Budgeting is Imperative to the Capital Expenditure Management Process
The organizational strategy determines the Capital investment level, allocation and priority. Organizations entering a growth phase will allocate a greater proportion of their reserves to long-term Capital investments to underpin and drive that expansion. Conversely, where a business unit is deemed a cash-cow, Capital investment will typically be tightly constrained with a focus on replacement and short-term cost saving measures only.
Required resourcing levels and anticipated operating performance will be forecast based on proposed Capital investment in new buildings, machinery and equipment and vehicles. Increasingly, growth relies also on investments in intangible assets such as software, trademarks and patents. This strategy-aligned proposed Capital investment program is represented by ‘the Budget’.
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The capital budget contains an approved list of 6 capital investments that are categorized by:
- Operating Unit (e.g. Plant, Division, Department)
- Asset Category (e.g. Fixed Tangible, Mobile Tangible and Intangible categories)
- Priority (initial prioritization based on strategic importance)
- Investment Reason (e.g. Compliance, Replacement, Saving or Growth)
- Scale (e.g. order of magnitude classification: major (>$5m), very large (>$1m), large ($>100k), regular (>$10k), minor (<$10k).
- Rough Budget Estimate Overall and spend by period (month, quarter or year)
For most organizations, the Capital budget is prepared annually and factors into the operating plan (eg assuming that we open the 3 news stores budgeted in Q2, I expect my sales and wages bill to increase by x% over last year, and my depreciation and cost of capital charges to increase by y%).
The Capital investment priorities reflected in the budget thus reflect the strategically aligned intent of the organization and needs to be carefully monitored and controlled. Indeed, capital expenditure variances to the approved budget are very carefully monitored by the most senior executive officers and directors. The approved budget and current budget availability status must be effectively communicated to all participants.
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Within SAP environments, the Capital investment budget is represented by an Investment Program (a hierarchical reporting structure) with assigned Investment Program Positions (the individual budget items). These Investment Program Positions (IPP’s) reflect either unique projects (large strategic investment initiatives e.g. Plant x Refurbishment) or investment pools (Spare Part replacements for Plant y).
Recommendations for the configuration of these Investment Programs is the subject for a different blog post on capital expenditure management processes.
The budget is typically filtered and confirmed by the executive committee based on Wishlist proposals. Therefore, whilst the Capital Budget is likely the most important step of the capital expenditure management process to help align Capital spend, the process commences one step earlier: with the Wishlist proposals.
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