58 I AFP Exchange September 2015

Corporate Finance

The keys to eff ective capital expenditure management Ankur Bhandari

PerspectiveCapex

KEY INSIGHTS:• Corporate treasury should expand its traditional focus from liability management to capital

deployment. It should shape the capital deployment strategy by better articulating the upsides (and risks) in investment ideas by quantifying the ‘optionality’ on an investment.

• Growth and maintenance capex demand a diff erent kind of focus: increased effi ciency for maintenance capex and eff ectiveness for growth capex.

• Implementation of benchmarking, post completion audits, capex-asset management integration and appropriate incentives (Like ROI / EVA) help drive change and organizational buy-in.

www.AFPonline.org AFP Exchange I 59

Traditionally, corporate treasury has focused on capital markets, cash management

and aspects of risk management. Today, treasurers are increasingly expanding their

focus to include capital deployment—which is a logical extension of their capital

procurement role. This article addresses questions that often arise from treasury and fi nance

professionals responsible for managing capital expenditure groups. It aims to address strategic

and process challenges that I have seen in my many years as a fi nance and treasury executive.

Decision making mindset First, treasury and fi nance executives must

approach capex with the appropriate mindset. Capital is scarce. But instead of perceiving capital as scarce with no cost, capital should be seen as abundant but with a cost. All too often, people limit capex spend in the hope that a budget/scarce capex dollars would lead to effi cient utilization. Often a mismanaged capex process can stifl e growth (since the budget number becomes sacrosanct) since the people with accretive investment opportunities may not have had budgets approved while others may indulge in a binge at year-end to ‘exhaust budget’.

This can be addressed by clearly communicating two things to the fi eld: all capex is not created equal and, as such, should be treated differently. Capex is broadly one of three types—maintenance, compliance and growth.

• For maintenance capex, the net present value (NPV) analysis usually comes out to be positive since the proof of concept has already been established and benefi ts far exceed the costs. Therefore, the focus should be on effi ciency— “keeping the lights on,” reuse/refurbishment of old equipment, etc. As such an assessment of the effectiveness of the asset management process is a must—Are assets accounted for? Is their effi ciency of use tracked/

managed? Is there a process for redeployment? If implemented correctly for a few years, the maintenance capex can become predictable, though carrying out a periodic ‘zero-based budgeting’ occasionally is an idea worth considering.

• On the other hand, the focus on analysis for growth capex should be to assess the NPV and create an environment where many such ideas are generated by the fi eld. This includes not just calculating the NPV in a static manner but also quantifying the upside potential for a proposed transaction. One way of accomplishing this is to use Monte Carlo simulation on the business drivers to determine the range of dispersion of the fi nal payoff. This also helps businesses more closely assess their assumptions. As a treasurer, it is a good idea to communicate to the business that they need to come with accretive ideas and that we will fi nd ways to fund these. It also helps tremendously to educate business leaders on the what and why of cost of capital

• Compliance capex is unavoidable, however, it can present opportunities for additional build that might have a legitimate business payoff. At the margin the cost-benefi t might be justifi ed that otherwise may not have. These should be evaluated.

60 I AFP Exchange September 2015

Corporate Finance

Components of an effective capex management process

Planning:Capex budgeting should be done by

business unit/function under the three heads (maintenance, compliance and growth) for ease of analysis. It is important to keep fine-tuning the real maintenance needs since these are often overstated. While compliance is a necessity, it might be accomplished by cheaper means than large implementations and these should be considered. Growth budgets can be evaluated by stack ranking, NPV, risk analysis, etc.

Reuse:The capex group and the asset management

group should be joined at the hip, especially to ensure that cost-benefit of asset transfers and reuse is considered before additional spend is authorized. This is facilitated by asset management systems/systems by which users are aware of surplus assets across the organization. This is especially important in geographically dispersed companies.

Scrutiny/capital approval committee: Some capex groups believe that a long

challenging approval process will breed discipline. For growth capex, this can send the wrong message and genuine maintenance requests suffer. Capex decisions should be taken expeditiously though with necessary rigor. These seemingly contradictory goals can be bridged in two ways—delegating authority to the field for smaller decisions (followed up by post-hoc audits), creation of standard evaluation templates for routine requests/capital return thresholds, etc. For larger or riskier requests, a capital approval committee comprising an inter-disciplinary team from operations, sales and finance is a great idea. Apart from approving business requests for capital, the committee should also monitor capex spend and strategy.

Workflow system: A workflow system should be implemented

to facilitate the approval process, preserve supporting documentation, and act as a source of input to the asset management group and for the payables process. This group also should be responsible for associated cash forecasting.

Post completion audit: A post-completion audit for individual

requests should be conducted. This audit ensures that efficiencies, headcount reduction and revenue increases forecasted before the capex approval were actually realized, and that exceptions are highlighted. Perpetual defaulters should be escalated to business heads.

Benchmarking: Benchmarking with competitors where possible

and certainly within the company (say between different regions) to identify areas of improvement is a great idea. Possible analytics include capex/revenue, capex/EBITDA, capex/FTE as well as by business segment and/or region.

Forecasting: A rolling forecast alerts the capex groups to

business changes and also helps in cash forecasting, constant benchmarking and forecasting can help the organization identify /replicate best practices quicker across the organization.

Incentive systems: Finally, incorporating additional measures

like enterprise value-added, ROI, sales or EBITDA growth into the incentive system can help drive down economically rational decision-making across the organization. These will induce business units to ensure adequate return on capital expenditures. Internal ‘asset-exchanges’ that provide visibility to and reward reuse of underused assets also go a long way in helping implement these. Implementation for these can start at the top of the house and gradually percolate down as the organization becomes more mature in understanding these financial concepts.

Ankur Bhandari is vice president, treasurer for Omnicare, Inc.