Capital Expenditure Requests
A Capital Expenditure Request (CER), sometimes termed Authorization for Expenditure (AFE) or Request for Appropriation (RFA), is the key step in the process to allow procurement activity to commence.
Due to the evolving nature of business and priorities, the Capital budget is seldom executed as planned. New ideas and imperatives emerge; so whilst CER’s are normally linked to a Budget item, there needs to be flexibility to accommodate both Unbudgeted Requests and Budget Shift (reassignment of budget between requests).
It is at this stage that a formal Business Case is normally required, and that delegation of approval policies are enforced.
On approval of a Capital Expenditure Request, an Investment Measure (Project Work Breakdown Structure or Internal Order) is generated in SAP, the approved budget is assigned, and procurement activities can commence.
Once Capital Expenditure is approved and procurement commences, the expected actual costs and timing become more certain. These updated cash flow forecasts are maintained to allow an aggregated view of funding and resourcing requirements to be managed.
Ideally, it is the responsible manager who should complete the forecast, subject to a review and approval by management. Forecasts are done on a periodic basis, and each forecast version can be retained to identify changes.
Effective budgetary control is enabled by comparing the overall budget to the incurred costs (actual, accrued plus committed) and the remaining forecast to complete.
Asset acquisition costs include all the related costs such as inbound freight, site preparation, labour and material costs to get an asset into a commissionable state on the capitalization date. These costs are controlled in an Investment Measure, which in SAP is either a Project Work Breakdown Structure (WBS) or Internal Order (short-term cost collector much like a Cost Centre, but with a defined purpose).
At the stage of project completion, the following activities are performed:
- The target accounting assignment is transferred from an Asset Under Construction to one or more ultimate Fixed Asset master records
- The Investment Measure status is updated to be Technically Complete to prevent addition costs being incurred
- The accumulated costs are re-allocated (settled) to the final fixed assets
- Any un-utilized budget is returned to the Investment Program to be available in support of future Capital Expenditure Requests
Every Capital Expenditure Request should define its anticipated business benefits. Some investment reasons are obvious, for example the replacement of critical equipment or adherence to new Health, Safety, Environmental and other Legislative compliance. However, even these investments tend to have a component of derived improvement to the status quo, or justification for more expensive alternative due to extended lifespan, risk profile or other qualitative benefit.
The key purpose of a structured Investment Review is to assess the benefits realization. If the actual results vary negatively, relative to those promoted, the review enables you to understand why, and adjust the assumptions, approach, and controls to help prevent recurrence in the future. In many organizations the Investment Review is undertaken by the Internal Audit functional on a sample basis. The knowledge that the business case outcomes purported in a Capital Expenditure Request will be subject to future review acts as a power factor in ensuring reasonableness, transparency and diligence in the preparation of investment proposals.
Of course, the future is always hard to predict, and often it is the higher-value, innovative investments that have the greatest degree of variability of success. It should not be expected that every investment fully achieves its targets, as it is not in the best interest of stakeholders for an organization to take no risks. What is important is that the organization learns to assess risk more effectively, and that through a diversified CAPEX investment portfolio achieves the threshold return commensurate with organization’s risk-tolerance profile. So, whilst some initiatives might not succeed, it is equally important that others achieve better than expected results. Any bias in the assessment of expected returns towards being too optimistic should be quickly identified by an effective Investment Review process.
Analyze and Adjust
The most crucial activity in the CAPEX process is the ability to surface relevant and reliable information at all stages in the process from the Wishlist items to the Post-Investment reviews. The goal should be to inspect the process and outcomes objectively, and to adapt continuously to deliver an optimal return on investment in line with the organization’s risk profile.
The ability to track and control Capital Expenditure in-line with the Budget is often seen as a process imperative. However, it should be recognized that the Budget itself is only a management tool to help align the strategic focus of the organization. Expenditure above or below this budget ‘line’ should be assessed on its merits. The Budget is primarily there to help identify where the variations are occurring, to help focus management attention, rather than to prevent any variations from occurring at all. Indeed, the classic ‘annual budget’ process in line with an organization’s Fiscal Year and reporting cycle, is deemed by many to be too rigid in today’s fast-paced environment. Many organizations are therefore starting to operate rolling forecasts as a basis for more agile control.
Furthermore, the line between Capital and Operating Expenditure is increasingly blurred. In line with the recently introduced International Financial Reporting Standard 16 regarding the appropriate capital accounting treatment of Leased Assets, these purchases are now typically processed through CAPEX, with the distinction only as to funding (outright or leased).
Much Capital Expenditure also has a significant Operational Expenditure component. For example, Software purchases typically have an on-going maintenance and support component. Therefore, for effective assessment of an organization’s overall CAPEX return, both Capital and Operational expenditures need to be tracked and evaluated against benefits realization. This detailed analysis of budgets, forecast plans, actual incurred costs and benefits achieved is most effective when based on an integrated single source of data, your SAP Intelligent Core.
The Capital Expenditure process is one of the most crucial responsibilities of management to ensure the long-term success of any organization. Key stakeholders include project sponsors and executive management, and all participants have a shared interest in accelerating and controlling the end-to-end process. The goal is the optimal investment of an organization’s financial and human resources to achieve its objectives. An effective CAPEX management solution will ensure policy compliance, seamless security and deep informational content to allow management to make effective choices efficiently and confidently. Comprehensive analytics will help the organization inspect and adapt its processes and outcomes for continuous improvement in efficiency, control and results.