The amount of money and inherent risk tied up in acquiring new plant equipment and technology means the planning and budgeting for capital assets and capital asset-related expenses is too important to bury within the annual budget. Capital expenditure (CAPEX) needs to be separated out so it is visible, open to scrutiny, and can be subjected to a separate approval process. So it’s no surprise that most vendors of planning and budgeting solutions offer a CAPEX module as an adjunct to their core offering. Functionality varies, but usually majors on:
- Collecting and collating the line-item details of each project and its funding requirements in a customizable template.
- Evaluation against standard criteria such as time to breakeven, return on investment and net present value
- Managing the review and approval process
As vendors embed CAPEX functionality into their enterprise planning systems, once projects are approved, the expenditure, depreciation, and interest charges ripple straight through into budgets, asset registers, cash flow forecasts, and balance sheet.
Today, finance needs to do more than simply manage the process
Standardizing the submission and approval process for CAPEX brings consistency and undoubtedly improves productivity in a busy finance function. But not all CAPEX is so straight forward. Major projects involve people from many different parts of the organization and large amounts of investment spread over a number of years that can have a major impact on cash reserves and profitability way into the future. These big CAPEX projects are the ones that can go wildly wrong, with staff and outside contractors routinely underestimating the costs involved in their part of a project. Collectively, this can result in huge expense overruns.
Because these large CAPEX projects often run many years into the future, planning for them involves making lots of assumptions about such things as the cost of capital, the timing of funding, exchange rates, and future revenue streams. Then there is the expert opinion about things such as the resulting productivity improvements or the useful life of the asset before it is superseded by newer technology. All of these things have a measurable impact on the viability of the project but are too complex for finance to just capture in a standard template. They need to collaborate with people across the business – and possibly even people outside the business such as technical advisers and bankers who may be funding the project – to model and understand how all these assumptions impact the financial viability of the project. Then there is the added complexity that different elements of a complex CAPEX project, such as property, plant, and professional fees, may need to be treated differently according to the prevailing accounting standards, in order to forecast exactly what the company’s balance sheet will look like 5 or 10 years into the future.
Taking CAPEX planning to the next level
Because they are offered as adjuncts to tightly prescribed planning and budgeting solutions that typically have limited modelling functionality, most CAPEX planning modules are restricted to working with financial data and primarily focus on the submission and approval process. While that is entirely adequate for the majority of simple CAPEX proposals such as acquiring office equipment and stand-alone plant and machinery, it does not really help in managing the risks involved in larger scale projects.
There comes a point where projects start to get business-critical and the sums involved commensurately large. That is when it becomes imperative to build highly granular models in order to assess how the technical and financial assumptions that typically underpin such complex projects impact their financial viability. Faced with such a situation, many folk would automatically resort to modelling on spreadsheets. But given that complex projects need inputs from business managers and technical experts from across the organization – and sometimes from outside too – there are considerable benefits to be had from using an enterprise-level solution that provides secure access control and makes it easier to share a common set of data. That way the finance team can collaborate with the key players involved in major projects; using the built-in audit trail to see how assumptions have evolved over time, and importing actuals to track variances against approved budgets.
However the majority of enterprise level planning and budgeting solutions fall short on two counts.
- Many still run in batch model rather than in real-time so users are not always able to carry out on-the-fly analysis to see how changing input variables impact critical measures such as ROI and NPV, or to identify the most critical assumptions to manage or mitigate.
- Secondly, building and maintaining models in enterprise level solutions usually requires expert skills beyond that found in many finance departments. That means every time dimensions and hierarchies need to be changed or new rules written, there is either down-time waiting for someone from corporate IT to become available or outside resource has to be brought in. Clearly it would be better if the finance people attached to major projects could do all of this themselves as that way they can quickly restructure models to keep them aligned with changing corporate structures, update the cost of capital, depreciation methods, asset categories, taxation rates, exchange rates etc., as well as building models for analysing the sensitivity of these complex CAPEX projects.
The role of finance in large CAPEX projects goes well beyond collating the data and managing approvals. Today, they need to be involved in capital planning and budgeting processes at the very beginning and develop a deep understanding of the underlying critical success factors and how different funding options impact a project’s long-term success. That means freeing them from the drudgery of collecting and collating disparate enterprise data and the limitations of modelling in stand-alone spreadsheets and giving them a solution that delivers the insight they need to steer the project team towards the very best outcome for the enterprise.
Some people would argue that CAPEX has become steadily less important. Certainly, many companies have built up considerable cash reserves in recent years and prefer to take as much expenditure as possible as operating expenses rather than as CAPEX, especially when it comes to spending on technology with its increasingly brief shelf life. At the same time, the steady shift away from on-premise systems to using cloud services is resulting in a greater proportion of spending going towards OPEX. But that still leaves the finance teams in most organizations with plenty of major CAPEX projects to get involved with. I know many companies have changed their policies on CAPEX in recent years, freeing up more time and resource to focus on the major projects. If you have experience of this shift inside your company, please share your thoughts in the comment box below.