Valuation of Stumpage

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Valuation of Stumpage

Stumpage is a term used to designate the volume of merchantable timber standing on a tract of Forest Land. It is usually applied to timber that is about to be cut and is bought or sold on the stump. 
Stumpage price is the price paid for a given unit of merchantable standing timber expressed in terms of measure, such as the board-foot, cubic foot, or cross-ties of given classes. 

Stumpage value is the value of standing timber obtained by multiplying its estimated volume by the stumpage price. 

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Growing stock is composed of merchantable and non-merchantable trees, which stumpage is concerned with mature true ready for harvesting. In clear felling system, all trees are to be removed constitute the stumpage.

Free market value
Free market value cannot be applied since buyers are very few during the auction or offering tenders and thus competition is minimal. 
Due to imperfect competition we cannot apply free market value to calculate stumpage value. 
It has been observed that the initial values of natural resources such as standing timber are residual and derived from the prices quoted in the next succeeding higher future market. But even then it becomes difficult to standardize residual values due to intervening future costs. But when residual value comes to the cost of logging, the possibility of standardization is limited to such routine operations as felling, loading and unloading which can be estimated fairly closely. 
The costs for future transportation, skidding, howling and extraction, route construction etc. can be evaluated by the trial and error method. Thus residual value is comparatively better approach to determine stumpage value which serves as a guide to the sellers and buyers of timbers. 
The residual value is the difference between the selling price of sawn timber at the first competitive market minus all costs of production + conversion losses before timber reaches the timber market. 
This residual value will give as an estimation of the stumpage value. 
Residual value (R.V)= Prince of sown timber –all costs of production +conversion losses. 

Selling price
This selling price is in first competitive market varies due to following elements of timber resources.
i)               Species
ii)             Quality
iii)           Size and density
iv)            Quantity sold
v)              Competitive demand
vi)            Kind of product to be manufactured from it
vii)          Location with respect to manufacture plants
viii)        Transportation facilities
ix)            Method of exploitation
x)              Taxes.
In order to work out selling price, we take the average of all the market prices taking into account the above-mentioned elements. (A.S.P) Weighted average is more appropriate to be applied for the determination of A.S.P. It will give the stumpage value at the market.

Cost of Production
The cost of production includes following aspects to be considered properly beforehand.
1)    Cost of labor,
2)    Cost of other supplies
3)    Depreciation on capital assets
4)    Transportation charges
5)    The conversation losses.
For cost again we work out the average cost of production (A.C.P)
Conversion surplus =  A.S.P – A.C.P
The entrepreneur wants to make a profit and financial returns. In anticipation of financial returns and profit, risks are involved. Some portion of conversion surplus is also taken to cover profit and risks charges. Therefore, the amount which lifts over after setting aside the profit margin and risks charges in considered as stumpage value.
            Stumpage value= conversion surplus – margin for profit and risk charges.
            How this margin is given?  there are two methods to determine it.
1.     Overturn method
2.    Investment method
Overturn method: Margin is an assumed percentage of the average cost of production in case of overturning method. 
Example.
            A.C.P = Rs. 40/cft, selling price  = Rs.100/cft.
Conversion surplus = 100.00 – 40.00 = Rs.60/-cft.
The assumed percentage for margin varies from 15 -20% . Buyers will go for higher percentage and owner for the lesser percentage. Suppose it is assumed as 20% so stumpage value will be calculated as  stumpage value = 60.00 -20% of Rs.40.00 (A.C.P)
                                                                        = 60.00 -8 = 52.00

Merit
1.     It is simple and short method when investment is very small in logging.
2.    Logging operation is for short period of time.
Investment method: Margin of profit is allowed as an assumed percentage of the average profit bearing investment.
The average profit bearing investment in worked out on total capital. The amount spent on fixed assets and depreciation is also charged on these assets. Moreover, the plan period of operation and lift of the assets are also taken into consideration. 
It is just possible that planned operational period is 5 years in which the life of the fixed assets is 10 years. So, it becomes very complicated procedure to work out average value. There is a very simple formula which can be used for this purpose.    
Average investment (A.I) = ____________________
Where i = initial cost of assets; r = serape/salvage/wrecking value of the assts; n = no. of years for which used; y = no. of years to be used/life and d = annual depreciation charges.
Supposed i= Rs.10.000/-, r = Rs.2,000/-, y = 10 years, n = 5 yrs.
D = Initial cost  – Residual value  = 10000-2000 = 800
                        Life                                  10
Average fixed investment  
Working capital:
It refers to the amount that the entrepreneur has to keep in hand in order to meet day to day expenses. Since by keeping this amount in hand he is losing interest, therefore this loss of interest on working capital is also kept into consideration. We have to add this working capital to the average fixed investment to get the total average investment.
Total average investment = fixed capital + working capital 15-20% of total average investment is added as the margin for profit and risks charge of the entrepreneur.
Therefore, stumpage value can be calculated as stumpage
 value = Selling price – Average cost of production                                                                              – margin for profit +risk i.e 20% of total average investment.
Application
1.     Where investment is large
2.    Operation is spread
3.    Longer period of time.

Overturn method is generally used in Pakistan

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For correction and improvements please use the comments section below. 

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Naeem Javid Muhammad Hassani

NJMH is working as Deputy Conservator of Forests in Balochistan Forest & Wildlife Department (BFWD). He is the CEO of Tech Urdu (techurdu.net) Forestrypedia (forestrypedia.com), Majestic Pakistan (majesticpakistan.pk), All Pak Notifications (allpaknotifications.com), Essayspedia, etc & their YouTube Channels). He is an Environmentalist, Blogger, YouTuber, Developer & Vlogger.

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