How to assess the quality of the capital expenditure of a company?

Capital expenditure (CAPEX) is the expenses incurred to reap future benefits by a Company. It’s the money used by the Company to buy, upgrade (restore or enhance), and manage tangible assets (physical properties, buildings, equipment) and intangible assets (patent or license), etc. These cash spending (non-recurring) expenses are for long-term assets and also for acquiring a new business. The quantum of CAPEX is sector-dependent and its need is based on the objectives behind it — maintenance or growth.

Review R&D budget in historical and competitive context

The quality of a Company’s capital expenditure can be assessed by reviewing its capital expenditure budget (CEB). The CEB involves estimates for purchasing capital assets in the budget period (land, building, plant, equipment, etc.). CAPEX needs considerable outlay of money. Check the Company’s CEB to generate its historical and competitive view of its revenue allocations meant to cover the CAPEX cost. 

Review management historical R&D expectations and compare to actual

CAPEX requires considerable financial outlay. The Company needs to undertake a budgeting exercise to assess the revenue generation potential for the capex proposed. Review historical R&D expectations of the management to compare with the actual CEB performance. Check the extent to which management R&D expectations and actual performance impacted the Company’s operational efficiency, revenue, and assets. Ascertain how R&D expectations and actual performance impacted the Company’s long-term investments.

Review product roadmap

Product roadmaps provide the direction and timeline coupled with the necessary tools for tracking product development. Product roadmap (PR) sets the product vision and also communicates it to all the stakeholders. CAPEX activities should follow the strategic understanding offered by PR (with proximity and some certainty) to tailor timely product offering. Ensure the Company uses PRs to efficiently navigate through market dynamics, technological evolution and ever-changing user expectations. Check what PR theme the Company has adopted: feature-dependent, outcome or goal-driven. Ascertain if or not the Company has enough resources to support a fitting PR approach and tailor it per its own requirements. In the Company’s PR, review the product vision, goals, and outputs (also outcomes). Ensure that the Company’s CAPEX is in-line with its technology and industry roadmaps.

Review analyst, customer and consultant outlook for product roadmaps

Review the strategic direction given by the analyst and consultant. Check how their outlooks are assisting the Company in serving its vital markets and also in acquiring new ones. Check their product strategy execution plan and if or not the internal stakeholders’ outlook is in alignment with the customer outlook. Review their communication strategy with customers (the external stakeholders). The options and scenarios planning are their outlook dependent upon should also be assessed?

Review components of capital expenditure in the historical and competitive context

Review historical changes in stock replacements and match that with competitor offerings and the competitive/market context. Check the timing and determinants of replacement expenditure, if or not they are in a reasonably identical proportion of capital. Analyze how replacement expenditure substituted expansion expenditure in a historical and competitive context (and changes in them over time). Review stability of the annual rate of investment in the context of expansion and replacement expenditures. Review replacement expenditure in a historic and competitive context to determine relative depreciation charges, current profit and age of capital stock. Review allotment of planned plants and equipment investment and check what quantum of investment is set for expansion, replacement, and modernization. 

Review pricing outlook for component costs

Review pricing outlook to monitor projection accuracy and to constantly assess optimization level across CAPEX components. Budgeting and cash flow statements are crucial documents in this case to prepare annual cash flow statements by setting input parameters and escalators. Consultants contribute in forecasting forward movements in specific cost areas through provision of real escalation rates.

Labour

Outlook for labour costs and other labour market issues pertaining to the business area must be reviewed. Actual escalation rates are linked to the Labour Price Index (LPI) measure of labour cost escalation. Reviewing pricing outlook for both internal business resources and external contract labour would ensure successful delivery of CE projects. The review process starts with scenario modelling, followed by allocating weightage to scenarios based on probability of the scenario eventuating.

Raw Materials

As for commodities, escalation rates are established using the respective material prices or indices. Consumer Price Index (CPI) is applied for plant and equipment, and other non-labour components. A comprehensive review of pricing outlook for all the CAPEX components including summary-level analysis of the capital project would ensure CAPEX transparency, reduce risk of cost misallocations.

Equipment

CAPEX has tangible equipment expenditure as its major element. Equipment and component pricing (cost) needs to be recorded in accordance with its utility and competitor capex activities. Assess the cost vs. ROI of equipment while considering economies behind company decisions to buy, repair, update, or improve a fixed company asset (such as equipment). 

Manage CAPEX efficiently to ease cash flow, boost growth, and enhance the competitive advantage. Ensure that the Company makes the capital investment portfolio a priority to achieve substantial growth and profitability. Unlock the Company’s overall capital investment value by using a defined capital-allocation strategy, facilitating enough cash returns. Always note that cash-generative CAPEX activities should be a priority for the Company.