Mothballing

The practice of taking certain equipment, assets, and/or production facilities out of operation

What is Mothballing?

As it relates to business, mothballing is the practice of taking certain assets, equipment, and/or production facilities out of operation. The equipment and facilities should still be effective operationally, meaning they aren’t being deactivated or taken out of use because they no longer function properly.

 

Mothballing

 

The primary purpose of mothballing is preservation – both of the company doing the mothballing and of whatever is being mothballed. Equipment and facilities are kept in good condition, either for later use (most commonly) or to be sold. Mothballing is particularly successful in helping businesses weather difficult periods in the marketplace when forces outside of a company’s control lead to an extended downturn in sales that ultimately affects the company’s bottom line.

 

Summary

  • Mothballing refers to the process of taking equipment and/or production facilities out of commission to be used at a later time or to be sold; it can also include ideas or projects that are temporarily set aside to be put into effect at a later date.
  • Mothballing is particularly useful to help cut down on operating expenses; high operating expenses cut into a company’s profits and can even spiral a company down into complete financial ruin.
  • Companies operating in industries that require large amounts of capital expenditures (CAPEX) are among those most likely to utilize mothballing, e.g., large, expensive equipment, or production facilities.

 

The How and Why Behind Mothballing

Taking actions such as shutting down one or two production lines during a time when sales are slack can help a company reduce its operating costs and thereby maintain a viable level of profitability. Then, when the economy or marketplace turns around, the company can take its sidelined equipment “out of mothballs” and ramp up production again.

Companies generally choose to mothball equipment that tends to drive up operating costs. It may also be equipment that the company perceives as not being as useful in action as it could be for the company’s liquidity if, at a later date, the company decides to sell the equipment. In other words, a company may choose to mothball equipment that, looking further down the road, it may consider selling to provide liquid cash.

 

Example – Mothballing Projects or Ideas

Mothballing doesn’t necessarily just relate to tangible, functional assets. A company may decide to mothball – or set aside – items and concepts that can be revisited for use in the future. It includes potential product designs, theories of operation, or major projects, such as the proposed expansion into an overseas market.

For example, assume that Company ABC is considering pursuing one of two possible major capital expenditures (commonly referred to as CAPEX) projects as part of its long-term growth that the company already planned for quite some time – opening an office and retail stores in China so that the company can market its products directly to Chinese consumers.

Both projects offer the opportunity for the company to substantially increase its revenues. However, Project A would require a much smaller investment – $10 million in additional production equipment, hiring some additional production staff, and the cost of a marketing campaign.

In contrast, moving to establish a physical presence in China – office space, warehouse space, the cost to relocate several key personnel, and to hire and train approximately 150 Chinese locals, along with several other notable expenses.

After a lengthy discussion, the decision is made to go with Project A. The thinking is that it won’t require nearly as much upfront investment as Project B, plus the company is likely to see a net positive return on its investment more quickly.

If all goes well, in an estimated three to five years, some of the profits from the new product line can then be used to help bankroll Project B – the move to China. However, for the moment, the move to China project is being “mothballed.”

 

The Issue of Operating Costs

High operating costs are the enemy of every company. Operating costs include any expenses a company incurs in the process of operating its normal, or primary, business. Costs of goods sold (COGS) aren’t included in operating costs but are instead calculated separately. COGS include overhead from manufacturing, the cost of materials, and capital expenditures on production equipment.

Operating expenses include:

  • Research costs
  • Rent on company properties
  • Fees for licensing
  • Office supply costs
  • Wages/salary for all staff (except labor directly related to manufacturing)

 

Operating expenses are the obvious costs a company incurs to function; however, a company is in business to generate a profit. As operating expenses increase, it cuts into the profit a company makes. To simply stay afloat, a company must earn enough from the sales of its goods and services to pay for the costs it incurs to produce the goods and facilitate the services.

When operating expenses rise, more money must be taken from profit to cover them. To prevent it from happening, a company will try to cut down on its operating expenses. Mothballing is one way it can be done.

 

Another Example of Mothballing

Frequently, industries that utilize mothballing are typically those that incur a lot of capital expenditures. The oil industry is one such industry. The price of oil is known to fluctuate drastically. Oil companies can own a vast number of oil rigs, trucks, and other equipment, all of which cost a substantial amount of money.

If the oil market starts to take a downward turn, an oil company will often choose to take some of its machines out of commission. It cuts down on operating expenses and preserves the equipment to be utilized when oil prices are back up, and greater production is warranted.

 

Personal Mothballing

Individuals frequently engage in mothballing also. Individual mothballing dates back to the origin of the term. Hundreds of years ago, when people would store away clothing that they didn’t expect to be wearing for quite some time (e.g., winter clothing during the spring, summer, and fall), they would put mothballs in with the clothing.

Mothballs are small balls containing either dichlorobenzene, naphthalene, or camphor. The chemical substances in the mothballs kept moths from eating the stored clothing, thus preserving it until the owner wanted to “take it out of mothballs” and wear it again.

Other examples of personal mothballing include people mothballing their motorcycles during the winter or their snowmobiles during the summer. Just as it is important for companies that mothball production equipment to store it properly and take steps to maintain it in good working order, such as regularly lubricating it to guard against rust, individuals likewise need to take care when mothballing equipment to ensure it is ready to run when they are ready to take it back out.

For example, if you’re mothballing your motorcycle for the winter, part of the recommended procedure involves taking proper care of the battery. You don’t want to roll your bike out of the garage on that first nice, spring day only to find out that it won’t start because your battery is dead.

Therefore, motorcycle manufacturers recommend that you remove the battery from the motorcycle, clean the terminals, and take the time to give it a charge for a couple of hours once or twice a month during the mothballing period.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Asset Retirement Obligation (ARO)
  • Economic Obsolescence
  • Negative Externalities
  • Physical Deterioration

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!