Financial Planning & Analysis

How to Create Better CAPEX Business Memos

At some point in time, all businesses will need to invest in new equipment, undertake a large project or take on several strategic initiatives to improve efficiency or generate additional revenues. Capital expenditures (CAPEX) are an inevitable part of growing and maintaining a competitive business.

Over the years, I have been involved in various CAPEX projects, both as a budget manager (or customer) requesting money for a new Business Intelligence tool and as the Finance Business Partner, supporting various divisions and teams requesting significant money for very large equipment purchases in excess of $50M. Through this experience, I have picked up some best practices around the process of requesting funds for CAPEX, the approval process, how to integrate the new equipment or initiative into a company’s current process and the subsequent reporting needed to maintain effective communications with the relevant project sponsors and the management team as a whole.

I’ve also developed an approach to a capital expenditure report that I’ve found to be particularly effective in communicating with management.

Let’s start by building a picture of what a typical CAPEX project used to look like.

Early on in my career, the typical CAPEX process resembled something like this:

  1. The manufacturing, operational or other specific group that identified the need would submit a request to the Finance team in the form of an e-mail or possibly a conversation detailing how much they expected to spend and the reason for the request (e.g., aging or obsolete equipment that needed to be repaired constantly).
  2. The Finance team would then put the request into a formal document, such as a Business Case, presenting this information for the CFO, CEO and Board (i.e., the budget approval committee) including the price, expected timing of the spend and the business rationale for requesting the funds.
  3. The budget approval committee would review the formalized Business Case proposal and make a decision, which would then be communicated back to the project sponsor of the department in question.
  4. The project manager then could start spending money.

This used to be the typical process and is likely similar across many organizations across the country.

Finance needs to be involved at the outset (and ideally continuously).

As mentioned earlier, the need for CAPEX typically originates at a functional or team level. To use manufacturing as an example (though it could be any function in the company), these are the folks that are a key part of the day-to-day production process. In an ideal world, they are already working closely with the Finance partner in managing their operating budget and identifying process improvements to integrate into the process on a continuous basis. If this partnership is functioning effectively, then discussions around potential capital investments are happening at this level between both teams.

The benefits of this cannot be understated. As Finance is working in the trenches with the business, very close to the underlying processes that need to be transformed or invested in, key questions become part of the conversation that leads to a CAPEX proposal.

  • If purchasing new equipment is the answer, does this improve the rate of production?
  • If so, can we approximate by how much?
  • Can the existing equipment be repaired to improve its longevity – and if so, is this financially feasible over the longer term?
  • If equipment is being replaced, can we eliminate some of our fixed costs (like maintenance personnel or spare part inventory)?
  • Will down time be reduced?

These questions and the conversations they start will help add a higher level of scrutiny that executives will appreciate. They also help prepare the team to articulate their needs in a more clear and logical manner.

Seek bids from multiple vendors.

CAPEX projects by nature involve significant costs as well as time commitment for the company in question. Part of the procurement process should involve seeking RFPs (requests for proposals) or quotes from three separate vendors at a minimum if this is possible. (In some cases, there are a limited number of manufactures for certain pieces of specialized components/equipment.)

Seeking multiple bids will not only ensure a robust process where a company can become educated about the investment required, it also raises further questions that may not have been identified internally by the company – particularly when the price quotes are significantly beyond the expectation of the company seeking the proposals. Vendors can provide valuable information about the key bottlenecks to avoid and advice on best practices given their unique position providing services to competitors.

Package the findings in a concise capital expenditure report.

The most critical aspect of the CAPEX process is the formal presentation to the executive team. In many instances, this may not even occur in person. Sometimes the executive of the function or division seeking the funding will get an opportunity to present their request formally to the rest of the executive team – and possibly the board.

Given that you may not have an opportunity to present your request in person, it’s critical to present all the salient features of the proposal in a concise capital expenditure report document. Emphasis should be on keeping it brief (ideally within 2 pages), as executives are invariably quite busy, without compromising on comprehensiveness in answering the main lines of inquiry. A format that has proven to be effective for me consistently is the following structure:

1. To/From/Subject

The document should be addressed to specific Executives and have a subject line. The approval committee are often reviewing multiple requests, so having a document for each helps provide specific insight and organize meetings.

2. Project Summary

Write a brief explanation of the background of the project, expected cost and benefits and potential risks. This should be no more than two paragraphs long.

3. Financial Summary

Offer a summary of the cost and accompanying ROI for the project with the main assumptions used. I have found adding a payback calculation is also very helpful for executives.

4. Transition Period Risk Management

What are the risks involved? How will the company manage these risks to reduce and/or eliminate them?

5. Strategic Opportunities

What are the main benefits of spending this money? Will the company reduce production times? Will there be savings in labor or other areas? Will specific KPIs improve?

6. Measurement/Reporting

Outline the expectations for when the Finance team will be conducting a post-mortem once the project has been completed. For many CAPEX initiatives, there are ongoing assumptions about savings in perpetuity (i.e., versus an older, relatively inefficient process). Describe the expectations for how long these savings are expected to accrue (in collaboration with the respective team or department) and how often will reporting need to be developed to review the actual savings versus those initially presented in the proposal. The expectation should be for the Finance team to prepare these reports with input and verification from the functions in question. (This is another reason why it’s critical for Finance to be involved from the outset – to document and be a central repository for this process as it evolves over time.) This is critical when tracking performance many months or years after the project has been delivered and the funds have been spent. (There’s more on this in the next section.)

7. Next Steps

What is specifically required from the approval committee and by when? It is also worth highlighting any lead times from vendors since they usually have an impact on the company – particularly when approvals take inordinately long to be processed.

Consider these metrics within your capital expenditure report.

Net Present Value (NPV)

The net present value (NPV) is also referred to as the discounted cash flow approach. It is generally the most widely used and simplest method for capital budgeting, and it’s also considered a measure to gauge the profitability or attractiveness of a capital investment. With this method, the company’s discount rate (or minimum required rate of return) must be a known input to derive the project’s NPV. To compute the NPV, all cash flows are discounted to their present value (hence the term net present value) and then aggregated.

A positive NPV indicates a project’s cash flow will exceed its cost. Conversely, a negative NPV indicates a loss of income/value, and such a project should not be undertaken (i.e., it is earning below the required rate of return for the company).

Given this logic, the higher the NPV, the more attractive a project – so the NPV method can be used to rank projects which can be very helpful when the company has limited capital to deploy and needs to optimize its investment decision-making.

Internal Rate of Return (IRR)

The internal rate of return (IRR) is another common financial measure for how attractive a capital investment project is. As a measure, it is considered one of the most practical approaches because it does not require having a hurdle rate (sometimes referred to as the company’s cost of capital) up front unlike the NPV approach. This method also discounts the project’s cash flows; however, since no discount rate is needed, the IRR provides the discount rate as an output.

Specifically, the IRR method computes the rate at which the NPV is zero. Said differently, the IRR calculates the maximum cost of capital that a project can bear for a capital project to break even.

There are a few considerations worth mentioning when using the IRR method. Generally, the IRR and NPV methods will provide similar if not identical analysis. Although if projects are mutually exclusive or have non-conventional cash flows, the IRR can be misleading. When the results conflict, the NPV is generally the most superior method to follow, although in practice, the IRR is more popular because it provides a percentage figure that can be compared to a hypothetical rate of return more directly rather than a dollar amount.

Communicate progress regularly.

Providing status updates to senior management is critical to ensure transparency and a robust process that senior executives can be confident with. This also provides valuable goodwill for the project sponsors (and Finance) that will be needed when further projects need to be discussed and reviewed for potential additional CAPEX. I have been involved in projects where future larger requests have been approved rapidly because executives are comfortable with the pace and regular updates on the previous projects (via e-mail or in weekly meetings). This helps executives also anticipate and field questions they may get from outside stakeholders, investors and the Board.

These are just some of the key steps that have proven to be very effective in getting capital expenditure projects off the ground seamlessly and over time they can be further refined to address specific processes (not just CAPEX) within the company.

Download our example capital expenditure report for more.

We’ve put together an example capital expenditure report for free download. It features an example CAPEX business case, so you can learn a little more about the process of putting together your own report and get a sense of what an effective memo looks like:

capex report template call to action image

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About the Author

Ebrahim has 17+ years of experience in finance across diverse industries including a global shipping terminal conglomerate, logistics, manufacturing, retail and consumer product companies. His experience spans mid-sized, Fortune 500 and private-equity-owned companies in England and USA. He has established FP&A processes from the ground up, spending most of his time in the trenches working with Operational and Financial Executives to understand performance through a range of analytical tools and by leveraging his deep experience in leading Operational Finance. His experience encompasses strategic planning, budgeting, forecasting, management and Board commentaries/reporting, financial/operational modeling, FP&A, P&L review/management, system design and process re-engineering. He has led the implementation of a company-wide BI system for an international terminal operator. He holds an MBA in Supply Chain from CSU Long Beach, an MS in Finance from Henley Business School. He is a Chartered Accountant (UK) and Certified Management Accountant.

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