The first two parts of this guide covered the basis of capital expenditures. We looked at what were capital expenditures, how they were treated. We covered the planning process of capex management, as well as how to get the requests approved. Finally, we listed items not to forget when creating the actual capex request.

In this last part of this guide, we will take a deeper dive into how we can extract the maximum benefits from a capital expenditure request and how we can improve the overall process in a company or organization. We will take a look at how capital expenditures can integrate with other elements of your business for additional benefits.

Finally, we will discuss about the players and the policies in which they navigate, and how they can positively influence the process.

Section A ‒ Incorporating additional benefits to the capex process

• How to improve the capex process
• Integrate other elements
• Players and policies

In many companies and organizations, the capex process works basically like this:

The role for the people involved in step b of the process is to assemble sufficient information for the people in step c to be able to approve the request. In some companies, some people might be involved in more than one step. For example, the person with the need might also be the person creating the request. A person assembling the business case for the request might be involved in the approval process also.

Unfortunately, this process tends to create silos within companies and organizations, and the result can leave behind some benefits that could have been obtained if the process was opened up a little.

For example, let’s consider Company A. This company manufactures widgets for numerous markets. Their widgets are sold all over the world.

The director or production of Company A is getting a request to increase capacity within a six-month timeframe. Sales & Marketing have secured long term orders for additional widgets. While this is excellent news for the teams in sales and marketing, for production, this creates a problem if their current production equipment cannot produce more widgets. Worse, they need to have the extra capacity within six months, so that leaves them very little time to purchase additional production equipment, receive it, install it, and to get it in operation.

A production team is quickly tasked with finding which equipment to purchase. Among a selected group of vendors, one vendor is chosen for its price and manufacturing capacity. The controller of the production group is tasked with rapidly creating a business case for the acquisition of a new widget production line. The controller then creates the request, using a mix of spreadsheets and attached documents to complete a business case ready for approval.

As soon as the request is finished, it is sent off for approval. The approval team at the plant level consists of the controller (who also created the request), the director of operations, and the plant manager. In addition to this, because of the amount of the request, the request must also be approved by the division VP Operations, the VP Finance of the division, and the Sector President.

A few weeks pass, and the request is finally approved, after being sent in internal mail from department to department. There were some delays because approvers had questions, and some details of the request were missing, so some email exchange occurred.

At this stage, the production group has a green light to purchase the new production line. They then create a project task which will be responsible for the purchase and installation of the new line.

We can fairly say that company describes what happens in many companies. The process and players might vary a little, but overall logic is the same.

Now, let’s consider Company B, which has developed a program of maximizing benefits into their capital expenditures.

Company B also manufactures widgets, and their Sales and Marketing departments just signed a new contract which will start in 6 months. Upon being informed of this, the production department quickly gathers its key team for a meeting. Current production is not sufficient, and they only have six months to increase production. A new production line will be required.

The team brings in various people to assist in creating the specifications for the request. People from the supply chain, R&D, IT, and energy saving are invited to a meeting. Upper finance is also invited since the cost of the new equipment will need their approval. At the meeting, the director of productions outlines what is the need of the plant and what they are looking for. Each member of the team adds some comments. For example:

1. The supply chain will want to know where the equipment will come from because it can help to reduce transport costs. They also want to know if the vendor selected might be one with which they already have agreements in place, with rebates in escalation tiers, so that could have an impact on the closing price of some vendors. There is also all the notion of warranties and services that they need to be involved.
2. R&D (research and development) are on standby to help discuss any potential grants that the company could get in the event that some modern technologies are being used, merely a new way to work.
3. The energy department is offering its guidance to help select the vendor. They point out that some vendors sell production lines that are more energy efficient than others. This needs to be considered since the production line will be using energy for at least the next ten years. They also need to understand how this new production line will influence the total energy consumption in the building. Finally, they point out that there could be grants and incentives from both the local utility provider as well as the State, depending on what equipment is ultimately selected. The grants and incentives could be substantial and should be integrated into the total cost when selecting a vendor.
4. IT and finance list their requirements and indicate their full support to expediting the request once they receive it.

The production team works with the other departments throughout the equipment and vendor selection process, and the information they provide is included in the capital expenditure request. They have selected a different vendor than Company A because of numerous reasons:

1. Supply chain already had an agreement with a supplier, resulting in volume rebates.
2. The new vendor happens to sell equipment which is more energy efficient
3. R&D and energy secured grants and incentives for the new equipment from numerous sources (new job creation, new technology installed, utility grants for energy saving)

The bottom line is that the elements provided by the various departments improve the financials of the business case. Company B presented a much better product than Company A. Since Company B already had a team in place comprising of members of different departments, no time was wasted, quite the opposite. Since all departments were involved from the start, few questions were raised during the approval process and upper management, knowing that finance was involved, gave a quick signoff.

Side note: if a company is planning to create a team that comprises of various departments in order to approve future capex request (i.e., IT, Procurement, operations, energy, R&D, legal, finance, and others such as consultants), it is better to assemble the team and get them to know each other in terms of what they will each bring to the table BEFORE there is an actual capex request on the table. Going over potential cases of what the team could be called to approved and having the team players share with the group how they would provide guidance to the process (and not slow it down) will prove beneficial later. Knowing in advance how the process will work will help mitigate some premeditated feelings that people (or groups) might have. For example, if the operations department know that the people on the approval team will be there to help them potentially optimize the capex request (getting grants, reduce energy and costs), they will be much more open to sharing their ideas before they put their capex request on paper. However, if they feel that the team will slow down the process, there is a good chance that the team will receive the capex request only once production has completed it, with the pressure now being put on the team members to approve it right away. After all, as production could point out, production is the department that creates finished products, so without production, we lose money. This is not a situation where the company wants to be in.

Let’s now look at the elements that the departments can bring to improve the capex process:

One of the most significant challenges in companies and organizations is reducing costs. So much that many managers now have their performance bonus tied to this single item. Today managers try to cut costs everywhere they can, and capital expenditures are not sparred.

Section B ‒ Reducing the cost of capex

•  What can we add to reduce the costs
•  Grants and incentives
•  Energy Saving
•  Lifecycle Cost
•  Money left on the table (MLT)
•  Policies
• Tools for the trade

We have looked at the planning process and the items to include in a capex request. For the next section of this guide, we will look at what else can be done to reduce the cost of capital acquisition requests and how they can be made part of the capex process.

Grants and incentives are, in many cases, free money. They might come with some strings attached, but those usually are parameters to standardize the process. For example, for energy incentives, the utility provider might promise an incentive amount but hold off a portion of the guaranteed amount for up to one year, solely to validate what the incentive receiver (the company applying for the grant) promised it would do. If a company is getting an incentive because it is implementing an energy reduction project which will lead to a saving of $500,000 per year, it would be reasonable for the provider of the incentive to wait a few months (or even a full year) to validate that the energy savings are indeed happening. However, if the company delivers on its promise, then the money will be there. The same thing can be said about grants related to innovation (research and development).

Grants and incentives are great ways to improve a capital expenditure’s return on investment. They do so by reducing the total cost of the capex.

For example, if a capex costs 1 million dollars and generates an annual saving of $100,000, we can say that the payback is ten years (1,000,000 divided by 100,000).

Take the same capex and apply a grant of $300,000, the capex now has a total cost of $700,000 (1,000,000 – 300,000) and the payback falls to 7 years.

Grants and incentives are, most of the time, very interesting. Enough so that many large companies have departments whose objective is solely to apply for them whenever possible. While smaller companies might not be able to have full-time people for this task, sometimes it can be done part-time and in concert with local consultants which can be brought in for a specific capex. Many of these consultants work on a percentage basis, so they only get paid a portion (between 10 and 30% on average) of what they can get in terms of grants and incentives.

The second element that we look at that now is energy saving. We briefly touched base earlier on the fact that if the company has a dedicated energy reduction expert, he or she can help the capex process by researching what grants and incentives could be applied to the expenditure. Regardless of if the expert is in house or an external consultant that the company works with on a regular basis, the logic is the same: that person should be able to provide insight as to what grants or incentives can be obtained by various sources (government, utility providers, others) and bring this information to the table when the company is assembling a capex request. Any dollar obtained via a grant or an incentive will help the capex’s financials.

However, beyond the free money that grants can provide because of an energy saving element within the capex, the concept of energy saving can be a valuable one. If we take a simple example where a company needs to replace a cooling system, say a chiller, in a building. The new chiller will be a capital expenditure, and surely, the company’s approvers will want to see a request or even a business case to justify the replacement. The company could decide to replace the equipment by a similar equipment, or they could look at it from an energy point of view and do a lifecycle cost analysis and determine that a more energy efficient chiller is the best solution, even if the initial capex cost is higher.

This example is pretty clear cut since it is dealing with cooling units and thus, is directly related to energy consumption. Most people that would be responsible for the chiller would be thinking about energy reduction and consider the energy usage of the chiller in the vendor selection.

However, let’s look at something less obvious. Let’s consider a production plant that needs to replace a large production unit. The proposed production unit consists of numerous sub components, such as AC and DC motors, heaters, and coolers. The unit is custom made by the vendor. The vendor purchases the steel for the structure of the production unit, then all the programmable controls, the motors, and the other subcomponents are purchased from different sub-vendors and assembled in the vendor’s manufacturing plant.

In such a situation, many companies negotiate with the vendor for pricing, delivery, installation, the capacity of production, as well as items such as maintenance, spare parts, commissioning, support, and training. They often leave out the energy efficiency of the sub-components simply because they are focused on the common elements, we list listed. However, when negotiating with the vendors, some companies do insert their energy saving personnel or consultants in the team. These people can question the vendor on what type of motors or sub-components will be installed, and how could they benefit from improving these components. For example, if the vendor was planning of have all AC and DC motor as standard efficiency, an excellent question to ask the vendor would be ‘what would be the additional cost for replacing the standard motors with high-efficiency motors?’ After all, if the production unit is going to work on a 24 hours-7-day cycle, the extra cost for the high-efficiency motors might come with a great (short) payback. It might influence the return on investment of the entire production unit itself nicely.

We briefly touched base on the notion earlier when we talked about conducting a lifecycle analysis for a chiller replacement. While most people agree with the definition of a lifecycle cost analysis and what elements they must include, these analyses are not, unfortunately, done in conjunction with a capex request as they probably should.

In the following pages of this guide, we will discuss the place of lifecycle costing in the capital expenditures process. We will also show when, and how, a lifecycle cost analysis can be used in the decision process. Finally, we will also touch on non-capital expenses and see how lifecycle can be a beneficial element of a supply chain and procurement process.

The ultimate guide to managing capital expenditures in companies and organizations

Capital expenditures are nothing new. They are an essential component of many companies since most of the new production equipment, building construction, renovation, or expansion projects (to name only a few here) involve capital expenditure. In many companies, the capex budget represents a sizable portion of the total budget.

Despite this, many companies have had problems in calculating the benefits of capital expenditure over the years. Most companies set policies and procedures for how capex should be approved, what information is needed for the approval process, and what elements should be included in a business case. However, these policies often lack a strategic analysis component. This is where tools like lifecycle analysis can help provide companies with guidance that can lead to better capex investment decisions.

Lifecycle Cost and its Popularity

Although the term remains popular, it is surprising that few companies use lifecycle cost analysis (LCCA) regularly. Some of the recurring arguments are that completing a detailed LCCA takes time, and it is not always easy to do. Others will argue that complexity can be a challenge and will defer to using a simple business case with standard financials such as payback, internal rate of return, or net present value. While there is some data collection required, doing a detailed LCCA requires using a standard method and sticking with it.

First, let us define what lifecycle cost is. The term lifecycle cost describes the total cost of a purchased item over the period of its useful life. To calculate this, we usually use the term Lifecycle Cost Analysis (LCCA).

The Lifecycle cost analysis is basically a detailed breakdown of the elements that make up the lifecycle cost.

Put simply; lifecycle cost analysis is the concept of identifying and quantifying, both in terms of cost and time frame, what is related to the element. Adding at time zero (today) all the positives and negatives (costs and benefits) of the item targeted by the analysis over the determined period will give us the total cost of the element. In addition to this, we can also chart the curve cost over time. This shows how much money the element is costing each year, and it can be useful for budget planning purposes.

Before we show how this is done, let us look at why and when a lifecycle cost analysis should be performed.

Why do a Lifecycle Cost Analysis

The first question that comes to mind, before doing an LCCA, is if there is going to be a benefit. If there is no benefit associated, why spend the time collecting the information and assembling the analysis?

Lifecycle cost analysis can be a great tool to help a user decide on a course of action, for example deciding on which product or equipment to purchase, or if it is better to replace or repair the equipment. The strength of the analysis is to be able to establish a baseline on which the user can compare items, whether these items are capital in nature (for example production equipment) or non-capital (e.g., equipment repair). The LCCA is a great tool because of the multiple elements that it includes, namely costs, and benefits, and when each of them occurs.

When to do a Lifecycle Cost Analysis

The second question that might come to mind is when does it make sense to do a lifecycle cost analysis? Let us look at a few scenarios where the analysis could be useful.

For this guide, and to simplify things, we will define a product as any physical element that a user might need to purchase for a company. This can include any equipment, component, or repair items, regardless of if they are capital expenditures or simply ordinary expenses. Also, because of the time and effort involved in doing an LCCA, they should be associated with products that cost a significant amount of money. For example, one would probably not do a lifecycle cost analysis for the purchase of a small equipment or equipment part, which costs a few dollars only. However, if the user needs to purchase many equipment or parts, and if the aggregated cost is significant, the lifecycle cost analysis might come in handy to help the decision process. Finally, it is worth pointing out that there is no cost threshold for doing an analysis. One company might not care about the difference in lifecycle cost for a piece of equipment that costs $1,000 while another company might set the minimum bar at $50,000. This is very subjective.

A piece of advice here would be to run LCCA and decide where the minimum threshold should be. Over time, if a user notices that there are differences deemed valuable enough with products that cost, say, $20,000, then that might become the threshold. However, keep in mind that in comparing products, the difference between lower cost products might be wider than between higher cost products. For example, there might be a greater difference in the LCCA (in percentage) between a particular type of motor that sells for $10,000 than another one that sells for $50,000. Each product is different, so each company will need to decide where to set the threshold depending on its needs.

Let us look at the situations where an LCCA could be helpful:

• Comparing multiple vendors when selecting a product
• Selecting a type of product
• Deciding if a purchase or replacement should be done

Correcting for the future

Let us look at each of the situations above.

Consider a company which needs to replace a piece of equipment. The standard process is to define the specifications of the equipment that the company needs to purchase (for example, type, capacity, size, speed…etc.) and put these specifications in an official request for proposal or request for quotation (RFP or RFQ). It either sends it out to suppliers on invitation or makes it public, depending on the situation and/or the company’s policies.

The company then receives several proposals, with each vendor providing its own set of specifications and terms and conditions (price, delivery date, what is included, warranty, other). These can be short or lengthy depending on the nature of the purchase, but the logic is always the same.

The company then proceeds to analyses the proposals it received. Unless the purchase is for a pure commodity (e.g., sugar), then there is a remarkably high probability that the proposals will differ from one another. In addition, even in a pure commodity purchase, they differ. As companies are always trying to take the best decision and comply with budget requirements, many of them will go and select the lowest price if the proposals offer equipment with similar specifications. However, unless the company integrates all the elements of the purchase, it does not know if it is selecting the lowest priced equipment. It only knows that it will choose the lowest priced equipment at the acquisition time. When all costs are considered, the company might actually be purchasing the most expensive equipment out of the proposed ones. The only way to know is to do a detailed lifecycle cost analysis. Unfortunately, many companies either do not take the time to do it or do not know how.

If the vendors want to differentiate themselves, proposing distinct types or models of equivalent equipment (by equivalent we mean that they would render the same service as what the purchasing company is requiring) makes sense. Each vendor can highlight one or several unique features of the equipment they offer. This makes it more difficult for the purchasing company to compare vendors but gives the vendors the ability to stand out from the crowd.

In this situation, doing an LCCA makes sense. If the purchasing company asks each of the vendors to provide detailed specs of the proposed equipment, it is possible to create a detailed lifecycle cost analysis and select the best equipment and vendor from the group.

Let us list the items that we could include in a typical lifecycle cost analysis, keeping in mind that not all items will be required for each LCCA.

What could be considered in an LCCA

1. Cost of purchase (the product itself)
2. Cost of delivery
3. Installation cost
4. Annual maintenance cost (including preventive and corrective as well as tools required)
5. Commissioning costs and ramp up costs
6. The yearly cost of energy
7. Hours of operation
8. The life expectancy of the product
9. Net resells (residual value) at the end of the life expectancy. The value is the price the product can be sold at the end of its life, minus the cost to remove it. We need to consider any cost that might result from the removal of the product, such as demolition/construction as well as restoration obligations. In many cases, the removal cost is equal to or higher than the reselling price.

Other items to potentially include in the analysis are:

10. On-going labor cost (to operate the equipment)
11. Learning and training as well as manuals and documentation
12. Any other expenses such as an annual fee for usage (e.g., franchise or licensing)
13. Warranty Costs
14. Benefits such as revenue or savings
15. Grants & incentives
16. Additional costs such as insurance, permits, storage costs for parts…etc.
17. Reliability and loss of operation
18. Restoration, remediation costs, and recycling
19. Taxes and interest

Let us look at a few of these items in detail.

Cost of purchase, delivery, and installation

This is the easiest one to get to conduct the analysis since the vendor will typically include it with the proposal. The cost of purchase of the equipment (or any type of product) is the total cost to have the product readily available for delivery.

Delivery cost includes all the costs associated with having the equipment or product delivered to your site.

Installation cost relates to the price paid for installing the product, so for example, it might include charges like bringing electricity and water to the unit. It might also include alterations that need to be done to the building to install the equipment properly.

Maintenance

This one should always be included in the analysis. However, estimating it over time is not a straightforward process. For some equipment, maintenance is linear over the lifespan of the equipment, but for others it is now. In most cases, the maintenance cost increases over a period. For some equipment, the maintenance almost seems like an exponentially growing cost, especially towards the end of the normal life of the equipment. While there are some ways to estimate the maintenance cost over time, none are perfect because it is impossible to forecast what will break and when correctly. Predictive maintenance and other tools are there to give general guidelines. However, using past field experience, manufacturer’s expertise, and other sources of information, it is possible to sketch out an idea of what the maintenance cost could look like from the time the equipment is purchased to the time it is disposed of. Keep in mind that since this is not an exact science, some errors will necessarily be introduced here in the lifecycle cost analysis.

Commissioning and ramp up

Often referred to as commissioning or ramp up costs, this item can be integrated with the product costs of purchase, delivery, and installations. However, we elected to describe it separately here. Commissioning costs are those associated with starting up the product. This applies mostly to equipment such as production (manufacturing) equipment or base building (HVAC) equipment. In both cases, the idea behind commissioning is to get the equipment up and running at optimal (manufacturer designed) performance. For example, if a piece of production equipment was manufactured to create 1,000 widgets per hour, then this should be the goal to reach during the commissioning process. In buildings, we commission the HVAC systems for them to perform their duties or provide heating and cooling to occupants and minimize energy consumption. These costs can be substantial and will need to be included in the lifecycle cost analysis.

Energy

The cost of energy often includes the popular electricity and natural gas, but it can also include water (supply and discharge costs), as well as any other source of energy (fuel, propane, coal…etc.).

When using the cost of energy in the analysis, keep in mind that it will introduce several errors in the analysis since the prices of utilities fluctuate over time. What companies know is the cost of energy at present and if lucky, the cost of utilities soon (next few months or next year). Rarely (if ever) have companies been able to estimate without error the cost of energy over a prolonged period. Some companies introduce hedging in their energy purchase, but this method of protection also has its limits in time. When a company purchases a piece of equipment with an expected lifespan of 20 or 25 years, no one will be able to predict precisely what will be the cost of energy over these years. What they can do is estimate the energy consumption as best possible and then estimate how much energy will change (i.e., usually rise) over time.

Hours of operation

The hours of operation for a piece of equipment can dramatically vary the lifecycle analysis since they represent a huge factor in the cost of service. Hours of operation influence the energy consumption as well as the wear and tear costs (maintenance). However, because they are not always easy to know with precision, they often (but not always) introduce a source of error in the lifecycle cost analysis. For example, if the equipment is known to work specific hours, then the amount of error can be minimal. However, most equipment related to building or operations have fluctuated hours each year, so they are not always easy to estimate. In addition to this, since the lifecycle cost needs to consider the costs over the lifespan of the equipment, determining the hours of operation of equipment over many years can be nearly impossible for many types of equipment.

Life expectancy

The life expectancy of the product is simply the number of years that the product is expected to be able to operate at the proper output. For example, if a sizeable cooling unit such a centrifugal chiller has a life expectancy of 25 years this would mean that the buyer of the equipment can expect the chiller to provide cooling for that period until the equipment needs to be replaced. Obviously, during such an extended period, there will be costs related to maintenance and normal wear and tear. However, the equipment itself should last 25 years before it is deemed to require too much investment to continue operating it and thus would need to be replaced by a piece of newer equipment.

Each product has a unique life expectancy, and people conducting lifecycle cost analysis should make a best effort to determine what will be the life expectancy of the purchased product at their site. To do this, one must consider the environment in which the product will operate as well as the amount of maintenance and repair that the company is willing to provide to the product. It is logical to think that if a company purchases a new cooling unit and does little or no preventive maintenance on it, the equipment will last a smaller number of years than if the manufacturer’s recommended maintenance is done religiously. The same logic can apply to the environment. If the equipment operates in harsh conditions where corrosive chemicals are in the open, it is reasonable to think that the equipment will not last that long. Same if the equipment is in tropical areas exposed to salt air. Cooling units located in hotel resorts next to oceans typically last many years less than units located much further inland, dryer (and non-salty) environments. It is merely a matter of common sense. This common sense should be used in the LCCA when estimating the life expectancy of the product.

Residual value 

Most of the time, when lifecycle cost analysis is performed; companies assume no value to the equipment. The main reason for this is that a small residual value many years in the future does not represent much in terms of present value. Also, since the driving reason for conducting a lifecycle cost is to evaluate all costs during the lifespan of the equipment, it is naturally assumed that at the end of the period used in the analysis, the equipment will have reached the end of its life, and therefore be almost worthless.

However, depending on the type, composition, and location of the equipment, a residual value of zero might not be appropriate. For example, depending on the type of equipment or project, it might still have an attractive residual value. Some equipment might no longer serve the purpose of the company, but it can be resold to other companies, which could use it. Also, depending on the composition of the equipment, it might have materials that have value. This can be the case with equipment with recyclable materials (metals like copper, steel, or silver, for example). In such a case, the equipment might have no production value whatsoever but value simple based on its material content.

As we can see, the residual value is not always zero. However, what happens when it is less than zero? In a rush to calculate a lifecycle cost, many companies fail to consider the cost of removal of the equipment. In some cases, depending on the nature and location of the equipment, the cost of removal can be substantial. For example, if a large piece of equipment was installed on the ground level, the cost for removal is probably lower than if it was installed on the roof of the building, especially if cranes need to be brought in to remove it. While some companies manage to make deals with recyclers to remove the equipment for free (in exchange for letting the recycler take the equipment), is many cases the money generated by the recycling of the equipment is not sufficient to cover the cost of removal. While it might be challenging to estimate the exact cost of removing equipment 20 years down the road, an estimate can still be made and included in the lifecycle analysis.

On-going labor costs

This cost is related to the hours of operation of the product. Moreover, because the hours of operation tend to fluctuate, calculating the cost of labor associated with operating the product can be a challenge. However, this cost can be significant and over time can represent many times the actual purchase price of the product itself.

Learning and training

The increasing complexity of equipment being purchased today, the costs associated with learning and training are on the rise. To the actual price of the training courses or sessions, we need to include side costs like documentation and other materials required, conference rooms with food and beverages (to host training sessions), as well as short term loss of productivity (people in training are not always doing their regular work during that time).

Annual fees for usage

Some capital expenditures require yearly fees for using the product. Some software, equipment, buildings, and others might have an annual cost solely for the annual usage. If so, it is essential to include them in the LCCA.

Warranty Costs

Some manufacturers will include a certain level of warranty with their products. However, in some cases, the manufacturer will offer an extended warranty, either to prolong the initial coverage period or to extend the range of what is covered by the original warranty. Before purchasing extended warranties, the capex initiator should understand what type of warranty is already included with the product and question if the proposed additional warranties are worth the cost. Many manufacturers or resellers (especially those in the office supply world) are notorious for selling extra coverage on coverage such as computers and printers, sometimes offering coverage for a more extended period than the company uses the equipment.

In any case, costs associated with warranties should be included in the LCCA.

Benefits

So far, we have described in fair detail all the costs associated with a lifecycle cost analysis. After all, it is called a lifecycle COST analysis. However, there are more than costs that need to be considered. Benefits represent a significant part of the equation. While not all capex can show the benefit that is easy to estimate, for those benefits that can be calculated in monetary value, they should be included in the analysis. If the capex helps the company generate revenue (increases sales) or reduce costs like production, energy, time or if it helps improve efficiency, that benefit should be included in the LCCA. When possible, break down the benefit to show the number of dollars, hours, percentage, an element that the benefit touches.

For example, if a lifecycle cost analysis is being done on a project of a robot that can replace three employees, the benefits of saving manpower should be detailed with number of hours (per week, month or year) saved, costs saved per hour (including salary, fringes, overtime, and other) should go against the costs in the analysis.

Grants and incentives

Grants and incentives have a positive effect on LCCA. Often referred to as ‘free money,’ they usually serve the purpose of helping companies and organizations go ahead with a purchase or project for which the company or organization would not usually conduct without the funds. That is in theory. In reality, many companies and organizations manage to get grants and incentives, even for projects that they would go ahead without receiving them. In those cases, the grants and incentives simply improve the numbers. Any grant and/or incentive that can be applied to a project or product purchase will help by reducing the cost of the product or project. So, for example, if a company decides to purchase new production equipment, if a government department provides a grant for the purchase of the equipment (say for job creation), the grant can go against the purchase cost of the equipment, to reduce its cost. This, in turn, improves the lifecycle cost analysis because it reduces the total life-cycle cost of the equipment.

Other costs such as insurance, permits, storage for parts…etc.

This is where we can add any other expenses that are not part of the group above. Charges related to insurance, licenses (to receive or operate), storage costs related to spare parts, these costs are often forgotten simply because they either do not represent a significant amount or they get bent. For example, the company might have an insurance policy which covers all equipment, so adding a piece of new equipment might not add to the insurance premium. This is true but depending on the nature of the equipment to be purchased, it might increase the insurance premium.

Keep in mind some of these costs (like permits, especially if building a new site) can represent a significant amount of money, and their cost should be included in the cape request.

Reliability and loss of operation

This cost is related to the reliability of the equipment or project. Although it is not extremely popular in lifecycle cost calculations, depending on the nature of the equipment or project, it might be interesting to introduce the notion of loss of operation, even if only after the lifecycle analysis has been performed. For example, a company receives several proposals for the purchase of equipment and conducts lifecycle analysis on the proposed equipment to determine which would be the best one to select. After the analysis, it is determined that two pieces of equipment have almost the same results. Looking into the potential costs derived from the loss of operations could help sort out a winner. Loss of operation can occur when a piece of equipment breaks down or requires maintenance, which takes time away from operations. If a piece of equipment is known to require more hours of interrupted operations to conduct maintenance, this can be included in the analysis.

Restoration, remediation costs, and recycling

This item is an evolving one, and it is growing each year. Many actions involving the environment that companies did decades ago are no longer permitted, or at least they are not free anymore. Today most countries have laws in place to protect the environment and to force companies to remedy their actions if they have adverse effects on the environment. For example, manufacturing companies that used to contaminate the soil with chemicals must now restore the ground when disposing of a site.

Recycling costs include all costs associated with returning the product to a recycler and having the product recycled. Governments sometimes impose a recycling cost to be paid at the time of the purchase of the product (ex: tires, batteries) and sometimes the cost is born when the company disposes of the product.

Regardless of the type of cost, whether it is for restoration, remediation or recycling, the company will need to reflect on the possibility that they will exist for their purchase and if they do, consider them when doing a proper lifecycle cost analysis.

Taxes and interest

We included this item last in the list, but it does not mean that this should be the least considered item on the list. Quite the opposite. Taxes and interest paid to acquire the product can represent two substantial elements in an LCCA. However, since each company is different, since each country has its own set of laws on taxes, providing examples that would suit all readers is difficult. What is important to remember is that tax can have positive and negative effects on a lifecycle cost analysis. For example, if the purchase of new equipment is tax deductible as it often is, the real after cost amount can be reduced. This can help the purchase of the equipment. On the opposite side, the interest paid for acquiring a piece of equipment only adds to the costs, even if they are deductible. However, here again, the tax (or tax deduction) on interest should also be considered.

For companies comparing vendors together, the effect of taxes and interest might not change much. After all, a vendor that is more expensive than another for a product with the same specification will be more costly with or without the effect of taxes and interest. However, to calculate a true lifecycle cost, the company will need to account for taxes and interest, if applicable to the company. We highly suggest talking with local accountants to determine how to treat taxes and interests in your analysis.

Conducting the Analysis

In theory, a lifecycle cost analysis is simple: Add up all the costs related to a piece of equipment (or project depending on the case) over the useful life of the equipment, then subtract the residual value and you have a lifecycle cost. One can also improve the calculation by adding a discount factor in order to improve the decision process, but this is simple mathematics.

In real life, we are often confronted with more complex situations. For example, different pieces of equipment rarely have the same life expectancy. How do we compare one piece of equipment with a life expectancy of 10 years with one that has a life expectancy of 15 years? Do we run an LCCA for ten years and consider the residual value of the most extended lifespan equipment or do we make the analysis on 15 years and consider the need to purchase a piece of new equipment for the one that only has a 10-year life span? In that case, at the end of the 15th year, that equipment will have only run half its life (five years out of a potential 10).

As we can see, in both cases, we need to include the value of one of the pieces of equipment that still has value, regardless of the selected time frame.

Here, as in most situations where we compare multiple products with different lifespans, there is no perfect answer. A company could try doing a ten-year analysis and then do a 15-year analysis to see if the analysis produces different conclusions on which equipment and vendor to select. Finally, depending on how the equipment is amortized may have an impact on the number of years to use. For example, if all equipment in this category is amortized over ten years, it might make sense to use a 10-year analysis for the LCCA.

Note: For companies that lease space, it might make good sense to conduct the analysis on a time frame that is the shorter of two possibilities: The product lifespan or the remaining term on the lease (some companies use the remaining term of the lease plus the duration of the first option, but each company can set their policies).

This scenario is somewhat like the situation above. In this scenario here, we are looking to select a type of product even before we invite the vendors to submit their proposals. For example, a company might be looking at replacing the floor covering and is looking to decide if it should replace the current covering with carpet or tile. While it may be possible to simply issue a request for proposal to various vendors and see what different solutions they might propose, the company might want to decide on carpet versus tiles before inviting the vendors.

They might ask local users (employees on the building floor) what they prefer or speak with an interior designer to align the color and texture of the carpet or tiles with the walls and furniture. Regardless of the reason, the company might need to compare the types of products.

Information needed. Much like the first scenario, in this case, an LCCA could be done to help guide the company in its decision. The results might go in opposite directions from what they want (of what the designer proposes in this situation), but at least the LCCA provides another argument for decision purposes. Information required is the same as when comparing vendors.

The LCCA can also be used to differentiate or optimize between multiple products proposed by the same vendor. If the company has already selected the vendor, but the vendor offers two distinct types or models of equipment, the lifecycle cost analysis can prove to be a useful tool to help decide which brand or model to select. For example, a company might want to determine if it wants to install double glass windows on a new building or triple glass windows. Using the cost of the different windows and the R factor (insulation factor) to calculate the difference in energy costs with both types of windows, a company could run an LCCA and decide which type of windows to purchase.

We often speak of the lifecycle cost analysis as a tool to help compare things. However, what about using it to initiate projects, or reject them?

If we take a scenario where a heating or cooling equipment is at the end of its normal life, and it must be replaced, then an LCCA to select the best replacement makes sense. In this case, nobody is really questioning the need for the equipment, only which one to purchase.

However, what if a vendor comes and proposes to replace the cooling or heating system one year after the company has installed it? The vendor is offering to replace any equipment that is still practically new (especially if the unit has a 15, 20, or even 25-year lifespan).

Why would a company even consider replacing a piece of almost new equipment? Well, it depends. It could be that the vendor proposes to replace the equipment with a newer one that requires less maintenance, costs less energy to operate, comes with an incredibly attractive grant or a mix of all these. In this case, it could be worthwhile to conduct an LCCA to see if the replacement makes any sense. In this situation, if the new equipment needed less energy to operate, the company could elect to do a simple payback analysis which would be done by dividing the cost of the equipment by the annual (energy) savings generated by the new equipment. However, paybacks often fall short because they do not consider a number of items. For example, what happens with the non-amortized portion of the existing equipment?

If the existing equipment can be sold for the same amount as the non-amortized cost, then that is one thing. In real life, the chances of that happening are probably slim so the user will need to consider the difference between the non-amortized amount and the residual value as a cost that needs to be added to the LCCA.

Another possibility is if the equipment was financed. If the company is
still paying for the equipment, the total cost to dispose of the equipment and cancel payments (if lucky) or most likely, finish paying for it will need to be considered.

In this situation, doing only a payback calculation on the new proposed equipment would be a mistake. Here, a detailed lifecycle cost analysis would prove valuable.

This scenario occurs too rarely, unfortunately. Correcting for the future involves doing an LCCA analysis upon equipment replacement, so when a piece of equipment has reached the end of its life. The idea here is to be able to see if the initial LCCA was good and if some assumptions need to be modified. The reasons, so few companies do this are numerous. First, few companies remain in business or keep their installations long enough to do this analysis. Second, for those that do keep their buildings almost forever (government, education institutions, some real estate managers, and manufacturers) going back in files 10 or 15 years is not always evident.

However, for some equipment, there is sometimes no need to wait for the full lifespan of the equipment to start correcting for the future. For example, if a large shopping center has many rooftop units on its roof, the operators might have a good idea of how long a unit is good for at the current location. In some cases, the lifespan of the roof time units in that shopping center might be shorter than the manufacturer’s recommended lifespan. Alternatively, (as it happens often), the shopping center employees became great at fixing the units and using parts from older units and they can extend the life of the rooftop’s way beyond any of the manufacturer’s recommended lifespan. In both cases, when purchasing a new rooftop, the company might want to take its own reality about rooftops into consideration when doing an LCCA.

The Limitations of LCCA

Although a great tool for selection and decision purpose, the LCCA does have its limitations and should not be taken as a unique tool for all decisions. For example, the LCCA will not factor in elements like criticalness (meaning how critical the equipment is to the operations). For example, when selecting between two equipment, a lifecycle cost analysis might recommend one particular equipment over another, but that equipment might break more often, and it might be part of operations that cannot afford to stop. In this case here, the level of the criticalness of the equipment might take priority over the results of the life cycle. Other factors that are hard if not impossible to integrate into an LCCA are quality (what is the quality of the output of the equipment, in the case of production equipment), delivery time, and customer service. If a company need to purchase a piece of equipment and the LCCA indicates that equipment A is preferred, but it also happens to be back-order for 12 months, the LCCA might prove to be of little usage, apart from pointing out (and justifying internally) the additional cost of having to select another equipment.

In a comparable situation, the equipment might be in an area were stopping the operating to service it could be cost prohibitive. While the maintenance cost itself might be low and impact the equipment positively in a lifecycle cost analysis (making it the preferred equipment), the production department might have a different opinion if the equipment maintenance forces operations shut down each time it needs a servicing. Here again, the lifecycle cost analysis results might take a back seat to other criteria.

Cumulative Costs

We saw in this text that the LCCA can be an excellent tool for comparing products when a purchase needs to be done. However, while the LCCA does an excellent job showing what the total cost over the entire lifespan of a product is, it falls short when the user needs to know what happens during that life span. For example, a building owner might need to replace an air conditioning system and wants to decide which equipment to purchase. Having four choices from four different vendors, the user goes and calculates the lifecycle cost of each of the equipment and finds the equipment with the lowest life-cycle cost. By default, this would be the equipment to purchase. However, this analysis only shows the total cost for the equipment, not what happens each year during the equipment’s lifespan.

One interesting way to look at the LCCA when comparing vendors is to look at the Cumulative Costs over a determined period. This can be done the same way as a normal LCCA, only instead of adding up all the costs and benefits over the entire product’s lifetime, we calculate a cumulative cost of the product for each year and then plot it on a chart. If the equipment has a lifespan of 10 years, we will calculate ten annual cumulative costs and add them to a ten-year chart.

Cumulative Cost

Another tool that companies can use to help them in the decision-making process is the Cumulative Cost. The cumulative cost is like the Lifecycle cost. The only difference in both analysis tools is that the cumulative cost does not always include a discount factor, to sum up, all costs in Net Present Value. However, it is possible to introduce a discount factor which would put it in line with the standard lifecycle cost analysis.

The Mechanics

To conduct a cumulative cost analysis, the user needs to calculate the total annual cost of the product or equipment for each of the years during the lifespan of the product or equipment. For example, if a company is looking to purchase a piece of new equipment which has a lifespan of Seven (7) years when comparing different equipment to purchase, the company could look at the annual cost for each year, for each of the equipment it is looking to compare. 

Plotting the Results

In the case above, the results could look something like the chart below. The chart shows a Cumulative Cost from year one to seven for each of the potential equipment (represented by Vendors A to D).

We can see that on the chart above, the equipment of Vendor B starts out to be less expensive (has lower cost) during the first year. The price for that year includes the purchase cost, the installation cost as well as all other costs of operation (including energy, maintenance, & labor).

At the other end of the spectrum, the equipment of Vendor D has the highest cost in year one. This could be that the price of acquisition and installation is higher than all other equipment. However, we can notice in the chart that around the third year, the equipment of Vendor D intersects the cumulative cost of the other equipment. Then in year number four, the equipment from Vendor D shows a total cumulative cost lower than all other equipment. By year seven it is clearly the least expensive equipment of the proposed group. The reason that the equipment from Vendor D has a lower slope than the others is because the annual cost is lower. This can be because the maintenance cost is lower, or the equipment is more energy efficient and thus requires less energy than the others to operate. It can also be another reason or a combination of reasons. The bottom line is that the equipment that costs the most in year 1 has a cumulative cost that is the lowest of the group in year seven.

Using the chart above, companies can make strategic decisions. For example, if the equipment in the example above is a part of a building and if the company is going to sell the building next year, it probably does not make sense to purchase anything other than the equipment from Vendor B (the less expensive on year one). However, if the company knows that it will keep its building for more than three years, then the equipment from Vendor D makes more sense.

Adding a discount factor to the chart on the previous example could be required if the company wants to include the cost of money or financing in the analysis.

If we add a five percent (5%) discount rate, we can see that the chart curves a little during the last years, but at that rate, it does not change the decision process. Depending on the discount rate used, the chart could look quite different, however.

The calculation of the LCCA is simply the addition at time zero (present time) to all the elements that influence the analysis. The mechanics are mostly the same as when doing a Net Present Value (NPV) calculation.

From the main section of the guide, we identified sixteen of the most common items to include. While not necessarily a complete list. Some specific industries in research, health, manufacturing, utilities, and government, to name a few might want to add other items. For example, a utility producer might want to add the environmental cost of building a new power plant or adding a piece of specific equipment to an existing one.

If we take the nineteen items listed previously:

1. Cost of purchasing the product
2. Cost of delivery
3. Installation cost
4. Annual maintenance cost
5. Commissioning costs and ramp up costs
6. The annual cost of energy (including water costs, intake, and discharge)
7. Hours of operation
8. The life expectancy of the product
9. Net resell value at the end of the life expectancy
10. On-going labor cost
11. Learning and training as well as manuals and documentation
12. Any other costs such as an annual fee for usage
13. Warrantees
14. Benefits such as revenue or savings
15. Grants & incentives
16. Other costs such as insurance, permits, part storage…
17. Reliability and loss of operation
18. Restoration and environmental remediation costs
19. Taxes and interest

The lifecycle cost analysis is simply the exercise of quantifying each of these elements above, positioning them in time (do they happen once and if so, when or are they recurring and if so, at which frequency). Once we have identified and quantified all the items, we simply sum them up at time zero, so we can add them in today’s currency (money).

Bringing back to time zero is done to consider all costs and benefits in today’s currency.

For example, if a product is purchased today for $10,000, this is the cost in today’s currency. If the product provides a saving of $5,000 twelve months from now, that $5,000 is worth less than $5,000 today because of the value of money in time. What we need to do is to actualize that $5,000 to bring it in today’s currency. Basically, calculate what is the equivalent today of $5,000 in one year from now. We do with by using a Discount Factor (DC). The discount factor is usually determined by the company. Without going into details in this guide, we can say that the discount factor can be influenced by many items such as inflation, cost of financing (WACC), desired return on investment or other. While the determination of the discount factor can be subject to a future guide, let us assume here that the company has decided to use a ten percent (10%) discount factor.

To bring to “today’s money” the $5,000, we need to actualize it by one year. The calculation is

Present Value
= $5,000 × 1 ÷ (1+DC)
= $5,000 × (1 ÷ (1 + 0.1))
= $5,000 × (1 ÷ 1.1)
= $5,000 × (0.9090)

Present Value = $4,545.45

This means that using a 10% discount factor, an amount of $4,545.45 today is worth the same as an amount of $5,000 one year from now.

If in the example above, we only had these two elements, a cost, and a benefit (savings) after one year, we could say that the LCCA is equivalent to:

Cost of product + Benefit (where the cost of the product would be a negative number since there is an outflow of money required to purchase the product.

LCCA= −$10,000 + $4,545.45 = −5,454.54

This means that the equipment has a total lifecycle cost of $5,454.45 over the course of the year.

Suppose now that we decide to include the residual value of the equipment, and it is $2,000 at the end of the third year (we suppose that the equipment only produced a one-time $5,000 savings one year after its purchase). In this case, we need to actualize that $2,000 residual value amount by three years, using the same discount factor
as previously used.

The LCCA would then be calculated as (using a discount factor DC of 0.1)

LCCA
= −$10,000 + $5,000 × (1 ÷ (1+DC¹)) + $2,000 × (1 ÷ (1+DC³))
−$10,000 + $5,000 × (1 ÷ 1.1) + $2,000 × (1 ÷ 1.1³)
= −$10,000 + $5,000 × (0.9090) + $2,000 × (1 ÷ 1.331)
= −$10,000 + $4,545.45 + $2,000 × 0.7513
= −$10,000 + $4,545.45 + $1,502.63

LCCA = −$3,951.92

We can see that LCCA is negative. This is the total cost of the equipment over the three years when we consider its acquisition cost, the generated savings, and the residual cost.

In real life, our new equipment would generate savings each year. To calculate this, we simply add the savings for years 2 and 3. Supposing all savings arrived at the end of the year, we would have:

LCCA
= −$10,000 + $5,000 x (1 ÷ 1.1) + $5,000 × 1 ÷ 1.1²) + $5,000 ×
(1 ÷ 1.1³) + $2,000 × (1 ÷ 1.1³)
= −$10,000 + 4,545.45 + $4,132.23 + $3,756.57 + $1,502.63
= $ 3,936.88

We now have a positive LCCA, so the equipment actually generates more savings than its cost.

Recap

As we have seen here, the lifecycle cost analysis is a great and underused capital expenditures management tool. However, it should be used only as a tool to help the decision process, not as an absolute decision maker. When done correctly, it can help highlight many elements that are not generally considered in other analysis. The role of the LCCA is first to serve as an adviser, pointing out all the positives and negatives of a product or project purchase in terms of cost and benefits to allow the manager to make a final decision.

Now, we would like to look at another tool that can be used for capital expenditures management. This one is more of a management concept or way of thinking. It is the concept of the money left on the table.

The concept of money left on the table is nothing new. Most people will define it as a lack of doing something, which results in not obtaining the maximum financial benefit. It can mean any money or funds that a person or company did not get for whatever reason. We could list hundreds of examples that would apply to both individuals as well as companies, but for the sake of this guide, we will limit ourselves to the world of companies and organizations as well as to the field of capital expenditures.

So how does MLT apply to capex? Think of all the ways a capital expenditure might not have to be maximized in terms of benefits. Few examples here could be:

1. 1. The company paid too much for the expenditure, did not negotiate enough or selected a more expensive vendor
   2. The company did not get all the grants or incentives that it could have received for the capex
   3. The company did not conduct a complete lifecycle cost analysis, and even though they did purchase from the lowest priced vendor when we include the cost of maintenance, support, training, and energy efficiency of the purchased item, the company is actually paying more than if sourced from another vendor.
   4. The company did not involve the procurement department and therefore did not negotiate tier rebates that came with purchase volume negotiated with preferred suppliers
   5. style=”padding-bottom: 20px;”The company did not include energy savings or available grants into their purchase decision.

These examples above are just a few of the many money left on the table situations that can occur. This is why it is always a good idea to keep an MLT list on the corner of the desk during the capital expenditure process.

We have talked so far about the capex acquisition process itself. However, behind the process is the underlying set of rules that the company must establish (and follow) to make things work properly.

The next chapter goes into the world of policies and procedures and seeks to reflect on them. For some, the policies in place at companies and organizations are meant to be set in stone. How often do we hear someone say something along the lines of: ‘we’ve always done it this way.’ For them, the rules are the rules, and people must comply.

For others, the mindset is more towards the ‘rules are meant to be broken’ ideology.

Between these two groups, there is a wide valley. This is where company policies operate. Sometimes they are followed, and some other times they are not. Moreover, when they are not, the offenders are fast to point out the flaws in the system.

The next chapter attempts to highlight ways that companies can evolve their policies to improve the capex process.

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Policies and procedures serve as the guideline for how things operate. Also, the world of capital expenditure management is filled with them. Without policies in place, it would be impossible to manage capex. Everyone would do what they want, and that’s often a recipe for financial disaster.

The policies of the company or organization do not serve the purpose of slowing things down and making life more complicated, even if they actually do feel like that sometimes. The goal of the policies in place in the world of capital expenditure management is to ensure that the proper people are tasked with planning, requesting, approving, and spending capital.

Enforcing policies

One of the main challenges of enforcing policies comes from the fact that many companies and organizations are still using a mix of spreadsheets and paper for the creation and approval of their expenditures. While worksheets are great tools, they were not meant to manage capital expenditures of multi-business unit companies. If all your operations are under one single roof, using paper requests is probably a good way to go. However, if your activities are spread out across various business units, at one in times, this might cause problems. We have identified here the most common issues that arise:

1. 1. Projects going ahead without having all the proper approvers review the request
   2. Spending over budget, often without any red flag raised in time
   3. Delays in getting the expenditures approved by all
   4. Lack of tracking and lack of insight

Without spending too much time on each of these sources of problems, let’s provide more detail and look at why they happen in the first place.

The first source of problems, having projects going ahead without prior approval of all players is popular in companies. It is not because people fail to see an approval on purpose. However, policies change, people are added to the approval group. People migrate from one sector/group/business unit/department to another. Keeping track of who must approve what is a task in itself.

Also, depending on the situation, people might see urgencies differently. If the production department needs new equipment for increasing output, they might need the equipment today, or at least, as soon as possible. Another department in the approval process might not see this request as urgency and simply add the new request to their work pipeline. At one point, it will be easy for production to go ahead with the purchase and deal with the consequences of their action later.

The second source of problem, spending over budget, happens when there is no alarm raised during the tracking process. People receive approval to proceed with a capital expenditure and start engaging funds against the approved capex. However, then something happens, and they go over budget. Some companies allow people to complete the expenditure and then report on what happened. Many will allow for some kind of ‘float’ of over budget amount, in dollars or percentage of the approved amount, before they seek re-approval. Other companies will force the people to stop and get re-approval the moment there is an overspending situation. Regardless of the case, tracking this comes with challenges.

Policies in place should be flexible enough to allow some ‘float’ on some projects while preventing other projects from becoming an over-budget disaster. This is a good example of where evolving policies can take place.

For example, let’s look at a large company with over 1 Billion dollars in sales and many business units. If a capex is for the purchase of a new forklift for a business unit of the company, does it matter if the final purchase price comes in at a few percentage points higher than planned? Not that it is a good thing, over budgets are almost always bad. However, what is the net impact on the business unit if forklift ends up costing 10% more than expected? At the company level, the net effect is close to nil.

However, what if the same company is building a new 400 million dollars manufacturing site. What if the cost goes over budget by 10%? That would probably cause a few ripples in the company, right up to upper management.

So having a flexible approval policy can be very beneficial. Many examples can include allowing for floats on smaller projects, raising alarms when a capex goes over budget by X number of dollars (instead of a percentage of the approved capex), allowing for urgent (with that definition to be clearly defined) expenses to be approved by a smaller group of people, or having them pre-approve the request in order to initiate the purchase, but still have the regular approvers review what was purchased, in order to make recommendations for future other urgencies of the same type.

The third source of problems, delays in approval, is probably the one most people working in companies feel the most. It also goes hand in hand with the first problem (going ahead without all approvers). Also, companies using spreadsheets instead of specialized software for managing their capital expenditure process feel it more than others. If the request for expenditure was created on paper, chances are it will spend more time in internal mail than on the desks of the approvers. If the capex requires the signature of many people spread out across different cities (or worse, countries), by the time it gets the approval of all of the approvers the delays caused might represent money. For example, the purchase of equipment which is tied to a currency exchange rate, or the price of a commodity. Take a company based in the US that negotiates with a vendor based in Europe for the purchase of production equipment. The equipment includes lots of steel and happens to be sold in Euros. The vendor includes a clause that the price of the equipment will be partially tied to the price of steel, so if steel fluctuates, so will the price of the equipment (although in smaller proportion).

To make things more complicated, the vendor requires 30 weeks for manufacturing the equipment. Depending on how long it takes for the company to get the approval to purchase the equipment from the vendor, the company making the purchase might end up having to pay extra because of the currency fluctuation (or pay to have some method of hedging in place but that also comes with a cost). It might have to pay more because of the change in the price of steel. Finally, the company might not receive their production equipment on time, which could cause lots of problems on the production floor.

Companies should have their approval policies flexible enough to recognize which capex request has the potential for such price swings. While most companies do prioritize their capex, this is too often accomplished by simply adding a field (priority 1,2, 3…) in the request. So, when that request ends up under a pile of other requests, the priority levels serves no purpose.

Bottom line, delays introduced in the approval process, whether coming from spreadsheets or other sources, can end up costing the company lots of money.

The 4^th source of problems derives from lack of tracking and lack of insight. This is problems from not having a clear picture of what was spent, why, and on what.

While many will say that this is the role of accounting and finance, unfortunately, many companies and organizations do not always correctly track where their capex money went. They can run reports on how much they spent per vendor and provide information on where it was coded (ex: building equipment), but that does not tell the whole story.

Was the cost of the building equipment initiated because of legislation or normal wear and tear? If it was legislation, was it the city requiring something? (Ex: a wall to reduce the sound to nearby residents) Alternatively, was it initiated by insurance (fire hazard) or a new regulation? Unless the company keeps track of the reasons, it becomes difficult to run reports and see how much was spent per reason for a business unit. Moreover, it becomes almost impossible for the head office to see the bigger picture of where the money went. So, in that case, overall capital expenditure planning becomes more difficult.

An evolving working process

In this guide, we have looked at the capital expenditure process, from the planning stage to the creation of capex requests. We have discussed how to improve the justification of an expenditure and what not to forget when submitting a request. We talked about some of the elements that can be added into the capex process to improve it. The capital expenditure management process is complex, and managing it daily traditionally involved the usage of numerous printed spreadsheets and text documents. People needing to create capital expenditures requests typically start by assembling the information needed, then they create spreadsheets to calculate the request’s cost and benefits. They then supplement the request with text documents to provide written justification for the request. Once assembled, they need to figure out who must review and approve the expenditure. Finally, they send the request either via email or more often, in the internal mail and then wait days (or weeks) for a response.

While a majority of companies continue to operate this way, many companies and organizations now realize that the increasing complexity of the capex process, combined with the growing and continually changing the list of reviewers and approvers within the company, can create substantial difficulties for managing capex the traditional way. This increased complexity also tends to add delays to the approval process, making it harder (and too often more frustrating) than before to continue to operate the traditional way.

This guide would not be complete without pointing out that the authors of this guide offer a capital expenditure management software. Sold as a SaaS on a per-user basis, Capexplan stands for Capital Expert Planning. Capexplan is a complete online software that enables companies and organizations to plan and manage their entire capex process across all their business units. It enables users to create complete capex requests and, using the company’s policies, reach out to the proper approvers. This results in substantial time and money saving.
The software also comes with the tools and reports to track where your money went and why. Capexplan is offered by Almiranta Corporation at www.almiranta.com or visit our product page for a free trial directly at www.almiranta.com/capexplan.

The world of capital expenditures is vast. Not only in terms of the amount of money it often involves, but also in terms of what it includes at companies and organizations. If the company replaces a large piece of equipment, chances are it will be categorized as a capex. Every project will probably fall under that category as well. New buildings, building expansions, they are all capex.

It is also an increasingly complex world, where new players, both internal to the companies as well as external, are continually coming to the table and get involved earlier and earlier in the process. No longer, advisors or simple gatekeepers, many have become part of the core capex review and approval teams.

Many companies and organizations would benefit in better planning their capital expenditure. The benefits are primarily monetary, but they are also about the efficiency of work. Better planning the capex process often means planning with a longer-term perspective in mind, gaining better insight as to why the company is spending for expenditures, and where. It also means establishing policies and procedures to optimize the purchasing process and taking concrete action to adhere to them to reduce the capex costs. And finally, it means involving as many stakeholders from within the company, as possible, and getting them to understand their respective roles before there is an actual urgent capex request that arrives. That way, people will have the time to know each other, work together, and appreciate the input that each can offer.

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