As we indicated earlier, this section of the document will focus on the capital expenditure acquisition process.
This part is divided into three sections:
Section A ‒ The planning stage of capital expenditures
- How to use long term planning to reduce costs
Of all the steps that are involved in the entire process of managing capital expenditures, probably none are more important than planning. It is not only the first step of the process but also the one that will dictate everything that follows. This step is the key to managing capital expenditures. It is the strategic step where short-, medium-, and long-term decisions come to play (and sometimes fight each other).
Now, let’s have a look at ways to reduce capital expenditure by improving the planning process.
The ultimate guide to managing capital expenditures in companies and organizations
Every company has a budget process. Without a formal budget process, things would quickly get out of hand. Companies would have no compass to be able to guide themselves. So having budgets is mandatory. In addition to this, most well-established companies have formal capital expenditures process in place. After all, capital expenditure often represents significant amounts of their budget. While most of them still rely on legacy spreadsheets for their capital expenditures management, they do have an approval process of some kind to be able to know who in the company has to approve what expenditure.
So far so good
How is it then, that companies with the very structured budget process, and having a formal approval process for capital expenditures, are often at a loss when asked simple questions like, “Where did their capital expenditures go over the past years?” and, “What was the return on their investments?”
Unfortunately, few companies can produce the proper answers without extensive research. Year in year out, those same companies will spend millions and millions on various capex equipment or projects.
This process is not only inefficient from a strategic perspective; it is also less than optimal from a cost perspective.
Some companies allocate their capital expenditures on a first come, first served basis, where the primary business units put together an acceptable business case for a capex gets it approved. Others will seem to have a capex allocation process that works by decibel level, where the person or business unit that is the loudest to make their request seems to win. Finally, many companies will have the head office allocate a capex budget for the year and will then work somehow to spread out the amounts across the various business units of the company. In this situation, companies often go back to the first two models listed before (first come and who screams loudest). Many times, to appease the people (buy some peace), management will allocate approximately the same amounts each year to the groups, sectors, or business units. These amounts might be according to the size of the business units, or their level of sales, or based on another metric such as profitability. Sometimes it is merely because a business unit or group has not received sufficient funding in the past few years. The result is that this strategy gives way to a process of evening things out, where all business units are equally unhappy to see their requests or anticipated projects cut (often in half or more).
Each year, it is the same thing, the business units submit their requests, only to have management spread out the capex budgets and ask the business units to live with the allocated amount. The irony in this process (which is usually based on saving money) is that it costs the company more money to manage this way.
A complete set of keys
To reduce the overall cost of capital expenditure over time, companies must do better jobs in their capex management. Unfortunately, this cannot be done in one-step, and maybe because of this do we see so few companies that have mastered the capex management process.
For the manager to transform the way they manage capex, think about the process as like a path with a series of doors, with each door needing one special key to open. To complete the path, all doors need to open. However, if only one door remains closed, then it is not possible to complete the path. Before embarking on this path, the first step is making sure that one has all the keys in her/his pocket.
Key number 1: Plan to reduce – reduce your plan
To reduce capital expenditures, the first step is to a better plan. This sounds trivial, and most managers reading this will raise their hands and explain how well they plan their capex. However, most managers will only plan capex a few years ahead. Few put together long-term capex planning strategies. This is one of the keys that the manager needs.
Many companies only plan capex ahead one or two years. Very few companies will set out to make a 20- or 25-years year capex plan. In many cases, this is precisely what is needed. While this might raise eyebrows, we will go into detail as to why a company would need such an extended plan, especially when some companies do not know if they will even remain in business next year. We will list some arguments towards a 20 to 25-year capex plan here and finish with examples of companies and organizations which should benefit from long-term planning.
The first thing people learn when they drive is to keep their eyes on the road and to investigate the distance. When you are driving on a highway, looking just ahead of your front bumper would be a recipe for disaster, as anyone who drives knows that if something happened, they would never have the time to stop. This is why people continuously look in the distance and occasionally look closer. Over time, we do this without even thinking anymore. In capital expenditure planning, we continually see companies who set up capex plans for one or two years and seem perfectly fine with this. The problem is that in today’s world, business moves too fast and not planning sufficiently is asking for trouble eventually.
Let us suppose company X decides to create a 25-year capital expenditure budget. The first thing to look at is all the items that should go into that plan. At first, people might feel at a complete loss, not even knowing what to put in the budget. However, a quick look at the past reveals that the capex approved by the company was mostly for building and production. The company then decides to look at the condition of its buildings. It then creates a list of all the items that would need to be replaced in the next 25 years.
The company then looks at when these expenditures could potentially happen. For example, if for one building there are five sections of roof that all have different ages, the company might decide that roofing is suitable for 20 years and from their estimate when each part of the roof will need to be replaced. After the roofs, the company looks at all the other building items from structure to parking to elevators, windows, HVAC systems, and others. For each item, the company evaluates in what condition the item (or equipment) is and when it could be replaced. For each item, the company will also write down a guesstimate, give it the best shot at estimating how much the item would cost to be replaced. Inflation is also added to the cost. At this point, there are still many uncertainties, namely of timing and cost.
Once all the building components have been entered in the 25 years capex template, the company will add up all the costs for each year to see what it looks like.
The results at first will probably not be beautiful. Some years might see huge expenses while another year might see a small amount or nothing at all. This is normal.
Capex Budget Per Year
As previously mentioned, at this point, the company has created the template with many uncertainties.
- It does not know if the items will need to be replaced in the year that it put the item. How can anybody know ten years from now if a section of the roof will need to be replaced or if it could still be suitable for a few years? Even worse, if the company is a manufacturer, how they can know in advance which production equipment will be needed? Especially if they do not know when new sales will happen.
It only estimated the costs for each item, so they all have errors and the items the most in the future probably carry the most significant errors.
However, it is a start. The next step the company takes is to look at what is planned for the short term, for the next 2 or 3 years and see if everything makes sense. Do the items really need replacement? Are they well estimated in terms of price?
Then, the company has a look at operations. Each year it spends on operations equipment. At this stage, the company does the same process for production equipment as it did for building items. It adds up all the costs for each year and then refines the production equipment and cost estimates for the first 2–3 years and finally, it adds that to the building items.
The company now has a 25-year capex plan, although it might be more precise (and better) for the first 2–3 years than the other 22–23 years. During the year, the company decides to collect more information, on an ongoing basis, about all the items that it listed in the years from say, year four to year 25.
If the equipment or building repair can be moved by a few years (advanced or delayed), the company makes a note of this. The idea is to refine the capex plan as much as possible, with the information available. Seeing a plan of 25 years will start to allow the company to smoothen total capex costs over the years.
For example, if in year nine the total capex was much higher than in years 8 and 10, perhaps it would be possible to accelerate or delay some items that were budgeted for year number 9.
For example, the company could delay some structure work from year 9 to year 10 and accelerate the planned equipment X purchase to year 8.
Doing so will reduce the total capex budget for year nine while increasing it for years 8 and 10.
The result shows that the totals now vary less from year to year.
What the company wants to achieve is to remove peaks or valleys and end up with total capex budgets that are relatively equal year to year. It may tweak the template to allow the total capex budget to slightly increase each year (say to take into consideration inflation), to remain flat or to decrease it a little each year.
Each time the company purchases a piece of new equipment or item, it then proceeds to put it back in the 25 years capex budget. For example, if it buys a rooftop unit that serves to cool a building, it might find out that the unit usually is suitable for 15 years so that it will add the cost (plus some inflation) of a new rooftop in 15 years from now — installing a new roof? It might plan for its replacement in 20 years (depending on the type & quality of the roof installed).
In the two examples above, we can see that the rooftop initially purchased for $120,000 is added to the budget in year 18, which is 15 years in the future. The amount is estimated at $190,000 to take into consideration some inflation. The roofing, which was purchased in year 3, has been scheduled for replacement in year 23, which is 20 years in the future. The amount in year 23 is the estimated amount the user estimates it will cost to replace the roof in that year.
The idea here is not to have a perfect plan for 25 years; this is merely impossible. As noted before, nobody knows if a roof section will need to be replaced in exactly 20 years or if a rooftop unit will be at the end of its life after 15 years. That rooftop unit might last 20 or 22 years with proper maintenance, maybe more However, what the company can do is refine the first years of the budget (2-3 years) so that it knows precisely how much it needs to spend on capex and for all the other years, adjust every few years by going back and evaluating the conditions of the building items or equipment. For example, the company might do an infrared scan on the roofs every two or three years to determine which will be the next sections of the roof to be replaced. Each time it has new data, the company might decide to accelerate or delay an expense. A production unit that was scheduled for replacement is now found to be in better shape than people thought. Its replacement might be delayed a few years. A structure has just been found in worse condition than expected. The company might advance the repair, as needed. Each year the company goes back and looks in detail at what is planned for the next two or three years, but it also takes a hard look at everything that is intended for the other 22 or 23 years in the 25-year budget.
Over time, the company will get better at estimating capital expenditures, and this exercise will become second nature, just like driving.
Note: we talked here about smoothing the budget charts to remove peaks and valleys. However, since every company is different, the goal of the capex planner is to align the budgets with the company. If a company is mature and sales are stable year after year, the capex planner might try and have cape budgets that are even year after year. However, another company that is growing fast might be ok with increasing capex budgets. Inversely, a company in a consolidation stage might prefer decreasing budgets. A long-term plan will help the capex planner adapt the capex budgets to any company situation.
If a company is seeing its capital expenditures rising each year, it might well feel that there is no end in sight. Over time, buildings and equipment get older and require more upkeep. New production equipment becomes more expensive each year, and companies are struggling to keep up with their competition. Because of this, capital expenditure is an essential part of the company’s budgets. Having long term plans can help see the bigger picture. While we would provide numerous examples here, we can list a few. The goal of these examples is to highlight the benefits of long-term planning.
For example, a company has a building where each year it is spending significant amounts in capital expenditures for a particular business unit. Year after year, it gets many requests for different building renovations and equipment. However, one year, the company decides to create a long-term plan for capital expenditure. After a 25-year plan is made, it is found that over the next ten years alone, everything (or almost) in the building will need to be repaired or replaced. Because the company was only doing capex budgets one or two years at a time, it never realized the condition of the building. Now that it has the information, the company can make some decisions. They could sell the building and either buy or lease a new building, preferably one in perfect condition. They could keep the building but see what they can spread out so that instead of having to renovate everything in the next ten years, they can do it over 20 years. For this they might repair some components instead of replacing them (e.g., parking, roof) and for other component or equipment, they might bite the bullet and decide to combine all the work that was planned over a period of a few years and do it right away in order to get a better pricing on the repairs.
Another example is if the company was spending capital expenditure on building systems year after year (heating, cooling, ventilation), instead of continually repairing some components or equipment, they might decide to create an energy saving project where they would replace various equipment and package it in a project that has a reasonable payback. The project might allow them to throw even in some components that carry no payback at all, but once blended in a project with excellent energy saving measures equates to an acceptable payback.
There are numerous other examples that could be described here, the idea to keep in mind is that by having more extended capital expenditure plans, it can allow people in a management position to have better information and from there, allow them to brainstorm on what could and should be done.
Planning is creating checklists of what to do. Also, long term planning is creating long-term checklists. Just as one prepares for a long journey (or holidays) by making a checklist of what to bring, what to do, long term planning for capital expenditures will help the user avoid forgetting things. For some components, it is easy not to ignore them, especially if they need to be replaced often. However, some others (think elevators or large transformers, for example) we buy and do not often think about replacing them until they break down. Then it is too late.
Planning a long time ahead will avoid forgetting things, and it helps avoid leaving precious money on the table.
Now, let us see what type of companies would benefit from this: virtually any company which spends significant amounts on capex each year.
While this might sound like about every large company or organization, it is precisely that. Too often, companies do not do an excellent job of combining their capex needs to get better pricing. For example, if a company has fifty business units spread out over the country, does it systematically align its capital expenditures so that each time there is a type of component, project, or equipment that is purchased, all business units get together to get a group price? Chances are, few do it unless the business units are centralized. However, there are many ways that procurement can help remove some of the money left on the table.
Let us look at an example here.
Company X has fifty business units, of which twenty have plans to purchase new production equipment next year. The business units did not talk to each other, but it seems that there are three leading vendors (which manufacture this type of production equipment) that will supply most of the equipment to the business units, with three other less popular vendors looking to sell to a few business units only. If nothing is done, the company will end up, during a 12-month cycle, buying twenty new pieces of equipment from six (6) different vendors.
Company Y also has fifty business units, of which twenty have plans to purchase new production equipment next year. However, Company Y has a capital expenditure plan that calls for analyzing all the proposed expenses, and it has a long-term capital plan. It finds that each year the company purchases about twenty new pieces of equipment of that type. It has been doing this for many years now and will need to do this for many years to come. Company Y also has cross-functional teams that debate which supplier to use, and they have selected two vendors to be their preferred vendors for that equipment, with one vendor being the first choice and a second vendor being seen as an acceptable second choice. Looking at their long-term plan, they find that they will need to purchase one hundred pieces of equipment over the next five years. The company then asks procurement to go to both selected vendors and ask pricing for twenty equipment and with discount clauses (tier discounts) for additional purchases right up to one hundred equipment, with delivery clauses (including price escalation) over the next five years. The company wants to select both providers to avoid being locked in with a single one, but the actual percentage of split (how much equipment are purchased) between the two vendors can vary.
Both vendors come back with pricing and procurement finds that the best mix of price and vendor is to purchase eighty equipment from the first vendor and twenty from the second vendor. The company locks in great pricing today and gets to have the equipment delivered over the next five years. With the savings that the company achieves, it can even purchase more equipment (or buy it sooner). The vendors are happy because they managed to lock in a large order, and they can also better plan their production, knowing how much equipment they need to manufacture in the coming years.
This is only one example of what is possible to do with long-term planning combined with proper procurement processes. Companies can apply similar strategies with many other capex items.
Key number 2: Allocate on merit, not because
As we previously mentioned, many companies will allocate capex budgets to various groups or sectors of companies, simply because they did this the previous years. The result is that each year the same groups receive roughly the same amount of capex budget simply because that is how they did it before.
The second key to the path of capex reduction is to allocate capex to individual merit. This means that capital expenditures are only awarded if specific performance criteria are met. These criteria should typically be financial. They can be a return on investment (for example a minimum Internal Rate of Return, a maximum payback period) or other criteria. However, each project should come with this.
While this might seem unfair because some business units might produce the best capex requests, eclipsing other business units, allocating capital on merit has many advantages. First, it forces the people in the company to produce promising ideas. Instead of having an annual amount for capex automatically carved out for them, each business unit will now fight for its food. Second, it allows the company’s management to sort all capex requests from best to worse and establish a cut-off at a specific point. Very soon, word will spread in the company of that cut-off point, and business units will be looking for ways to improve their capex request to meet the threshold. Some business units which like to control their ship might become more open to head office suggestions about cost reduction ideas such as group purchase, finding grants and others.
Key number 3: Consider the lifecycle cost whenever possible, because cheap is too expensive
Too often, companies seeking to purchase a piece of equipment or do a project put together a request for proposal and then select the lowest price when all specs are considered equal. The problem with this is that specs are rarely equal, and not considering everything might end up a costly decision. Including lifecycle cost analysis is an essential part of the capex process, and we think it deserves its chapter. Chapter below focuses on lifecycle cost.
Key number four: Proper tools
Tools have been around for almost as long as humans have been. To say that they have tremendously evolved over the centuries is an understatement. However, they have always had the same purpose: to help the user do better, do more, do faster, do stronger.
In management, companies have tools to help them do better, do more, do faster, and do at less cost. Having the proper tools can help create and manage a cost-effective capital expenditure process. While many companies still rely on homemade spreadsheets for this, having more specialized software can make a significant difference in reducing the cost of capital expenditures overall. Chapter xxx touches on this subject.
Other items to consider
We have covered the capital expenditure planning and detailed ways that companies and organizations can implement management methods to reduce their cost of capital. In every situation, we have considered capital expenditures. However, there are other ways that companies can reduce their capex costs, at times, by avoiding them. While not always possible, it is still good to have a look at alternatives to straight capital expenditures, and we will list some of the other options here.
Purchase vs. lease.
The notion of capital expenditure involves the purchase of an equipment, component, repair, or project. However, in some cases, the company might be better off to lease than to purchase. Although not always applicable, it is something to be considered, depending on the nature of the capex and the intended usage by the company. For example, if a company needs a forklift for its operations, it could go ahead and purchase it like regular capital expenditure. It would pay for it outright (or have it financed) and then amortize it over several years. However, since this equipment is a forklift, and several suppliers lease these types of equipment, the company could decide to lease the forklift. It could also include the maintenance and repairs in the leasing agreement, to have a better knowledge of the costs right from the onset, instead of having to budget for unexpected repairs in the coming years. In addition, leasing the equipment would remove the uncertainty of the residual value (or having to find a buyer for the old forklift in a few years).
By performing a detailed cost analysis of lease vs. purchase, the company can find out what would be the best decision for this type of equipment. The same can be done for several other equipment or components.
One point, in this text, we do not discuss capital lease vs. operational lease, the point here above is only to outline potential alternative to standard capex purchase.
Recap
As we saw up in this section, companies could benefit from improving the planning and management of their capital expenditures. By doing so, they can ultimately reduce their overall capex costs in a few ways.
Now we will take a look at the process of getting a request for capital expenditure approved in a company or organization. This process is a crucial one. After all, one might have the best idea for a project, but if the project is not approved, if the project is not funded, it will remain at the idea stage. Getting the capex approved means that a request was created and assembled in a way that it is sellable. That is, sellable to the people with authority to approve the request.
The following section of the guide will look at how to assemble the information to get your capital request approved.
Section B ‒ Improving the odds of getting your capex request approved
- How to assemble a request
- Anticipate questions from approvers
The ultimate guide to managing capital expenditures in companies and organizations
People that oversee and approve capital expenditures in companies usually get to review the business cases that come with the capital expenditure request. Most companies and organizations do request some kind of business case to be created before giving the green light for any project or capital expenditure that is not pre-approved. Moreover, even when it is pre-approved, most people still need to re-justify the capex before they initiate the expense.
If you are part of the approval process of capital expenditures in your company or organization, you know that all these requests come with a reason. People that seek approval of capital expenses use several reasons for their justification, and this in itself is probably one of the most critical elements of the business case. However, over time, the process of capital expenditure approval has seen an increase in the number of reasons used for justifying them and its adding complexity for everyone involved.
Let us explain
Over the past years, companies have typically spent money for capital expenditures for several reasons, such as the need to replace older existing equipment or acquire new equipment to grow their business or complete some significant repairs to a building. Later, when efficiency improvement became more popular (and such equipment became available), companies started to replace current equipment with more efficient ones, to gain efficiency by reducing workforce (by automating processes), waste, and energy.
These are only a few reasons for spending on capital expenditures, but they illustrate that reasons have evolved over the past decades to include new ones. Over many years, companies evolved their justification criteria for spending on capital expenditures. If one hundred years ago, most capital expenditure was justified by replacing old equipment or doing major repairs, new justifications for capital expenses would be much more complex and varied today.
Reasons today, in addition to the previous ones used in the past, now include legislation, insurance, disuse, energy-saving, health and safety, and environment to name only a few. Of course, traditional reasons such as replacing equipment which has reached the end of their life, are still popular. Nevertheless, we are seeing new reasons relating to fields such as the environment becoming more popular these days.
The problem for people in a capital expenditure approval position is that getting to understand the reasons for the capital expenditure demand is also getting more difficult because of the evolving reasons for the request. Also, without a good understanding of the reason for the capex request, many people can take a fallback position (that may seem risk-free) of denying the capex request. After all, if we reject the approval, do we eliminate the possibility that the project or the capital expenditure would have been a wrong decision? Moreover, what about the good projects that are being denied simply because the approvers do not fully understand the reason behind the capital expenditure request? Unfortunately, numerous companies and organizations are missing opportunities because of this.
If replacing an equipment, because it is too old to function correctly, is a concept that everyone can understand and are approved without too much pain, getting to replace a perfectly good equipment for another one, which will improve quality, reduce staff and the company’s carbon footprint at the same time is another story.
The same thing applies for retrofit projects whose primary purpose is to save energy. Instead of having to simply compare between keeping old equipment running and purchasing a new one, the capital expenditure approver now has to understand new concepts and see the cumulative effect of a combination of factors. In addition, often, the first thing that the approvers will normally do is seek more information before making their decision.
For the person seeking to get a projector purchase approved, it also means that he or she will need not only to answer these questions but to explain in a language that the approver will understand and in the same process, do it convincingly.
Questions from the approvers can be very varied, depending on the nature of the capex request:
- Can you explain how this retrofit project will help us save energy and reduce our carbon footprint at the same time?
- How much of this project is for saving energy, and how much is simply to make us look greener?
- I do not understand this project. How do we measure the immediate benefits for the company?
- Do we do use standard methods such as Payback, Net Present Value (NPV), or Internal Rate of Return (IRR)?
- Can we get grants for the project?
- How many grants are we estimated to receive, and how much is based on internal guesstimates?
- Is this for safety reasons? Why was it safe last year and suddenly, it is now not safe? What has changed?
- Are we replacing it because of legislation? We just changed the equipment last year; can we continue as we are doing now?
- Insurance wants us to spend for what? Is this an absolute requirement (if we do not do this, do we lose our insurance protection) or another one of their nice-to-have proposals?
- Is this capex for a production unit for a new client? Do we know for how long we will keep the new client? What happens if we lose the client before the new equipment has been fully paid for?
- What is the lifecycle cost for this equipment, and did we do a lifecycle cost analysis for any other alternatives?
- What is the urgency suddenly? Things were working well until today.
- The savings related to this equipment purchase are based on a reduction of headcounts. Have we clearly identified whom we will let go and all the costs associated with this?
These are only a few examples of questions that come up all the time. These days there are many, many more questions and rightfully so. However, how often are capital requests denied because the approvers did not fully understand the
Because of the explosion of reasons, getting projects approved requires that the initiator of the request do more homework than before. No one really expects the capital expenditure approvers to be experts in all fields such as legislation, health, and safety, energy-saving, insurance, and others, but the approvers need to be able to analyses the capital expenditure requests that are initiated for very several reasons.
How can the initiator of the capital request and the approver get to be on the same level, so that the good capital expenditure requests are approved and those that provide less value to the company are rejected?
First things first. It is up to the initiator of the capital request to provide enough information for the approver to understand fully what he or she is approving. In the capital expenditure request, the initiator must clearly state at a minimum:
- What the expenditure request is about, providing as many details as possible on the project, the purchased equipment, the cost, timeline, and other elements that are associated with the capex request such as warrantee, performance guarantee.
- The reason or reasons behind the expenditure. This is providing information on the benefits that the expenditure will bring (help to increase production, reduce costs, comply with legislation, save energy, add security to workers…etc.).
- Any explanation on why the capex needs to be approved now can be useful. A request for capital either triggers an event (the company wants to invest in a project or machinery), or it is triggered by an event regardless of if the event happened suddenly (the equipment broke down) or over time (the entire roof needs to be changed). In any event, the capex seeker will need to explain why now.
- The total cost, meaning the cost and all potential additional costs that may arise. This is usually an excellent time to include an element of risk in terms of possible cost overruns. If the capex request is a simple equipment purchase, this can be simple to isolate, but if the capex is for the expansion of a manufacturing plant and includes process equipment as well as the building, there might be multiple sources of a potential cost increase.
- The other risks (all of them). Capital request that is for more complex equipment or projects should include information on the potential risks; this shows the approver that homework has been done. For example, if there is a risk that the new equipment the capex request is seeking may take more time to install and get running up to the desired production speed, there might be production downtime because of this, and it should be considered in the analysis. Risks can be apparent (ex: delay in equipment installation can cause delays to production, which in turn can cost the company money), but they can also be less noticeable. For example, if the purchase of new equipment is meant to replace employees, have the costs of terminating the employees and the risks associated (being sued by the employees or problems with unions) been adequately evaluated?
- The benefits to the company/organization. These include the standard financial benefits (payback, NPV, IRR), quality (improvement of production quality), and health, safety, cost reduction, marketing/sales/image benefits (if the project helps the environment for example). The benefits and the reason usually go together; although, some capital expenditure might not have many benefits. For example, if a new municipal law requires a company to install something new, say a fence, while this new law will be the reason for the capex request, but it might not bring any benefit for the company (apart from getting the city off the company’s back).
- The downside of not doing the project. If there are benefits to the capital expenditure that is requested, there is probably a downside to not doing it. It is important to outline the downside or potential consequence or loss of opportunity that would result from not getting the capex approved. This can range from government penalty (suppose the company does not authorize a capex request that was for something related to legislation) to loss of insurance coverage (supposing the request is from the insurance company as is mandated to keep the coverage).Finally, it can also lead to negative public news (suppose the capex request was for replacing a chimney that emitted pollution next to a residential area). These are simply examples, and there are many other potential downsides. The important part is to provide the information on the capital expenditure request for the approvers to understand fully the consequences of not approving the capex. However, it is up to the people seeking to get the capex approved to highlight the consequences (if any) of not pursuing a capital expenditure.
- Depending on the nature of the capex request, a description of how, who will implement the project, component, or work, and when. While this might be straightforward if the capital expenditure is for the acquisition of a forklift, if the capex request is for a building expansion or a new production unit, there might be many elements to consider here.
- Information on alternatives. Since the vast majority of capital expenditures have alternative solutions, it is best to be well prepared and have several alternatives in terms of what to do, what other vendors to consider or other potential equipment to purchase. Showing to the approvers that some alternatives were considered shows that homework was done and will help avoid some of the questions such as, “What are the alternatives?”
Alternatives can be other types of equipment, other vendors, but they can also be other forms of getting equipment. For example, an alternative to purchasing equipment might be to lease it. Instead of replacing equipment, we can look at an overhaul. An alternative to buying new might be to buy second-hand. Whatever the nature of the capital expenditure, there are often alternatives that can be found. - Any technical information that the approver needs to understand should be presented in a straightforward way so that the person (or persons) in the position of approving the capital expenditure can take a sound decision. The more information and explanation that is provided, the more the approvers will understand what the request is about and in many cases, the more they can tend to be favorable to the request (if the request already meets the company’s criteria of course).
Recap
The process of capital expenditure has evolved, significantly, over the years. Today, there are more reasons to initiate a request for capital than there used to only a few years ago, and this tendency is probably going to continue in the future.
People seeking to get their capital expenditure approved should consider that the multiple reasons available for their capital expenditure justification only makes the work of the approvers more complex and therefore, they should provide them with as much information as possible in order for the approvers to take decisions that make great business sense for their companies or organizations.
Section C ‒ Things not to forget when creating a capital expenditure request
- All the important elements to consider when assembling your request
We have looked at the planning of capital expenditures as well as how to justify a request. For the next chapter of this guide, we will provide you with a list of items that should be kept in mind when creating a capex request. We have assembled a list of the most essential elements to consider for a capex request. Because each request is different and each company has different needs, it is possible that not all items on the list apply to all capital expenditures request. Therefore, this list should be used more as a ‘do-not-forget-to-think-about’ list than a finite list of items to be included in every capex request. A final note, the list does not sort the items by level of importance. Here again, because each company is different, some items on the list might be very important for a company and of less significance to another.
The ultimate guide to managing capital expenditures in companies and organizations
Most complex tasks these days require some kind of defined checklist before people can start. Take an airplane, for example. One would probably not want to fly on a plane where the captain and co-pilot have not gone over their checklist to review essential elements like fuel, doors, and many other items on their list. Going to be pure memory is not in the best interest of anyone in this case.
Therefore, why when people in companies put together a capital expenditure (capex) request, they often fail to go over a checklist? One explanation could be the rush to get the capex approved.
Although this argument would not explain everything; for many companies, by the time that the people put together a business case for a capex, they are already running behind their schedule. If the capex concerns the replacement of production equipment, every hour lost can represent lost production. However, this would not explain all situations. There are many cases where people have sufficient time to plan for the capex, and they still fail to go over detailed checklists.
Instead of trying to find out the “why” companies do not have a checklist, we will focus here on the checklist itself, so highlight the items that should be addressed, regardless of how fast the capex needs to be approved. After all, most of the elements contained in the list can be addressed at the very time that people are putting the capex request together. Also, even at times where it is simply not possible to put together a formal capex request, people in companies can still use the list to integrate the elements in their purchase.
Regardless of the complexity of the purchase, having a good checklist handy can prove useful, even when the purchase seems like a repeat of something the company already previously purchased. Also, if this idea applies to seemingly standard equipment, it indeed does apply if the equipment is something brand new and coming from a foreign country.
So, what should be a capex checklist? Although the reader will probably find other items that can be added to the checklist below, the items listed here should constitute the minimum to keep in mind when purchasing a new piece of equipment.
1. What is the real price?
That is the total price with everything included
This first item on the list might seem trivial. After all, price is a central piece of any capex. However, the price can take many forms. For example, if the capex is for a piece of equipment, does the price include only the equipment or does it also include installation? Does the price include the start-up of the equipment? Does the price include tax and other fees or duties? Does it include shipping cost, insurance, etc.?
2. When will it be delivered?
The exact day it will arrive at your site
The second most crucial element is the delivery date. This again seems obvious, but depending on what the people want to purchase, they will need to validate if the agreement is talking about when the equipment is going to be delivered or ready to operate.
For example, if the contract states a turnkey installation, is the delivery date the date that the equipment arrives at the customer’s site or the date the equipment is ready to operate? If the equipment is set to be delivered at a port, is the delivery date the day that it enters the port, or the day that it has cleared customs and is ready to be taken. The date is simple to understand, but knowing exactly what the date is referring to is not always so simple.
3. Where is the delivery point?
Learn the incoterms if possible, do not get surprised if the delivery is at the manufacturer’s place if it is written, “Ex works” in your contract
Incoterms are great because they enable people to speak the same language. That is, for people who already speak the incoterm language. For others, it may be a little tricky. Terms such as “free on board” and “ex works” mean quite different things. It is important to understand what the meaning of the terms, and if in doubt, to seek help from people that speaks incoterm language. Remember that incoterms cover a wide range of elements, such as delivery points and costs such as insurance and transport (to name a few).
4. When do you take ownership?
When is ownership transferred to you?
While this item is usually covered in the Incoterms, when there are Incoterms, in the case where the agreement or contract is in another format (plain text for example), it might be a little more challenging to understand when the company takes ownership of the purchase. If the purchase is equipment, the information should be clearly spelled out in the agreement or contract. If the purchase is a project or group of equipment, then depending on the situation, there might be multiple dates for transferring ownership from vendor to buyer. Having a complete understanding of when the ownership is transferred is important to know.
5. When do you take responsibility?
If something breaks, when is it under your insurance?
In most cases, the responsibility is transferred when the company (client/buyer) takes ownership from the vendor.
This, however, is not always the case. In some cases, there might be a third party involved (a contractor, an installer, or other) and the dates at which the ownership is transferred are different from the date at which the buyer becomes responsible for breaks or additional costs.
6. Who provides insurance, and for what amount?
Unsurprisingly, insurance is never a popular topic. Most of the time it is a necessity which people hope they will never need, while most always regretting having to pay for this when nothing happens. It is a tricky situation; however, it is also necessary in most cases. Having the proper amount of insurance will provide some peace of mind, but companies need to remember that they also need to look at what they need to have covered by insurance.
In the case of simple equipment, is insurance needed for replacement of the part only? Does the insurance cover all the costs such as transport and other duties? What if the component takes 30 weeks to manufacture and gets lost along the way, will equipment replacement insurance be enough? Will, there are other forms of insurance (loss of production) available, the goal of this item here is simply to make the reader reflect on the insurance that he or she has on the capex, and who pays for it (vendor, buyer, or other).
7. What happens if there is a problem?
Can I return it? What if the equipment is received partially broken?
Most buyers normally assume that if the equipment is broken, the vendor will supply a new one. However, depending on the nature of the capex, this item can rapidly become a complicated one.
For example, what if the equipment breaks once it is installed and cannot be removed? Will the vendor repair the equipment locally? What if the capex is a project? Who pays for what in the event that it needs repairs? In the case where the equipment can be returned, who pays for the transport, duties fees, insurance, and other costs?
8. How do we pay?
Check, transfer, letter of credit, or other methods
Depending on the capex, payments might be small and be paid with a simple check or wire transfer. However, in other cases, if there are other means of payment like letters of credit, it is important to know the details involved.
9. When do we pay what?
Timeline for actual payments
The timeline of payments may be a small element if the capex is a small one. However, if the capex is for a piece of equipment, which costs millions of dollars, the payment terms take on a vastly different magnitude. In these cases, it might be important to talk with the treasury department of the company (or whoever oversees handling the money in the company) to secure the funds when they are needed. It is also good to know if there are penalties for past due payments, in the purchase agreement.
10. Are there taxes to be paid, how much, and to who?
Taxes are so much an intrinsic part of the business that we do not often forget. However, it is important to know all the taxes that need to be paid, both local and foreign.
For example, if the equipment is coming from a foreign country, and they impose an exit tax (most often called some kind of duty name), it is important to know who needs to pay for it, when, and how much it represents.
11. Performance clauses
Quality, speed, number of items, efficiency, and durability
This is the most complex of all items on the checklist. When a capex represents something like complex assemblies, production equipment, or projects, the notion of performance often surfaces. Performance can take many forms such as speed, quality, and the number of items produced, efficiency or durability, as well as a combination of all these forms. Having a proper performance clause will protect the buyer, to various levels, from surprises. The goal is to keep in mind what is important.
For example, if the equipment is purchased for production, some of the characteristics might be more important than others. The important thing to know is what will happen is one of the characteristics that do not materialize. For example, if the equipment needs to operate to a certain speed, but only achieves 80 percent of that speed, does the purchase agreement have a mechanism for compensation to the buyer?
What if the production equipment is simply of no use to the buyer if it achieved this speed level (supposing it is attached to other production equipment, and it absolutely needs to run at a higher speed)? Can the buyer send back the equipment and be compensated for it? Are there any penalties for the vendor that applies in such a case? Covering all the bases here is mandatory to avoid costly surprises, especially for production equipment. However, even in the case of other types of equipment, it is important.
For example, if the capex is for a rooftop unit, which serves for cooling a building, what if the unit does not deliver the cooling capacity that it is expected to? Does the agreement say that the vendor can supply a second unit to increase the cooling supply? What if there is not enough place to install a second unit? Can the buyer force the vendor to replace the unit with a larger one? Again, having a strategic reflection of what is expected from the equipment, component, or project outlined in the capex is important.
12. Installation requirements
Electricity needed, mechanical, plumbing to plan for, settings required, access in building to bring the equipment inside, permits, or any other installation requirement
This item is often a source of budget overruns when it should not be. Regardless of the complexity of the capex, if there is a component of the installation, the capex seeker should outline the additional costs that will be related to the installation. Nobody wants to present an entire capex business case, for a project, only to have to come back to management later to explain that installation costs were forgotten in the process.
13. What are the dimensions of the package or the equipment, and what is the weight?
For most purchased equipment, the size and weight are already known. However, if the equipment is part of a new project, it might be important to know in advance the dimensions of the equipment. Nobody wants to end up having to order a crane at the last minute for something that was supposed to go into a freight elevator.
Weight can also be a factor. For example, if a component or equipment needs to go on the roof of a building as part of a project, knowing the weight in advance might help plan for roof reinforcement (if required). Even when the equipment represents a replacement for an existing one, knowing in advance the dimensions and weight of the new equipment might avoid some unwanted surprises.
14. What is the packaging, labeling, and in what language do instructions come in?
This item is often forgotten. However, unless the purchased product is made locally, it is important not to take for granted that all information will be provided in English, or any other language that is needed. The capex seeker simply needs to validate with the vendor, what will be the language or work, and documentation. It is better to be safe than sorry.
15. Security concerns (are guards required, extras, etc.)
This item relates more often to projects than to simple equipment purchases. For example, if the capex is for the construction of a new building, who will be responsible for ensuring the security of the site during construction time? While this is usually a subject between the contractor and the client, it can still be an element to consider in the total cost of the capex request.
16. Patents, potential lawsuits if we are buying something new
Does the seller have the patents?
This is an element that few companies think about, but that has the potential to cause headaches.
Suppose a company purchases a piece of new production equipment, and after visiting the manufacturer’s facilities and seeing the equipment operate, the company makes the decision to buy a piece of equipment. However, two months after the equipment is installed and running, the manufacturer is hit with legal action because someone claims that the manufacturer stole the patent to the equipment.
Worse, the legal action is seeking to have all equipment removed from all sites or demand that the end user pays a hefty fee. What happens, in this case, and who will compensate (and protect) the buyer in this case? New equipment and modern technologies are great; however, making sure that the seller/manufacturer is habilitated in delivering what is in the purchase agreement is important. At a minimum, the seller should be able to guarantee, in writing, to protect and compensate the buyer in any event that the manufacturer gets sued and that someone comes to claim something from the buyer. However, even if the legal case does not directly affect the buyer, what if it is sufficient to bankrupt the manufacturer? Where will the buyer get support, training, parts, and service?
17. The solidity of the company
(Two guys in their basement versus an international company)
This one is trivial and does not always allow the buyer to make many changes to the agreement, but sometimes the buyer can introduce some clauses to help protect him/herself. For example, if the supplier is providing specialized equipment, the buyer might want to add terms to offer extra training (in case the manufacturer goes belly-up). The buyer might even ask for some information to be placed in an escrow, to be used in the situation where the manufacturer goes out of business.
While this is more common for software purchases, where the software company can place the source code in escrow to allow the purchaser some usage in the case where the software companies goes bankrupt or ceases operations, this kind of protection for the buyer can sometimes be applied for other purchases, such as capex (although not always).
The key item to remember here is that if the company has concerns about the solidity of a company, doing credit reports will not do much to help. Today even large companies with thousands of employees can go bankrupt overnight, and credit checks will not prevent this. The best for the buyer is to protect itself by analyzing where the risks lie and mitigating them as best possible. Sometimes the mitigation can be as simple as finding a second supplier that can take over in case the first one goes out of business.
18. Support
Cost, hours, extras, what is included and what is not
Depending on the nature of the capital expenditure, these items might represent substantial cost. Anything dealing with support to the equipment, component, or project should be addressed at the same time as when the main item is negotiated. Knowing what is included, and what comes at extra cost is always good to know.
19. Training
Where it is given, at what cost, when is it given, how long does it last, what is the cost of extra training if needed
Like the item above, anything related to training and the cost associated with it should be made part of the agreement.
If training involves bringing in people from outside the city (or even the country), it is essential to determine who will pay for what (travel, room, and board).
20. Spare parts kits
What is recommended, frequency of anticipated repairs, the budget required
Spare parts are not often forgotten when it comes to production equipment, as most people involved in the capital expenditure process will naturally have this element in mind when negotiating new equipment or a project. However, for other equipment or components, it might not always be automatic to include them in the capex request. Depending upon the situation, the cost of the spare parts and the cost of maintenance could be included in the cost analysis of the capital expenditure request. In some cases, these costs can tip the scale towards one supplier versus another.
21. Is this a new technology
If that is the case, has it been thoroughly tested elsewhere before?
Item 16 above cautions the capex seeker about potential litigation problems if a manufacturer does not have all the required intellectual property. However, even in the case where the manufacturer does have everything, if the equipment or technology purchased is new, does the buyer know what he or she is getting into? Has the equipment been tested with success elsewhere? It is one thing to purchase simple software and must report a bug, which can be easily fixed in a brief period. It is an entirely different story to buy a new million-dollar production unit that does not work.
22. Are you helping to develop the equipment?
If so can you get a non-compete or protection clause for a while?
This item is one of the rarest, but something to consider depending on what is at stake. For example, a company decides to purchase new production equipment and have it modified for the company’s needs. The modifications will stand to make the equipment much better/faster/efficient/reliable than before. However, to complete the changes, the manufacturer asks the company to help. The agreement between the company and the manufacturer states that the manufacturer and the company will work together to improve the equipment. The company will allow the manufacturer to conduct tests on the company’s production line until the modifications are complete.
This is a win-win situation. The company gets different equipment, giving it a competitive advantage over its competition (and it even gets a rebate from the manufacturing company for being so helpful). The manufacturer gets to test and improve its product on live production, something difficult to replicate on a manufacturer’s site.
The manufacturer is happy to have created improved equipment, and the company is pleased to have such great equipment for its production. However, six months later, the company learns that the manufacturer just sold six improved pieces of equipment to its biggest competitor.
This is not a situation that any company wants to find itself: Developing something to be used by others. At least not for a while.
It is not always possible to prevent this from happening, but it can sometimes be possible to insert wording into the purchase agreement to delay the time to market for the manufacturer. This can sometimes give the purchasing company a head starts over its competition.
23. When does the warranty start to kick in and when does it end?
For simple equipment purchases, the warranty clause might be simple. However, if the capex involves a group of equipment or a project, there might be several different warranty clauses, each with their own set of terms and conditions. Going over these terms with a fine-tooth comb can be helpful to avoid future unnecessary costs. Items to look for are what are included in the warranty when it starts, and when it stops, under what conditions it can be used, and what can void it.
24. How many items are we really buying?
A single unit, a group of units?
This one is probably one of the most obvious items of all but can be a source of costly errors. Knowing how many items/equipment/components the agreement includes is obviously important. However, going over the contract while keeping in mind how many items the parties are negotiating is always good. Nobody wants to sign an agreement that calls for the purchase of a dozen items when only one is needed.
25. Is the city ok with the installation of the equipment?
Especially if this is installed outside
If the capex is for the replacement of existing equipment, this item is generally not a source of concern.
However, for new installations, it is sometimes important to make sure that the city will approve the installation. For example, if the capex is for new production equipment and requires some of the components to be installed on the roof, does the city need to approve of what is installed on the roof for noise, pollution, visual or other? Having the proper permits and authorization from authority entities is, without saying, necessary.
26. Is the landlord ok with what will be installed in or on the building?
If you are a tenant
This item is like the previous one. If the company planning the capex purchase needs to install equipment in a building, if this building happens to be leased, the company should make sure that it has the green light from the landlord (in writing) before engaging any costs. This is another ‘better safe than sorry’ item.
27. Is your insurance company aware of what you are buying and installing, are you still covered?
As previously indicated, insurance will never win a popularity contest. Because of this, it is normal to forget to inform the insurance company upon installing new equipment or components. Usually this is done when the capex relates to a larger project. However, depending on the nature of the equipment, not only will the insurance company be notified, but the new equipment might also modify the overall risk (and premium cost) of the company or the building which hosts the equipment. Also, the insurance company might require additional measures to be added to the equipment (like special sprinklers, for example) before approving the installation.
These items can increase the cost of the capex and should be considered when putting together a capex request business case.
28. For how long is the quoted price good for and is it for everything in the quote?
Quotes are typically valid for a defined period, and one should not assume that the price would remain the same after that period. When getting quotes, it is important to make sure that the supplier’s quote remains valid long enough to be able to get the capex request approved. In addition, one should ensure that everything in the quote is valid for the same period. Sometimes suppliers will provide a validity period different for labor than for equipment, so it is always good to carefully read the terms and conditions of the quotes and when in doubt, have the terms confirmed in writing by the supplier.
29. Is everything in the quote of the same currency?
Also, although it might sound trivial, understanding correctly which currency is used is essential. Equipment made in Asia, for example, might be quoted in local currency but the vendor might ask to be paid in equivalent USD at the time of the sale.
30. Has someone from a legal department/firm reviewed the agreement?
In some companies, sending the purchase agreement to the internal/external legal department is standard procedure. For others, it is on a case-by-case basis, depending on the number of dollars involved, or the complexity of the capex, or a combination of both. While many view the role of the legal as a watchdog (that often seems to slow down the process), when done correctly legal can be a powerful ally to have on one’s side.
For starters, they usually speak the language of the agreements and can help spot clauses that other people might not naturally catch (obligations, automatic renewals, others). Bottom line: The more significant and more complex a capital expenditure is, the more legal should probably get involved in helping.
31. Are there any grants or research and development credits or incentives that you can get when buying the equipment?
This item can potentially be a source of cost reduction for capital expenditure. Taking into consideration grants and incentives can improve the return on investment of capex.
32. Is energy saving been considered?
When done right, energy saving can be integrated into the capital expenditure process and help improve the financials of the capex request. We provide a section on this specific topic later in the guide.