Why Are Capital Expenditures in Your Operations Plan?

Capital expenditures planning is as necessary to your business, as business planning is for business growth.

What are capital expenditures? To be sustainable, businesses need to invest in capital acquisitions and also need to focus on managing the capital investments, such as physical facilities or plants (or additions); equipment; property; and other major improvements.

There are accounting definitions for these type of expenditures and the importance of the definition is in the accounting treatment (depreciation, amortization) of the asset. I am not an accountant. The focus of this page is not on how to treat your investments but how to plan for these type of expenditures and why it's important to do so. Get tax advice in terms of how to handle these expenditures (different treatments in different countries).

Capital expenditures need to be part of your business operations plan; they have an impact on cash flow management and can be a drain on your business unless you plan properly. Therefore make sure that capital expenditures are on your business plan outline checklist (under the Operations Plan).

Usually small businesses do not enough money to do all the capital projects or buy capital equipment that they might want or need. Therefore capital projects need to be cost/benefit justified.

Some ways to look at cost justification of expenditures are (for the most part, financial ratios are used):

• a return on investment (ROI) basis, which measures the efficiency or value of the investment (often used to compare investments or expenditures);
• payback period, which is the length of time the investment takes to payback the cost(shorter is better);
• internal rate of return (IRR), (also known as economic rate of return or ERR), which is the internal return rate of an expenditure (net present value of cash flows at zero); the higher the IRR, the better;
• discounted cash flow analysis, which is the value of a business in today's terms, based on analyzing or projecting what the business will make in the future (the discounting is the value of cash will be less in the future - due to inflation - than today);
• and net present value (NPV), which compares the value of today's dollar to the value of that dollar in the future (assuming a specified inflation rate and rate of return). If the NPV of an expenditure or investment is positive, that's a good thing. If it's negative the investment should likely not proceed.

Your expenditures should be focused on achieving your business objectives.

For example, you plan to expand your business by adding a number of new inventory items. Your business will need to add warehouse space. The capital investment project to buy the space next door to expand existing warehouse space and then to build the additional space is in alignment with your business objectives for growth. Providing an acceptable return on investment (this analysis should also look at the payback of adding new inventory items) over a defined period (say two years - of course, one year is better and would be a very good project or investment), and with an IRR of 19%, will make the decision to go ahead on this project easy.

Capital investments can be divided into a number of different categories: discretionary; maintenance; business growth. If you have to pick and chose - maintenance and business growth expenditures should come far ahead of discretionary spending. However recognize that all expenditures will have a number of drivers (e.g. safety, environmental, what you need to provide good customer service, etc.) and therefore assessment of these investments must also keep those drivers in mind.

Capital expenditure planning needs to be done for 3 to 5 year periods and reviewed and updated annually.

Return from Capital Expenditures to Small Business Plan.

Or Return From Capital Expenditures to More For Small Business.