What is meant by Governance & Assurance of Capex Spending

What is meant by Capex?

Capital expenditure (CAPEX) is a company investment in fixed, physical, non-consumable

assets, like a building, a computer, or a new business. The two main categories of capital

expenditure: Acquisitions required to maintain current levels of operation within a company

and purchases made to support future expansion. A capital expenditure may be physical (like a copier) or intangible (like a patent). Both tangible and intangible capital expenditures are regarded as assets in many tax regulations since they may be sold if necessary. An asset’s useful life must be longer than one year for it to count as a capital expense. The

number of years the asset is projected to be used determines how long depreciation will last.

For example, A fleet of servers purchased by a firm for its data center, for instance, would

lose value over five years.

What is Capex Governance

The governance of capital expenditure (CAPEX) spending is of key importance to provide confidence to stakeholders about the delivery and cost of capital projects. Capex governance reassures stakeholders of project delivery, costs, and provides independent evidence-based assurance to funders, investors, and taxpayers that planned benefits and value from the capital investment will be realised.

Many businesses use retained earnings for CAPEX investments in future capital or revenue-generating assets, research, development, and technological improvements/innovation. These require governance through reviews and audits to provide some certainty to stakeholders that the financial investment will realise planned benefits and value. Investing in CAPEX can improve operational efficiency and enable businesses to gain a competitive edge, but capital expenditure can create both benefits and risks and they may fail to perform as planned resulting in financial losses on budgets that could have been allocated to other assets. In today’s world, businesses need to be both viable for the long term and sustainable. Capital expenditure investments can help with boosting or transforming the operating capacity of a business and enabling more innovative and sustainable practices.

What is the Capex process?

The Capital Expenditure process is one of the most crucial responsibilities of management to ensure the long-term success of any organisation. Management makes investment decisions on behalf of owners and other stakeholders. Since all participants, including project sponsors, financial controllers, resource managers, and key stakeholders, have needs, it is the governance obligation to ensure that an end-to-end CAPEX process is efficiently designed to suit their demands. The main steps of this CAPEX process and how they interact with related follow-up activities are as follows: whilst proposal, Budgeting, Expenditure requests, forecasting, project completion, investment review, Analyse & Adjust.

Capital Expenditures Governance

Capital expenditures otherwise known as CAPEX refers to investments undertaken by a business to improve or create revenue-generating long-term assets. These are assets a company invests in to increase the economic value or that the business will use over an economically useful life of more than one year. These investments aim to increase the value of the company, outputs, or production capacity. Common examples of these are property, infrastructure, plant, or equipment. It is vital to note that costs spent on repairing or maintenance of CAPEX assets are not capital but revenue expenditure which should be charged to the income statement. An income statement (also known as a profit and loss statement) is one of a company’s primary financial statements that evidence profit, and loss incurred over a period. The costs, therefore, incurred on CAPEX such as repair and maintenance, should be charged by the business and expensed in the income statement.

CAPEX management as Capital Generating Assets

Capital expenditure is a necessity for businesses to maximise their return on capital. Most large corporations and SME businesses looking to scale reinvest profits or retained earnings into assets to augment and maintain their competitive advantage throughout varying economic cycles. Governing investments in these assets is essential and to realise the planned return on investments businesses must actively manage/mitigate risks, and take advantage of opportunities such as grant funding, research and development tax cashback and capital allowances. Decisions to invest in CAPEX that can generate future cash-flows can be simple for SME businesses with profits to reinvest or those with the financial backing to obtain funding from banks or investors. For larger organisations and the government, this can be an extremely complex investment in infrastructure that require significant sums and multiple parties to fund, design, and build the asset. These are governed by contracts such as NEC 3/4 engineering construction contracts and audits clauses to protect the interests of the parties involved. Without these assurance controls being governed investors will likely fail to realise planned returns, benefits and value.

Source: Infrastructure and Construction Pipeline GOV.UK

Here are some advice and Capex management best practices you can put into practice immediately to help you manage your Capex projects more successfully:

Recognise the differences between Capex and Opex.
Set long-term objectives for your business.
Create a process for examining and approving budget requests.
Create a strict budget.
Recognise the risks and challenges associated with capital expenditures
The success of the project must be measurable and evaluable.

Funding Opportunities and Government Backing

In supporting small and medium-sized enterprises (SMEs) (who account for over 99% of UK businesses, approximately 50% of private-sector employment and private sector turnover) the UK government in their SME agenda set an ambitious 33% target to spend directly or indirectly with SMEs. These include the Department for International Trade (DIT) supporting SMEs with funding investments in exports and innovation. Other opportunities include the investment fund grant by the European Regional Development Fund (ERDF) for SMEs with fewer than 250 employees investing in capital assets, machinery or equipment, hardware, software, refurbishment, or new premises benefiting from up to 30% of grants to cover investments costs. The chart above also shows planned investments in each sector in the investment section of the infrastructure pipeline between 2021/22 and 2024/25 with a full breakdown in the investment section. This significant multi £bn spend excludes investment in regulated utilities, social infrastructure, economic infrastructure, and other investments.

Independent Governance of Expenditure

These CAPEX projects or programmes will require resources with the right skills and expertise. Independent reviews are necessary to provide assurance and safeguard the interest of all parties as these involve huge sums of capital from investors, pension funds and taxpayers. The direct, indirect, fixed, and variable costs of CAPEX spending can be significant and should be carefully planned and optimised. Before embarking on the investment simple techniques such as business case payback, cost-benefit analysis, and suitability tests must be undertaken to minimise failure with experts used for more advanced tests like IRR and NPV methods used to evaluate viability on larger projects. Another vital point is options analysis at the decision-making phase to validate whether an investment is suitable, feasible or acceptable (SAF) and aligned with the long-term strategic plans or if the better option is to not invest. It is key to evaluate alternative options available before embarking on a CAPEX project to increase the chances of success and return on capital.

The Capex Investment Business Case

Data, information, and assumptions, it is vital to obtain and use accurate comprehensive information that the business can rely on for evaluating and assessing the viability of long-term CAPEX investments in helping a business achieve its strategic goals. The acceptability of a CAPEX investment should be dependent on the affordability of financing costs, operating expenses that must be carefully planned and budgeted for to safeguard success.

The importance of actively managing the capital expenditure plan cannot be overstressed to minimise risks, overspends, and cost overruns. This is because capital expenditure involves substantial investments and for return on capital invested in future years, it must be carefully planned by the business, considering all relevant costs, market expectations, realistic business growth projections, which are key in developing a CAPEX business case.

Key CAPEX Challenges

Funding budgeting, and accounting for CAPEX can be complex requiring expertise
Managing CAPEX risks and opportunities needs active management of uncertainty
Financing investments to generate capital without impacting short-term cash flow
Applying contingency planning to mitigate uncertainty and short-term monetary loss.
Developing a business strategy that sufficiently manages risks and cash fluctuations
Incorporating long-term strategic planning as CAPEX investments are long term
Reviewing cost and benefits gained proactively compared to original business case
Implementing policies and protocols for CAPEX investment business case spending

Capex expenditure examples

The assets purchased through capital expenditures are long-term investments with a useful

life of at least one year. Purchases of real estate, machinery, equipment, land, computers,

furnishings, and software are examples of capital expenditures.

How CFBL can help

Delivering training and upskilling on capital expenditure controls and protocols
Undertaking independent audits on Capex projects and contracts
Implementing CAPEX financial and commercial assurance controls and protocols
Developing robust models’ CAPEX investment business cases for funding
Incorporating risks, opportunities, and sustainable value into CAPEX for evaluations
Investigating and developing opportunities for revenue-generating assets
Providing technical and strategic supporting CAPEX business case and funding
Identifying, mitigating risks, monitoring and evaluating CAPEX success KPI’s

References