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.
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.
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 "A"s are at the top and the "C"s 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).
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.
This article has been provided by The Big Picture. Author Marty McGhie (email@example.com) is VP Finance/Operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations. For more information, please visit their web site at www.bigpicture.net.
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