A capital project is something that intends to create an asset for a company. In other words, it’s a project that has the potential for creating future cash flows for the company. This can be in the form of gains from selling assets or some kind of income-generating business, or it could be in the form of an improvement to current assets with higher expected future cash flows like an increase in production capacity, or lower costs.
The definition of a capital project according to Fintalent’s capital projects consultants is not fixed, however. In many situations the line between capital investment and operating expense may be blurred, especially for small companies. It’s debatable whether certain expenses should be considered capital projects or operating expenses because they do not necessarily make the company more liquid (i.e., their spending capacity). For example, if a company builds an addition onto its headquarters using borrowed money, it is clearly a capital expenditure. If it builds an addition using cash from operations, it is less clear whether this should be considered a capital expenditure or an operating expense.
Capital projects are essential to the success of any firm. Capital projects usually entail construction or renovation and involve significant investment. The process of planning and executing capital projects is similar in nature to a top-down approach, where the project manager is appointed from within the company, which ensures that all activities are focused on completing the project successfully.
A capital project can vary greatly in terms of its scope with some requiring only paper work and some requiring hundreds or thousands of hours worth of work by employees and contractors. All require careful planning though, both from a financial perspective as well as an organizational perspective.
The following questions can be used to determine the need for capital projects:
- What is the age of your business? If you’re young and growing, then you know that cash flow demands must be met. You might start with some little things like buying out coffee breaks or giving employees your parking spot at lunch. Little things add up over time and are actually quite inexpensive to do. A Capital Project(CP) requires that your company has enough funds available for when it is completed so as not to put them in jeopardy should something bad happen. Having enough funds for when the project is completed is a lot different than having enough funds for when you start the project. Now, you’re carrying cash out of the business as you complete it instead of bringing money into it.
- Do you know how to evaluate your options? If you’re evaluating a Capital Project and haven’t decided which option to go with, chances are that none of them are great ones. You may have options but they aren’t viable because one or more characteristics are missing. It’s important not to be the guy who says “I don’t care where we go to dinner tonight, as long as it’s not Mexican”.
- Are you able to take on debt? Sometimes it is possible to get a better interest rate and that can help your bottom line. If you don’t have sufficient cash flow, you may have trouble getting the best terms, but if you need to go into debt and other options really aren’t feasible, then it may be worth exploring loan options.
- Do you have a good reputation with contractors? You can get better pricing from your vendors by having a good relationship with them. One way to get that is by paying them promptly and treating them well when they are in your office. Often times, Capital Projects are not just about the price of materials but also about the quality of work being done.
- Have you performed any Capital Projects recently? A good expert can be worth his weight in gold when it comes to determining a good Capital Project. You can also get help with marketing, cost estimation and planning.
- What is the current risk level of your business? You might have been getting by for years with cash on hand but once you make a CP, that could change quickly. You might think that bringing on a new employee is risky but doing so on a project also risks losing that employee should something go wrong during the project. The same can be said regarding hiring contractors or vendors for specific portions of the project as well.
- Do you have problems with retention? Retention is an issue for most companies. If you’re doing a Capital Project that will employ people on a temporary basis, you may find that it’s more difficult than usual to find or keep good workers.
- Are you currently under construction on facility or equipment? When you make a CP, this usually means that your company is going to be undertaking construction or renovation. It’s important to keep track of what projects are already in the works so that they are coordinated as best as possible. You don’t want someone working on your building while someone else is doing their project, only to have neither one end up looking like they should.
- How important is your reputation? Your reputation could mean everything when it comes to doing Capital Projects. If you’re a non-profit, it might not matter as much since people associate with you for different reasons. However, if you have a business where your employees are valuable because of their knowledge and attitude, then having their environment be satisfactory to them is important.
- Do you have several projects going on at one time? Sometimes it’s better to keep things separated, so that the work at the end of one project is seamless into the work for another. By separating them out, only certain portions of each project are finished when they should be instead of completed all at once and then moved into the next stage.
- Do you have a core team? In many cases, it’s good to have one individual in charge of all things in the middle level. This can make life a lot easier for everybody involved while also making it very clear who is supposed to be doing what. The core team will help coordinate the work and ensure that everyone follows direction properly.
- Is the project going to cost more than you are willing to spend? This is an important factor especially with Capital Projects that extend beyond normal operating expenses. These types of projects can put your company at risk if they don’t come in on budget or are late.
- How long are you committing to? If you know that you’re going to need to use money from one project to complete another, then set aside funds for them now so they don’t get delayed. This can be a good way of securing funds even if you don’t want them right now. However, if your team knows that money is coming in and it’s generally all going into the same project, then they may be more likely to take risks and go over budget.
- How likely are your vendors to help? Depending on your business model, it might make sense for you to approach vendors asap so there isn’t a delay with their products. However, if you’re planning to approach some vendors to get work done on a Capital Project and you haven’t gotten cash back for the work before now, it might not be a good idea to approach them with requests for more work. Some vendors will refuse to help because they don’t want your business.
- How much does it cost? This is important since having an accurate budget is usually one of the first things that you’ll need to do once you decide on your options.
- How much can you afford? This is a definitional question in regards to Capital Plans. If you’re a large company, then you should be able to withstand some small blips in your budget. However, if your business is doing well and your revenue keeps increasing, it may make sense not to run the risk of making sure that every penny has been accounted for from this point on.
Capital projects are important because they can allow companies to generate cash in the future and allow them to grow. A company may need their own cash flow in order to invest in potential upgrades or new plants elsewhere. Companies can also use capital projects as leverage when negotiating with other companies. For example, they can get more money by agreeing to upgrade a plant because they have previously invested in it rather than pretending there is no problem.
Examples of capital projects
(1) Equipment upgrades – replacement of older equipment or adding new ones that are more advanced. For example, a company might replace computer systems and hardware or update their design software to increase efficiency or cut costs. They might also get rid of old machinery and buy more advanced machines that can produce higher-quality products.
(2) Real estate – this can mean the purchase of industrial land, office space, a farm, an apartment building or some other type of real estate. For example, a company’s current plant may be too small to handle increased demand for its products and it has to expand elsewhere in order to meet increasing demand for its products.
(3) Expansion of product lines or services – for example, a design company may want to acquire other companies that will allow it to offer new services. A technology company may want to acquire companies that can provide additional software or hardware in order to provide more products and services. A real-estate developer may want to buy parcels of land in a specific location for later development because the land is undervalued, or a hotel chain might want to buy out an inefficient competitor so they can expand their service offerings.
(4) Acquisitions – these are expenditures on other businesses in order to increase the size and scope of operations, diversify the operation’s base and reduce risk. For example, a retail manager may want to buy out the store next door so they can expand their operations into underserved markets. A company might purchase a smaller competitor in order to acquire any desired technologies or patents, or it might acquire another company for its assets such as land or equipment.
(5) Research and development – this can be done in-house or contracted out to a university or another business, and it includes creating new products, new technology and improvements on old ones. For example, a business may need to hire research specialists in order to design the next generation of hardware. They may also want to buy patents from an existing company.
(6) Marketing – this includes the design and advertising of products or services and the personal selling of these items. A company might hire a team of agents to sell its product lines to local businesses. It may also use advertising to promote its products or services, including other companies’ products and services. An advertising agency may also create commercials that show the benefits of the company’s products. Advertising can be done manually in handbooks, flyers, posters or other media such as radio, television or internet advertisements.
(7) Sales training – this is hiring professional sales representatives who can teach others how to sell their products. A manager might hire a consultant who will teach his sales team how to use the company’s software in order to increase their sales.
(8) Sales force – this is hiring people who will sell products and services to current customers. For example, a company might hire a field sales representative who goes door-to-door in order to solicit new customers (referral marketing). The goals of the field sales representative are to close deals with the customer who becomes a new client, and also to obtain prospective customers.