Today I want to talk about capital expenditures, or CapEx.
We talked in a previous blog post about emotional buying and how to avoid it, but the fact remains that you have to lay out for new equipment sometimes. Some CapEx is necessary, but it requires planning and strategy.
The reason it’s so important to talk about this right now is that return on investment (ROI) on CapEx has changed in recent years. It’s (usually) less than it used to be.
Because of this, I’m advising my clients to spend less on capital purchases, to outsource more equipment, and to be very particular about what they choose to own and maintain. By reducing overspending on CapEx, you reduce pressure for empty revenue because of equipment sitting around idle that you know you need a return on for many, many years.
On the other hand, if you underspend on CapEx, you risk your image and the quality of your output. So keeping your technology up to date is important, especially if it’s foundational equipment that represents your business.
But, if you misspend, you’ll lose flexibility and margin.
How do you find balance? Develop a CapEx budget.
Why You Need to Develop a CapEx Budget
The biggest advantage of a CapEx budget is that it helps reduce reactive spending. It helps you become more thoughtful about CapEx spending, which pays off for years and years to come.
A good CapEx budget helps you avoid some of the biggest spending mistakes we often make in this industry:
- Underestimating the true cost of things
- Prioritizing cool toys over practical updates
- “Squeaky wheel syndrome,” where we win a big project and want to have control of all the widgets on it
Having a CapEx budget helps you slow down and become more thoughtful about those decisions, so you don’t waste money on things you don’t really need.
The underlying philosophy behind all of this is that CapEx is an investment. And you need to have a return on an investment. It’s no different from investing in your retirement fund. You’re investing money in one place, hoping it will be worth more later. But there could be better ways to use that money to create more return in the future.
With that in mind, we need to be very thoughtful about ROI. We need a CapEx strategy to help prioritize expenditures and plan better and more transparently.
The template below will help.
The CapEx Template
You need a CapEx budget, but where does it come from? Honestly, that’s a much bigger question than I can cover in this one post. To wrap our heads around it, we’ll walk through my CapEx template using an example from an $8 million company that has allocated 8.2% of the prior year’s revenue for the current year’s CapEx.
The template has five tabs: Summary, Budgets, Requests, Bills of Materials (BOM), and Price Sheet. (If you’re a visual learner, you can watch my video walk-through for greater detail.)
The summary tab provides updates on what’s happening so you can keep your eye on the big picture. For our imaginary company, we have $700,000 allocated for the CapEx AND expense budget.
CapEx, of course, includes items that are going to depreciate over time. These are generally the bigger items in your inventory, or systems that have bigger items in them.
Expenses are the smaller items that you usually charge to the current period. These are things like a $98 microphone. If it breaks, you’re probably just going to throw it away and buy another one. You might barcode it, track it, and allocate it, but you don’t need to capitalize it — unlike a projector that costs $50,000. It’s easy and sometimes useful to reclassify an item out of the CapEx budget and into the expense budget.
It can be easy — and tempting — to reclassify larger items as expenses so you can get out from under that CapEx budget. That’s why you need to define both budgets clearly, so there’s no room for the team to play loose with the money. You need a finite budget. Then, depending on their tax strategy, owners may reclassify some of this with their CPAs at the end of the year, but that’s not our concern at this point in the game.
Once our imaginary business has budget allocated for CapEx ($500,000) and expenses ($200,000), they’re not going to make it all available at once.
I recommend withholding about half the CapEx budget until mid-year and focusing on the highest-priority items first. Why? Well, what if it turns out you don’t have a great year? With this approach, you make sure you’re really thoughtful about how you use that money.
Similarly, you can release expense budget in two batches as well. However, I typically allot more to the first half ($125,000 in this example). Extra cable, spare black boxes, cases, etc. — all of these are great expenses to front load because they’ll make operations more efficient the rest of the year.
Now that we have our CapEx and expense budgets, let’s break them out by department.
In our example template, there are 10 departments, plus a bonus budget line. It’s important to break these out and think their budgets through because, very often, one department or the other gets neglected.
One department might say, “Oh, that’s rigging. Let lightning take care of it.” Don’t let that happen. Aim for transparency so things don’t get overlooked. Lighting might need to spend more money on moving lights rather than rigging.
Departmental budgets help you not miss opportunities to spend where it counts.
Everything needs to go in here — IT, office equipment, warehouse equipment. If you want a new pallet jack, or new shelving, allocate it under its appropriate department budget.
Each department receives a certain amount allocated for both CapEx (the big purchases) and expenses (the little widgets).
The last line in the budget breakout is a strategic holdback that isn’t tied to any department — because things change. This allows management to 1) react strategically to an opportunity, and 2) allocate money to a department that needs it when more needs than originally budgeted for crop up.
It’s basically a slush fund. It’s having a plan for change.
After you’ve exhausted the CapEx and expense money already allocated to each department, you can talk about where to best put your strategic holdback to work.
The requests tab gives you transparency in all the things that all departments think they would like to have. And it’s going to be very, very full.
Seeing all requests in one place allows you to prioritize them more effectively. At a glance, you can see:
- Which department a request comes from
- Type — CapEx or expense
- Product name
- Description of the item
- Whether it needs a bill of materials (BOM)
- How many units requested
- Price per unit
- Additional costs (shipping, etc.)
- Total cost
The template will also have a column for notes and whether the request is under consideration, approved, or denied. Sometimes, a request may need to be returned to the sender because it’s missing components.
For example, maybe a department requests some speakers and amps, but forgets to add a BOM including the racks and cases that go with them. Their request gets sent back to the department to fill in the missing pieces.
Bills of Materials
The BOM tab shows detailed breakdowns of all the components in each request item. Systems, especially, are going to have multiple parts. If you only budget for the main piece of a system, your CapEx can end up being twice what you planned.
If you order a four-channel wireless mic system, for example, the BOM should list its base station, transmitters, lavaliers, rack space, antennae system, etc. It all needs to be broken down and priced.
Once the department requesting those speakers goes back and modifies their BOM, they can resubmit and hopefully get approval.
The BOM also sets standards by designing a repeatable order.
Where do all the prices you track on the BOM and requests tab come from?
To keep you from having to look up prices over and over again, there’s a master price sheet. Any time you look up a new price for a piece of equipment, you record it here because you’re going to need it again.
Will the prices change? Sure, a little. But the price sheet will give you a good starting point from a budgeting standpoint.
In practice, you’ll find that you actually buy at a better price than you were quoted because you have better negotiating power when placing a large purchase order.
And when the actual cost comes in under the estimated cost of a purchase, that department ends up with more budget left to spend. That’s a win for everyone.
Take the Template for a Spin
Now it’s your turn. Consider how much to allocate for your company’s CapEx and expense budgets, and start breaking in this template for yourself.
If you haven’t yet, take a look at my walk-through video for a more hands-on look at using the template. You’ll be able to see the nitty-gritty details all laid out, as well as some further examples.
The bottom line in all this is that having a strategic CapEx plan pays off. Avoid emotional investments that don’t bring a worthwhile return. Take control of your expenses with a carefully considered CapEx budget.
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