Part II: Systematic Annual Capital Planning

Annual capital planning is a systematic way of planning for capital expenditures (CapEx) around a specific target budget which includes identifying all required CapEx spend that are seeking funding.  Most of our customers begin with a budget that is aligned with the company’s capital availability and cashflow requirements.  The following steps are required to develop a comprehensive capital planning process:

1. Budget Target – Develop a budget target by either analyzing historical spend or working closely with your finance teams to understand availability of capital and how much of it will be allocated to CapEx investments for the planning period. Usually, it’s a combination of looking at historical spend and identifying the big ticket must have strategic investments that will determine the budget.  At the divisional level, the budget targets may be passed down from the corporate level.

2. Committed Investments – Next, start with committed expenses. Most capital plans have about 40-50% multi-year initiatives.  These are initiatives that are already committed and, in most cases, have already started.  For example, if you are building a new data center or manufacturing plant that will take three years, the CapEx spend associated with this investment for years two and three will be carry-forward investments and will be part of the starting point of your new plan.  Some companies have an agile budgeting process and will require justification to continue funding existing initiatives.  This is common in more complex organizations and may apply to investments that exceed a funding threshold. Once you have captured all of your carry-forward investments and understand the financial impact you are ready for the next step.

3. New Investments – Create a list of new investments including estimated capital spend. Since you are in the planning phase these investments can be at the specific project, program or portfolio levels.  Data capture should be standardized to prevent errors and provide the ability to quickly run analysis and reports.  An important part of this process is to create a list of required information.  For example, project/program name, business unit, CapEx spend, timing, business owner, etc. This will allow for easy aggregation and analysis.

4. Prioritization – It is very common to have investment funding requirements that exceed available funding. The demand for capital will almost always exceed the supply of capital.  Developing a prioritization process to identify initiatives with the highest strategic value and lowest risk is very important.  This should not be a politicized process that leads to a lot of pet projects that are not aligned to the overall strategy of the company.  We suggest developing a strategic value scoring methodology that aligns investments to corporate strategies.  We also suggest a risk assessment to identify investments that are very risky.  This can be a high-level process during planning and a more detailed process during the capital appropriation request stage.  Using a scoring methodology, create a prioritization ranking model and select initiatives that are most important to the company.

5. Baseline Plan – To create a baseline plan you will need to add your carry forward investments to your new investments. This provides visibility into the portfolio at an aggregate level and allows for further analysis.  Compare the total spend to the budget target set in Step 1.  In almost every case, the total capital plan will be higher than the budget.  Continue to reprioritize the portfolio until you reach the desired mix of investments that align to the budget targets.  Beyond eliminating investments, you can also adjust timing of investments and defer them into future years.  This final process is usually managed in a stage-gate process.  There are usually three stages or passes of the plan resulting in budget adjustments based on company performance and refinement until a final plan is approved.

Once the plan is complete and business impact is understood it is usually approved by an operating or steering committee.  This committee will ask for quarterly updates (more frequent for smaller companies).  The quarterly updates are captured in part IV of this series.  Also, the plan is revisited at least twice a year and rebalanced as needed.