Being able to translate safety information into terms that business leaders will more easily understand and relate to is an important skill for EHS professionals. Understanding key business principles and when to apply them provides some synergy between the safety function and the business itself but it also solidifies the EHS professional as someone who understands the business side of things and how to incorporate safety into the overall business strategy.
This article will discuss several key business principles, processes and calculations including Cost of Loss, Return on Investment, Life Cycle Cost Analysis and Cost Benefit Analysis, putting them into easier to understand terms and providing safety related examples of how each might be used.
Cost of Loss
Understanding Cost of Loss and how to calculate it is a good place to start because this information is frequently needed to perform other calculations. Cost of Loss is a very powerful concept to understand because it calculates how much money or revenue a company will have to generate to offset the cost of a loss from an injury or illness in the workplace. What makes Cost of Loss so important to understand is that it can be used to show how injuries and illnesses in the workplace can directly impact a company’s profitability—something that leadership isn’t always keenly aware of.
To perform this calculation, you’ll need the total costs of an injury or illness and your company’s profit margin. If you’re unsure what “total costs” are for this calculation, these are the direct costs of injuries and illnesses. Direct costs will be things like workers’ compensation costs, medical bills, the costs of supplies to treat injuries and illnesses and any costs associated with job accommodations, among other things.
The formula for calculating the Cost of Loss looks like this:
(Total Cost) / % Profit Margin / 100) = Revenue Required to Cover Losses
Here is a simple example of how to calculate Cost of Loss:
|Company’s Profit Margin = 3% or 0.3||
This company would need to generate an additional $58, 333 in sales to cover the costs lost from this injury or illness.
|Total Cost of Injury/Illness = $17,500|
|$17,500 Total Cost = $58, 333|
|0.3 or 3% Profit Margin|
If you’re interested in multiple calculations or aren’t quite sure how to calculate total costs for injuries and illnesses, OSHA has developed a very handy calculator which can help estimate the impact of an injury or illness on a company’s overall profitability. While this tool is simply an estimation tool, it does use data from the National Council on Compensation Insurance, Inc. (NCCI) and provides an easy way to more easily understand how injuries and illnesses affect the bottom line.
Life Cycle Cost Analysis (LCCA)
The Life Cycle Cost Analysis or LCCA is used to estimate the overall cost to own an asset over its useful life. The LCCA compares the total annual costs to the total annual savings to determine whether an option is financially beneficial or not. This tool is especially helpful when multiple options are being compared. For example, if a community is going to build a bridge to help reduce congestion in a particular area of the town, the engineers might have several design options each using different types of construction materials. In this case, the LCCA would be used to evaluate the overall costs to design, install, operate, maintain and then decommission or dispose of the bridge at the end of its useful life.
Within the safety function, an LCCA might be calculated for things like:
- Installing a ventilation system that will eliminate the need for respiratory equipment
- Purchasing equipment to automate a process which will help improve quality and reduce repetitive motion injuries
Here’s a safety related example of how an LCCA might be used.
A small manufacturer producing custom wood cabinets currently sands each cabinet door by hand. This operation is slow, produces unreliable results and has contributed to the number of injuries experienced at the company. To try and improve this situation, the company is looking to purchase automated sanding equipment which they hope will improve speed and quality as well as reduce the injuries associated with hand sanding.
The cost to purchase and install this equipment is around $100,000 and if maintained properly, should last about 5 years before it will need to be replaced. Annual maintenance on the equipment for things like replacing the sanding belt and changing the filters will cost about $2000. The monthly utility costs to run the equipment will be about $150. This new equipment is expected to reduce the need to rework out of spec cabinet doors which will save the company at least $8,000 annually.
By eliminating the hand sanding operation and going to an automated process the need to purchase specialized gloves and dust masks will be eliminated, saving the company about $15,000 in annual PPE costs. In addition, each year the company experiences an average of four minor hand injuries, each costing about $750 has experienced one long term, repetitive motion injury about every five years, each costing the company approximately $60,000 to diagnose and provide ongoing treatment for.
To calculate the Life Cycle Cost of this equipment:
|Total Annual Costs|
|Automatic Sander @ $150,000/5 Year Expected Life||$30,000/year|
|Monthly Utilities @ $150 x 12 Months||$1,800/year|
|Total Annual Cost:||$33,800|
|Annual Rework Savings||$8,000/year|
|Glove & Dust Mask Elimination||$15,000/year|
|Reduce Minor Injuries (4 @ $750 Each)||$3,000/year|
|Reduce Long-Term Injuries (0.2 @ $60,000)||$12,000/year|
|Total Estimated Annual Savings:||$38,000|
The total annual cost to install and maintain this equipment is $33,800 which is less than the total estimated annual savings of $38,000. For this company, purchasing the automated sanding equipment and eliminating the hand sanding operation provides several very real benefits that affect both the financial bottom line but also the safety bottom line. Being able to successfully collaborate on things like new equipment purchases is a great way for EHS to show how safety truly is imbedded in every aspect of an operation.
Return on Investment (ROI)
Return on Investment or ROI is probably the most familiar of the concepts we’re discussing. It’s normal for companies to want to fully understand what kinds of benefits they can expect to see after making an investment of some sort. This is especially true during times of economic hardship. When calculating ROI, you’ll need to know the amount returned (or the investment gain) and the amount invested (investment cost). To perform the ROI calculation, you’ll determine the “net return” by subtracting the investment gain from the investment cost and then divide that number by the investment cost. This will provide a percentage, which is the ROI.
Let’s look at a safety related example of how ROI works.
After an impromptu environmental inspection lands a company in hot water for failing to manage their air permit, they decide it’s time to invest in EHS software. During the inspection, the company is told they have exactly one year to make a laundry list of improvements or they will be fined $8,000 during the next inspection. After several software trials and a lot of discussion, the company settles on the right EHS software package for their needs which costs them $6,000.
The following year, the state environmental regulators show up to reassess the facility and to determine whether the company has made the required improvements. Overall, they are impressed with how the company has completely turned things around compared to last year. The inspectors leave the site without writing any citations which means they will not receive the $8,000 penalty.
To calculate the ROI for the EHS software, the company would simply subtract the investment cost from the investment gains and then divide the results by the investment cost. In this case, the ROI is 33.33% - which is good! Clearly the purchase of EHS software allowed this company to better manage their environmental requirements.
One drawback with using ROI is that there can be a lot of variability when supplying the cost and/or gain information. What one person includes in the cost, another might not so if you decide to regularly use ROI, it’s a good idea to establish clear definitions of both “cost” and “gain” to ensure uniformity and that the results are as accurate as possible.
The National Safety Council (NSC) has come up with a second model for calculating ROI which provides more of a dollar amount instead of a percentage. Using their model, you simply take the safety investment (or investment cost) and multiple by 2. The idea here is that a company’s future savings are essentially doubled so, if a company spends $100,000 this year on safety improvements, their estimated future savings will be double that. While this is a very simple calculation to perform, it’s not nearly as easy to back up with solid, company specific data which might make it a harder sell with leadership.
Cost Benefit Analysis (CBA)
The Cost Benefit Analysis or CBA is a method that’s used to choose the most effective or most beneficial option for something. It’s calculated by comparing the total expected costs to the total expected benefits. When calculating the CBA, the most structured and organized way to start the process is by collecting all of the direct and indirect costs. Within the safety function, the best way to think about direct and indirect costs is to remember them like this:
- Direct Costs = Insurable Costs (workers’ compensation costs, medical care, medical treatment supplies, etc.)
- Indirect Costs = Uninsurable Costs (lost production, lost revenues, costs to hire and train new workers, etc.)
It’s important to note that indirect costs can sometimes be difficult to calculate however, it’s really important to include them in a CBA calculation because they can be huge factor.
Let’s use a safety related example to calculate CBA.
A company has a 4 person EHS team that includes four hourly workers, each working 50 weeks per year and making about $25/hour. The EHS team is required to provide somewhat detailed weekly metrics reports for their respective shifts. Because EHS data is logged on an Excel spreadsheet, weekly metrics calculations must be performed manually, taking each team member about 5 hours per week to complete—which is time that could be spent out in the field working on improvement opportunities. To improve this situation, the company considers spending $8,000 on EHS software which would allow the company to capture data electronically and then generate metrics reports in a few minutes compared to a few hours.
If using the software will save one EHS team member 5 hours per week and they earn $25/hour, that’s $125 per week per worker. If we multiply that by the four EHS team members we arrive at a weekly savings of $500 per week. If the software costs $8,000, we’ll divide that by the $500 per week savings to arrive at 16. So, it will take them 16 weeks to recoup the cost of the software.
Another way to determine whether an option is financially feasible is to perform the calculation another way. Let’s look at an example.
After a repeated increase in hand and finger injuries, a company is interested in implementing a glove program which will cost the company about $15,000 per year. Over the past five years, the company has experienced 3 major hand injuries with direct costs of $15,000 and indirect costs of $22,000 each. With this new glove program, the EHS Manager estimates the risk of hand injuries will be reduced by about 50%.
To determine if this new glove program is financially sound, we must perform a CBA.
- Step 1: Add the costs of all the injuries together: $15,000 + $22,000 =$37,000
- Step 2: Multiply the total costs of $37,000 x 3 (number of injuries over 5 years) = $111,000
- Step 3: Divide $111,000 by 5 years = $22,200 (average hand injury cost per year)
- Step 4: Divide the average injury cost of $22,200 by 2 (for a 50% reduction in injuries) = $11,100 (average remaining annual hand and finger costs)
- Step 5: Subtract the annual remaining injury costs of $11,100 from the estimated annual costs of implementing a glove policy of $15,000 per year which = -$3,900.
In this case, the company would be spending $3,900 more on a glove program than they’d be saving, making this not financially feasible. Now, if an EHS professional wanted to find a way of financially justifying a glove program, they would need to find less expensive gloves that would still provide the same level of protection. In this case, they’d need to find gloves that cost less than $11,100 per year to purchase. Instead of the PPE option, the EHS Manager could also consider a permanent solution to engineer out the hazard instead, especially since PPE should always be used as a last resort.
A Final Thought
One of the most difficult aspects of the EHS profession is often finding a way to get through to company leadership about how big of a role safety plays within the overall business. When an EHS professional is able to use business concepts to translate that message into terms leadership can more easily understand, it makes the safety function a little less intimidating, which is a win-win for everyone.
If you found this article helpful, you should check out our other blog articles or even better, reach out and let us know what else you might be interested in reading about. We’d love to hear from you!