The latest Chamber of Commerce & Industry QLD report continued to show low investment in capital expenditure by businesses. Respondents to the survey said they would hold off capital expenditure until they were more certain of a stable future for the economy. The NAB business confidence survey released last week showed a big decline in business confidence and capital expenditure. Phil Ruthven of IBIS World, in a recent article, laments the negative impact this short-term approach has both on the business and the economy. Is it a sound business practice to adjust your capital expenditure plans up and down based on how you see the economy? Or is it better practice to take a long term view?
Spending on capital, whether it be machinery, trucks or property is something you should expect to have for a long time and receive a long term benefit. Such a decision needs to fit with your long term plans, rather than be a decision because a good opportunity has come along or a need has arisen.
Capital expenditure is generally for the following reasons:
• Replacement of a worn out asset
• Reducing labour costs or other costs
• Increasing productive capacity and hence sales
• Reducing risk
• Investment purposes in relation to property
Capital expenditure will generally increase your debt levels. It will also suck your cash flow if it is not a wise investment. Before committing to the purchase, determine the return on investment you will get. What additional income or cost reduction will you get from this investment? You want this to be an amount that is well in excess of the loan repayments you are making.
Due to the financial commitment businesses cannot undertake all the capital expenditure they would like. There is a need to prioritise what is the most important. What will make the biggest positive impact on your business? The best answer to this question comes when you consider where you want the business to be in three to five years’ time. What capital expenditure will be most important to get the business to that point? From this, a priority and timing list can be developed. Planning enables good prioritising and gaining the best return from your investment dollars.
A good annual budget should incorporate your capital expenditure needs. The budget also looks at addressing your debt levels. Perhaps part of the strategy is reducing debt levels to give you more capacity for future capital acquisition.
Once you have made an investment in capital expenditure it is important to monitor that you actually achieve the expected return on investment on it. If not then it may mean the plans around the capital expenditure have not been fully implemented.
Wise use of capital investments can make a big difference to the competitive advantage of your business and its long term growth and profitability. This requires planning.
Peter Ambrosiussen is the principal of Ambrosiussen Accountants & Advisors www.ambrosiussen.com.au
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Published by Toowoomba Chronicle www.thechronicle.com.au on Saturday 23 November 2013