Analyst Perspectives

Effective capital planning and capital investment are vital to a company’s long-term success. The choices a company makes in this regard – how much to invest and in which facilities or projects – almost always have a profound impact on its competitiveness and performance. Because they have limited financial resources, well-managed companies take pains to ensure that these decisions support their long-term strategies and are made as rationally as possible. To do this they must have a disciplined approach to assigning priorities to capital investments within the context of the company’s specific strategy and objectives, as well as the ability to easily identify and eliminate unnecessary projects or excessive spending. And since business environments are dynamic, companies must also continually review their investment portfolios to assess their performance to plan and their strategic value while they also consider new investments to support and expand the existing long-term portfolio.

Some aspects of planning are easier to handle than others. For example, large majorities of companies in our Office of Finance benchmark research said that they handle the basic functions of accounting (83%) and external financial reporting (78%) well or very well. In contrast only half (49%) said that they perform strategic and long-range planning well or very well. One reason for the discrepancy may be the tools that they use. Almost all (91%) companies said they use spreadsheets to manage their long-term planning and investment processes. Spreadsheets are the wrong choice for any repetitive, collaborative company-wide processes such as strategic and long-term planning. For example, tracking and revising projects and major company initiatives over time in desktop spreadsheets is time-consuming because they lack capabilities designed for these purposes, such as the ability to manage projects as a set of resources and activities along a time dimension. With such capabilities planners are able to see quickly the financial and operational impact of delaying or accelerating a capital project. Unlike spreadsheets, software dedicated to planning often includes built-in analytics and visualizations that help executives formulate plans and assess performance. Spreadsheets don’t make it impossible for companies to plan and manage strategic and long-range projects and investments, but doing that is so time-consuming organizations may not have time to do more valuable work – for example, comparing the impacts of different economic or business scenarios on a set of investment alternatives, or performing side-by-side assessments of existing project portfolios. Dedicated software can enable a company to gain agility in adapting its portfolio of projects and investments. By shortening planning and review cycles and being able to examine the impact of different scenarios on the fly, decision-makers can do more frequent in-depth reviews and reassessments of investment performance or priorities.

Dedicated planning software also can improve executives’ ability to do long-range planning to ensure they have the right strategy to succeed in the markets they serve and the right assets to support their strategic objectives. To achieve those goals they must allocate investments in those assets as optimally as feasible and possess sufficient resources (both financial and other, such as personnel with the appropriate skills) to support those investments. These are the key activities in the long-range planning process:

• Establish the best strategic course based on a company’s current market position, its resources, the competitive landscape and external factors such as economic and demographic trends, the legal and regulatory environment and technology trends.
• Determine the assets required to support the company’s strategy throughout the planning period.
• Identify the ongoing operating activities, such as research and development projects or brand advertising, needed to support the strategy.
• Ensure that there is adequate funding to support investments and ongoing operating activities over the planning period.
• Ascertain that the capital structure is adequate and optimized to support the needed investment.

Companies face multiple challenges in managing their long-term planning processes. These include:

• Determining the appropriate methods for assessing plans and their constituent investments
• Achieving alignment between company strategy and the long-range plans of the constituent parts
• Ensuring consistency in the preparation of long-range plans across the organization
• Optimizing investment decisions consistent with long-term strategy
• Maximizing the productivity of the long-range planning process, which means minimizing the amount of time required to execute the purely mechanical aspects (acquiring data, validating it, creating, maintaining and running the appropriate analytical model) to enable more time to be spent on the analytical and assessment aspects
• Performing comprehensive what-if scenario planning
• Reducing cycle times to allow for a more nimble process.

In capital spending decisions, project champions must make a convincing case that an investment is not only worthwhile in itself but also better than alternatives. Strangely, though, once a capital project is approved, few if any companies assess whether the projected returns were ever realized. In the decades that I have been asking this question, I have yet to find a single company that does any post-investment measurement of specific projects. As a rational numbers guy, I’ve long wondered why. One reason might be that, acknowledged or not, optimizing capital investments is not one of the main objectives of the capital spending decision-making process. Rather, it’s simply to separate the obviously bad ideas from the rest. Applying a methodology to quantify potential returns from a capital project is bound to expose most of those that have limited potential, faulty assumptions or too much risk. Yet I think this approach sets a very low bar. Having a more rigorous post-investment analytical process would enable companies to do a more effective job of allocating resources by seeing where they have wasted them before. Dedicated software can facilitate these sorts of reviews and enable companies to adjust their planned investments when business conditions and results dictate the need for changes.

Ultimately, the success of a company’s long-range planning and investment process can be measured over time in its gross return on assets relative to its competitors’ and, if it is publicly traded, partly by the company’s share price. A gross rather than net asset approach is useful because it reduces accounting distortions in cases where companies may have written off poor investments or used different reported depreciation approaches for similar asset classes.

Companies – even small businesses – should use a rigorous long-term planning and capital spending discipline to ensure that they successfully manage for the long term. Companies that already have such a process in place should re-examine it regularly to determine where it is falling short or failing to identify the right path and the appropriate investments for their strategic direction. Executives should recognize that using desktop spreadsheets to support their strategic and long-range planning processes prevents them from doing these things and support investment in more capable tools designed for the tasks.

Regards,
Robert Kugel
Senior Vice President Research

Follow Me on Twitter @rdkugelVR and connect with me on LinkedIn.