Navigating the Financial Maze with Capital Budgeting [By Hazel Yew]

“I can’t seem to make sense of the numbers.”

“I don’t know if this investment will pay off.”

“How do I ensure that my management team is making the right decisions when it comes to capital expenditure?”

Do these questions sound familiar?

The struggle with numbers is not uncommon amongst SMEs in Singapore. Coming from an operational and technical background, many SME owners find themselves at a loss when it comes to financial knowledge. They have built their business from a simple start-up to what is now a SME who hires just over a hundred employees. Without the necessary financial knowhow, many of them continue to make capital investment decisions arbitrarily. Without a proper budgeting process, it can be a challenge to evaluate the performance of the company. It is also difficult to predict and control the company’s profit and loss.

 

Budgeting – the unspoken word in most SMEs

A budget should consists of operating budgets as well as capital budget. Operating budgets, as the name suggests, are items that are operational and recurring in nature, such as manufacturing cost, staff salaries and rental. A capital budget, on the other hand, is for activities such as building a new plant, purchasing a property or major equipment and investing in a new venture. It is also known as “investment appraisal”.

 

The Case for Capital Budgeting

The process of capital budgeting is crucial for managing capital expenditure in any business. The nature of capital investments is long-term and therefore should always be evaluated carefully. When done properly, capital budgeting should improve financial visibility for SME owners when it comes to decision-making. At the same time, it allows for accountability and measurability. This is important in allowing the owners to delegate responsibilities downwards for further growth and development.

 

What can you do?

If you are a SME owner, you can start by implementing a simple capital budgeting process. The four basic steps to follow are:

  1.  Establish Objectives and Requirements

Always start by determining what your company’s long term goals and needs are. From there, determine what capital investments are required in line with your objectives.

  1. Assess Current and Past Situation

The next step is to evaluate the current situation of your company. What is your cash flow position? Is the company generating sufficient revenue to support the expenditure? What are the current and past capital investment and how was their performance?

  1. Evaluate Investment

Perform the necessary research and justify any stipulated investment with adequate financial analysis. For example, projecting the rate of return, net present value, return on investment and payback period. Consider the financing method for the purchases as well as the timing of the cash inflows and outflows. Make sure that your cash flow remains healthy.

Some other important questions to ask are: What are the strategic implications the investment can have on your company’s brand and reputation? Are there any tax implications that may arise? Will the decision to accept or reject this investment have an impact on your current business? What are the alternatives if you do not make this investment?

  1. Monitoring

Lastly, monitor your investment. Identify a suitable task owner. Schedule quarterly or half-yearly updates to review the investment returns. Investigate any huge variances that occur unexpectedly.

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