What are your most effective capital expenditure business case tools?

I am polling CFOs/VP Finance/FP&As for their favorite tools for capital expenditure decisions. Specifically, how do you create the best understanding of the true business value (and risks) and convey that to the decision-makers (CEOs and Boards)?

What innovative evaluation techniques unearth important insights of value and risk?
What presentation / communication methods(charts/tables/other) are most effective at conveying those insights to decision makers so they can make their best decisions?

I am looking for practices beyond the traditional discounted cash flow calculations, SWOT analysis, etc., but if you have developed unique techniques for getting greater value out of the traditional tools, I am eager to hear of those as well!

Answers

Katherine Simmonds Agent • November 16, 2012

I have seen some companies design a what if business case form, that when completed is submitted to an approving committee or budget owner for approval.

Example: mining industry needs new land mover - costed out including 5-10 years of maintenance they can tell when they need to sell and repurchase to avoid extensive repair costs. Same with lease vs buy decisions. All of these factor in a time value of money and maintenance is based on average historical costs of similar equipment.

Other companies poll their operational departments annually and those departments make a list of desired projects, each project has to include a business case and show either cost savings or efficiency savings that will repurpose workers to more beneficial tasks.

SAP has an Investment planning module, so those types of engineering budgets and what ifs can be planned and approved and put into production. I think it has an annual plan feature.

In reality even though I have done a lot of fixed asset work and data planning, I have not worked for companies that actually do capital asset planning. Always to their own detriment of course. But in a large company getting a few hundred divisions to use one tool seems daunting.

If you can figure out a new cloud service - I think you might have a winner. And it would have the support of CPAs assuming you could meet the security and integration needs.

Best.

PS: I have noticed that until someone answers a question, no one else seems to post, so I am breaking the ice for you hoping that others will help you out even though my comment is of little value.

Sarah Jackson Associate Editor • April 1, 2013

You mgiht also get some value out of this free white paper we have here at Proformative titled

"Benchmark Study: The State of Capital Planning"

https://www.proformative.com/whitepapers/benchmark-study-state-capital-planning

Proformative also offers online courses, including this one titled,

"Estimating the Cost of Capital"

https://www.proformative.com/courses/estimating-cost-capital-training-course

Enjoy!

Best... Sarah

Robert Fetterman Chief Financial Officer • November 17, 2012

I have done a lot of capex modelling and decision analysis. The first step, of course, is a high level evaluation of CapEx opportunities. Typically this is a wide net to managers gathering ideas for projects and potential costs, along with a very high level description of purpose (eg payback, strategic, maintenance, etc.) and for payback projects a high level idea of payback.

Best practices is to have these projects prioritized by functional or SBU area and then a cross-functional team (Directors or VPs) review the projects and prioritize them overall. Based on a high level goal usually set by the CEO there is a rough cutoff. Projects near the cutoff are analyzed more closely to get a final draft list which is then shared at the senior level for a final prioritization decision, usually by the CEO.

Once projects are raised to be launched, a more detailed analysis is done, validating the payback, for example. For major investments I have coupled a payback graph showing by year the cumulative cash flow, which is helpful on a quick view. In addition, adding an optimistic and pessimistic scenario, and a sensitivity table for key assumption changes, helps quantify the risks involved in the major project.

For huge projects, I have also used simulation modelling to better understand the project financials and risks. I have used an Excel add-on to develop distribution curves for key inputs, instead of statis numbers. For example, instead of 3% growth, maybe you use a normal curve distribution with a mean of 3% and a standard deviation of 2%. This is extremely helpful in seeing the distribution curve of an outcome, such as the NPV or IRR. I then look at the % risk we will be below our cost of capital or have a negative return.

David Belgum CFO • November 23, 2012

I believe the basic analysis should consider the cash flow from the capex and the time value of money using the cost of capital for funding a capex project. I agree with Robert that it is useful to project different expected outcomes given the risks inherent in the project. I would add a couple of comments:
1. Often much of the justification for an expenditure can't be quantified, and so listing out qualitative reasons for acquiring an asset can help decision makers understand the relative merits of one project over another.
2. Showing how the acquisition of an asset is aligned with a company's strategies or goals will be useful information.

Suku Sukumar CTO • December 2, 2013

Excellent question(s)! Unfortunately, in today's world, business cases are created and socialized more as a 'sales' pitch to seek approval to spend rather to create and justify the true value of potential investments.

By true value, I mean looking at the Total Value of Ownership (TVO) by considering not just project spend (CapEx and up-front OpEx), but as well the ongoing OpEx spend, benefits (such as cost saves, avoidance, and revenue gains that occur beyond the project period), and non-financial business impacts & outcomes

The traditional DCF and P&L impacts do relate to and convey ROI, NPV, Payback Period, and IRR, but financial benefits are not the only metrics to consider. While CFO and financial experts are interesting in knowing that a certain investment will yield a 38% ROI and 26% IRR over the period of 7 years, CMO and product owners may be interested in knowing that the same investment will result in a 42% year-over-year revenue growth and whereas the CIO and IT executives may be interested in knowing that the exact same investment will lead to increasing the website traffic by 39% and result in increasing the overall storage capacity from 20 TB to 58 TB.

The point I am trying to make is that different stakeholders get different benefits out of the same investment, and there is a need to capture the true and total value of an investment from diverse perspectives.

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