Capital Budgeting with Minimal Cash (#145)
/In this podcast episode, we talk about how to deal with fixed asset acquisition issues when there is not much available cash. Key points made are noted below.
The last episode was about alternative ways to review a capital budgeting proposal. A listener contacted me and pointed out that there’s a scenario where you have to throw out most of the project evaluation rules and try something different. So, this episode is about capital budgeting when you don’t have much cash. This could involve a startup company, or any business that’s fallen on hard times. The chances are good that you’ll encounter one of these bad cash flow situations sometime during your career, so the following discussion might be of some use.
How to Conserve Cash Outflows in Capital Budgeting
Now, obviously, the one and only principle in this situation is to conserve cash, which is kind of hard when the very nature of capital budgeting is to spend cash. So, we need to figure out ways to get the maximum return on investment as fast as possible, while spending next to nothing. Here are some options.
First, see if you can repair what you already have, or root around in the warehouse and see if you have old equipment that can be repaired. Repairs are usually way less expensive than buying a whole new machine. Now, the machine may be inefficient, but since you’re not spending much money on it, that could be OK.
Next, see about the extending the operating hours of the existing equipment. It may be a lot less expensive to have a few people work an extra shift – even if they’re not very efficient – than to buy new equipment. Better yet, don’t just work two shifts – run the machine for three shifts. Efficiency will absolutely go down if you do this, because the machine will need more maintenance time – but it still saves cash.
Also, focus hard on outsourcing instead of capital purchases. Even if the returns are a bit worse by shifting work to a supplier, that’s still better than having to invest cash in new equipment. The situation – hopefully – will improve at some point in the future, so keep your options open for bringing production back in house. This might mean signing off on just a short-term deal with a supplier.
Another point, and which I talked about in the last episode, is putting a major focus on buying second-hand equipment. It can be so much less expensive that you may want to create a company rule that only the CEO can authorize the purchase of new equipment. Now. Old equipment may not be overly efficient, and it may be in need of repair, and it may have a short useful life. Doesn’t matter. As long as it’s cheap.
Also, take a hard look at leasing. The company may not be in very good financial condition, but it may still be possible to get a leasing company to issue a lease, since it can use the equipment you’re buying as collateral. This is worth it just to avoid an up-front cash payment.
How to Maximize Cash Inflows in Capital Budgeting
That pretty much covers the cash outflow end of things. Let’s look at the corresponding cash inflows. The focus needs to be on providing an immediate benefit – as in, cash receipts tomorrow. So if you can acquire equipment that can generate revenue in a day, that’s better than acquiring equipment that takes so long to set up that you can’t even get it operational for a month.
This also means that you have to focus on capital purchases for revenue that’s in the low hanging fruit category. In other words, to paraphrase the Field of Dreams movie, if you buy the equipment, they will come. If there’s any chance at all that revenues won’t happen, then skip the purchase. This is no time to be taking changes on speculative revenues.
Parting Thoughts
And that about covers it. You may have noticed that I didn’t talk about net present value analysis. That’s because the scenario I’ve been addressing is pure survival mode. And when you’re in survival mode, you do not worry about multi-year returns on investment. The main point is to survive for another day, so net present value is not overly relevant.
Also, I’ve kept pointing out that some of the investment choices may not result in the most efficient operations. That’s OK in the short term, but should be addressed in the long term, when you’ll presumably have more money to enhance operations.
And an additional problem is that following the recommendations I’ve laid out here could very result in a hodge podge of equipment that doesn’t work together very well. That may be OK if you’re buying used equipment, since the useful lives of these items may be fairly short.
So if you do everything right and cash flow starts to go back up, you can sell off these old machines in a year or two and use your new excess cash to buy what you wanted in the first place.