Creating a Capital-Budget Tool

The decisions you make regarding the acquisition of assets are
a key component of your company's success. When it comes to
capital expenditures, poor decisions will usually cause a drain
on productivity”?and can dearly cost a company on the bottom
line. Conversely, good buying decisions can propel sales and productivity
upward, thus creating profits and positive cash flow.

But what is a “good” decision and what is a “bad” decision? To
help you make that judgment, let's put together a tool for taking a
more systematic approach to capital-expenditure decisions.

A matter of priorities

Begin by compiling a “wish list” of capital expenditures that will
enable your business to remain competitive this year. Include in
your list the assets that you
need to buy, as well as
those you may just want.
Ideally, your needs and
wants don't stray too far
apart. For instance, we all
want a new sports car, but
you probably don't need
one for the business. (A
sample capital-expenditures
tool has been posted
with this article at www.bigpicture.
net.)

When compiling this list, make sure you include your key
people in what should be added. Invariably, you will find that
your management and the production employees will have differing
views on which assets may be the most important.
Nonetheless, their insights and feedback will prove to be a great
resource in the decision-making process.

Once the list is complete, review it with those who helped
compile it. Then, label each acquisition either “A,” “B,” or “C,” with
the “A” purchases being the most important, “B” being less
important, and “C” being the least important. Assign the proper
cost to each potential acquisition”?but don't confuse the priority
labeling with the cost of the asset. For purposes of this list, cost
and priority are not related. In other words, there may be some
very inexpensive assets that you desperately need and, hence,
are assigned an “A” rating, while a piece of very expensive
machinery or equipment may get a “C” assignment.

After you have assigned each potential item its priority label,
sort the list so the As are at the top and the Cs are at the bottom.
Now, re-examine each section (A, B, C) and re-sort the individual
sections based on their priorities. The most critical capital expenditure
should appear at the top of the list, and the least critical
expenditure should appear at the bottom. Again, solicit input
from those employees who helped you compile the list (you are
looking for “buy-in” here).

Timing, paying cash, and financing

Now examine the financial ramifications. Add another column
onto your worksheet to accumulate the dollars you will have to
spend to purchase all assets; as you move down the list, the
overall dollar amount increases incrementally. Although this column
can be discouraging”?moving down the list, the overall dollar
amount increases at an alarming rate”?it's critical in determining
cash flow and the timing decisions on acquisitions.

The running total of dollars spent will provide you with an
immediate budget for capital expenditures, and it will assist you
in deciding whether to use operating capital or to finance each
acquisition. Typically, your list will have a total dollar amount
higher than what you can afford. That's okay”?some of the Bs
and Cs on the list may have to carry forward to next year.

Your decision on whether or not to finance a given acquisition
is an important one. Pulling cash out of working capital has
its pros and cons: Paying cash will save you the interest you
would otherwise pay if you leased or financed the purchase; but
pulling too much cash out of operating capital may hamper your
ability to operate in the day-to-day business environment.

Relying exclusively on debt financing, however, can leverage
your company's cash flow into a dangerous position. In our business,
we typically make all smaller capital expenditures out of
operating capital, and save the high dollar items for a financing
model. If you do decide to lease or finance an asset on your list,
don't remove it from the capital-acquisition list; it's important to
track all capital acquisitions regardless of how they are paid for.
Instead, adjust the cumulating column so the cost of the asset
reflects a monthly expense rather than a one-time expense. This
will track the true cash outlay for your capital investments. Transfer
the lease or finance expense to your monthly cash-flow budget
and evaluate with your monthly cash outlays. This will help you
assess if you can afford this purchase on a monthly basis.

The decisions you make regarding your capital expenditures
will make or break your business. One bad purchase, if large
enough, can bring a business down. On the other hand, watching
technology pass you by without ever pulling the trigger can be
just as detrimental.

Marty McGhie ([email protected]) is VP finance/operations
of Ferrari Color, a digital-imaging center with Salt
Lake City, San Francisco, and Sacramento locations.