Budgeting – Part II Capital Budget

Capital Budget

OK, it’s time to talk about your capital budget.  That’s the long-term planned spending that needs to cover larger spends, usually on assets.  It may be that you don’t need to handle a capital budget in first line management roles, but you do need to know how it correlates with your operating budget.

Your capital budget (Cap Ex – short for Capital Expenditures) should reflect expenditures for assets or the creation of assets that have useful lives (as defined by the Finance department with input from your department) of three or more years.  If the useful life is less than the company standard, the item is usually expensed.  Again Rule #6 applies, “When in doubt, ask your Finance department.”

Rule # 9: Always know your Capital Budget number.

Over the years I have developed a categorization that is useful for understanding a capital budget and for presenting it to upper management.  I recommend that you use the following categories:

• Existing Cap Ex due to growth and expansion
• Existing Cap Ex that is a continuation from the previous budget year (e.g., multi-year projects)
• New Projects due to current business growth and expansion
• New Projects due to infrastructure change
• Strategic Projects due to new business opportunities
• Strategic Projects due to technology change

Let’s examine each of these with examples and guidelines for each (note that these are not meant to be all inclusive):

Existing Cap Ex due to growth and expansion.	If you are tracking and storing more data or adding more customers or products, there will be natural growth in data that results in the need for purchases such as additional data storage. (Note that this example does not make any assumptions about archiving or purging data, which can help to limit the need for additional capacity).  If employee growth is in the budget, then equipment expenditures for new PCs and servers to support employee growth would also fall into this category.
Existing Cap Ex that is a continuation from the previous budget year (e.g., multi-year projects).	If you have a multi-year project that has been approved, and assuming it is to continue into the current budget year, then you need to plan for that capital expenditure.
New Projects due to current business growth and expansion.	You need to be extra careful because if you listed all the projects that the business wanted you to do, it would likely exceed your company’s Cap Ex capabilities for the year.  So, the process to follow is to list all projects, prioritize them and determine where the cut off is in terms of either spending limits, ROI, or whatever criteria your company chooses to use.
New projects due to infrastructure change.	If you have infrastructure that needs to be replaced because the SW or HW is obsolete, or the vendor is no longer in business or the maintenance cost exceeds the replacement cost, then those items would fit into this category.
Strategic Projects due to new business opportunities.	This category is for strategic investments that go beyond the current business Cap Ex as defined in the above four categories, such as a new business venture that may have startup costs for SW and HW.  Mergers and acquisitions that require Cap Ex would also be captured in this category.
Strategic Projects due to technology change.	This category is for investments in new technologies that will make your business more productive such as digitizing assets instead of storing the physical assets themselves or the introduction of a new digital technology such as OCR.  You may have difficulty differentiating between this category and New Projects due to infrastructure change – these will be judgment calls for you.

Most companies have determined (within a certain range) what their annual Cap Ex budget they are capable of supporting can be.  Others can expand or contract based on factors such as cash flow, access to capital, or ROI.  Capital expenditures are an investment in the business that will have a useful life of 3-7 (or more) years.  Cap Ex will be included in the company’s balance sheet and depending on the size of the company, may or may not have a material effect on the balance sheet.

PRESENTING YOUR CAP EX

In order to present your Cap Ex budget in the most useful way, so that the CFO and other key executives can see how this investment is being allocated, use categories defined above or create your own – you will find the ones that work best for you and your company.  A table or pie chart can be a very effective way to present the budget broken out by category.

Another way to look at Cap Ex is by Corporate and Operating Units.  In the following example, infrastructure is included in Corporate, but need not be if it can be allocated to a particular business unit.

Rule # 9: Always know your Capital Budget number.

This may not be exactly the way you want to present it, but it should be the way that your audience understands it.

One of the big issues that arose in one of my departments was that the big projects were always the ones that could be justified and so they got the bulk of the Cap Ex budget, but there were some small projects could also result in some great benefits to the departments and it was important that they not be overlooked.  To reduce the angst associated with this situation, I recommended and got approved, that we carve out a portion of the Cap Ex budget, say $400K per business unit to give it to each Business Unit as a “Discretionary Fund.”  The rules we established were as follows:

• The money had to be spent with my department.
• The money could be used for HW, SW or any combination
• The projects selected did not have to be justified
• The project costs were estimated by my department.
• The money had to be spent in that budget year
• The projects were subject to my department scheduling them

This was a home run for my department as the user got to implement many small projects that would otherwise not have been approved and addressed in the normal Cap Ex budget process.

On the other side of the spectrum, many companies will at some point have large one-time projects such as an ERP (Enterprise Resource Planning) system, which are usually high cost, multi-year projects. They find themselves making a capital expenditure for these projects that would easily consume most, if not all of a department’s normal Cap Ex budget.  In these “one-off” situations the funding decision is usually taken outside of the normal departmental budget.

A snapshot of some capital budget line items and a possible format to use is as follows:

Item	Amount	Category	Lease vs. Buy
New servers	$5,000	Infrastructure change	Lease
New servers	$15,000	Financial Systems Project	Lease
New PCs	$50,000	Existing growth	Lease
Sales Reporting System	$20,000	New Projects	Buy