Chris Gash/theispot.com
The circular economy is a key enabler for businesses to achieve sustainability targets. However, traditional financial analysis models can be inadequate for evaluating circular business models. While circularity helps reduce waste, recover materials, and extend product lifespans, it also fundamentally changes how value is created and measured. Yet, most financial models remain rooted in linear assumptions — where profitability is assessed through onetime product sales and predictable cost structures.
This misalignment creates significant risks. Circular businesses generate revenue across multiple life cycles — through leasing, refurbishment, resale, and material recovery — but linear analysis overlooks these ongoing value streams. Additionally, cash-flow timing, revenue recognition, and asset management complexities must be restructured to ensure financial viability. These analytical gaps can lead to undervaluing circular investments, misjudging payback periods, and deterring financially viable circular strategies.
To make circular business models financially competitive, executives need new approaches to financial analysis — ones that capture multi-life-cycle revenue, asset utilization, and residual material value. This article introduces practical financial considerations tailored for circular models in order to equip leaders with rigorous methods to assess profitability, risk, and long-term financial performance.
Why Circular Models Defy Conventional Analyses
While circularity is often seen as a sustainability lever, its commercial potential and financial implications are just as significant. Unlike linear models, where financial analysis ends with a single transaction, circular business models generate value across multiple life cycles, requiring a fundamental shift in how profitability is measured. (See “How Revenues and Costs Differ for Direct and Circular Business Models.”) This shift introduces several unique financial challenges:
- Higher product and infrastructure costs hitting the bottom line. Designing for circularity — such as using durable and recyclable materials or considering modularity and disassembly — raises cost of goods sold (COGS). While innovation can bring costs down, the need for higher-quality materials or complex manufacturing processes would inevitably be costlier compared with linear equivalents. Likewise, establishing reverse logistics systems for tracking, recovering, and processing used products demands significant capital. For example, while reusing toner bottles has saved Ricoh money compared with paying for virgin bottles, the process of recovering bottles after use accounted for over 60% of their cost as of 2022.1
- Revenue cannibalization threatening top-line growth. Extending product lifespans means that customers might purchase fewer new products. Businesses may also be concerned about cannibalization of primary product sales if customers opt for secondhand, repaired, or refurbished items, especially if they are sold at lower prices.
- Revenue timing requiring the restructuring revenue and cash flow models. While linear models rely on immediate, onetime sales, circular models derive income through extended product life cycles — leasing, repair services, or resale of refurbished goods — or even through recurring revenues via rental or subscription models. This alters the dynamics of cash flows and working capital management. Companies adopting service-based models, such as rental or subscription models, must also account for holding assets on their balance sheets.
These challenges are rooted in a mismatch between linear-based financial analysis and circular models. In linear models, revenues, COGS, and profitability are typically assessed across a single cycle of product sale, use, and disposal. In contrast, circular businesses can generate income across multiple life cycles, requiring a fundamental shift in how profitability is assessed. This is especially pertinent when looking beyond efficiency-oriented circular practices that directly translate into cost savings, like waste minimization does.
Rethinking Financial Analysis for Circular Models
Leaders should reframe financial analysis around a central principle: decoupling revenue growth from the use of virgin and nonrenewable materials. The World Business Council for Sustainable Development’s Circular Transition Indicators, a framework for measuring circularity, calculates the circular material productivity metric by dividing revenue by the quantity of virgin, nonrenewable materials used to generate that revenue.2 The goal in circular models is to increase this metric, where revenue growth is achieved without corresponding growth in use of nonrenewable materials. In an ideal scenario, all revenue is generated from products that incorporate reusable materials.
To assess the financial viability of circular business models, companies must move beyond traditional financial analysis and integrate multi-life-cycle revenue modeling, asset utilization tracking, and residual value estimation. Below, we outline three essential financial considerations for evaluating circular strategies.
1. Recognize multi-life-cycle revenue and costs beyond primary sales. Linear financial models assess revenue based on a single cycle of sales, but circular design is ultimately an investment into material longevity and reusability. Businesses should map out the revenue streams and costs seen over a product’s or material’s multiple life cycles.
Value derived over the lifetime of a product or material in a circular model may include revenue from these sources:
- The initial sale of the product as a new item.
- Income from potentially multiple cycles of resale of used, repaired, and refurbished items.
- Income from subscription, rental, or pay-per-use models.
- Income from value-added services, such as making repairs or selling replacement parts, as well as from digital or advisory services that aren’t directly tied to circularity.
- Revenue from selling or repurposing recovered materials, factoring in value preservation or uplift from activities such as repair.
Circular models also affect the COGS in areas like the following:
- Initial production costs, where raw materials, manufacturing, design and R&D, packaging, and distribution may be more expensive.
- Reverse logistics systems and activities to recover reusable materials or items, including collecting, sorting, and transporting them, and offering customer incentives like buyback or trade-in programs.
- Product refurbishment, repair, and maintenance, including labor, parts, and quality assurance, potentially repeated over multiple cycles.
- The cost of operating a rental subscription-based model, such as customer service, asset tracking, insurance, and software for managing leased products.
- End-of-life management costs like disposal and recycling for nonrecoverable materials.
The concept of maximizing product or material lifetime value is similar to the more established notion of customer lifetime value — total revenue generated from a customer — but with a material-centric lens. For example, furniture supplier Desko has a “three-tier buyback” model: Used desks are bought back from customers for 10%-15% of their initial price and are remanufactured and resold at around 50% of new item prices, with an average 5% repair and refurbishment cost.3 This is repeated for a third cycle, at 5%-7.5% for buyback and 25% for resale prices. This comes with a carbon savings: The carbon footprint of remanufacturing a desk is only about 6.5% of the footprint for making a new one. Heavy equipment manufacturer Caterpillar recovers and remanufactures used parts for resale at prices ranging from 15% to 55% of the cost of new items. Since materials constitute almost two-thirds of Caterpillar’s costs, material reuse offers clear economic advantages that the company can pass on to its customers through lower prices.4
Both of these cases demonstrate how additional revenue and costs should be considered across multiple life cycles. By considering total product or material lifetime value, the higher COGS associated with circular design becomes an investment into expanding revenue opportunities beyond primary sales while spreading costs across multiple revenue life cycles and reducing overall carbon emissions. Higher upfront design, material, or production costs could also lower future costs of value-retention activities like refurbishment or repair, when seen from a total-life-cycle-cost perspective.
There is a structured way to evaluate this: the circular profit multiplier, which is expressed as CPM = Total Life-Cycle Profit / Initial Production Cost. While a holistic ROI analysis would consider total life-cycle net profits over total cost, CPM adds insights on how much additional profits are generated from upfront costs in circular design. A higher CPM indicates how investments in circular design drive total life-cycle value, either through additional revenue, extended product lifespans, or reduced costs for repair or remanufacturing. (See “Assessing Circular Models: An Example.”)
2. Analyze the residual value of end-of-life materials. Another consideration is how circular practices affect the value of products and materials at end of life, potentially as material inputs for new products or through their sale to others. Conventional depreciation methods in linear models often write down such assets to zero or minimal scrap values, but circular activities can preserve value through ongoing repair, maintenance, and remanufacturing. Circular design considerations, such as durability and ease of future disassembly, further reduce the cost of resource maintenance and recovery, thus increasing profits from reuse or resale. Missing these value-preserving factors could disincentivize circular model adoption.
Resale value can also be considered across conventional industry boundaries. A compelling example is the reuse of retired electric vehicle batteries. Batteries that have degraded to 70%-80% capacity are typically unsuitable for vehicle use but could be remanufactured into stationary energy storage systems for buildings or an electrical grid. A study in China showed that the resale of retired batteries could generate a 20%-30% profit.5 While an item’s specific value depends on its category and market conditions, there is a compelling opportunity to integrate residual-value tracking and cross-industry resale potential into the financial analysis of circular opportunities.
Furniture manufacturer Royal Ahrend takes a different approach in its furniture subscription service. Rather than considering residual values, it estimates the costs of maintenance and refurbishment that would be required to resell the product into the market and integrates those costs into monthly fee calculations.6 This approach prioritizes future resales and long-term reusability.
3. Rethink inventory management. Traditional inventory turnover and asset depreciation models may not reflect circular assets’ extended use and reusability. In linear models, the inventory turnover ratio measures how efficiently companies sell products and is generally calculated as Inventory Turnover = COGS / Average Inventory.
Circular models can increase turnover by repeatedly selling or leasing the same physical items (for example, as used or refurbished electronics or furniture) without constantly adding new items to inventory, thus recognizing revenue multiple times from the same pieces of inventory. In such cases, COGS may rise while the average inventory level remains stable or grows more slowly. This increases the inventory turnover ratio because companies are generating more COGS relative to their total inventory on hand.
Circularity may also lower average inventory holdings by encouraging just-in-time refurbishing or a service-based model, which can reduce the amount of unsold raw materials or unfinished goods. If the average inventory decreases and revenues remain stable or rise, the inventory turnover ratio naturally increases.
Another ratio to consider is fixed asset turnover, which measures how effectively a company uses its fixed assets to generate sales. In a circular model, assets may be used in multiple refurbishing or recycling cycles, often generating additional revenue with minimal new capital expenditures. This is calculated as Fixed Asset Turnover = Net Sales Revenue / Average Fixed Asset.
This ratio can be particularly pertinent with product-as-a-service models, where companies own products as assets and provide them to customers as subscriptions or rentals. One such example is Swapfiets, which provides a bicycle subscription service for a monthly fee, inclusive of repair and maintenance. This allows the company to reuse the same bicycles across multiple customers, generating revenue from the same asset for longer. Swapfiets also extends the lifespans of its bicycles by designing for easy repair and using durable, recyclable materials, which have reduced breakdowns by two-thirds.7
Managing Financial Uncertainties
Because of the high level of uncertainty regarding revenues and value recovery from future life cycles, financial analyses can be challenging when a company is transforming existing products into circular offerings or creating new circular products.
A prominent uncertainty factor is what happens to products when they leave the custody of the provider. The conditions in which products are returned can impact repair or remanufacturing costs and resale values, regardless of how well products are designed for durability or repairability. In this respect, service-based models can be double-edged swords. On the one hand, retaining ownership of an item, including repair and maintenance responsibility, reduces uncertainty about item condition and recovery. However, careless consumption — where customers treat products that they do not own less well — can be a risk in service-based models like product rentals, subscriptions, or sharing (as in car-sharing businesses).8
One way to mitigate that uncertainty is to give customers financial incentives to comply with maintenance requirements. For example, Caterpillar and Hitachi use refundable-deposit schemes contingent on customers returning parts against acceptable criteria.9 Buyback guarantees are another method. In a circular construction project to build a new town hall in Brummen, the Netherlands, components like timber and metals can contractually be returned with at least 20% of their original value to suppliers after 20 years for further reuse.10 Deposit and buyback schemes also help de-risk cash flows for the seller while maintaining customer loyalty to help secure future revenues.
These strategies need to be embedded into financial modeling. Monitoring items through connected sensors and using data analytics can also help improve the accuracy of valuation models by tracking actual item conditions.
Revenue Timing and Balance Sheet Implications
Circular models can also shift how and when revenue is recognized. For instance, leasing, subscription, and pay-per-use models generate recurring payments instead of upfront sales, which increases the working capital requirements to accommodate upfront costs such as production and logistics. Businesses need to map out the financial timelines of their circular models. This involves forecasting when costs and revenues will be realized and planning for working capital. Some businesses include upfront sign-on fees for new accounts to help bridge potential cash flow gaps.
In service-based models, businesses also need to hold products as assets, which requires capital and can inflate balance sheets. Businesses may also consider off-balance-sheet financing measures. Swapfiets tackled this by collaborating with financiers to lease bicycle assets. It also established a corresponding tires-as-a-service model in partnership with its supplier, Vittoria2Go, which owns, maintains, and recycles tires. Royal Ahrend created a special-purpose financial vehicle, called Circular Interiors, that owns the furniture provided to customers via its subscription service.11
While introducing complexity and financing costs, off-balance-sheet financing strategies can reduce the pressure of balance sheet extension while also aligning costs and revenue timing and cash flows.
Another financial management challenge of circular models is that forecasting beyond the primary sales cycle can be tricky, especially for businesses or products new to circularity. Various factors introduce uncertainty into the financial analysis, such as asset lifespan, the cost and viability of refurbishment, customer willingness to pay for reused or refurbished products, and variability in product recovery conditions. While secondary markets can offer indications of potential values for refurbished goods or recycled materials, companies should be cautious about relying on such figures unless the market has already matured to account for circular dynamics.
Our research has found that most successful businesses develop their circular models progressively over time. For example, businesses typically have a good understanding of their products’ primary-use technical lifespans. A viable first step might be to introduce sales of refurbished products in order to learn and gather data before expanding into models such as product-as-a-service. While every company’s journey is unique, a common factor is the need for piloting, testing, and making iterative improvements to refine financial assumptions over time.
Questions for Financial Analyses of Circular Models
As we’ve explained, adopting a circular business model requires companies to rethink financial analysis. Business leaders must consider several critical financial questions to ensure that circular strategies are both sustainable and profitable. Leaders can make more informed decisions and unlock long-term financial value by answering the questions that follow.
To evaluate the full life-cycle value: How does the total revenue and cost across multiple life cycles compare with a linear sales model? What circular revenue streams, such as resale, refurbishment, leasing, and material recovery, might be appropriate for your business?
To assess cash flow dynamics: How will the timing of costs and revenues shift in a circular model? Do we have the working-capital strategies needed to manage extended revenue cycles, recurring income streams, and potential cash flow changes?
To quantify residual value: What is the potential end-of-life value of our products and materials? Can we estimate resale, refurbishment, or recycling revenue, and how do activities such as repair and maintenance affect depreciation and asset management?
To determine profitability impact: What is our CPM? How do upfront investments in durable design or take-back systems translate into long-term financial gains?
To align financing strategies: Are our current financial structures (such as balance sheet management, leasing models, or off-balance-sheet financing) optimized for a circular economy? Should we explore partnerships or alternative financing mechanisms to reduce our capital burden?
To adopt an iterative approach: How can we phase our transition to a circular model through pilot programs and incremental steps? What financial metrics should we track to refine our assumptions and scale successfully over time?
Overall, adopting a circular business model may require higher upfront costs or initial investment and careful longer-term cash-flow management than traditional product models do. However, the total lifetime profit and margins often improve because companies are able to extract more value from each product through circular economy practices such as refurbishment, reuse, and material recovery. In many cases, this leads to stronger overall financial performance (such as a higher total margin and improved ROI) once companies account for all of the extended revenue streams and avoided waste costs — though it does require a shift in how these companies track and measure profitability over the product’s life cycle rather than focusing solely on the initial sale.