Capital Investment Basics

Now that you have a handle on budget and cash flow, it’s time to move ahead with new projects. But first you must answer these questions: (1) Is there enough capital? (2) What projects will get priority?
The best time—indeed, the only proper time—to make capital investment decisions is well before the actual funds are needed. Far too often, capital spending plans are made on a crisis basis, with the “squeaky wheel getting the most grease.” A slick presentation for someone’s pet project is no true basis for committing part of the firm’s financial resources, no matter how well intentioned that project may be. As a manager with decision-making authority, you need a long-term approach—a system that will enable you to analyze each proposal and then compare it with other possible projects.

How to Prepare a Capital Investment Proposal

Sooner or later, all serious capital spending proposals are submitted for inclusion in a capital budget. There they are classified, analyzed and evaluated before management makes a final decision on which proposals are most suited to the firm’s needs and objectives. Keep in mind, however, that a successful capital investment program must take your company’s long-range goals and objectives into account. Ideally, you and your staff should provide input in generating and developing capital spending proposals. You should always think in terms of contributing to overall business strategies when choosing among various spending proposals.

This link with strategic planning can be accomplished in a variety of ways, depending on your company’s size and the complexity of its operations. Following is a brief rundown of the steps to take in preparing a capital spending proposal. They mirror many of the steps your firm uses in preparing a company-wide capital budget.

● Establish objectives: To set your department on the right growth plan, you must first decide where you want it to go. You must set long-term objectives and take into account top manage-ment’s expectations for the future.
● Develop strategies: Once broad objectives have been established, your department can start to consider various strategies that would help your company achieve its long-term objectives.
● Present proposals: Make each proposal as detailed as possible and include estimated costs and preliminary projections of possible savings. All these steps are essential because your plans will be competing with those of other units in the company. Upper management will evaluate and compare each unit’s spending plans. Those not fitting into strategic goals, or that do not have a good balance between financial stability and growth potential, will end up on the chopping block.

Classifying Capital Spending Projects
Most firms tend to treat all capital spending projects alike, an approach that can sometimes lead to serious errors in judgment. There are at least four broad categories of capital projects, each requiring a different planning approach and corporate strategy.


1. Mandated expenditures: These are expenditures required by law, such as OSHA safety regula-tions or EPA requirements. In addition, you can include spending projects to protect against product liability lawsuits or possible product recall.

2. Maintenance expenditures: Projects in this category include all those necessary to maintain production levels. Existing facilities or equipment often require repairs or replacement. Because your company’s output will be affected if the expenditures are not made, you should give capital spending for maintenance a high priority.

3. Cost-saving expenditures: This category includes all projects designed to make current operations more efficient or productive. Cost-saving proposals usually involve a choice between the existing method and proposed expenditure, so they should always be supplemented by cash-flow projections.

4. Growth expenditures: This is at once the most important and the most elusive category of capital spending. It includes all expenditures designed to stimulate your company’s growth, whether by introducing new products, entering new markets, purchasing equipment, adding facilities or making acquisitions.
Although capital expenditures made for growth can exert a profound long-term influence on a firm, it is usually possible to defer them without undue penalties.

For this reason, you should put growth investments at the low end of your capital budget priority scale. Seek funding for mandated and maintenance projects first because they are necessary to keep the firm functioning. Next come cost-saving projects, primarily because they can have an instant impact on the bottom line. Only after spending plans for the first three categories are final should you turn your attention to growth projects.