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Financial Aspects of Safety

Tom Cecich, CSP, CIH

2018 Indiana Safety and Health Conference March 14, 2018

Linking Together Key Concepts

Making the Business Case

Return on Investment (ROI)

Measurement(Metrics)

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Return on Investment (ROI)

The amount of benefit received

for a given investment of resources

ASSE Executive ForumLas Vegas PDC

Executives: Organizations:

Riley Bechtel, Chairman, CEO Bechtel Corporation

Hassain Tadayon, CEO Bahrain Petroleum

Paul Tebo, VP SHE DuPont

John Murphy, Chairman Bell Helicopter

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Executive Forum – Key Points

Relate costs to benefits

Benefits may not all be financial

Risk reduction is important benefit

Relate safety investment to improvement in metrics

Business interruption can be important investment criteria

Understanding Organizational Finance

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Peter Drucker:“Economic performance is first responsibility of business. (Without economic performance) a business cannot discharge any other responsibilities, cannot be a good employer, a good citizen, a good neighbor.”

$ Finance is the language of business $

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Ultimately, risk can’t be zero and neither can the profit margin, so organizations must strive for a workplace balance. That’s most possible when representatives from operations, scheduling, safety/risk and other key units are involved in every meeting, discussion and decision.

Joel Haight, University of Pittsburg, February 2018

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In the world of Finance, business activities are classified according to how they impact the Income (P&L) Statement:

- Revenue Generating Activity

- Non-Revenue Generating Activity

In the world of Finance, business activities are classified according to how they impact the Income (P&L) Statement:

- Revenue Generating Activity

- Non-Revenue Generating Activity

Where Does Safety Fit In?

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Profit Center Versus Cost Center?

As A Cost Center, You Must Be Able To Demonstrate Value To

The Organization.

$10,000

9,000

$1,000

$1,000

$10,000

SIMPLE FINANCIAL MODEL:

=10%

(Before Taxes)

PROFIT MARGIN =

REVENUECOST (Expenses)NET PROFIT

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FINANCIAL TOOLS - Used to analyze investments to ensure owners (stockholders) get a rate of return proportional with the risk assumed by the investment.

(Not unique to safety)

Net Present Value (NPV)Future ValueRate of ReturnPaybackCost-Benefit AnalysisDepreciation

Financial Decision Making Tools

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Most financial analyses are based on the principle that a dollar today is worth more than a dollar next year --

THE TIME VALUE OF MONEY

From a Cost Analysis Viewpoint Safety Professionals Can Help Organization Reduce Costs by:

1. Reducing Injuries and Illnesses (Losses)

2. Improving Business Processes(lower costs, higher sales)

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The Cost of Accidents

How Much Does An Accident Cost?

What Are the Measurable Financial Benefits of Safety?

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Liberty Mutual’sWorkplace Safety Index

Cost of job related injuries is up

Frequency of occupational injuries is down; Frequency of serious injuries is down, BUT not nearly as much

Based on cases with 6 or more lost workdays

Accident Costs:

Direct vs. Indirect

Insured vs. Uninsured

Measurable vs. Intangible

Quantitative vs. Qualitative

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Accident Costs:

Direct (Insured)

Medical Costs

Worker Compensation

Damaged Product

Legal Costs - if….

Accident Costs:

Indirect (Uninsured)

Reduced Productivity

Reduced Moral

Investigation Time

Hiring and Training Time

Management Focus

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THE ICEBERG EFFECT

Ratio OfIndirect vs Direct Costs?

2:1 3:1 5:1 10:1

Problems: It Is An Average

Convincing Management It Is Real

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From OSHA’s “$afety Pays” Program

In general, the magnitude of indirect costs varies inversely to seriousness of injury.

For less serious injury the ratio of indirect to direct is 4-5.For more serious the ratio of indirect to direct is 1-2.

Indirect Cost Ratios Used in “$afety Pays”

Direct Costs Indirect Cost Ratio$0 - $2,999 4.5 $3,000 - $4,999 1.6 $5,000 - $9,999 1.2 $10,000 or more 1.1

Source: Business Roundtable publication, Improving Construction Safety Performance, and are based on a study conducted by the Stanford University Department of Civil Engineering.

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Liberty Mutual’s Executive Survey of Workplace Safety

Executives Surveyed Reported:

95% report that safety has positive impact on financial performance

61% receive 3-1 return on investment in workplace safety

70% say protecting employees is leading benefit of safety investment

Liberty Mutual’s Executive Survey of Workplace Safety

Accident Costs:

93% of executives see relationship between direct and indirect costs

40% of executives surveyed see a relationship of $1 direct cost = $3-5 indirect costs

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The Challenge With Indirect Costs

Finding a budget to assign the savings, i.e.,

whose budget is it coming out of?

How Is Cost Of Safety Defined?

Bottom Line(P&L)

vs.Opportunity Cost

(efficiency, continuous improvement,or sometime cost avoidance)

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So What is the Overall Cost of Safety

Compare to:The Cost of Quality

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Prevention and Appraisal Costs

Prevention CostsSupport activities whose purpose is to reduce the

number of defects

Appraisal CostsIncurred to identify

defective products before the products are shipped

Internal and External Failure Costs

Internal Failure Costs

Incurred as a result of identifying defects before

they are shipped

External Failure Costs

Incurred as a result of defective products being delivered to customers

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Examples of Quality Costs

Prevention Costs• Quality training• Quality circles• Statistical process control activities

Appraisal Costs• Testing & inspecting

incoming materials• Final product testing• Depreciation of testing equipment

Internal Failure Costs• Scrap• Spoilage• Rework

External Failure Costs• Cost of field servicing &

handling complaints• Warranty repairs• Lost sales

Distribution of Quality Costs

When quality of conformance is low, total quality cost is high and consists mostly of

internal and external failure.

Companies can reduce their total quality cost by focusing on prevention and appraisal.

The cost savings from reduced defects usually swamps the

costs of the additional prevention and appraisal

efforts.

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Quality Cost Reports: Graphic Form

$10

9

8

7

6

5

4

3

2

1Appraisal

0Prevention Prevention

1 2Year

Qu

alit

y C

ost

(in

mil

lio

ns)

Appraisal

Internal Failure

External Failure

Internal Failure

External Failure

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18

16

14

12

10

8

6

4

2Appraisal

0Prevention Prevention

1 2Year

Qu

alit

y C

ost

as

a P

erce

nta

ge

of

Sal

es

Appraisal

Internal Failure

External Failure

Internal Failure

External Failure

Quality reports can also

be prepared in graphic

form.

Question

Can an analogy be made between the cost of quality and the cost of health and safety?

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Safety and Health Investment Decision Making:

Making the Business Case

How much to budget for maintaining the safety management system?

What safety initiatives to undertake?

Is a safety improvement project cost justified?

How much risk is acceptable?

Decisions, Decisions, Decisions

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TYPICAL BUDGETING DECISIONS

Capital budgeting tends to fall intotwo (2) broad categories...

1. Screening Decisions• Does a proposed project meet some present

standard of acceptance?

2. Preference Decisions• Selecting from among several competing

courses of action

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1. Define alternatives clearly; Try to determine the differences in consequences of alternatives

2. In so far as practical, express differences in terms of money

The Business Case Process

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3. Apply time value of money criteria to proposed investments

4. Choose among alternatives applying financial criteria giving consideration to the differences among alternatives not reduced to financial terms.

The Business Case Process

Safety projects that are purely financially driven can be

evaluated as any economic decision, however. . .

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Financial ROI

The hard fact is that demonstrating a quantifiable financial return on safety

investments can be very difficult.

Why?

Defining Safety Related ROI

Hard to define in Financial Terms

• True cost of injuries and illnesses

• Impact of pain and suffering

• Organizational inefficiencies from losses

• Low employee morale

• Compliance assurance

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BackgroundLeading Worldwide Company

Industry Leader

Highly Respected

Strong Safety & Health Culture

Board Overview Presentation Needed

Safety Budget Example

Costs:Investment:

Programs & Staff = $18MM

Losses:Worker’s Compensation = $7MM

(Direct)

Indirect & Other Costs = 10x Direct =$77MM

Safety Budget Example

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Industry Comparison

Accident Frequency = 38% of industry sector

If Accident Frequency was the industry average, total cost would be:

$77MM = $200MM

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Safety Budget Example

Savings to Corporation From Investment In Safety and Health Programs:

$200MM (Industry Avg.)

- 77MM (Company Costs)

$123MM savings

Cost/Benefit Ratio = 123/18 ~ 7:1 Ratio

Safety Budget Example

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What made the analysis successful?

Accurate

Logical

Timely

Realistic

Understandable

DATA!!!!

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What happens when there is insignificant financial justification to demonstrate the required financial ROI?

Can a business case still be made for a safety investment without significant financial return?

Safety Paradox

The better the safety performance of an organization, the more difficult it is to justify expenditures based on accident reduction. ROI (benefits) from safety investments become more intangible and harder to measure (and to justify).

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Non-Financial Business CaseCan be developed around:

Organizational metricsRisk reductionOrganizational valuesIntangibles• Injury prevention• Compliance• Increased morale• Enhance productivity

OSHA’s $afety Pays Program

http://www.osha.gov/dcsp/smallbusiness/safetypays/index.html

Hint: Google: OSHA’s safety Pays

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Goals of $afety Pays

The "$afety Pays" program will: Offer choices from a set of Lost Work Day injuries and illnesses Prompt users for information to do the analysis Allow users to input the actual loss figures or workers' compensation costs Generate a report of the costs and the sales needed to cover those costs (based on the organization’s profit margin)

Profit Margin Percentage

This measure indicates how muchof each sales dollar goes toward the

organizations overall profit.

Profit Margin Percentage

ProfitSales

= = $3,000$100,000

= 3%

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OSHA Safety PaysDirect to Indirect Cost Ratio

Direct Costs* Indirect Cost Ratio• $0 - $2,999 4.5 • $3,000 - $4,999 1.6 • $5,000 - $9,999 1.2 • $10,000 or more 1.1

*The direct cost estimates in this program cover medical expenses incurred from injuries received in an accident and indemnity/compensation payments to injured workers while they are away from work.

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Presentation SummaryBuilding the Business Case1. ROI on productivity improvement

2. ROI on direct cost savings

3. ROI on direct/indirect cost savings

4. Remaining Competitive

5. Improving organizational metrics

6. Continuity of supply

7. Reducing inherent risk

8. Improving compliance position

9. Aligning with corporate values

In Closing

Work the business case…but don’t lose focus on what we are about.

Remember…there is a lot more to safety than economics.

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March 15, 2001

PETROBRAS OIL PLATFORM INCIDENT

• 1 Year After Completion

• World Largest Oil Rig – 40 Story Building

• 120 Miles Off Brazil’s Coast

• 10 People Killed in Explosion

• 400,000 Gallons of Oil (Exxon Valdez – 11 Million)

• Insured $500 Million – Revenue Impact $100 Million/Month

• Petrobras Profit in Y2000 - $5 Billion – Will Impact Brazil’s Trade Balance

• Cause Unknown

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"Petrobras has established new global benchmarks for the generation of exceptional shareholder wealth

through an aggressive and innovative programme of cost cutting on its P36 production facility.

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Conventional constraints have been successfully challenged

and replaced with new paradigms appropriate to the globalised corporate market place.

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Through an integrated network of facilitated workshops,

the project successfully rejected the established constricting and negative influences of prescriptive engineering,

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onerous quality requirements, and outdated concepts of inspection and client control.

Elimination of these unnecessary straitjackets has empowered the project's suppliers and contractors to propose highly economical solutions,

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with the win-win bonus of enhanced profitability margins for themselves.

The P36 platform shows the shape of things to come

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in unregulated global market economy of the 21st Century.“

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1. At the end of the day you may not be able to completely define safety and health in financial terms.

2. World Class organizations achieve their financial goals, however they recognize that protecting their employees, assets, the public and the environment are key part of the responsibility of being world class.

Lessons Learned

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Remember

Work the business case…but don’t lose focus on what safety is all about.

Remember…there is a lot more to safety than economics.

Questions Or Comments?

Tom Cecich

(919) 601-5224Tom@TFC-Assoc.com

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(End of Presentation)