Cost Revenue and Financial

Performance

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 Cash flow and the art of survival
 During prosperous periods when funds flood in , company must meet
the challenge of investing wisely for future growth and a commercial
return on capital.
 The challenge is to create sufficient financial strength when times are
good to avoid unwelcome decisions such as selling ships for scrap
when times are bad.
 It is the company with a weak cash flow and no reserves that gets
pushed out during depressions and the company with a strong cash
flow that buys the ships cheap and survives to make profits in the next
shipping boom.
 It is not therefore the ship, the administration, or the method of
financing that determines success or failure, but the way in which
these are blended to combine profitability with a cash flow sufficiently
robust to survive the depressions that lie in wait to trap unwary
investors.
 In the last resort what sorts out the winners from the losers is financial
2 performance.
 The shipping industry unit cost function
Unit Cost = LC+ OPEX+ CH
PS
 The unit cost of transporting a ton of cargo in a particular
ship depends on the capital cost of the ship (LC),
 the cost of operating the ship over its life (OPEX)
 the cost of handling the cargo (CH)
 divided by the tonnage of cargo it can carry (PS).
 Unit costs generally fall as the size of the ship increases
because capital, operating and cargo handling costs do not
increase proportionally with the cargo capacity.

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 Unit Cost = LC+ OPEX+ CH
PS

 For example a 280,000 dwt tanker only costs twice as

much as an 80,000 dwt vessel but it carries more than
three times as much cargo
 Thus the cost of carrying very small cargo parcels is much
higher than the cost of large parcels and economies of scale
dominate shipping economics.

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 The shape of the cost
function relates the
cost per ton of cargo
transported on the
vertical axis to the
parcel size on the
horizontal axis.
 The shape of the cost
function shows how
unit costs escalate as
the parcel size falls
 Negative relationship
between cost and size

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6
 Financial performance and investment
strategy
If financial performance is the key to survival in the shipping
market, the next question is: 'How is it achieved?'

The three key variables with which ship owners have to

work with are:
1. The revenue received from chartering/operating
the ship;
2. The cost of running the ship;
3. The method of financing the business.

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 The relationship between these cash flow in Figure 5.2.
Revenue, represented by the box on the left, is received from trading the ship.
From the revenue What is left after
earned by the ship costs subject to
must be deducted taxes. The residual
running costs and is paid out in
dividends or
capital payments
retained within
the business

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 Although shipowners do not generally control the price they
receive per ton of cargo, there are various ways of squeezing more
revenue out of the ship:

 Increasing cargo capacity to achieve economies of

scale is one solution.
 Increased productivity by operational planning,
 minimizing time off hire,
 cutting cargo handling time.

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 The choice of ship influences the running cost. Day-to-day cash
costs are higher for old ships with ageing machinery requiring
constant maintenance, a rusty hull requiring regular steel
replacement and high fuel consumption.
 Modern vessels with lower crew costs, reliable fuel-efficient
machinery and negligible maintenance cost less to run.
Running a successful shipping operation is not just a matter of
cutting costs. It also involves squeezing as much revenue as
possible out of the ship.
 Revenue can be increased by careful management, clever
chartering and flexible ship design to minimize time in ballast
and ensure that the vessel is earning revenue for a high
proportion of its time at sea.

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 Financing strategy
 If the vessel is financed with debt, the company is
committed to a schedule of capital repayments, regardless
of market conditions.
 If the ship is financed from the owners's cash reserves or
outside equity finance there are no fixed payments to
capital.
 In practice if a shipping company has only limited equity
capital, the choice is often between an old ship with high
running costs but no debt and a new ship with low running
costs and a mortgage.

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 Classification of costs
Cost of running a shipping company depends on a
combination of three factors:

 The ship sets the broad framework of costs through its fuel
consumption, the number of crew required to operate it and its
physical condition, which dictates the requirement for repairs and
maintenance.

 The inflation in the cost of bought-in items particularly bunkers,

consumables, crew wages, ship repair costs and the interest rate all of
which are subject to economic trends outside the shipowners’s control.

 Third costs depend on how efficiently the owner manages the company,
including the administrative overhead and operational efficiency.
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 Five categories of the costs classification in shipping
 Operating Costs: are the costs which constitute the expenses involved in the day-to-day
running of the ship- essentially those costs such as crew, stores , maintenance, insurance and
administration that will be incurred whatever trade the ship is engaged in.

 Periodic maintenance costs: incurred when the ship is dry-docked for major repairs
usually at the time of its special survey. In older ships this may involve considerable
expenditure.

 Voyage Costs : are the variable costs associated with a specific voyage and include such
items as fuel, port charges , tugs , pilotage and canal dues.

 Capital Costs: depend on the way the ship has been financed. They may take the form of
dividends to equity, which are discretionary, or interest and capital payments on debt finance
which are not.

 Cargo Handling costs: represent the expense of loading, stowing and discharging cargo.
They are particularly important in the liner trades

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 There are two important cost-related principles which we must
explore, first the relationship between cost and age, and second
the relationship between cost and size.

 Within a fleet of similar sized ships, it is found that the old ships
have a completely different cost structure from new ships.

 As the ship ages its capital cost reduces, but its operating and voyage
costs increase relative to newer ships which are more efficient due
to a combination of technical improvements and the effect of aging.

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15
 Unit costs and economies of scale

C = OC + PM + VC + CHC + K
tm t tm tm tm tm tm
DWT
Tm
Where :

C = Cost per dwt per annum.

OC = Operating costs per annum
PM = Periodic Maintenance
VC = Voyage costs per annum
CHC = Cargo handling costs per annum
K = Capital cost per annum
DWT = Ship Deadweight
T = Year
M = Ship

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17
 First: Operating Costs
 Operating costs are the ongoing expenses connected with the day-
to-day running of the vessel (excluding fuel, which is included in
voyage costs), together with an allowance for day to-day repairs
and maintenance (but not major dry dockings which are dealt with
separately). They account for about 25 per cent of total costs

 The principal components of operating costs are:

OCtm = Mtm + STtm + MNtm + Itm + ADtm
where: M = manning cost
ST = stores
MN = routine repair and maintenance
I = insurance
AD = administration
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 An example of the operating cost structure of a Capesize bulk
carrier is shown in Table 5.2, subdivided into these categories
In summary, the operating cost structure depends on:
 the size and nationality of the crew
 maintenance policy
 the age and insured value of the ship
 the administrative efficiency of the owner.

 Table 5.2 shows the relative importance of each of these

components in operating costs and compares them for ships of
three different ages, a 5-year-old ship, a l0-year-old and a 20-
year-old.

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 Table 5.2

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 1- Manning Cost -Crew Costs
1-Crew costs include all direct and indirect charges incurred by the crewing of the
vessel, including basic salaries and wages, social insurance, pensions, and
repatriation expenses.
2-The level of manning costs for a particular ship is determined by two factors,
the size of the crew and the employment policies adopted by the owner and
,the ship's flag state.
 In total manning costs may account for up to half of operating costs,
 The minimum number of crew on a merchant ship is specified in regulations
laid down by the flag of registration. However, it also depends on
commercial factors such as:
 The degree of automation of mechanical operations, particularly the engine
room, catering and cargo handling;
 The skill of the crew;
 The amount of on-board maintenance undertaken.
The reduction of crew numbers by automation and reliable monitoring systems
has played a particularly important part in reducing crew numbers
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 Table 5.3

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 2- Stores and consumables
 Another significant cost of operating a vessel, accounting for
about 11 percent of operating costs is expenditure on
consumable supplies. These fall into three
categories :
1. General stores such as spare parts,
2. Deck and engine room equipment,
3. Cabin stores cover the various domestic items used on
board ship while the largest is lubrication oil.

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 3- routine repair and maintenance
covers all
 This item, which accounts for 12 per cent of operating costs,
outside charges associated with maintaining the vessel to the
standard required by company policy, the classification society
and the charterers of the vessel who choose to inspect it.

This cost can be subdivided into two categories:

 Routine maintenance. Includes maintaining the main engine and auxiliary
equipment, painting the superstructure and carrying out steel renewal in
those holds and cargo tanks which can be safely accessed while the ship is
at sea. As with any capital equipment, the maintenance costs of merchant
ships tend to increase with age.

 Breakdowns. Mechanical failure may result in additional costs outside

those covered by routine maintenance. Work of this type is often taken by
ship repair yards on 'open order' and is therefore likely to be expensive.
Additional costs are incurred owing to loss of trading time.
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 4- Insurance
 Insurance accounts for 37 per cent of the operating costs of a bulk
carrier, which is likely to vary most from ship to ship. A more
appropriate range might be 15--40 per cent. .
 A high proportion of marine insurance costs is determined by the
insurance of the Hull and Machinery (H&M), which protects the
owner of the vessel against physical loss or damage,
 Protection and Indemnity (P&I) insurance, which provides cover
against third party liabilities such as damaging a jetty or oil
pollution.
 Additional voluntary insurance may be taken out to cover against
war risks, strikes and loss of earnings.
 Two important factors in determining the level of H&M insurance
are the owner's claims record and the claimed value of the vessel.

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 5- administration cost

 Included within the annual operating budget for the ship is a charge to
recover shore-based administrative and management charges,
communications, owners' port charges, and miscellaneous costs.

 The overheads cover liaison with port agents and general supervision.

 The level of these charges depends on the type of operation.

 For a small company operating two or three ships they may be minimal,
whereas a large liner company will carry a substantial administrative
overhead.
 With improved communications, many of these functions can now be
undertaken by shipboard personnel in companies. It is also an increasingly
common practice for day-to-day management to be sub-contracted to
specialists for a predetermined fee.
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 Second: Periodic Maintenance
 Periodic maintenance is a provision set aside to cover the cost of interim
dry-docking and special surveys.
 To maintain class for insurance purposes, all merchant ships must undergo
regular surveys. The ship must be dry-docked every two years and every
four years must have a special survey, approving its seaworthiness. At its
special survey the vessel is drydocked, all machinery is inspected and the
thickness of the steel in certain areas of the hull is measured and compared
with acceptable standards. The extent of these measurements increases
with age.
 All defects must be remedied before a certificate of seaworthiness is
issued. In older ships these surveys often necessitate considerable expense,
 for example in replacing steelwork that, owing to corrosion, no longer
meets the required standards, which would reduce the operating efficiency
of the ship.

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 Third: Voyage costs
 voyage costs, can be defined as the variable costs incurred in
undertaking a particular voyage. The main items are fuel
costs, port dues, tugs and pilotage, and canal charges.

 VCtm = FCtm + PDtm + TP,m + CD,m

where:

VC = voyage costs
FC = fuel costs for main engines and auxiliaries
PD = port and light dues. etc.
TP = tugs and pilotage, etc
CD = canal dues

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 1- Fuel Costs
 Fuel is the single most important item in voyage costs, accounting for
47 per cent of the total.

 The shipping industry's response to changing prices provides a good

example of how the design of ships responds to changes in costs.
 Although the shipowner cannot influence fuel prices, he does control
the level of fuel consumption.
 Like any other piece of complex machinery, the amount of fuel burnt in
a ship depends upon the way it is designed and the care with which it is
operated.
 For any given speed, fuel consumption depends on hull design and hull
smoothness

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 Table 5.5

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 2- Port Charges

 Port-related charges represent a major component in

voyage costs and include various fees levied against
the vessel and/or cargo for the use of the facilities
and services provided by the port. Charging practices
vary considerably from one area to another, but broadly
speaking they fall into two components - port dues and
service charges.
 Port dues are levied on the vessel for the general use of
port facilities, and the provision of the basic port
infrastructure. The actual charges may be calculated in
four different ways, based on:
➢ the volume of cargo;
➢ the weight of cargo,
➢ gross registered tonnage of vessel;
31 ➢ the net registered tonnage of vessel.
 3- tugs and pilotage
The service charge covers the various services that the vessel
uses in port, including pilotage, towage and cargo
handling.
 Pilotage is an essential part of a Ports Safety Management
System and compulsory pilotage is considered to be the most
effective and important form of navigation safety regulation.
 Pilots come aboard vessels by small boat or helicopter at the
most critical phase of a vessel’s voyage to assist with the
conduct of navigation in waters with limited draught, widths,
variable currents and other traffic competing for space.

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 port costs
The actual level of port costs depends on:
 the pricing policy of the port authority,
 the size of the vessel,
 the time spent in port
 the type of cargo loaded/discharged.
 Under a Voyage charter, all port dues and charges related to
the vessel are charged to the shipowner, while all charges on
the cargo are generally paid for by the charterers, except for
cargo handling charges, which are generally agreed under
the charter terms.
 Under a trip charter or time charter, all port charges are
33 carried by the charterer.
 4- Canal dues
 The main canal dues payable are for transiting the

Suez and Panama canals.

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 Fourth: Cargo handling costs
 The cost of loading and discharging cargo represents a significant
component in the total cost equation, and one to which considerable
attention has been paid by shipowners, particularly in the liner business. A
traditional cargo liner can easily spend half its time in port. The relationship is specified
in the equation representing the sum of loading costs, discharging costs and an
allowance for the cost of any claims that may arise.

 CRCtm = Ltm + DIStm + CLtm

where: CRC = cargo handling costs
L = cargo loading charges
DIS = cargo discharge costs
CL = cargo claims

 The level of these costs may be reduced by investment in improved ship

design - to facilitate rapid cargo handling, along with advanced shipboard
cargo handling gear. For example, a forest products carrier with open
holds and four cranes per hold can achieve faster and more economical,
cargo handling than a conventional bulk carrier relying on shore-based
cranes.
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 Fifth: The capital Cost and Financial Performance

 Capital costs account for 39 per cent of total costs.

 In cash terms capital behaves very differently from other costs.
 Crew costs, bunkers, insurance and the other cost items are
paid for as they are used.
 Capital costs may appear in the cashflow in three ways.
➢ First, there is the initial purchase;
➢ Second, cash payments to banks or equity investors who put up
the capital to purchase the vessel; and
➢ Third, cash received from the sale of the vessel.

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