It’s a money thing…

Successful companies continuously strive to seek out and connect with new business opportunities, so why not see the environment as a business opportunity? Effective environmental risk management offers significant cost savings, financial incentives and a boost in reputation. Cliff Warman, senior manager in the Environmental Liability Management Group at Deloitte & Touche, explains.

Externalities such as competitor activity and the state of the general economy have historically demanded most attention with environmental issues generally being considered as relatively insignificant in terms of their financial impacts on the running of many core businesses. As a consequence environmental issues in business have seldom received considerable high-level attention.

Business opportunities

Environmental opportunities in business can arise at all stages of the business lifecycle as a consequence of the fact that the structure and processes of many businesses will usually be in a state of continuous flux.

The rate of change being implemented, and the severity of its functionality, are driven by changes in the overt external pressures being placed upon the business and the strength of the perceived need for making pro-active adjustment. Particular types of strategic and operational change bring with them a number of new and potentially exciting business opportunities and may offer associated environmental improvement opportunities or perhaps additional environmental risk.

At times when a potential acquisition is being muted, a purchaser will need to appraise themselves of the detail of the main environmental risk inherent in the potential deal structure. This could ultimately either impose a long-term liability on the post-acquisition integrated business or may, on reflection, actually offer an opportunity for positive asset revaluation or the implementation of environmental cost savings through process rationalisation.

These costs, and savings, may have an impact on the ultimate value of a business, and therefore provide a benefit in some way to either the purchaser or the vendor. In order to realise the financial benefits offered by the management of environmental issues, it is important for the potential purchaser to appraise themselves of the scale and nature of environmental risks involved and to consequently consider these risks in the context of the financial incentives being offered to take them on.

Financial incentives may be offered by the vendor themselves, in terms of reduced asking price, or by the government in the form of tax breaks and grants to allow environmental improvements, post acquisition, to physically take place.

For example, discounts on purchase price associated with the transfer of liabilities for contaminated land ownership; the management of licences associated with landfills; the management of asbestos in existing buildings and the implementation of essential equipment up-grades to maintain the ‘licence to operate’, should all be considered because they may make material adjustments to the price being paid.

Where the environmental risks in the divested business are relatively well understood, and where the financial incentives being offered to accept these liabilities out-weigh the costs of the required remedial action, it may be well worthwhile for a purchaser to enter into a deal where environmental liabilities are to be transferred.

During the post-acquisition integration phase, there may be further opportunities for making significant cost savings on environmental expenditure across the enlarged business by applying for the corporate tax incentives being offered, for example, to businesses planning to remediate historically polluted land or property.

Significant cost savings

Where a business is entering into a contaminated land remediation project on a site where they themselves were not the original polluter, there currently exists an opportunity to receive an enhancement of all qualifying costs incurred in undertaking such remediation work so that an ultimate tax saving, or a rebate for a loss making company, can be gained for the year that the expenditure took place. Such incentives may make the remediation of contaminated property a viable economic proposition for certain businesses where before it did not.

With the evidence suggesting that environmental performance, either as a direct or indirect contributory factor, may promote the profitability of a business continuing to gain acceptance, there may be a perception that investing in almost any form of environmental improvements would lead to future financial benefit.

However, decisions on the timing and scale of environmentally-focussed investments, and the likely success of gaining some form of stakeholder credit for implementing process improvements must always be underpinned by commercial, as well as environmental, decisions.

It is obviously critical that financial viability and shareholder value are viewed as primary aims of the business, and that these factors remain as major considerations when making any management-led decisions.

There are currently in existence a number of financial incentives, and indeed disincentives, which have the express aim of encouraging businesses to make investment in environmental improvements. The Climate Change Levy, for example, is a tax on the carbon in fossil fuels that is automatically added to the energy bill of a company. The levy can result in a significant increase in the annual energy costs of many high-energy utilisation companies.

Financial incentives

A concurrent business opportunity exists under the same legislation, as it is possible for companies requiring IPPC authorisation to become eligible for certain types of a tax rebate in return for entering into a negotiated agreement to reach certain energy reduction targets. For high energy users the development of energy efficiency initiatives will then become a part of the overall business strategy.

Assessing the financial impact that the Climate Change Levy will have on energy expenditure and then determining the likely possible cost saving opportunities that could be realised by obtaining a rebate associated with reduced energy use, is a fundamental business opportunity. There may also be a case for receiving enhanced capital allowances for the purchase of certain types of low carbon equipment.

Committing to any form of financial investment to fund growth, be it internally or externally funded, will ultimately require an assessment of the credit worthiness of the project against a view on the return-on-investment, whether measured in financial terms or in terms of improvement in environmental quality. Both the financial viability and long-term environmental sustainability of a company as a whole may be used as indicators for banks and shareholders to assess whether the investment is morally justified and financially worthwhile.

The current migration of some of the more specialist investors towards Social Responsible Investment (SRI) and the wider use of Corporate Social Responsibility and Environmental Reports to assess the credibility of a company has led to certain companies actively promoting their improvements in environmental performance.

The value of reputation

In the Socially Responsible Investment Survey undertaken by Deloitte and Touche in 2002, over 80 per cent of those responding suggested that ‘good environmental, social and ethical performance are important elements of reputation and brand value’. A correlation between ease of access to capital and the growing interest of the investment community in company environmental performance may therefore also become apparent in the future.

Consideration should also be made within the business planning process of issues where investment needed to achieve a ‘beyond compliance’ position today could be beneficial in delivering the medium and long-term objectives of the business plan. In fact, implementing a more costly environmental improvement programme in the short term and communicating this to stakeholders may become a unique selling point against which additional revenue could ultimately be predicted for the future.

Experience shows that few companies account for the costs associated with everyday environmental management and the costs of undertaking environmental improvement programmes in a comprehensive way. Staff will often use standard expense codes to book time spent undertaking environmental related activities and invoices for equipment upgrades. Specific environmental projects are often lost in the general accounting processes.

In addition, but just as importantly, it can often be difficult for a company to pin-point exactly where cost saving opportunities may exist, especially in terms of issues such as energy or water use, or over-use, since the data required to assess potential wastage are seldom available.

Companies who have implemented a process of improving environmental data quality and its interpretation through the management of monitoring data and related cost information may have seen cost saving opportunities materialise within the overall environmental programme. The process starts by making a wish list of the essential information needed to track costs and then reviewing cost saving opportunities based on the solid data to decide whether the company is truly ‘measuring what matters’ and ultimately deriving value from the process of implementing process improvements.

Predicting the environmental liabilities of a company is in some cases a statutory requirement of the financial reporting cycle. The costing of provisions held against contingent liabilities and the realistic structuring of their expenditure can be greatly enhanced if the correct type and quality of environmental data is available at the outset.

Commercial benefits

Commercial benefits to a company can be envisaged, both in terms of making a reduced tax payment against the provision amount and in reducing the necessity to make unforeseen payments for unmeasured liabilities in the future.

Financial planning for possible future environmental expenditure is likely to take the form of a quantum estimate and a structuring exercise which takes into account the type of expenditure to be incurred and its timing.

Corporate governance credentials should be promoted where the size of a financial provision stated in the year end accounts are seen to be both comprehensive and realistic, whilst the way that provisions are broken down between, for example Capital Expenditure and Operational Expenditure components, can leverage distinct tax benefits for the business.

It therefore remains to say that is vitally important that companies view expenditure on environmental management and environmental improvement programmes as offering tangible, as well as having a more intangible, benefits to business.

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