How do the railroads make their profit?

[Junctionfan]

We all know how the railroad made it or crumbled back then; but now, what make their pocket green?

After deregulation and other factors came into play, mergers fell into place, what now make the railroads their profit and what do they consider making a profit?

[PNWRMNM]

Junction,

A railroad is like any other business, you sell enough or something at enough of a margin to cover your overhead and leave something fot the owner.

Railroads sell transportation, predominately low cost low value transportation at that. Truckers produce about the same volume of transportation, in net ton miles, but their revenue is 10 times that of the railroad industry's which speaks volumes about the value of railroad service as seen in the marketplace.

A primer on railroad accounting. Revenue is what you get paid for what you do. Operating cost is the cost of doing business, except the cost of borrowed money. The ratio of operating cost to revenue is the operating ratio. Most railroads are happy to have it in the 70s. An OR of 75 means you carry 25% forward to cover your fixed costs. Fixed costs are dominated by interest paid on debt. This is a substantial cost for most railroads, If there is any income, income taxes are deducted and the balance is after tax net income. That is what you can pay dividends to your shareholders from.

Of course there are two major items on the cash flow statement depreciation and capital investments. If business is growing capital investment will oftern exceed depreciation so you have to borrow more money but this does not show on income statement.

One of the industry's major problems is that it takes about $3 of investment to generate $1 of gross income. That means the your 25% margin (or $.25) has to pay interest on $3. A key indicator of financial health is "coverage ratio" which is the number of times that Operating Income (berore taxes) covers interest. The bond rating agencie, Moodys and Standard and Poors, like to see three or more. If less than 1 you can not pay your current interest from current income which is a bad thing. If this goes on too long you are bankrupt.

Mac

[kenneo]

Mac

That is one of the best descriptions in so short a space on this subject I have ever seen!!

Good Job!

[Junctionfan]

What kind of costs are considered part of the operations? What are the other costs involved?

[bobwilcox]

QUOTE: Originally posted by PNWRMNM

Junction,

A railroad is like any other business, you sell enough or something at enough of a margin to cover your overhead and leave something fot the owner.

Railroads sell transportation, predominately low cost low value transportation at that. Truckers produce about the same volume of transportation, in net ton miles, but their revenue is 10 times that of the railroad industry's which speaks volumes about the value of railroad service as seen in the marketplace.

A primer on railroad accounting. Revenue is what you get paid for what you do. Operating cost is the cost of doing business, except the cost of borrowed money. The ratio of operating cost to revenue is the operating ratio. Most railroads are happy to have it in the 70s. An OR of 75 means you carry 25% forward to cover your fixed costs. Fixed costs are dominated by interest paid on debt. This is a substantial cost for most railroads, If there is any income, income taxes are deducted and the balance is after tax net income. That is what you can pay dividends to your shareholders from.

Of course there are two major items on the cash flow statement depreciation and capital investments. If business is growing capital investment will oftern exceed depreciation so you have to borrow more money but this does not show on income statement.

One of the industry's major problems is that it takes about $3 of investment to generate $1 of gross income. That means the your 25% margin (or $.25) has to pay interest on $3. A key indicator of financial health is "coverage ratio" which is the number of times that Operating Income (berore taxes) covers interest. The bond rating agencie, Moodys and Standard and Poors, like to see three or more. If less than 1 you can not pay your current interest from current income which is a bad thing. If this goes on too long you are bankrupt.

Mac

Very good explanation!

Let me add a railroad marketing perspective. Railroading in the early 21st Century is virtually a commodity business. There are lots of people that provide the same service. You have competition from ohter railroads, transportation modes, off-line markets and/or substiute products. Therefore, you will only survive if you are the low cost carrier. If you are a high cost carrier; like the SP vs. BN or UP out of Texas you are doomed.

[PNWRMNM]

Junction,

Go to any American Railroad's web site. I like the BNSF presentation but thery are all pretty much alike, and the 10K Forms are identical since form is prescribed by SEC.. You can find financial statements under the "investors" tab.

Operating costs are everything except interest. More Specifically and without attempting to name all accounts

Transportation
Fuel
On train Labor
Yard Labor
Taxes on Labor
Car hire
Loss and Damage
Clearing wrecks
Depreciation

Maintenace of Equipment
Parts purchased
Labor
Taxes on Labor
Depreciation

Maintenance of Way
Materials purchased and installed
Labor
Taxes on Labor
Depreciation

Geneal and Administrative
Labor of President and executive staff
Labor for Marketing
Labor to operate your computer center
Labor of HQ clerical forces
Cost of Lawers both on staff and outside
Power bill for HQ

I can not remember where equipment leases go, Transportation probably.

In short the costs of everything you do to run the train and maintain the track and equipment are operating expenses.

The operating expenses are identified on the Income Statement.

The balance sheet is very important because it shows the assets and liabilities. Assets may be liquid or illiquid. Ca***he the ultimate liquid asset. Marketable securites are next most liquid. Equipment is less liquid, Investment in fixed plant, such as rail, ties, ballast, bridges, roadbed, and land is illiquid which is a two dollar word for toughtto sell quickly.

The Cash flow statement helps you figure out changes to the ballance sheet.

Basic accounting says debits and credits have to match. Debits are entries on the left of a two column account and credits are to the right. Increases to assets and expenses are debits. Increases to Liabilities and Equity are credits.

Consider issuance of $150,000,000 in 15 year notes used to purchase locomotives and for general corporate purposed. Sale of the notes increases cash and increases liabiliteis by an equal amount. Debit the asset cash $150,000,000 Credit the liability Notes Payable $150,000,000. These show on the cash flow as an increase in cash, and as an issuance (increase) of debt.

Purchase locomotives $100,000,000. Debit Locomotives (an asset) Credit cash.

Now you depreciate the locomotives, a non cash expense. Debit Depreciation Expense $10,000,000 and Credit Accumulated Depreciation Locomotives, which is a "contra", or offsetting account, to Locomotives. This is called Accumulate Depreciation on the balance sheet. Book value of the locomotives is now $90,000,000.

You include the depreciation expense in your income statement. On the cash flow statement you ADD the amound reported as depreciation, becuase while it is an expense you did not pay it out in cash.

The interest is a cash out expense of course. It shows only on the income statement

Repayent of the principal shows as a decrease to Cash (a credit) and a decrease of indebtedness (a debit) on the Cash Flow statement. It is a partial unwinding of the original transaction.

The major liability on any rairoad balance sheet is bonded debt. Railroads like to issue long bonds 50 or 100 years. Most are mortage bonds, secured by all or part of the fixed plant of the railroad. There will also be shorter term debt such as Notes and Equipment Trusts. Notes are often short term and not securred by any particular assets. Equipment trusts are typically 15 years and are securred by the specific equipment purchased with the funds borrowed for the purpose. The lender's security is the equipment, which is reasonably liquid. Lenders will usually require a down payment by the railroad to give them a cushion if they have to reposses the equipment, which is a very rare occurrance.

Mac

[Junctionfan]

Thankyou for the detailed information; this definately helps me understand more what the railroads go through.