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Justifying CAPEX decisions

Justifying the CAPEX decision

By James Nicholson-Smith, The FD Centre

Many businesses have suffered greatly during 2009 , and their balance sheets are showing it. Business owners in the manufacturing sector can either wait for a meal ticket to arrive on a telegraphed silver platter OR they can get on with re-energising their business with new products, new production lines and a new belief in the future.

The reality is that telegraphed silver platters do not come along very frequently and you have to be looking in the right place to see one. Therefore, the choice most entrepreneurs have made is to look for ways to re-energise their businesses with the limited resources they have at their disposal. For many manufacturing companies, this invariably means investments, in new capital projects.

There are 4 stages to justifying capital expenditure:-

Is this project a strategic fit for the business?
This stage can only be carried out if the business’s management team have a clear business plan which explains what the business’s position is within its market sector and what it’s unique selling points are. For example a business that specialises valve manufacture for the sub-sea pipeline sector could easily justify a new production line to produce valves for overland pipeline valves. However setting up a new facility to produce the tubes for pipelines may be a very poor strategic fit because it’s a different supply chain to the customer or a different area of expertise.

Is this going to increase sales throughput?
Many manufacturing businesses invest in equipment to “increase capacity”. However, many businesses do not look close enough at the entire process through a business to understand where the core constraints are. If the bottleneck is somewhere else in the factory, the benefits of investment will not be enjoyed because the limiting factor is still the bottleneck. It is vital that manufacturers understand all of the processes in their factory and work the constraint areas as hard as possible before considering further investments elsewhere. These are the limiting factors to growth and are often ignored.

Similarly, many manufacturers justify capital projects as increasing capability. This is often justified without looking at the pipeline of opportunities and sales and marketing channels for securing orders for this new capability. Where the increased sales will not come from additional orders from existing customers, the business will have a job to penetrate a new customer base. This will have to be incorporated into the cost of the investment and greatly increases the risk of failure.

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