If you have sufficient capital and are considering deploying it to grow your business with long-term investments, then capital budgeting is essential. The tips below can help you move through the process strategically.
Get Unstuck From Last Year's Numbers
Chances are, your current numbers look different than the previous year’s. Likewise, so should your budget. If you’re stuck in last year's budget numbers, use several fact-based, objective criteria to define new projections, estimate sales potential and create new targets based on your models. You'll be in a better position to get buy-in on capital spending with projections that reflect both current and future conditions.
Don't Put All Your Capital Budgeting Analysis in One Basket
When it's time to determine which investments are worth moving forward with, it's wise to attack the analysis from a few different angles. This means using multiple techniques to crunch the numbers.
Internal Rate of Return (IRR) is the most commonly used technique. It creates a return on investment percentage by dividing the expected profit by the expected investment. The IRR can be created for each proposed investment and then used as a comparative tool.
Net Present Value (NPV) is often considered the most accurate way of looking at how much cash will be generated by the investment, minus the cash required to fund the investment, taking into account the value of that cash today and in the future.
There are others, as well, such as Sensitivity and Decision-Tree Analyses. The more techniques you use with a favorable outcome, the more confident you can feel about making a long-term investment.
Get Your Wish List Approved Up Front
To save valuable time and be able to capitalize on opportunities when they present themselves, it's useful to have a contingency plan for budget surpluses. Once you've identified the projects to move forward with this year, include a list of future projects and review it with your board of directors.
If you find yourself in the fortunate position of being able to fund one of these "wish list" projects, you'll get faster buy-in since the investment has already been vetted. Instead of waiting for next year, you can initiate growth today.
- "Capex vs. Opex: 5 Tax Considerations to Keep Your Small Business Going Strong," Kylee Swenson Gordon, Line/Shape/Space, Feb. 19, 2014, http://lineshapespace.com/capex-vs-opex-tax-considerations/, accessed April 28, 2014
- "11 Contingency Planning Tips," Bill Fry, CFO, Oct. 30, 2013, http://ww2.cfo.com/budgeting/2013/10/11-contingency-planning-tips/, accessed April 28, 2014
- "Three Primary Methods Used to Make Capital Budgeting Decisions," Evangeline Marzec, Houston Chronicle, http://smallbusiness.chron.com/three-primary-methods-used-make-capital-budgeting-decisions-11570.html, accessed April 28, 2014
- "Capital Budgeting Methods," Jim Wilkinson, The Strategic CFO, July 23, 2013, http://strategiccfo.com/wikicfo/capital-budgeting-methods-2/, accessed April 28, 2014
- "Is Your Budget Process Stuck on Last Year's Numbers?" Dan Lovallo and Olivier Sibony, CFO, http://ww2.cfo.com/budgeting/2014/03/budget-process-stuck-last-years-numbers/, accessed April 28, 2014
The information contained in this article is intended for general educational purposes only and is not to be construed as legal, tax, or financial advice. Please consult with your own legal, tax or financial advisor for guidance with your own particular circumstances.