In the past, I have heard some accounting people say that capital spending should not exceed your prior year depreciation expense. When I think about that rule of thumb, I am not sure what difference it really makes. There are many aspects to capital spending, some related to Sec. 179 of the Internal Revenue Code. Under Sec. 179 some investments can be expensed in the current year. However, you should always consult your CPA/tax preparer before making any capital investments based on Sec. 179. The lease versus purchase is sometimes a complicated decision and is best left to a discussion with your CPA.
For any business owner, deciding whether or not to make a capital investment is based on two things. The first is, does the company have the money or access to money that will allow the purchase? Second, will it produce revenue directly or indirectly? Is it a replacement item (your delivery truck is on its’ last leg and must be replaced) or an expansion (your current delivery truck can’t get around to all the customers on a timely basis). When I was growing up, my father, an attorney, always drove a new car. He believed that clients didn’t want to hire an attorney who didn’t look successful. Is that true anymore? Do we base our decisions on how successful someone looks?
For larger companies, there should be a formalized capital projects processes and procedures. For instance , a request can be created, either on paper or electronically, for the capital item. Information attached to the request ideally would contain at least 3 bids/quotes. Sometimes, the item is so specialized that there may be only one source for it. The bid is then circulated to a group of approvers, generally the controller, CFO, President, COO, etc. This keeps all members of senior management in the loop. Once it’s approved, then a purchase order should be prepared. But all of the processes and procedures pale in comparison to making the wrong decision about a capital investment. Strategic capital spending is critical to the success and survival of any business. The most important part is the justification process where there is a dialogue that thoroughly explores the need for the investment. If you want more information on setting up a capital projects procedure, send me an e-mail at email@example.com.
In closing my series on WHY CASH IS KING! I want to emphasize one thing. You cannot save yourself into a profit. Too many controllers and other management level people turn themselves in to penny pinchers. That is not what cash flow management is about. It’s about MANAGING the money available and making sure that dollars invested in inventory and fixed assets have been deployed to maximize income. Remember, as controller or owner, you should always be able to answer the question ‘how much am I owed?’ and ‘how much do I owe?’.
Next week, I’ll start my newest series called ‘THINK LIKE A CONSULTANT – HOW TO STREAMLINE YOUR COMPANY FROM THE INSIDE’.