value in its many forms.
Identifying how to offer it and gain it. That’s the game we’re in.
So, try talking asset management in terms of outcomes and not the
widgets”
David McKeown CEO IAM
April 17 Newsletter

4. Agenda
1) Asset Valuation
2) The roles of financial modelling
3) Lifecycle / WLC planning
3) The essential metrics
“We need to learn to talk money”

5. “The word value… has two different meanings, [it] sometimes
expresses the utility of [something], and sometimes [the purchasing
power of it]. The one may be called "value in use;" the other, "value in
exchange." Adam Smith “Of the Origin and Use of Money”
We’re first going to need to understand what we mean by “Value”
“The regard that something is held to deserve, the importance, worth
or usefulness of something.” Oxford English Dictionary
“The total amount of money for which something can be exchanged in
a market” CIMA Dictionary of Finance and Accounting
Value

6. Most of us as proponents understand the usefulness (value in use) of our
suggested initiatives (be they asset investments or new methods of
working or entire major projects).
Value
 Can we always express this in terms of financial value (value in
exchange) in ways others can understand?
 Are we always offering the best value option?
 Can we explain why?

7. Cash Flow: “the movement through an organisation of money that is
generated by its own operations…
It is the money that a business actually receives from sales (the cash
inflow) and the money that it pays out (the cash outflow).”
CIMA Dictionary of Finance and Accounting
Cash Flows for Asset Valuation

8. Cash Flows for Asset Valuation
Inflows:
Revenue
Tariffs, Unitary Charges,
Volume Payments etc.
Income generation
Loans / Investments
Reliability-based rewards
Reduced un-reliability penalties
Savings (vs. do-nothing options)
IN

9. Cash Flows for Asset Valuation
Outflows:
Ongoing: Opex Costs
FM operating costs
Management costs
One-off: Optioneering / Due Diligence Costs
One-off / ongoing: Capex Costs
Ongoing Lifecycle replacement /refurb. costs
Ongoing: Loan / Investment repayments
One-off: Purchase Price / Initial Investment Costs
OUT

10. Cash Flows for Asset Valuation
Net Cash-flow
Inflows less Outflows
Cash-flow coverage ratio
(multiple on investment)
Inflows vs. Outflows
:
-

11. Cash Flows for Asset Valuation
Cash Flow Statement
Fiscal year begins:
(Pre)
Startup JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC Total
05/01/2012 EST 05 05 05 05 05 05 05 05 05 05 05 05 ItemEST
Cash on Hand (beginning of month) 100 100 -125 45 -1 224 269 269 269 269 269 269 269 269
Cash Receipts
Cash Sales 125 120 130 100 475
Collections fm CR accounts 75 45 120
Loan/ other cash inj. 50 50 50 50 200
Total 0 175 170 180 225 45 0 0 0 0 0 0 0 795
Total Cash Available (before cash out) 100 275 45 225 224 269 269 269 269 269 269 269 269 1064
Cash Paid Out
Purchases (merchandise) 400 226 626
Purchases (specify) 0
Purchases (specify) 0
Gross wages (exact withdrawal) 0
Payroll expenses (taxes, etc.) 0
Outside services 0
Supplies (office & oper.) 0
Repairs & maintenance 0
Advertising 0
Car, delivery & travel 0
Accounting & legal 0
Rent 0
Telephone 0
Utilities 0
Insurance 0
Taxes (real estate, etc.) 0
Interest 0
Other expenses (specify) 0
Other (specify) 0
Other (specify) 0
Miscellaneous 0
Total 0 400 0 226 0 0 0 0 0 0 0 0 0 626
Cash Paid Out (Non P&L)
Loan principal payment 0
Capital purchase (specify) 0
Other startup costs 0
Reserve and/or escrow 0
Owners' withdrawal 0
Total 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Total Cash Paid Out 0 400 0 226 0 0 0 0 0 0 0 0 0 626
Cash Position (end of month) 100 -125 45 -1 224 269 269 269 269 269 269 269 269 438

12. “Financial modeling is the task of building an abstract representation
(a model) of a real world financial situation. This is a mathematical model
designed to represent (a simplified version of) the performance of a
financial asset or portfolio of a business, project, or any other
investment.”
Wikipedia, Financial Modeling Jun 17
Financial Modeling

13. Financial Modeling
Numerical expression of the legal contracts of a company
Financial models serve several different purposes, dependent on the
stage of business / project maturity:
Assess the size of the market or opportunity
Explain the business model / project approach
Demonstrate the potential profitability (or otherwise)
Demonstrate compliance with covenants
Quantify the investment requirement
Facilitate valuation of the business / project

14. Financial Modeling
Financial models allow the representation and analysis of all elements of the
project or business cash-flows.
Facilitate assessment and sensitivity analysis to be performed evaluating
various “what-if” scenarios (options appraisals).
BUT a model is only a model and it needs feeding.
The accuracy of inputs determines the accuracy of the outcome.
Poor quality in = poor quality out.

15. Life Cycle Costing is “[the] methodology for the systematic economic
evaluation of life cycle costs over a period of analysis, as defined in the
agreed scope. Life Cycle Costing can address a period of analysis that
covers the entire life cycle or (a) selected stage(s) or periods of interest
thereof.”
ISO 15686-5:2008, 3.1.8
Life Cycle Costing

16. Life Cycle Costing

17. Life Cycle Costing

18. Discounted Cash-flows:
Metrics, Methods & Misery Challenges
Discounted Cash Flow (“DCF”): “the discounting of the projected net
cash flows of a capital project to ascertain its present value.
DCF you may know as Capital Investment Appraisal:
“The application of a set of methodologies whose purpose is to give
guidance to managers with respect to decisions as to how best to
commit long-term investment funds.”
CIMA Dictionary of Finance and Accounting

19. Methods used include:
Yield or Internal Rate of Return in which the calculation
determines the return in the form of a percentage;
Net Present Value in which the Discount Rate is chosen
and the present value is expressed as a sum of money; and
Discounted Payback in which the Discount Rate is chosen and
the payback is the number of years required to repay the original
capital investment.”
CIMA Dictionary of Finance and Accounting
Discounted Cash-flows:
Metrics, Methods & Challenges
%
£
Days/
time

20. Discounted Cash-flows:
Metrics, Methods & Challenges
TIME VALUE OF MONEY
“Measurement of the difference between future monies and the present
day value of monies [reflecting uncertainty]” BS 8544-2013
DISCOUNT RATES
Inflation
Weighted Average Cost of Capital
Expected / target returns (IRR*)
Risk appetite / premium

21. Discounted Cash-flows:
Metrics, Methods & Challenges
So what do we need to know for a DCF Analysis?
CASHFLOW – INFLOWS & OUTFLOWS (if relevant)
Initial capital investment – sources and costs
Planning and construction costs – sources and uses / sensitivities
Future maintenance / renewal costs – sources and uncertainties
Future end-of-life / decom costs – sources, scarcity and uncertainties
INVESTMENT PERIOD / Period of Analysis
DISCOUNT RATE
A FORMULA / CALCULATION

22. Discounted Cash-flows:
Metrics, Methods & Challenges
DISCOUNTED CASH-FLOW ANALYSIS
ANALYSIS PERIOD 20 YEAR
DISCOUNT RATE 7.5%
INFLATION RATE 2.50%
TOTAL Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15 Y16 Y17 Y18 Y19 Y20
OUTFLOWS -8500 -2500 0 0 0 -1000 0 0 0 0 -2000 0 0 0 0 -1000 0 0 0 0 -2000
INFLOWS 9500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500
NET (REAL) 1000 -2500 500 500 500 -500 500 500 500 500 -1500 500 500 500 500 -500 500 500 500 500 -1500
INFLATION 103% 105.06% 107.69% 110.38% 113.14% 115.97% 118.87% 121.84% 124.89% 128.01% 131.21% 134.49% 137.85% 141.30% 144.83% 148.45% 152.16% 155.97% 159.87% 163.86%
NET CASH-FLOW (NOMINAL) 1600 -2563 525 538 552 -566 580 594 609 624 -1920 656 672 689 706 -724 742 761 780 799 -2458
NPV £144
IRR 9%
CASH-FLOW RATIO 1.12:1
Option A

23. Discounted Cash-flows:
Metrics, Methods & Challenges
ANALYSIS PERIOD 20 YEAR
DISCOUNT RATE 7.5%
INFLATION RATE 2.50%
TOTAL Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15 Y16 Y17 Y18 Y19 Y20
OUTFLOWS -8000 -5000 0 0 0 0 0 0 0 0 -1500 0 0 0 0 0 0 0 0 0 -1500
INFLOWS 9500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500 500
NET (REAL) 1500 -5000 500 500 500 500 500 500 500 500 -1000 500 500 500 500 500 500 500 500 500 -1000
INFLATION 103% 105.06% 107.69% 110.38% 113.14% 115.97% 118.87% 121.84% 124.89% 128.01% 131.21% 134.49% 137.85% 141.30% 144.83% 148.45% 152.16% 155.97% 159.87% 163.86%
NET CASH-FLOW (NOMINAL) 3076 -5125 525 538 552 566 580 594 609 624 -1280 656 672 689 706 724 742 761 780 799 -1639
NPV -£458
IRR 6%
CASH-FLOW RATIO 1.19:1
Option B

24. Discounted Cash-flows:
Metrics, Methods & Challenges
Option A or Option B?
Spend-to-save?
Which metrics are most important to your decision makers?
OPTION A OPTION B
NPV £144 -£458
IRR 9% 6%
CASH-FLOW RATIO 1.12:1 1.19:1

25. Questions