In the final part of our Mining Financial Basics series, we briefly cover ten common financial terms you might hear around the mine site.
Welcome to Part 11 of Mining Man’s Mining Financial Basics series (click here to see the full series).
This is the final post in the series, and I hope you’ve enjoyed the series and learnt a little about the financial concepts you’re likely to encounter around a mining operation or mining company head office.
To finish off, here’s a brief list of some other common financial terms you might hear:
Earnings Before Interest and Tax – this is the most common measure of what we normally call profit. It is total revenues minus total costs, but excluding the costs of paying interest on borrowings or paying tax. Interest and tax are excluded to basically show the net profit achieved before taking into consideration taxes and finance costs. We exclude interest and tax as these costs are not directly related to how profitable or well performing the operation is. They are more like costs of doing business rather than directly telling us how well we are going. EBIT is the most common form of measuring operational profit.
Earnings Before Interest, Tax, Depreciation and Amortisation – another measure of profit. This time it is revenues minus costs, again excluding the costs of interest and tax. This time we also exclude depreciation costs (see below) and amortisation costs (see below). Again this is just a different measure for profits taking out some additional measures that aren’t directly related to operational performance (i.e. depreciation is more related to capital assets than how well the business actually did).
Depreciation is basically how much the assets of the business decline in value. For example your car will decline in value over time – if you were a business, the amount by which it declines in value each year could be claimed as a depreciation cost. It is recognised as a cost even though no cash is involved. It is essentially a cost item which recognises how much value the company’s assets have lost each period.
Amortisation is the same as depreciation, except it applies to loss or gain in value of intangible assets of the company. Where depreciation applies to physical capital assets, amortisation applies to intangible assets. Intangible assets are those things a company puts a value on, even though there is nothing that physically exists. Intangible assets include things like the value of goodwill, a brand, deferred tax assets, patents, and capitalised R&D - things that make the company worth more even though you can’t actually see them. Amortisation then is recognising the change in value of these assets as either a cost or revenue to the company, which once again is obviously a non-cash item.
Capital Costs vs Operating Cost
Generally, capital costs refer to the purchase of major items or the investment in major projects. Capital costs are generally things that will be used to generate revenues over a long period of time, whereas operating costs are the costs of actually performing business this month or this year (i.e. they are the costs of operating the business). The real differentiator is that capital costs are treated differently to operating costs in accounting methods – capital costs are usually allocated as expenses over a period of years, while operating costs are usually accounted for in the same period in which they occur.
Fixed Costs vs Variable Costs
In the context of the mining operation, fixed costs are those things that don’t change from one period to the next regardless of how much production there is. For example labour costs are fairly fixed in any one month, no matter how many tonnes are produced. Labour is usually one of the mine’s largest fixed costs, other fixed costs might include machine rental, corporate overheads, and environmental management costs. Variable costs are those cost items which vary depending on the level of production. Examples of variable costs include explosives, fuel, ground support consumables, drilling consumables, tyres, and royalties.
A cost curve for a specific industry (i.e. coal mining) is basically a graph of the production costs for all the mines or companies in that industry. This curve then allows an individual mine to see how its production costs relate to its competitors. Cost curves are important in industries like mining where most producers receive the same or similar prices for their products. Companies will often refer to the quartile of the cost curve in which they sit. Usually you want to be in the lowest quartile, i.e. the 25% of the industry with the lowest costs.
Economies of Scale
The term economies of scale refers to the fact that we commonly find the cost of creating a single item reduces as we make more of those items. And likewise, the cost per item for bigger businesses is generally lower than that for small businesses. For example, if my mine produces 1000 tonnes of coal, it might work out that it costs me $10,000 per tonne to mine it. However, if I produce 10 million tonnes it might only work out to cost $100 per tonne.
This principle is very important in the mining industry, especially in commodities like iron ore or coal – the more the mine produces, in general the less it costs to produce each tonne. Economies of scale are related to our discussion above about fixed and variable costs. The more items we make, the more items we have to divide the fixed costs over.
As mines tend to have quite high fixed costs (especially labour and equipment), the more tonnes we can divide these fixed costs over the better. Other things also contribute to economies of scale, including more purchasing power to get better deals from suppliers when you are bigger, the ability to invest more capital in return for lower operating costs, and improved logistics leading to lower transport costs.
Any other terms or acronyms we haven’t covered here – please let me know in the comments section below!
Thanks for following our Financial Basics series, click here to see the full list of eleven topics in case you’ve missed any.
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- Jamie Ross
Mining Man - Great Safety, Leadership and Productivity Ideas for the Mining Industry
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