Do Your Homework When Trying to Justify Capital Expenditures

Oct. 1, 2004
Have you ever had a must do project fail to get funding even though you knew it was a winner? The problem with funding requests is many people often fail to make a good case in terms of the financial, managerial, and cultural issues involved. Making a good pitch requires time and research. Although these efforts won't guarantee your project's approval, they'll considerably improve your odds. Your

Have you ever had a “must do” project fail to get funding even though you knew it was a winner? The problem with funding requests is many people often fail to make a good case in terms of the financial, managerial, and cultural issues involved. Making a good pitch requires time and research. Although these efforts won't guarantee your project's approval, they'll considerably improve your odds.

Your goal. What are you really trying to accomplish by purchasing this capital equipment? What's the ultimate benefit? For example, if your goal is to know how much current you're drawing per phase on a particular service entrance, that fancy power monitor is overkill. However, such a goal is too narrow. If you adjust the scope of your goal to the reduction of problems from power anomalies, then that monitor takes on a whole new significance and becomes the answer to many problems. The benefit you seek requires exactly the features a power monitor provides. Go after the right goal, and make the rest of your request fall in line behind it.

Determine what it takes to meet your goal. Think of this as the block diagram level. Suppose you know a power monitor is key to your success. What else do you need? If your project involves the installation of programmable logic controllers, factor in the skill level and training requirements of your maintenance staff, as well as installation and grounding considerations for the hardware.

Your company's business needs. Determine if this project fits with your company's long-term goals. It makes no sense to install a new Cat. 5 network in a building your company plans to vacate in six months. Ask your managers what the company plans to do with existing assets before delving too deeply into a project.

Determine exactly what this project's benefits are in terms of the big picture. If your project will increase line speed by 25%, will that result in an overall increase in product out the door? The answer will be “yes” only if that line is a production bottleneck. If not, then increasing its output means you're only going to make the finished product sit idle longer.

Resolve all resource questions — not just the obvious ones. Look at lifetime costs, training needs, and availability of parts and supplies. Look at maintenance. Consider floor and wall space. Will you need to relocate other equipment? Can your floor support the new equipment? At what cost? Envision the location. Are overhead pipes and cables safe when you need lift truck access? Will you need to add lighting, security, or emergency egress? What about added load on air conditioning and other infrastructure?

Determine if the implementation is sustainable. If the project's long-term success depends on the force of your personality or on the specialized knowledge of a few people, change its design. The project isn't likely to be sustainable if its success requires any unusual resource, including overtime, shutdowns, single-source supplies, and proprietary third-party products. If you can't develop a plan for making it sustainable, you lose major points in the approval process.

Your project options. If your capital request shows you investigated several options, you'll earn points in the approval process, but a simple list isn't sufficient; include a strengths, weaknesses, opportunities, and threats (SWOT) analysis as an attachment to your request. Follow that with a cost-benefit analysis (Sidebar above). Selecting the best option can be a matter of judgment, as you may have equally viable options.

Performance assumptions. Assumptions may form the basis for your calculations, but base them on solid information, not guesses. If you can't get solid information, say so — and show your reasoning for your assumptions. Suppose your request claims the new control system will require 25 maintenance hours per year. If you have no manufacturer information for this assumption, but instead got it at an IEEE meeting from a friend whose similar control system requires that much maintenance, you can still refer to him in your request. Just remember to provide contact information. Question the validity and accuracy of every number you use. Ask yourself, What's the proof for this? Then provide it in a separate section of the request. If you don't have concrete information, assign confidence factors to “gray area” information. If you're unsure, say why.

The accountant. Your accountant can be your best friend when you want to fund a project. Make an appointment early in the process. Ask him to outline the best format to use in presenting your proposal — a standard format may exist. Ask what words and phrases raise red flags. Ask to see a copy of a request that was previously approved. Finally, request a copy of a request that bombed.

Your request. Consider the “feel” of your request. Omit statements that risk insulting the reader. Eliminate judgment statements, such as “this will be the best thing the company has ever done.” Justify all assumptions. Unsupported assumptions that make perfect sense to you may alienate someone else. Showing why you assumed an annual maintenance cost of $3,500 allows the reader to trust you — or find something you missed. Prepare a half-page executive summary — it also allows an executive to review your request at a glance. This can score you major points.

The big picture. Diligence is the most important factor when preparing your request. Take a methodical approach. Checklists keep things from falling through the cracks. Back all claims and assumptions with hard data or other substantiation. Present your facts so they're unquestionable. The intent of your request is to sell the benefits that are important to the gatekeepers — not to reveal the technical aspects that fascinate you. If you focus on appealing to those who can say yes, that's what you're likely to hear.

Lamendola is an independent technical consultant in Merriam, Kan.




Sidebar: Financial Measurements

Cost/benefit analysis. A cost/benefit ratio is a simple calculation. First, total the costs. Then total the benefits. Finally, divide costs by benefits. The higher the number, the better. List “unmeasurables,” such as safety, separately. Don't guess their value.

IRR/MIRR. Rates of return are expressed as percentages. IRR and MIRR are “internal rate of return” and “modified IRR.” The formulas for these are so complex, businesses simply didn't do the calculations before electronic means became available. Managers like rates of return, while financial types think in terms of cash flow, which a rate of return doesn't reflect. The formula for IRR fails under some conditions. Always include IRR or MIRR in the executive summary, because executives expect to see a rate of return.

Payback. This is a measure of how soon your project will earn back the original investment. If your $900 project will save you $90 a month, then its payback is 10 months. Prior to the advent of IRR-enabled spreadsheets, payback was an important part of every capital request. Today, payback is largely irrelevant to project approval — but it still is a good initial screening tool. Don't use it in your final request unless asked to.

NPV. Net Present Value (NPV) addresses the time value of money. It's equal to the present value of future cash flows (discounted at the cost of borrowing the money to generate the cash today). This extremely complex calculation allows financial types to control cash flows with precision that's simply not possible without NPV. And unlike the rate of return methods, NPV allows you to compare projects of any type in any combination. Most businesses base capital allocations on NPV.

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