Written by: Richard Frykberg
Capital Expenditure is typically classified as either Growth Capex or Maintenance Capex. Both types of capital expenditure are crucial to the long-term success of every organization. While Maintenance Capex ensures the sustenance of business-as-usual activities, Growth Capex underpins the achievement of strategic objectives.
This blog takes a deep dive into the details, similarities and differences between these types of capital expenditures to assist you in modernizing your long-term capital planning and supportive technologies.
What is Maintenance Capex?
Maintenance Capital Expenditure is the necessary investment in assets required to sustain business-as-usual operations – to keep the “lights-on” and business running efficiently. Maintenance CAPEX is prioritized by the need to replace depreciated assets when they approach the end of their useful life to avoid the risk of disruption to ongoing operations. For example, replacing an ageing conveyor-belt in a manufacturing plant before it fails. The more critical the component, the greater the urgency for replacement as it approaches end-of-life. Operational assets will commonly be replaced prior to technical obsolescence to avoid catastrophic stoppages and to maintain high levels of operational efficiency. For example, an ageing diesel forklift may be replaced with an electric forklift. Provided the motivation was to avoid breakdowns and minimize operating costs, the purchase would classify as Maintenance Capex, even if an ancillary benefit is a reduction in greenhouse gas emissions.
Key characteristics of Maintenance Capex include:
- An existing asset to be replaced can be identified (note this can include intangible assets such as computer software)
- The purpose of the investment is to mitigate operating risk or sustain operating efficiency
- The replacement does not significantly enhance the core functionality of the replaced item – for example, replacement of a delivery motor bike with a delivery truck would not be classified as maintenance capex.
Maintenance Capex is also referred to as ‘replacement’ or ‘sustenance’ capex. An indication of the required annual level of capex is provided by the depreciation reported in the annual financial statements. Where the annual maintenance capex is less than the annual depreciation charge, it is likely that the organization’s capital base is being eroded, and the organization is in a declining phase.
The valuation of Maintenance Capex is calculated net of the profit or loss on the sale or disposal of the replaced item in accordance with the Maintenance Capex Formula presented below:
Maintenance Capex = (Net Present Value of all project costs) – (Operational Expenditure) – (Sales Price achievable on replaced asset) – (Net Book Value of replaced asset)
What Is Growth Capex?
Growth Capital Expenditure is discretionary investment that enhances an organization’s capital base in pursuit of strategic objectives with new capacity, geographic reach, operating efficiencies and technology capabilities. These investments are made with an eye toward positive return on investment and growth over time. Growth Capex is prioritized by both the absolute value of the return (Net Present Value of future resulting cashflow inflows or savings) and the relative return (Profitability Index or Internal Rate of Return) when resourcing and capital are constrained. For example, opening a new store in a new country may present a high net present value opportunity. Extending an existing store may be considerably cheaper and offer a high rate of return. In an environment of constrained sources of funding, the higher return initiative should be prioritized.
Key characteristics of Growth Capex include:
- The investment does not simply replace an existing capacity or capability, but either represents a brand-new asset, or significantly improves on an existing asset. For example, replacement of a delivery motor bike with a delivery truck would typically be classified as Growth Capex.
- The investment is discretionary, and not required to sustain business-as-usual operations
- The purpose of the investment is to help the organization achieve its strategic objectives, which for commercial businesses include return on investment through either new cash inflow or a reduction in expenditure.
Growth Capex is also referred to as ‘Return Capex’, ‘Growth and Savings Capex’ or ‘Strategic Capex’.
The valuation of Growth Capex is calculated net of the amount that would have been required to simply replace any existing assets to their current operating capabilities and capacities in accordance with the Growth Capex Formula presented below:
Growth Capex = (Net Present Value of all project costs) – (Operational Expenditure) – (pure Replacement Capex amount)
Similarities of Growth Capex and Maintenance Capex
While Growth and Maintenance Capex define different types of expenditures, they share some core similarities.
Any Type of Asset
Both Growth and Maintenance Capex can be of any asset class including tangible assets such as land, building and equipment and intangible assets such as computer software, trademarks and brands.
Capex or Opex, Why it Matters
With both types of Capex investment, it is important to segregate the Capital (Capex) and Operational (Opex) components of the investment. A repair of a machine is Opex, a replacement of a machine is Capex, but what about an overhaul? The distinction typically becomes one of degree, frequency and longevity. A major overhaul of a plant component done on a 5-yearly cycle, is Capex. An annual service of another component done annually is Opex. A typical annual maintenance shut-down and overhaul project will thus have both Capex and Opex components. Read more about Capex Vs Opex.
All Capex can be Urgent
Investment proposal evaluation should always include the concept of urgency. For Maintenance Capex, the urgency is typically assessed via a risk of failure classification. The more likely the risk of failure as the asset depreciates, and the greater the impact on the entire organization, the higher the risk assessment, and therefore urgency of replacement. For Growth Capex, the urgency assessment is more subtle, but just as important. Opportunity Cost is the typical measure of urgency for a growth initiative, and the higher the opportunity cost, the more urgent the project. For example, the Opportunity Cost of not implementing a new technology may be significant loss of competitiveness and market share.
There are Always Options
In evaluating both Capex and Maintenance investment proposals, consideration should be given to options. Even with Maintenance Capex, there will almost always be a like-for-like replacement option as well as a ‘major competitor’ or ‘alternate technology’ solution. That is why, even for Maintenance Capex, alignment of the options to the strategic objectives of the operating unit should be considered. For example, if the responsible area has an objective to cut greenhouse gas emissions, the electric option may be preferred.
An Element of Risk
All Capex involves a degree of implementation risk that should be assessed when evaluating business cases. Normally, the replacement of existing assets involving known technology and internal skills is significantly lower-risk, than Growth Capex which may involve completely new partnerships, processes, technology and skills.
Differences Between Maintenance and Growth Capex
It’s important to point out several differences between Maintenance and Growth Capex which often makes them difficult to manage without a seamless Capex management system.
It Depends on the Industry
Organizations in heavy capital-intensive industries (e.g. Utilities, Manufacturing, Mining) will allocate the majority of their capital expenditure on maintenance and replacement of their capital plant and equipment. Organizations in technology or fast-moving consumer goods industries (eg IT, Retail, Professional Services) will allocate the majority of their Capex on growth and savings initiatives, to achieve sustainable competitive advantage.
Who Identifies the Need?
Maintenance Capex is typically identified by maintenance engineers, and formal plant and equipment inspections and maintenance plans. Growth Capex opportunities emerge from anyone in the organization noting a problem or opportunity.
How to Measure Value
The benefit of replacing even the smallest, but crucial, component of an organization’s capital base, may be enormous where the alternative is a complete stoppage. The cost of the replacement is essential and not negotiable. However, it would be senseless to evaluate every replacement project on the same cost and benefit assessment. Therefore, Maintenance Capex is typically assessed primarily on the urgency of replacement. On the other hand, Growth Capex is directly assessed on the benefits to be derived. Typically, this includes core financial metrics such as NPV and IRR.
When Projects are Done
The timing of Maintenance Capex is frequently driven by the annual shutdown or overhaul planning cycles. Growth Capex can be more flexibly incurred. A determinant in the scheduling of Capex projects includes these key dates, as well as resource and capital availability.
Which Projects to Choose
Maintenance and Growth Capex initiatives are evaluated, scored and ranked on different dimensions.
Who is Involved
The collaboration, review and approval process of maintenance and growth initiatives will vary. For example, the engineering manager and fixed asset accountant is likely to be key participants in the review of Maintenance Capex. For growth initiatives, the business development team are likely to play a leading role. Flexible workflow automation is key to ensuring that all the right people are involved in the process.
How to Integrate to Back-End Systems
Maintenance Capex will not necessarily require the identification of assets and equipment to be replaced. Large complex Maintenance Capex initiatives will likely require a project to be created in your Enterprise Resource Planning system for effective management. Some new Growth Capex initiatives may be effectively controlled using simpler temporary cost-collectors (such as Orders in SAP).
Don’t Forget Other Investment Reasons
In addition to Maintenance and Growth Capex, organizations may further classify their Capex initiatives. Other investment reasons include compliance, environmental, social, and governance objectives. These other reasons may have their own scoring, evaluation, workflow and system integration variations.
How to Improve Allocation of Maintenance and Growth CAPEX
Spreadsheets, SharePoint and other disconnected Capex management systems are not sufficient to gain a competitive advantage in today’s business environment. When it comes to Maintenance and Growth Capex your capital expenditure system should be able to:
- Enable budget allocations by each category in-line with an organization’s appropriate allocation of funding
- Facilitate the feed-in of initiatives from a range of sources
- Support different scoring models for evaluation of maintenance and growth initiatives.
- Accommodate selection variations and support automated portfolio optimization.
- Identify project inter-dependencies and the demand on scarce resources to deliver an optimal capital project portfolio
- Accommodate ERP system integration variations
Both Maintenance Capex, to sustain an organization’s operations, and Growth Capex to expand, extend and enhance those operations, are essential to long-term success. Identifying the underlying investment reasons for initiatives will likely impact the people, process and portfolio selections.
If you enjoyed reading this, then please explore our other articles below: