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Landfill Accounting Ratios: Like any other business, landfills are in business to make money. However, the unique nature of landfill operations presents challenges to the proper accounting methods needed to track how well a landfill or waste management company is making money.
While the subject of landfill accounting could fill a book, this article will focus on certain key issues, such as reporting methods, pricing the cost of a landfill’s airspace “inventory,” determining break-even, application of standard financial ratios, and the issue of shareholders versus stakeholders.
Reporting Methods
Cash-flow accounting (budget based) is the standard method of accounting for many businesses, including the waste industry, especially those landfills and waste hauling operations owned and operated by local governments. In cash-flow basis accounting, revenues are recognized only when money is received, and expenses are recognized only when money is paid. Reporting is done on a cash flow statement, which records changes in a company’s financial position showing sources and uses of cash. The other standard method of accounting is the accrual method, where expenses incurred are matched with related revenue to determine a meaningful net income. This method does not depend on when exactly the cash changes hands.
Full cost accounting (FCA) is a third accounting method developed by the EPA specifically for the waste industry, especially for those waste operations run by municipal and county governments. According to the EPA, FCA goes beyond cash-flow accounting and takes into account “direct and indirect (overhead) operating costs of MSW services as well as up-front (past) and back-end (future) expenses.” FCA recognizes costs over the lifetime of the waste management operation, including up-front costs (those costs required to get the operation started), overhead, and future costs. These include public education and outreach, land acquisition, permitting, facility construction and modification, operation and maintenance, capital costs, interest payments, “hidden” environmental costs, site closure, building and equipment decommissioning, post-closure care, and retirement and health benefits for current employees. Many of these costs would not appear in a public waste management department’s annual cash-flow budget.
FCA recognizes costs as resources that are used or committed, regardless of when money is spent. In this way it more resembles accrual accounting. This allows an accurate accounting of those often significant costs that occur before and after landfill operations. True landfill costs can be distorted by focusing exclusively on current financial actions. FCA is in conformance with generally accepted accounting principles but is based on five key principles:
- FCA distinguishes between outlays (an expenditure of cash to acquire an asset or resource) and costs (the value of a resource when it is used). By emphasizing costs, FCA more accurately reports depreciation costs incurred by equipment wear and tear.
- Hidden costs are recognized even if there is no cash outlay. Equipment acquired from an environmental grant would be accounted for even if the equipment acquisition involved no actual cash outlays by the community waste organization.
- Overhead and indirect costs (even those shared with other departments or agencies) are recognized by FCA. Legal services obtained by the entire community on a retainer basis would be prorated and allocated as needed to the waste management organization. So would administrative support, billing, policing, and other functions.
- Past and future expenditures are accounted for with depreciation and sinking fund costs.
- Cost categories are organized as activities or paths. Activities are associated with the waste management system’s facilities, such as collection trucks, transfer stations, landfills, and recycling centers. Paths are the expenses associated with the waste management process from point of collection to disposal or recycling and resale.
Airspace Inventory
In addition to the basic format of the landfill company’s accounting and reporting system, there are methods of pricing the landfill’s “inventory” of airspace. In effect, a landfill is selling air. This is air that has been configured, constructed, lined, and capped to provide a secure and permanent resting place for collected waste. When looked at this way, the airspace provided by the landfill’s current disposal cell is not different than a coal pile or silo full of grain. But instead of removing physical objects from a pile and leaving air, physical objects are put into a preconfigured pile of defined volume and dimensions to replace the existing “air.” The “goods” available for sale can be defined as the volume of the airspace made available for disposal by each constructed disposal cell. Since landfill cells of equal size can have differing potential disposal volumes resulting from the overlay of waste deposited in a newer cell on waste previously disposed of in an older adjacent cell, the unit costs of airspace for each cell will differ over the operational lifetime of the landfill.
For example, a hypothetical landfill’s first disposal cell is 10 acres in area with boundary dimensions of 660 feet by 660 feet. With maximum 4:1 waste slopes, its maximum height would be 83 feet. This gives an above-grade volume of 442,000 cubic yards. Below grade, due to hydrogeological considerations, the depth is only 40 feet, providing a volume of 383,000 cubic yards. The first cell has a total disposal volume of 825,000 cubic yards.
Assume a landfill’s first 10-acre cell costs $400,000 per acre to construct, with installation of a liner and leachate management system, for a total of $4 million. Also, assume that its exterior slopes (amounting to 5 acres) must receive final cap and cover as well as a landfill gas management system and surface water runoff controls at a cost of $300,000 per acre, for a total of $1.5 million. Total capital costs involved in the construction and subsequent closer of this initial disposal cell is about $5.5 million. The cost of the goods for sale in this case would be $6.67 per cubic yard.
However, when the next square 10-acre disposal cell is constructed immediately adjacent to the first disposal cell, it can take advantage of the adjacent intermediate waste slopes of its neighbor to deposit waste. This overlay of waste results in the next cell having a total disposal capacity of 925,000 cubic yards. It also has 10 acres of liner but only 3 acres of final cap and cover, resulting in a total cost of $4.9 million. This results in a cost of goods sold of only $5.30 per cubic yard.
If an average of both cells is taken (1,750,000 cubic yards at a total cost of $10.4 million), the cost of goods sold would be $5.94 per cubic yard. As the cost per goods sold in the first phase is the highest (due to its relatively low volume-to-area ratio), the overall airspace unit costs for the landfill as a whole may be as low as $4 per cubic yard.
Given this cost information, there are four basic inventory pricing methods: specific identification, weighted average, first-in–first-out, and last-in–first-out. Using specific identification, the unit costs of airspace for each cell are calculated separately and used until the cell is closed out. Assuming that the site uses 100,000 cubic yards of airspace each year, the unit costs would be $6.67 for years 1–8 and $5.30 from years 9–17. However, if the landfill uses the weighted average method of inventory pricing, the unit costs would be $5.94 for years 1–17 (or the overall average of $4 over the landfill’s operational lifetime). The first-in–first-out method would result in unit costs similar to that of the specific identification method, since the phase costs occur sequentially. The last-in–first-out method is not appropriate, since a landfill cannot apply the costs of the last operation phase constructed and operated years or decades after the first phase.
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Break-Even Analysis
Landfill operations are unique in having high capital costs and relatively low operational expenses. As a result, they have a relatively high break-even point followed by high profit margins. The break-even point is the level of business volume at which total revenue equals total costs. Total revenue is the “unit sales price” (USP) multiplied by the “unit volume” (V). In landfill terms, the unit sales price is derived from the per-ton tipping fees charged at the gate scale. The subsequent disposal and compaction operations in the landfill effectively translate incoming tonnage into disposal volume. Assuming that the landfill described above charges $30 per ton in tipping fees and achieves a compacted in-place density of 0.67 ton per cubic yard, the resultant USP would be $20 per cubic yard of airspace.
Total cost is the sum of the “total fixed cost” (TFC) plus the multiple of the “variable costs per unit” (VCU) times the “unit volume” (V). In the example above, the total fixed cost for the first cell is $5.5 million and $4.9 million for the second cell. Typical variable costs include equipment, staff, leachate collection and treatment, and engineering. For a typical landfill, variable operating costs would equal approximately $600,000 per year. Assume that the landfill receives 600 to 700 tons per day, or 200,000 tons per year. At a compacted in-place density of 0.67 ton per cubic yard, this is equivalent to 300,000 cubic yards per year. The VCU would then be $2 per cubic yard. The relationship between these values for the first phase is expressed as follows:
USP * V = TFC + (VCU * V)
$20(V) = $5,500,000 + $2(V)
$18(V) = $5,500,000
V = 306,000 cubic yards or 200,000 tons (approximate)
Since the first cell has a volume of 825,000 cubic yards, the first cell exceeds the amount needed to break even and shows a profit.
For the second phase, the break-even volume would be:
USP * V = TFC + (VCU * V)
$20(V) = $4,900,000 + $2(V)
$18(V) = $4,900,000
V = 272,000 cubic yards or 181,000 tons (approximate)
Since the first cell has a volume of 925,000 cubic yards, the second cell greatly exceeds the amount needed to break-even and shows a profit.
For both cells together, the break-even volume would be:
USP * V = TFC + (VCU * V)
$20(V) = $10,400,000 + $2(V)
$18(V) = $10,400,000
V = 578,000 cubic yards 385,000 tons (approximate)
Since the two cells have a volume of 1,750,000 cubic yards, the two cells exceed the amount needed to break even and show a profit.
These examples illustrate the critical importance of achieving the highest possible density of deposited waste through in-place compaction.
Financial Ratio Basics
Once the break-even point and costs of airspace are determined, a landfill can accurately account for its operations. These accounting values can be used to calculate ratios that determine the overall financial health of the landfill and/or its parent company. There are basically four families of financial ratios used to evaluate the current performance of a company: profitability ratios, asset management ratios, liquidity ratios, and debt management ratios. Each has a somewhat unique meaning for landfill operations.
Profitability ratios evaluate the company’s financial value as measured by its profitability:
- The price-to-earnings ratio (P/E) is defined as the price of a single share of common stock divided by the company’s earnings per share (net income less any preferred dividends divided by the number of shares outstanding). A company’s current P/E is typically based on last year’s earnings or the sum of the earnings of the last four quarters. With short, but expensive, periods of capital outlays due to the construction of liners, caps, and landfill gas systems, year-to-year P/E ratios for individual landfills can be volatile. Capital expenditures reduce overall net income causing the P/E ratio to spike temporarily. This can be avoided to a large extent by making regular disbursements to a sinking fund designed to mature at a value equal to the next anticipated round of capital outlays.
- Gross profit margins (GPM) and the associated net profit margins (NPM) both before and after taxes indicate whether a company is covering expenses and making a profit. GPM examines sales and the direct cost of products and services sold (in the case of landfills, this means the cost of airspace utilized for disposal). Unlike most industries, GPM for individual landfills may be unstable. As mentioned above, large capital outlays often occur at irregular intervals, and can temporarily reduce GPM. NPM incorporates all expenses, including overhead costs not directly related to production. As such, NPM tends to be more stable for landfills.
- The operating-expenses-to-sales ratio is a measure of operating expenses as a percent of net revenues and measures the total overhead. A more efficient industry will have a lower ratio resulting in higher profits. As mentioned above, landfills tend to have relatively low operating expenses per unit of operation (cubic yard of airspace). Once above its break-even point, a landfill can expect relatively high profits.
- Return on assets (ROA) is the ratio between after tax earnings and the value of a company’s assets (cash, plant, equipment, or land). Landfill assets include the value of the land, book value of its vehicle and equipment fleet, current cash accounts, buildings, etc. Since landfills are often sited remotely on land of marginal value, utilizing relatively small equipment fleets and housing the office operations in trailers, the value of assets may be relatively small. This can result in a relatively high ROA.
- Asset-management ratios determine how efficiently a company is utilizing its current and fixed assets. Current assets (like cash or airspace) are intended to be utilized within the current reporting period. Fixed or long-term assets, like equipment, facilities, and land, are utilized for longer periods.
- The turnover of working capital (the excess of current assets over current liabilities, aka “cash”) compares the dollar value of net revenue with cash available during the same reporting period. This is less sensitive to irregular landfill capital construction outlays, as these are obviously financed instead of paid for with cash.
- Fixed-asset turnover, on the other hand, measures how well revenue is being generated by the company’s fixed assets by considering only the landfill’s equipment, land, buildings, etc. This is far more important for a capital-intensive industry such as waste management.
- Liquidity ratios measure a firm’s ability to pay off debt and other expenses in a timely fashion.
- The current ratio and the related quick ratio compare current assets to current liabilities, measuring the near-term ability of a firm to pay its current debts as they come due. The current ratio is used by potential lenders to evaluate a company’s ability to measure a company’s liquidity. The quick ratio only considers cash as an asset when computing its ratio. Landfills may have extensive non-cash assets (especially land and equipment and vehicle fleets), but can sometimes find themselves relatively cash poor due to the demands of capital construction. So it is not uncommon for individual landfills to have (at least temporarily) a significant discrepancy between current and quick ratios. Waste management companies as a whole, however, dampen these swings, as each landfill in a company’s inventory may have a unique construction schedule and associated cash disbursements.
- Receivables turnover is a ratio that in effect measures the time between sale and cash collection. It indicates how fast the company is getting paid for goods and services. For most landfill and waste collection operations, this does not present a serious problem as regular monthly or quarterly billing ensures a steady cash stream and a relatively short receivables turnover rate. Like comparable consumer purchases of utilities and phone services, trash pickup is usually paid for on time.
- Debt management ratios indicate how well a company is controlling and using its short- and long-term debt. Debt is the funds provided to the company by creditors and can include both current liabilities (accounts payable, salaries and wages, taxes payable, and short-term notes or lines of credit), as well as long-term debt (mortgages, bonds, etc.). There is an eternal tug-of-war between creditors who like low debt and less risk and owners who prefer the magnifying effect of leverage on earnings and the control afforded by using “other people’s money.”
- Fixed (long-term) assets-to-net-worth is a liquidity measurement that indicates to potential creditors how well a company can liquidate its assets to meet debt obligations. A lower ratio is better, since it indicates a smaller investment and more security for the creditors. Though many landfill assets (especially vehicles and construction equipment) can be used by other businesses, a landfill’s main fixed asset—its land—is very difficult to liquidate. Though landfills can have commercial and recreational developments built on them, the need for long-term monitoring and maintenance of a closed landfill negatively impacts its value (even without potential liability concerns).
- The debt-to-equity ratio compares the ratio of capital investments made by owners and shareholders with outstanding debts. It’s primarily a measure of risk to the capital contributors and gives an indication of company’s ability to borrow if necessary. However, with increased risk comes increased leverage and the potential for increased returns. Excessive high debt-to-equity ratios combined with excessively low quick ratios indicate financial weakness. The first indicates that company’s credit is running dry; the second shows depletion of its cash reserves (“no cash, no credit—no business”). Such situations occur either when individual landfills have been poorly run and are facing serious fines due to environmental degradation or when a landfill overbuilds airspace capacity in anticipation of an increase in disposal volumes that doesn’t occur. The second case can be said to have occurred to the entire landfill industry during the shake-out of the early 1990s.
Given the frequent need for landfill companies to float performance bonds, mortgage the land (often hundreds of acres in size) that the landfill is sitting on, and make disbursements into sinking funds to ensure that closure and post-closure care obligations can be financially met, long-term debt-to-equity ratios are of significant importance. Therefore, the ratio of a landfill’s long-term debt to the equity of shareholders can be relatively high for the industry as a whole.
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Shareholders Versus Stakeholders
There has been a great deal of discussion lately concerning stakeholder rights as opposed to shareholder rights where business operations are concerned. When a factory closes and hurts a community’s overall economy, when a company engages in massive layoffs that cause ripple effects throughout an entire industry, when a company’s activities alter or harm local aesthetics or the environment—people not directly employed or investing in the company are affected. These people are referred to as stakeholders, and some would argue that as members of society that have voluntary or involuntary relationships to the company they should have a say in the company’s business operations. The classical response to this is, “No, they don’t.” They only social duty owed by a company is to maximize the profits of the owners and investors.
Yet, this argument is often beside the point. The waste industry is already one of the most heavily regulated industries and is directly influenced by stakeholder and political interests. From the first regulatory agency review of the proposed site’s engineering plans to the approval votes by elected officials and often raucous public meetings involving hostile citizen groups, stakeholders already affect the business operations of a landfill.
Suffice it to say, if a landfill didn’t to a large extent meet the needs of its local stakeholders, it wouldn’t exist in the first place. The landfill industry is one where shareholder rights are dependent on stakeholder interests.
Daniel P. Duffy, P.E., is an environmental engineer employed by URS Corp. in Akron, OH.
MSW
- March/April 2007
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