Cashflow & the art of Survival Every company faces the
challenge of navigating its way through the succession of booms,
recessions and depressions which characterize the shipping market.
During prosperous periods, it must meet the challenge of investing
wisely for future growth. In recessions the challenge is to keep
control of the business when the market is trying to force surplus
capacity out of the system by squeezing cashflow and take advantage
of the opportunities. What sorts out the winners from the losers is
financial performance.
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Financial performance & investment strategy The three key
variables with which shipowners can survive in the shipping market
are: The revenue received from chartering/operating the ship The
cost of running the ship The method of financing the business
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Financial performance & investment strategy The way
shipping companies manage these cost & revenue variables
significantly influence the financial performance of the business:
The choice of ship influences the running cost: Day to day costs
are higher for old ships with ageing machinery requiring constant
maintenance. Running a successful shipping operation is not just a
matter of costs: it also involves squeezing as much revenue as
possible out of the ship. Revenue may be steady on a long-time
charter or irregular on the spot market. It may be increased by
careful management, clever chartering and flexible ship design to
minimize time ballast and ensure that the vessel is earning revenue
for a high proportion of its time at sea.
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Financial performance & investment strategy Financing
strategy is crucial: 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 cash revenues 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 vessel
with high running costs but no debt or a new vessel with low
running costs and a mortgage.
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The classification of costs Three broad categories 1. Vessels
cost Fuel consumption, number of crew, physical condition 2. The
cost of bought in items Bunkers, consumables, crew wages, ship
repairs, interest rates 3. Management efficiency Administrative
overheads, operational efficiency
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The classification of costs Operating Costs, which constitute
the expenses involved in the day to day running of the ship-
essentially those costs such as crew, stores and maintenance.
Periodic maintenance costs are incurred when the ship is dry-docked
for major repairs, usually at the time of its special survey.
Voyage costs are variable costs associated with a specific voyage
and include items as fuel, port charges and canal dues. Capital
costs depend on the way the ship has been financed. Cargo handling
costs represent the expense of loading, stowing and discharging
cargo (especially in liner trades).
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Ship age and the supply price of freight
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In market recessions ship-owners with old vessels have to
strangle with how long they can keep their vessels lay-up In market
recessions ship-owners with newbuilt vessels have to strangle with
how long they can keep paying the capital cost (sometimes exceeds
operational cost) In this way market filters out the substandard
owners as well as the substandard vessels
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Unit costs and economies of scale Another economic relationship
which dominates shipping economic is the relationship between cost
and ship size, referred as economies of scale. Where C is the cost
per dwt p.a, OC the operating cost p.a, PM the periodic maintenance
p.a, VC the voyage cost p.a, CHC the cargo-handling costs p.a, K
the capital cost p.a, DWT the vessels deadweight, t is the year and
m stands for the mth ship.
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Unit costs and economies of scale
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The cost of running ships
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Operating costs Operating costs, are the ongoing expenses
connected with the day to day running of the vessel, repairs and
maintenance. They account for about 46% of total costs.
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Operating costs The principal components of operating costs
are: Where M is manning cost, ST represents stores, MN is routine
repair and maintenance, I is insurance and AD administration.
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Operating costs of a Capesize by age
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Operating Costs components Crew costs: include all direct &
indirect charges incurred by the crewing of the vessel including
basic salaries and wages, social insurance, pensions, victuals and
repatriation expenses. Affected by size of the Crew, Vessels Flag
State, Automation of mechanical operations (engine & cargo
handling) Early 1950: 40-50 members of crew per vessel 1980: 28
members, 2014: 22-25 Stores & Consumables: Domestic items used
aboard the vessel, lubricating oil. Repairs and maintenance:
Routine maintenance needed to maintain the vessel to the standard
required by company policy & Classification Society.(engine,
auxiliary equipment, painting) mechanical failures: may result to
additional costs spares: replacement parts for the engine or on
board machinery
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Operating Costs components Insurance: Typically insurance
accounts for 14% of operating costs, though this is a cost item
which is likely to vary from ship to ship. Two-thirds of the cost
is to insure the hull and machinery, which protects the owner of
the vessel against physical loss or damage, and the other third is
third party insurance, which provides insurance against third party
liabilities( e.g collision damage, pollution) Hull & Machinery:
Insurance Company Third party insurance: P&I Club (investigate
claims on behalf of ship- owners, provide legal advice on
negotiation /claims, holds reserve funds to settle claims on behalf
of their members. General Costs: Costs such as registration fee to
the flag state. Administrative cost (low to dry bulk higher for
liner companies)
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Voyage costs VC tm = FC tm +PD tm +TP tm +CD tm Where VC
represents the voyage cost, FC the fuel costs, PD port light dues,
TP tugs and Pilotage and CD canal dues.
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Fuel Costs Where F is the actual fuel consumption (tons/day), S
is the actual speed, F* is the designed fuel consumption and S* is
the designed speed. The component has a value 3 for diesel engines
and 2 for steam turbines.
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Fuel Costs
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Port Charges Represent major component in voyage costs Fees
levied against Vessel & Cargo for the use of facilities and
services Volume of Cargo Weight of Cargo Gross dwt of vessel Net
dwt of vessel Charging practices vary considerably from one area to
another
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Canal dues The main canal dues payable are: Suez Canal Panama
Canal Suez canal fee: Calculated by the classification society Suez
canal special tonnage certificate ((Gross dwt+Net dwt)/2)+10%
Panama canal fee: A flat rate charge per net tonne
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Cargo handling costs CHC tm + L tm +DIS tm +CL tm Where CHC is
cargo-handling costs, L is cargo loading charges, DIS is cargo
discharge costs, and CL is cargo claims. The level of these costs
maybe reduced by investment in improved ship design to facilitate
rapid cargo handling, along with advanced shipboard cargo handling
gear.
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The capital Cost of the Ship These obligations take three forms
1. There is the initial purchase and the obligation to pay the
shipyard. 2. The periodic cash payments to banks or equity
investors who put their money to purchase the vessel 3. Cash
received from the sale of the vessel (?)
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Profit is a concept to measure the financial returns from a
business. It is calculated by taking the total revenue earned by
the business during an accounting period and deducting the costs
which the accounting authorities consider were incurred in
generating that revenue. The difference between Cashflow represents
the difference between cash payments and receipts in the accounting
period. E.g Vessel (payments on construction-loss of value through
time) Known as depreciation Profit
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Investing in vessels means long term by nature. Investors need
to estimate how much profit the company is making and that depends
on how much depreciation is deducted. The ship is written off in
equal proportions over its expected life straight line
depreciation. Estimating depreciation
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Between 1995-2000 (weak market conditions) Bulk carriers were
on average scrapped at 25.2 years Tankers were on average scrapped
at 24.7 years In 2006 (strong market conditions) Bulk carriers were
on average scrapped at 30 years Tankers were on average scrapped at
28 years Specialized vessels have longer lives Cruise ships 43.8
years Live stock 33.9 years Passenger ferries 30 years. Steel ships
over 50 years Estimating depreciation
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Voyage charter The freight is paid per unit of cargo
transported (e.g $12/ton) Under this arrangement the ship owner
pays all costs, except cargo handling Ship owner takes both the
operational and market risk The classification of revenue
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Time charter The hire is specified as a fixed daily or monthly
payment for the hire of the vessel ($10,000/d) Operational risk is
undertaken by the shipowner Market risk by the charterer along with
the majority of the OPEXs Fuel, Port Charges, Stevedoring etc The
classification of revenue
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Bareboat Essentially a financial arrangement, in which the
charterer hire only covers the financing cost of the ship. The
owner finances the vessel and receives a charter payment to cover
expenses. OpEx, voyage cost, cargo handling are paid by the
charterer Charterer undertakes operational and market risk. The
classification of revenue
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The basic revenue calculation 1. Determining how much cargo the
vessel can curry in the financial period measured in tons, tonmiles
etc 2. Establishing what price or freight rate the ship owner will
receive per unit transported. The revenue per dwt can be viewed as
the product of the vessels productivity Freight revenue
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Vessels productivity
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R = Revenue per dwt/p.a P = the productivity in ton miles of
cargo p.a FR = Freight per ton mile of cargo transported t = time
period m = ship type Vessels productivity (cont)
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Optimizing the Operating Speed When a vessel is earning unit
freight revenue, the mean operating speed of the vessel is
important It determines the amount of cargo delivered during a
fixed period and hence the revenue earned. According to the levels
of bunker costs and freight rates the ship-owner must decide the
operating speed of his vessel. Its a trade off: High speed low
freights = losses High speed High freight = gains Low speed Low
freights = gains Low speed High freights = losses