Decisive Actions Required for Large Capital Expenditures

By Merrill Martin, VCT/QualTeq Division

Every business is faced at one time or another with making purchasing decisions on major capital equipment. The process can often consume a great deal of time and effort—time that is difficult to come by in a busy executive’s day. However, a decision must be well thought out and planned, or else the impact on the business can be catastrophic.

The best approach in dealing with the decision-making process should be the adage that “no decision is the worst decision.” Start with referencing your Strategic Plan. Question what stage your product is in within its life cycle. What is the present and future market like? What equipment is necessary to resolve current plant capacity restraints? What downstream impact will the equipment purchase have on the rest of the manufacturing process? For example, in the card industry, if you plan to purchase a multicolor press to add printing capacity, will it require upgrades to pre-press or added laminating and punching capacity? This analysis is best made in advance of the equipment purchase to avoid additional financial surprises. The total cost of the equipment should include freight and duty costs, training, initial complement of spare parts and site preparation.

Before making a major equipment purchase, it must be well thought out by key members of the management team.

It should include Production, Sales, Marketing, Finance and Human Resources. This plan should be in written form and be compelling to the Corporate Office or Business Owner. The Capital Expenditure Request should contain the following components:

Executive Overview – This narrative prepared by management should explain why the expenditure is required. It should state the reasons in general terms, such as a customer demands, ability to participate in market growth, quality requirements, competitive issues, equipment obsolescence, etc. It should include the assumptions made that support the financial and operational analysis.

Marketing/Sales Analysis – This section includes reasons why the marketplace will support the equipment expenditure through increased sales opportunities. It will identify a new or existing market and the sales force necessary to market the product to customers. This section also quantifies any competitive advantages such as improved production quality or manufacturing cycle time.

Customer Analysis – This is a narrative that justifies how the equipment will meet your customer’s needs and requirements. It may cite improved color graphics, cost reductions and improved delivery times.

Cost Savings/Payback – This section quantifies the advantages related to the expenditure. It addresses incremental sales or additional sales of a new product, the cost of the additional sales, initial selling and administrative expenses, and the cost of capital. It also factors in savings such as headcount, improved production yield and labor productivity. This information is presented in a pro-forma income statement that should be projected out three to five years in the future. The results of the income stream will aid in calculating financial information such as cash flow, cash payback and internal rate of return on your investment.

Manpower Requirements – This area is often the most overlooked. It should identify the manpower necessary to run the equipment, the technicians required to service and repair the equipment, and related training costs.

Not every capital expenditure requires this level of analysis. If the purchase is for replacement equipment, the amount of analysis is significantly less. If the purchase represents a major capital expenditure or entry into a new market, the importance of quality analysis is increased exponentially.

The process should be thorough so that the most informed decision can be made. On the other hand, it must not be too unwieldy that management gets bogged down in minutia that becomes irrelevant in the decision making process.

Capital expenditures are the lifeblood of maintaining or growing a manufacturing business. Accountants measure the economic useful life of an asset and reduce its worth with depreciation. If depreciation expense consistently exceeds capital investment over several years, the business is essentially going through a self-liquidating process.