In a fast moving, growing and rapidly evolving market, an owner and operator needs to carefully and thoughtfully evaluate how best to expend capital resources.
While there are many factors to consider, this article will provide some tips and important considerations to make an effective long term capital decision in support of your investment when selecting an extraction solution.
Extraction of Essential Oils and Capital Purchase Decisions
When preparing your capital budgeting analysis, factors to consider and include are:
- Total amount of your investment
- Cash flows the investment will return
- Annual cash flow of the investment
- Sensitivity analysis to test assumptions
Let’s take a look at each.
Determine the Total Amount of Your Investment
First, determine your total investment and total capital expenditure to fund your project. This total investment should include infrastructure costs, production equipment, finishing equipment, safety equipment and the like. Beware, many pieces of equipment perform only one function or thing and require additional equipment to produce your products.
Here’s a tip: The acquisition of systems (as differentiated from equipment) can provide you with significant advantages, including simplification of your extraction/production operations and reduce the amount of capital (as well as operational) expenditure required to fund your project.
Determine the Cash Flows the Investment will Return
When considering the cash flows your investment will return, think through the end products where your extract/concentrate will be able to be used. Certain extraction methods offer boutique extracts, whereas other methods provide for greater flexibility to produce end products such as edibles, distillate, and cartridges. Flexibility of platform provides for greater revenue generation capabilities, thereby supplying some insulation to your investment, meaning revenue flexibility of your investment.
Calculate the Annual Cash Flow of the Investment
Once you have decided to commit your capital and make your investment decision, you will then have to operate your equipment. When assessing what is required to run your investment, carefully assess:
- FTE’s: How many full-time employees will be required to run your equipment? This is an expensive and important variable to calculate. More recently, availability of employee resources has become limited. Thus, systems which provide for effective use of your employee resources offer significant benefits to your operations, cost structure and investment thesis.
- Operating Costs: What is required to operate the equipment? What supplies are required? What solvents are required? How is the system or equipment sustainable?
These factors should be carefully balanced and calculated with your expected cash flows (as described above) to identify how your investment will return positively for your organization.
Run a Sensitivity Analysis
What this encourages you to do is “test” and challenge your assumptions. What is your probability or percentage of successful execution on your revenue assumptions? How many factors are required to get your product to market? Of these factors, which are controlled by your organization? For what factors are you dependent on others?
How much of your investment thesis is dependent on or subject to regulatory approvals? What is the status of your licensing? Often, operators encounter delays (with license issuance and associated approvals), and this factor of time should be included in your sensitivity analysis.
In association, think through your employee requirements. Flexibility is important to provide to your employees and an investment which helps you to achieve this flexibility can be of and provide enduring benefit to you and your organization.
You can then assess your probability of realized investment and return by taking your calculations for cash flow, annual cash flow and factoring these by your probability percentages determined in your sensitivity analysis.
This provides you with a more realistic calculation of return – one which will be challenged or tested based on the realistic assumptions of your investment, thesis, and associated sensitivity analysis.
Methodolgy: To assist you with a calculation to determine how your investment will perform and generate return, there are options available to you. These include using a calculation such as:
In general, of the above methods outlined, Payback Period is typically the easiest to calculate. That said, any of these methods will provide you with valuable information to assess your investment and its viability.
We hope this article offers you some important considerations to structure, test, and assess your planned investment for the extraction of essential oils. Please contact CBG Biotech or visit https://www.cbgbiotech.com/cannabis for more information.