Introduction to Capital Asset Planning

Before buying an asset in an organization, you must justify the decision to buy the asset and obtain the necessary approvals to invest and release the funds. This series of analysis steps where a cost-benefit analysis is performed to justify the decision to purchase a potential asset is called the capital planning process or simply capital budgeting.

Traditionally, these decisions were based on relatively simple assumptions or historical experience, but as organizations grow, they need more detailed justification for capital expenditures, which simple traditional approaches cannot provide because , with scale, the amount of expenditure that involves substantial exposure to risk increases. For most organizations, this is a strategic and complicated process that involves the participation of interdisciplinary teams and has a high degree of inherent uncertainty.

Capital management planning examines all options for activities and investments in the future, then develops a set of plans that outline what will be done, when and by whom. Decision-making is based on an understanding of CAPEX and OPEX costs and associated risks to optimize asset investments in terms of timing, choice of an asset, or both. In order to do this effectively, the costs and risks associated with an asset, and how these vary over time or with use, must be understood.

In this chapter, we will discuss a wide range of issues involved in the capital budgeting process in any large-scale organization and the generic process typically used to address these concerns.

Capital Planning Challenges

Capital budgeting is a complex activity that involves uncertain projections and a high degree of risk due to reliance on a range of expertise and the need to link long-term projections to financial plans. The following section describes these challenges and some of the ways organizations are addressing them.

  1. Capital projects are distinguished by their significant scale, multi-year timelines and overall complexity, which adds significant uncertainty to their management
  2. In the case of large capital projects spanning several years, there is a high degree of inherent risk leading the best intentioned projects to be derailed.
  3. Link long-term projects to financial plans, financial appraisal and risk assessment
  4. Capital assets involve huge sums of money to invest and organizations face the challenges of integrating multiple areas of expertise to weigh expert technical opinion against finance
  5. With different aspects of capital planning carried out in functional “silos”, changes in one area are not automatically reflected in the other. (for example, technical and engineering costs and assignments are carried out separately from the financial plan and the forecast balance sheet)
  6. This results in a lack of visibility and collaboration that compromises the integrity of plans and introduces unwanted delays into the planning process.
  7. Cumbersome approval procedures as projects require special funding and attract high levels of risk, which in turn requires board-level review and approval
  8. Increased risk due to inaccurate or inadequate asset data and information, as well as uncertainty about asset deterioration rates and future maintenance costs
  9. Because complex assets tend to be multifaceted, they often require a variety of accounting treatments, rigorous record keeping and reporting. Providing the level of detail required to account for these various accounting treatments is one of the biggest challenges in capital planning.
  10. Lack of an appropriate system to support budgeting, planning and forecasting processes

Benefits of capital planning

  1. Enables management and shareholders to better understand the prospects of their companies when investing in fixed assets
  2. The capital planning phase allows everyone involved in the process to evaluate multiple options by introducing visibility and collaboration between the various functions of the organization involved in capital planning, strengthening the integrity of the plans and eliminating unwanted delays in the planning process.
  3. Ensures that the detailed financial plan reflects a realistic anticipated return on investment for the project
  4. Helps by linking financial capital planning with operational capital planning ensuring the financial and operational integrity of proposed expenditures.
  5. Enables technical and financial experts to visualize the effect of their changes on overall operational planning assumptions.
  6. Enable organizations to plan for all phases of an asset’s useful life, from planning and construction to maintenance and decommissioning.
  7. Ensure that appropriate asset data and information to support subsequent asset management decision making, record keeping, accounting and maintenance is captured in the process. Supports common capital planning tasks such as asset categorization, depreciation calculations, financing, and cash flow options over the life of a project and allows users to plan capital expenditures such as maintenance costs, repairs and insurance.
  8. Helps link the budgeting process to the accounting process and budget resources to financial requirements

To mitigate these challenges, specialized functionality is required for capital planning with guided workflow and process support to turn capital planning into an accurate and reliable process flexible enough to adapt to change.