CAPITAL

EXPENDITURE Dr Palash Bairagi

CONTROL
WHAT ARE CAPITAL EXPENDITURES ?
Capital expenditures refer to funds that are used by a company for the
purchase, improvement, or maintenance of long-term assets to improve the
efficiency or capacity of the company.

Long-term assets are usually physical, fixed and non-consumable assets such as

property, equipment, or infrastructure, and that have a useful life of more than one
accounting period.

Capital expenditures include the purchase of items such as new equipment,

machinery, land, plant, buildings or warehouses, furniture and fixtures, business
vehicles, software, or intangible assets such as a patent or license.
CONT…
Capital expenditures normally have a substantial effect on the
short-term and long-term financial standing of an organization…
Because..

To maintain the levels of their historical capital expenditure to

show investors that the managers of the company are
continuing to invest in the growth of the business.
CONT…
There are normally two forms of capital expenditures:

(1) Expenses to maintain levels of operation present within the

company (acquisition expenditures) and

(2) Expenses that will enable an increase in future growth

(Expansion Expenditure).

 A capital expense can either be tangible, such as a machine, or intangible,

such as a patent. Both intangible and tangible capital expenditures are usually
considered assets since they can be sold when there is a need.
MEANING…

Capital expenditure controlling refers to the actions, processes and tools used to
identify, forecast, assess, decide and manage capital expenditure.

Capital expenditure can be used

to replace or expand existing plant and equipment,

to invest in new equipment or

to make use of strategic opportunities in new production or market contexts.

It can be used on tangible or intangible, financial or current assets.

In the broader sense capital expenditure controlling is also applied to expenditure incurred in the
context of campaigns or projects typical for areas such as marketing or research & development.
NEED OF CAPITAL EXPENDITURE CONTROLLING
1. It supports the evaluation of alternative investments and makes use of
quantitative and qualitative decision criteria to optimally allocate
funds, to alternative investment options in accordance with strategic
requirements.

2. To Measures and coordinates the long-term planning of machine and

human resources in coordination with sales and production planning.

3. To contribute as effectively as possible to optimal allocation of

capital and portfolio management.
CONT…
4. It helps in entire process, from authorisation to preparation,
implementation and in actual usage in order to achieve greater capital
efficiency and quality of planning.

5. To ensure sufficient and up-to-date transparency throughout the entire

process of planning and implementing investments.

6. Also fulfils the increasing demands resulting from risk management

OBJECTIVES OF CONTROL OF CAPITAL EXPENDITURE:

1. To make an estimate of capital expenditure and to see that the total cash
outlay is within the financial resources of the enterprise.

2. To ensure timely cash inflows for the projects so that non-availability of

cash may not be a problem in the implementation of the project.

3. To ensure that all capital expenditure is properly sanctioned.

4. To properly co-ordinate the projects of various departments.

5. To fix priorities among various projects and ensure their follow up.
CONT..
6. To compare periodically actual expenditures with the budgeted
or.es so as to avoid any excess expenditure.

7. To measure the performance of the project.

8. To ensure that sufficient amount of capital expenditure is

incurred to keep pace with the rapid technological
developments.

9. To prevent over-expansion.
PROCESS…
CONT…
Identifying investment opportunities

An organization needs to first identify an investment opportunity. An investment

opportunity can be anything from a new business line to product expansion to

purchasing a new asset.

 For example, a company finds two new products that they can add to their product

line.
CONT…
Evaluating  investment proposals
Once an investment opportunity has been recognized an organization needs to evaluate its
options for investment. That is to say, once it is decided that new product/products should
be added to the product line, the next step would be deciding on how to acquire these
products. There might be multiple ways of acquiring them. Some of these products could
be:

Manufactured In-house

Manufactured by Outsourcing manufacturing  the process, or

Purchased from the market

CONT…
Choosing a  profitable investment
Once the investment opportunities are identified and all proposals are evaluated an
organization needs to decide the most profitable investment and select it. While
selecting a particular project an organization may have to use the technique of
capital rationing to rank the projects as per returns and select the best option
available.

Example, the company has to decide what is more profitable for them. Manufacturing
or purchasing one or both of the products or scrapping the idea of acquiring both.
CONT…
Capital Budgeting and Apportionment

After the project is selected an organization needs to fund this project. To

fund the project it needs to identify the sources of funds and allocate it
accordingly.   The sources of these funds could be reserves, investments,
loans or any other available channel.
CONT…
Performance Review
The last step in the process of capital budgeting is reviewing the investment. Initially,
the organization had selected a particular investment for a predicted return. So now,
they will compare the investments expected performance to the actual performance.  

In our example, when the screening for the most profitable investment happened, an
expected return would have been worked out. Once the investment is made, the
products are released in the market, the profits earned from its sales should be
compared to the set expected returns. This will help in the performance review.
TYPES OF CAPITAL EXPENDITURE DECISIONS /
CONTROL
A capital budgeting decision is both a financial commitment and an investment. By taking on a
project, the business is making a financial commitment, but it is also investing in its longer-term
direction that will likely have an influence on future projects the company considers.

Example: The decision to open new stores, because management must analyze the cash flows
associated with the new stores over the long term.

Types are:

1. Pre-sanction Control –

2. Operational Control –

3. Post-sanction Control -
1. PRE-SANCTION CONTROL –

The board approval of a capital expenditure request or revenue expenditure request enables
the project to be stared.

Of course, even the directors, if making a decision on a major project, would not make it
unless all board member were present or, if not present, then consulted for their opinion so as to
enable a decision to be made with unanimous support if the decision could not be delayed. This
unilateral support for a project is essential, as all directors are equally liable for the results of their
joint decisions.

The procedure for approving the capital expenditure request and revenue expenditure request
will be made by the board and recorded in the minutes by the company secretary. The signing
of the capital expenditure sanction or revenue expenditure sanction would be by board authority,
even if it is not physically done during the meeting.
CONT….

Example:

The board may delegate the approval of capital expenditure requests or revenue
expenditure requests for the purchase of replacement assets, motor vehicles or new
assets below a specified value - say, $ 1,00,000 to the CEO. This would allow the CEO to
make the final decision on the exact start date, but it would be unusual for this to be done
without consultation with either the chairman or another director. Allowing the CEO
this level of authority would be necessary if the board did not meet regularly or the board
had a high degree of confidence in the CE0's judgment.

1. Levels of Authorities

2. Reporting
2. OPERATIONAL CONTROL -

The decision making process for long term planning of a business's activities is mainly
the domain of the directors and the highest levels of management. Internal controls at
the high levels of management are not as formalised as those for lower levels of
management. At the higher levels of the internal control system there is more policy
direction than practical procedures. However, there are internal controls and they need to be
observed. 

The top managers in a firm are usually in regular contact with the directors and are
'supervised' by them directly.
CONT…..

The operating controls for this sub-system are the continuing reviews of the business's
operations to ensure that projects can be paid back by savings or other efficiencies and
that financing costs and repayment of loans can be covered from expected profits.

The accounting section will be responsible for the recording and reporting aspects, but
the planning, consideration of alternatives and long-term financing decisions will involve
other sections and not the accounting function.

Long-Term Planning

Short-Term Planning
LONG-TERM PLANNING

Long-term planning would be carried out by an operations research or planning section

from policy direction issued by the directors and studies of economic trends and
forecasts.

This would be an ongoing activity, being reviewed and modified probably every quarter.
These long-term views of the company's operations would be provided to the directors to
enable them to carry out a continuing review of capital expenditures and financing
alternatives.

For major projects, detailed feasibility studies on cost and revenue projections would be
compiled to justify the project's inclusion or modification so as to be able to meet the required
rates of return.
SHORT-TERM PLANNING

This involves the budget for the current year and forecasts for each quarter. The
forecasts for each quarter are the final control on whether the planned capital
commitments included in the current-year budget can go ahead.

The basic point is that no matter how much research goes into preparing a forecast or
budget, unexpected changes can occur. A firm that is able to cut back at the first
warning sign will probably be saved from having to implement drastic measures
later.
3. POST-SANCTION CONTROL -

A reporting system which enable the board to see the Trends and behaviour of the
organisation or bank loan portfolio is a basis ingredient of board supervision.

While large lines of credit should be approved by the board itself (or by the Executive
Committee, if necessary) and the board should consider carefully all the relevant data
and policy issues before according its approval,

Like…..a monthly statement of all loans sanctioned in the course of each month by the
Managing Director and other Bank officials in their respective discretionary powers
should be submitted to the Board giving important particulars of each loan including past
behaviour in case of its extension, renewal or increase of an earlier facility.
CONT…

Example:

1. The Board may like to exempt small loans from detailed reporting requirement and may
allow these loans to be reported only on consolidated basis.

2. Minutes of the board meeting in which such advances are discussed should record these
discussions in detail.

3. The Auditors' observations have to be given due weight but the Board would do well
not to wait for its Auditors to ask for write off or provision. It is of course to be
remembered that for every loss that accrues or is likely to accrue to the Bank, the
management is answerable to the Board and the Board is answerable to the
shareholders. If the losses are large and have any bearing on the solvency of the bank, the
accountability to the wider body of depositors and creditors cannot be escaped.
 TOOLS & TECHNIQUES OF CAPITAL EXPENDITURE CONTROL

1. Performance Index,

2. Technical Performance Measurement,

3. Post completion audit.

4. Earned Value Method.

A schedule performance index is a ratio of earned value to planned value and shows if a project is
on, behind or ahead of schedule.
Example 1: A Simple Calculation of Cost and Schedule Performance Indexes
Let’s start with a simple example first.
Situation
The books and records of your PMO show the following numbers:
 This example illustrates the beauty of the
indexes: the absolute numbers of the cost
Cost and Schedule Performance Indexes
variance do not immediately show impact of
variances in relation to the plan. The cost
performance index and schedule performance
index, on the other hand, indicate the intensity
of the deviation. The cost performance index
value of 0.86 in this example may require
corrective actions in most circumstances. A
schedule performance index value of 0.95 may
be acceptable or tolerated in some projects
(e.g. if buffers or ‘nice-to-have’ work were
planned) or phases (e.g. early stages) and
might not require immediate action.
Example: Case Study of a Project in a Turnaround Situation
Let’s look at an example of how these metrics are used in practice:
A project has been going on for 3 months. The project manager feels that it
has not started too well as he notes less earned value than planned at higher
cost than expected. However, she thinks that the performance improved
significantly and wants to share a positive outlook with the stakeholders.
How can she prove this perception, using the earned value analysis
technique?
Situation
The project’s records of budget, plan and cost show the following numbers
(per period, not cumulated):
 Cumulativ
Month 2 Month 3
Month 1 e
Planned
100 130 200 430
Value
Earned
60 120 220 400
Value
Actual
90 150 200 440
Cost

The project is planned for a duration of 1 year with a total budget of 2,500.
As you see, the variances changed from SV (m1) = -40 and CV (m1) = -30 in the first month to SV (m3) = +20
and CV (m3) = +20 in the third month, with both SPI and CPI above 1.
The numbers in month 3 look quite positive though as the cost overrun has been stopped and the earned value
is even exceeding the planned value in that month. These numbers do actually support the project manager’s
view (assuming the positive development of EV and AC are sustainable).
Observation:
The cost variance (CV) and schedule variance (SV) indicate the deviation from
the project plan and budget in absolute numbers, usually currency units or time-
effort units such as man-days. The cost performance index and schedule
performance index set these values in relation to the project plan and indicate the
relative impact. If CPI or SPI are consistently and significantly higher or lower
than 1, it may indicate that a re-planning of the project might be appropriate.
Thank You……!!