Overview
Capital expenditures are generally large expenditures, for which the benefit is not immediate. As such, considerable effort is often expended to plan capex, with efforts made to align it with the firm's strategy.Accounting Treatment
Even though capital expenditures spend large amounts of company resources, they do not initially show up as expenses on the financials of the firm. Rather, they are usually interpreted as purchases of assets and capitalized on the balance sheet as an asset.This treatment recognizes the fact that the benefits of capex are realized over time, and therefore tries to match the expense to the revenue through depreciation.
Capital Budgeting Process
Many companies of sufficient size develop a budgeting process by which projects (or programs) are evaluated and given the green light. The process is usually integrated with the processes of the project management office and/or the program management office.The key decision in a capital budgeting process is the decision to proceed with a project or not. There are typically two factors that materially influence the decision.
- Financial Estimates
- typical financial estimates include a pro-forma projection of the costs and
revenues associated with the project. If the project is deemed to have a return
sufficiently greater than the firms
cost of capital,
then the project is deemed worthwhile.
Alternatively, the committee can use Real Option Analysis to evaluate the effectiveness of a project. - Alignment to Strategy
- Evaluation Measures