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on September 28, 2020 in Digital Transformation, Capital Planning

What is Capital Planning: A COVID Adjusted Perspective

Capital planning is an integral component of overall corporate planning.  It is particularly important when considering projects and programs representing significant overall investments to add or enhance an organization’s capabilities to generate revenue, save on current expenses, or avoid projected future costs.

The focus of this article is the explanation of capital planning with COVID adjusted information in a detailed and understandable manner and then explaining how the Inpensa Platform handles the typical problems and modeling better than traditional methods that capital planning usually encounters. Capital planning is the identification, optimization, and ongoing management of costs recognized across the useful life of the assets.  Capital expenses contrast with operating expenses, incurred and recognized simultaneously.

Capital Planning During the Pandemic and Beyond

Global dis-location beginning with the pandemic in early 2020 and extending to long-term structural changes in many segments have brought several capital financial planning trends to a sharper point and focus.

Zero-based budgeting focuses on driving decisions based on the necessity and efficiency of a projected expenditure instead of relying on the historical level of spending from prior periods.  This approach has become increasingly attractive as executive teams conclude that the past is no longer a reliable prelude to the future.

For capital planning professionals, this means access to data and context surrounding proposed capital expenditures is more crucial than ever.  Because the capital process proceeds independently from the strategic initiative assessment process, capital planners’ ability to track and assess the characterization and development of business cases associated with proposed capital expenditures is very important.

Finally, capital budgeting must integrate with an ongoing contingency planning process.  It is critical to understand the revenue and profitability impact of deferral or delay of certain capital expenditures and accelerated depreciation for eliminated initiatives.

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Capital Planning Models

Depreciation and amortization represent the two broad categories addressed in capital planning models.

Fixed assets, such as buildings, facilities, and computing equipment, are usually depreciated.  Financial statements recognize fixed asset costs as expenses across the useful life of the item.  Item life varies widely by type.  For example, a data center computing infrastructure’s useful life may be five years, while the rating of a commercial building’s useful life is at twenty years.

Depreciation uses one of two methods:

  • Straight-line, where, after deducting an asset’s salvage or resale value from the purchase price, the remaining amount is recognized evenly across the asset’s useful life. For example, a $120,000 piece of construction equipment with a ten-year useful life and $20,000 salvage value is depreciated at $10,000 each year using the straight-line method.
  • Declining balance, which recognizes the rapid obsolescence of certain assets by accelerating the depreciation schedule in the early years of an asset’s useful life.  For example, $1.2 million of telecommunications switching and routing equipment with a five-year useful life and $200,000 in salvage value may depreciate at 30% annually, as opposed to 20% in the straight-line method.  With the declining balance method, the equipment depreciates at $300,000 in the first year, $210,000 in the second year, and so forth.

Assets that are intangible and have no salvage or resale value, such as a perpetual software license or franchise rights, for example, are capitalized through amortization.  Costs for amortized assets are typically recognized using the straight-line method.

Labor capitalization is possible in certain circumstances.  Eligibility typically corresponds to activities associated with the creation, modification and implementation of a specific associated asset.  Executives should work closely and carefully with the organization’s independent auditors before embarking on a program to capitalize labor.  Auditors will reference Generally Accepted Accounting Principles (GAAP) as guardrails to develop a GAAP-compliant approach to form corporate policy for labor capitalization.

Finally, a capital planning model includes standards around the in-service period, which defines the time between receipt of an asset and its productive use.  In-service periods for each asset type should be consistent.  For example, two months for all computing equipment compared to three months for all telecommunications equipment.

Capital Planning Process

The capital planning process is distinct from the method used to source ideas for new initiatives and advances select ideas for developing comprehensive business cases for analysis, evaluation and, as appropriate, approval as projects scheduled for execution.

Capital planners extract capital expenses from proposed projects and assess these expenses from a profit and loss statement and balance sheet perspective.  Capital planners may use an organizational structure for evaluation and analysis that is different from the approach used to assess initiatives overall.  For example, the business unit organizational structure may frame the assessment of strategic initiatives.  At the same time, capital planning may occur at the country or regional level based on an organization’s standards for reporting financial results.

Also, the long-term capital planning process must incorporate new requests for capital in the context of many other factors already impacting profit and loss and balance sheet reporting:

  • Construction in process.  Assets already received but preceding the in-service date.
  • In-service assets.  Depreciation and amortization schedules are already active.
  • Projected write-downs.  Accelerated depreciation for any discontinued use and impact.
  • Potential schedule additions.  Items associated with proposed initiatives.
  • Cash flow considerations (i.e buy vs. lease)

When capitalizing labor, human capital planning becomes significant, as well.  It requires close collaboration between capital and workforce planning teams to determine the right blend of permanent and contingent resources that map to capitalized labor requirements.

Capital Planning Software

The capital planning process is inherently complex, detailed, and requires a long-term view to ensure effective up-front planning and execution.  These characteristics combine with the uncharted nature of waters ahead to make it more critical than ever for professionals seeking best practices in capital planning and budgeting to utilize a purpose-built technology solution.

The Inpensa Platform provides the capabilities required to implement standards and automate data capture to ensure high fidelity information is available to planners in real-time.

The Platform addresses the full life-cycle of strategic investment management from early idea capture, to business case development and analysis, to tracking initiatives in flight from set-up through to the value period.  This broad perspective informs the capital planning process with the comprehensive data and context required.  The platform bridges the gap between the fixed asset ledger and the income statement and provides transparency in real-time.

Inpensa also provides powerful Contingency Planning capabilities that automatically integrate interactive capital planning to offer a global perspective on the impact of decisions in response to any number of rapidly emerging situations.

 

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