Making Prudent Capital Investments

Posted on Nov 30, 2011 in Articles | 0 comments

When it comes to the long-term success of a business, one of the key drivers is prudent capital re-investment.  Unlike operational expenses that are used to run the daily business or working capital to purchase inventory, money invested in the business that yields incremental income is known as capital investment. Generally, these investments are made with a long-term expectation in mind and the return is achieved through added earnings.

Business owners are faced with many capital options over the life of their operation and depending on the state of business, all are viable.  For instance, when “cash is king” becomes paramount; investing bottom-line profits in the bank to earn interest may be a key consideration.  If the business is highly leveraged, paying down some debt may help the overall stability of the company. A third option would be to re-invest in income generating projects designed to make the business more vibrant in both the short and long-term.

The best operators are always looking to grow through ongoing investment by plowing a portion of their earnings back into the business.  They identify the best income-generating projects, bring them forward with detail, compare them with other projects and prioritize them to identify the projects with the greatest merit.  Detailed projects with solid business plans, would then go to a review committee to determine the best investments and timing.  This discipline and forward-thinking mindset, enable operators, to constantly stay ahead of their competition and position their business with the greatest chance to maximize opportunities.

In general, determining which projects to pursue should follow a process along these lines:

  1. What we want to do and why.
  2. Cost and return on investment.
  3. Competitor information.
  4. Store management information.
  5. Trade market information.
  6. Punch line:  Why should we make this investment?

With that in mind, here are some key items to include in your capital investment management program:

Form A Capital Review Committee:  Even if it is with one other person, setting up a Capital Review Committee creates discipline in determining the most prudent way to invest dollars back into your business.   Bouncing ideas off one another and comparing potential investments make the process more scientific and less anecdotal.  The committee should get together monthly or quarterly with the goal of reviewing projects for consideration, checking on the status of projects already in the queue and conducting post audits on projects that have been previously approved.  The goal of the committee is to improve the business through prudent management of investment dollars spent.

Stay-In-Business Capital:   Stay-in-Business capital is exactly how it sounds – it is required capital to keep the business in operation.  Known as maintenance capital, these investments keep your operation in shape by fixing broken equipment or renewing software licenses for example.  While this is a necessary part of keeping your business viable, there are few expectations for incremental revenues from these expenditures.  That being said, combining these capital expenditures with revenue-producing discretionary projects should produce a desired aggregate return on investment.

Discretionary Capital:   Discretionary capital investments, on the other hand, are designed to generate incremental revenue to the operation over a period of years.  Generally speaking, capital targets are in the 3 to 5 year range to payback the investment.  Discretionary projects take the form of a) system and infrastructure improvements; b) quick-payback projects that are accretive to earnings in the short-term; and c) long-term strategic investments.  At its simplest method, combined with stay-in-business capital investments, store operators should reach a targeted payback percentage covering 3 to 5 years.  More complex methods of capital budgeting are internal rate of return or discounted cash flow that take into account the net present value of the cost of money.

Identify Compelling Projects:   One of the most pertinent issues of which to be cognizant, is that a capital budget is not an allowance – returns are expected.  As importantly, returns are expected above and beyond normal operating returns.  In other words, if anticipated revenues are to increase 5% without capital investment, you must add the return from the capital investment to your already anticipated increase.  If your project is anticipated to have a 5-year payback, then it is imperative that the earnings from that project are carried forward for each of the five years. Targeting the projects that are proven winners, shows discipline.

Team Role In Capital Management:   Everyone on your team should have an active role in your capital management process.  In many cases, the best ideas are those that bubble-up from the field.  Lean on your team to identify and develop a business case for each investment.  This will make your team engaged and as importantly, empowered to deliver results on the investment.  Your staff will be well positioned to deliver on the business plan, if they are involved in the entire process.

Capital management can be the lifeblood for your business and if properly executed, provide the means to long term growth.  The discipline surrounding the selection of where to invest your hard-earned dollars is critical in order to prudently pursue the best returning projects as opposed to the most popular ones.

John Matthews is the founder and president of Gray Cat Enterprises, Inc., a strategic planning and marketing services firm that specializes in helping businesses grow in the restaurant, convenience and general retail industries.  With more than 20 years of senior-level experience in retail and a speaker at retail-group events throughout the U.S., Matthews has recently written two step-by-step manuals, Local Store Marketing Manual for Retailers and Grand Opening Manual for Retailers, which are available at www.graycatenterprises.com.