Investing in high-cost fixed assets such as office space and technology needs serious planning, analysis, and execution.
As an SME, you can't afford to spend your limited capital without careful planning, analysis, and execution. However, that shouldn't stop you from investing in assets that can help scale your operations and grow your business.
What is CapEx?
The investment made (including any funds used to purchase, maintain and upgrade) fixed assets is referred to as CapEx. Typically, fixed assets are building, machinery and furniture. But it can also include
While operational expenses (OpEx) are expenses incurred in day-to-day operations (salaries, G&A expenses), capital expenditures are long-term investments, so an asset must have a useful life of at least one year (as building, machinery, and furniture would naturally have).
What is CapEx planning?
As mentioned, investing in long-term capital assets (building, machinery, and furniture) demands serious commitment.
Capital expenditure planning is the process of budgeting for those assets. As a founder, you're responsible for making investment decisions. By going through CapEx planning procedures and comparing them to your growth goals and objectives, you can assess what assets you should prioritize. In most cases, the required budget, time to break even and to get an ROI (some businesses also calculate the payback period, and the net present value of investments), and complexity determine the priority of a specific project.
CapEx process best practices
Find your CapEx budget
If you find a CapEx project worthy of investment, devise a budget plan. Involve your finance team and other operational teams and set up a maximum willing amount that you can invest.
Separate CapEx from the annual budget
Most companies separate their CapEx budget from the annual budget. As the financial implications and benefits of CapEx projects spread beyond a single accounting year and even decades, it's necessary to separate your CapEx budgets.
Create a standard approval process
Time is the most valuable asset to any company. While planning your CapEx project, think about how much of your and your team's time you can allot to it without disrupting your business operations.
CapEx planning requires input from many departments. Create a standard approval process based on pre-determined criteria and your budget to avoid wasting time and getting lost in the noise. This will quicken the time it takes to approve CapEx investments and minimize the wastage of time.
Prepare for the unexpected
Despite weeks of planning, there can be unforeseen changes. For instance, imagine if you invested in office space in 2020, and now your team is on a hybrid work model. You need to recoup that principal amount, and always plan and forecast for the unexpected.
Why CapEx planning is important
There are several reasons to create a proper capital expenditure plan.
Proper planning will aid revenue growth
Committing your capital to carefully thought-out projects can ultimately bring in revenue. CapEx planning can improve your production capability and revenue potential if you plan wisely.
To avoid unnecessary expenses
Capital expenses are long-term and will require constant repairs and maintenance. For instance, your office space will require the replacement of HVAC units, monthly deep cleaning, and door repairs. If you do not plan appropriately for these expenses, you can end up damaging your cash flow. It's always a good idea to forecast your expenses.
To gain a competitive advantage
With increasing capital expenditure and depreciating value, the product cost starts rising. Without proper CapEx planning, product costs can skyrocket and you lose your competitive edge in the market. By ensuring the viability of your CapEx projects, you can maximize profitability and market share.
To control the project budget
Changing requirements and constraints often make CapEx budgets spiral out of control. If a top line isn't set before the project's initiation, you may be forced to pour more capital into it or abandon it altogether, making you lose more money. CapEx planning ensures you're prepared for the time, resources, and funding before starting a new project.
The bottom line
Capital expenditure is the upgradation or acquisition of physical assets. CapEx planning is the process of effectively preparing the funds, resources, and time for the project. The reasons for CapEx planning include loss minimization, gaining a competitive advantage, and controlling the budget. The planning process often involves assessing the impact, allocating funds, and standardizing the approval process. Moreover, the planning process also discusses the allocation of resources and time.