Capex Planning: Meaning
Capex Planning is the planning for the capital expenditures that a business organization proposes to make in the near future. It involves thinking, brainstorming, proper assessment, and evaluation of long-term asset requirements of the organization that will last and serves the company beyond the current financial period. The management has to decide if the capital expenditure requirement will work for the fulfillment of the organization’s objectives or not. Also, it has to make sure if it has the necessary resources for the same. It becomes extremely important for the management to properly plan for such decisions. They will involve considerable resources of the organization. Also, once such expenditures are made, they are usually irreversible. They can cause severe losses to any organization if the decision backfires or fails.
Capital expenditure planning can be very simple if the need is imminent and urgent. It may be hindering the day-to-day operations of the business. For example, suppose a large portion of factory premises has suffered physical damage, and it is no longer safe to work there. It may be possible that certain production operations and procedures are being hindered due to the damage. This is the case of an urgent need for capital expenditure in the form of renovation of the factory premises.
Certain capital expenditures can be optional too. It may be possible to postpone or delay them or incur them in phases. For example, a company may decide to upgrade its IT infrastructure or implement some new technology in the current financial period. It may also decide to postpone this capital expenditure decision for some time if the company’s resources do not allow for the same. Or it may break down the total task over 2-3 years. This is to make sure that enough resources will be there.
How do we do Capex Planning?
Capex planning involves the following steps:
Assessing the Capital Expenditure Need
The first step in planning for capital expenditure requires a proper and thorough assessment of the need for that expenditure. The managers should make a cost-benefit analysis to ascertain that the benefits from Capex far outweigh its costs. For example, suppose the managers feel that their department requires a technology up-gradation. In that case, they should ensure that this up-gradation is absolutely essential for increasing the efficiency and well-being of the organization. They must also work out the monetary benefits it will have over the years. Of course, the total monetary benefits expected over the years should be substantially more than the CAPEX proposed.
Also, they should analyze all the available alternatives first before indulging in an item of expensive capital expenditure. If there is an alternative way of doing things without incurring capital expenditure, they can opt for it.
Proper Budgeting for Capital Expenditure
An organization shall have a distinct budget for CAPEX. This budget should be separate from other budgets, including the operational expenditure budget. This will give the confidence in managers to plan for capital expenditures properly. They will know that they will be able to materialize a good plan because of the availability of sufficient resources within the organization.
In advance, the management should work out an operational expenditure budget that may arise out of the capital expenditure. For example, if an organization plans to build a new factory, there will be several operational costs that will stand up along with it. These costs can be wages and salaries of personnel, utility bills, cost of raw-material and other inputs, etc. Therefore, proper planning is essential for multiple budgets to work in tandem. There should be no bottlenecks later on in the efficient running of the organization once the building is ready or, for that matter, once the CAPEX is over.
Specifying Time and Spending Limits
A capital expenditure plan can be successful only with a proper and specific time period for its accomplishment. Also, the time period should be achievable and realistic. A short time period may ruin the Capex plan and cause unnecessary panic. Devoting more time than what is necessary to build an asset may create lethargy and inefficient use of the company’s resources. And of course, as the time span increases, various direct and indirect costs of execution also increase. And sometimes, a lethargy may lead to overrun and budget constraints. The budgeted time period for accomplishment should be achievable. It should give sufficient time to the management to build and deploy the necessary resources for the successful execution of the plan.
At the same time, the capital expenditure budget should have an upper ceiling to the expenditure that the management can incur to fulfill the plan. This will help keep the expenditure with regards to multiple processes in limit. Also, this will lead to more efficient use of the firm’s limited resources.
Efficient Implementation and Control
Once the management decides to go for an item of capital expenditure, it becomes important that the Capex plans are implemented effectively. The implementation process should be smooth and efficient. The resources of the organization should not be blocked unnecessarily for a long time. The management hierarchy should be clear and transparent. There should be no confusion within the chain of command and responsibility for executing decisions so that there are no roadblocks to the effective implementation of the plan. There should be constant monitoring of the execution of the plan. So that the plan does not suffer on account of delayed decisions and/or any circumstantial change can be addressed immediately. Moreover, it will help management to make a course correction if something is not going right as per the plan.
The management has to then look into the final results of their capital expenditure planning. They have to evaluate if the plan is a success or not. They can use several metrics for measuring the same such as Return on investment, payback period, net present value, etc. These results will help the management to gauge the effectiveness of their capital expenditure plan. Also, they will help them to introspect, improve and make better decisions in the next planning phase.
Capital expenditure decisions are very crucial for any organization as they help it to maintain and develop capital assets that are necessary for the long-term growth and development of the company. Also, such expenditures can cause a severe resource drain on the organization. Hence, it becomes extremely important for the management to engage in Capex planning and implementation seriously so that they can achieve high levels of efficiency with minimum wastages and delays.
Frequently Asked Questions (FAQs)
Capex Planning is thinking, brainstorming, proper assessment, and evaluation of long-term asset requirements of the organization that will last and serves the company beyond the current financial period.
Steps for CapEx planning:
1. Assessing the capital expenditure need.
2. Proper budgeting for capital expenditure.
3. Specifying time and spending limits.
4. Efficient implementation and control.
Capital expenditure planning is crucial as it helps in maintaining and developing capital assets that are necessary for the long-term growth and development of the company. Moreover, such expenditures can cause a severe resource drain on the organization.