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FP&A Closing the Gap represented by man jumping from cliff to cliff peak

Written by: Richard Frykberg

Operational expenditure (OpEx) is easier to analyze and control as it is more predictable, and variances are immediately visible. By contrast, capital expenditure (CapEx) is much harder to plan, budget, forecast and analyze. CapEx remains on the balance sheet and the impact of this expenditure may take decades to eventuate. The high value, impact and strategic significance of capital expenditure, makes it critical to optimize and control.

A critical role of FP&A is to identify the difference between CapEx and OpEx, which becomes cumbersome without a single source of truth. Yet, for many organizations, the financial planning and analysis of capital project portfolios relies heavily on spreadsheets. FP&A professionals often have to manually collect and manipulate data from multiple sources to produce meaningful insights.

What is FP&A?

Financial Planning and Analysis (FP&A) is the process of preparing and analyzing financial plans, budgets and forecasts. The goal of FP&A is to provide insights into an organization’s financial performance to support strategic decision-making.

This blog identifies the critical obstacles to effective FP&A of capital project portfolios. It supports using technology to improve the CapEx process and to help FP&A professionals be more efficient and effective. Ultimately, this will help ensure that capital investments achieve strategic objectives at lowest cost and least risk.

Risks of using Spreadsheets for FP&A

Static Business Case Templates

Many organizations struggle with right-sizing their capital expenditure (CapEx) planning processes. Sometimes the approach is too naïve, and sometimes too complex. The most common FP&A tool is the spreadsheet. Unfortunately, spreadsheet-based planning templates don’t effectively accommodate differences in project motivation, nature, and scale for FP&A modern-day calculations.

Project Planning Spreadsheet Templates are ineffective for FP&A

Risk vs Return Business Cases

In practice, the bulk of CapEx relates to periodic replacement of old plant and equipment. This expenditure follows a routine and you can forecast the capital requirements for sustaining current operations with reasonable accuracy. At least for steady state organizations in mature industries – of which there are few.

Extrapolating operational capital requirements into the future using a simple spreadsheet is quite straight forward. However, it is also misleading. Any organization that plans to continue as before, need not bother. In today’s hyper-competitive environment, laggards will soon be displaced by those more agile and ambitious FP&A teams.

Newcomers and new technologies can easily disrupt your assumptions. Competitors are just a click or a shipping container away. So, perhaps, you shouldn’t take the predictability of the sustenance proportion of your CapEx budget for granted. Don’t just increase your capital budget each year, prioritize it like your strategic investments.

Typically, organizations justify strategic capital projects based on complex spreadsheet models. Sponsors tailor these models to produce glowing financial metrics. They discard the rigid templates provided by the FP&A team in favour of intricate calculations and projections.

Sponsors colourfully adorn capital committee presentations with impressive charts and figures. Whilst few members truly understand, all still nod agreeably under the spell of enthusiastic proponents.

Whether we can confidently rely upon all those varying charts and metrics is the problem. For example, there are at least four different methods of calculating payback period. Does everyone involved understand the small differences in the assumptions and calculations used in the various spreadsheets?

Nature of Investment and Source of Supply

The information required to effectively plan for projects also varies by the nature of the investment.

The risks associated with fixed land and buildings vary to those associated with intangible IT projects, for example. Repeat purchases of vehicles from an existing trusted supplier requires less governance than the acquisition of new equipment from a new supplier. Long duration construction projects are always more concerning than off-the-shelf acquisitions. Gathering just the right amount of supporting detail is challenging with static spreadsheet-based planning templates.

Scale of Investment

The size of a purchase will also naturally impact the quantity and quality of planning data collected. Lower value purchases typically require less onerous data input, and faster approval cycles. By contrast, high value commitments typically require comprehensive analyses and involve many senior executives. Spreadsheet-based planning templates and email-based approvals do not easily adjust to accommodate these variations.

Spreadsheet-based business case templates are also difficult to validate and secure. The most loved feature of spreadsheets by FP&A teams is their unconstrained flexibility. The inevitable downside of that flexibility, however, is that it is almost impossible to ensure the consistency of underlying assumptions and calculations. Individually prepared and shared by email, the confidentiality and integrity of spreadsheet-based business cases is virtually impossible to control.

In addition to being disparate, inconsistent, and insecure, spreadsheet-based planning tools are also not integrated into capital budgeting and approval processes.

Optimization of the Capital Budget

The objective of capital budgeting is to allocate scare human and capital resources to initiatives that matter most. Many organizations do capital budgeting in two stages. At the start of the year, FP&A teams allocate budget to the most-promising initiatives based on departmental wish lists. Then, when projects begin, they release budget based on detailed detailed business cases.

In an unpredictable world, more imperative projects will frequently emerge that supersede the budgeted project list. FP&A analysts expect substitutions and reallocations of budget. The annual budget helps align an organization’s operations and serves as a reference for comparing actual project selection. The release of budget to individual projects is the baseline to measure actual expenditure.

The problem is that for many organizations there is a disconnect between these two processes. Department heads submit a wish list annually at budgeting time, typically under time pressure. The CapEx controller will then distribute the budget top-down through business units and departments. Ultimately, annual they allocate capital budgets to projects based on some naïve project ranking order.

Once an area manager receives their capital budget allocation they will start developing and submitting CapEx requests. They often submit these CapEx request through an independent tool and process. They identify budgeted projects by clicking a checkbox on the Authorization for Expenditure (AFE) form. However, this often requires verification from the CapEx controller to confirm the budgeted status and available amount.

Budgets, Expenditure Requests and Project Status are disconnected in FP&A

The disconnect between budgeting and spending requests has more consequences than just inefficiency in collaboration and reconciliation. CapEx controllers may not optimally allocate budget, which has a more serious impact.

Only preparing budgets once a year is a problem. We may not be include worthy projects as they may not by identified in time. On the other hand, we may include bad projects simply because they score highly on a simple measure.

A more effective budgeting solution would involve considering initiatives at all stages. This would ensure that future capital allocations yield the maximum benefit, regardless of any incurred expenditure. For example, it may make sense to stop a failing project, and re-direct the funding to a more urgent initiative.

While many FP&A tools in use today are effective at examining the past, they are weak at forecasting the future impact.

Forecast Project Costs and Impacts

While financial accountants focus on reporting historical operational results, the focus of FP&A teams is towards the future. FP&A teams plan, budget, and forecast outcomes to provide executives insights. These insights enable executives to steer the organization to achieve strategic objectives sooner, at lowest cost and least risk.

Managers enable organizations to achieve strategic objectives by investing their time and money wisely. Justify capital investment based on the benefits you expect to derive. Revise assumptions and update schedules based on actual costs and experience.

Even though you can easily compare actual performance to plans and budgets, most organizations struggle to forecast future cashflows. Two critical components to consider when analysing future cash flows are forecast investment cost and forecast future returns:

Forecasting of both capital costs and anticipated project benefits for effective FP&A

To effectively report project performance, it is most important to analyze variances based on the forecast at completion. Measuring variances requires actual costs, actual percentage completion, and forecasts to complete. Preparing forecasts at completion helps identify budget or schedule problems early. This allows senior managers and FP&A executives to address any issues promptly.

But just as important as monitoring costs, is reassessing future benefit realization and returns. Most existing tools and processes are woefully ineffective in this regard. Assessing the portfolio impact of business cases locked away in isolated spreadsheet silos is extremely difficult. The sensitivity and impact of changes in underlying assumptions is difficult to asses when each business case is independent.

For example, what is the impact of a rapid change in interest rates? How has this impacted the Net Present Value of long-term projects? Should we continue these projects or reallocate the capital?

Conversely, a project running way over budget and schedule may produce better than originally expected results.

A single source of truth to plan, budget, and forecast both costs and future financial returns is the biggest gap for most organizations.

Bridging the FP&A Gap

The challenges experienced by corporate financial analysts relying on stand-alone and spreadsheet-based processes include:

  • Inconsistent business case definition and financial models.
  • Sub-optimal project portfolio selection.
  • Inefficient budget availability tracking.
  • Unreliable capital forecasts.
  • Limited visibility of project impact and future benefits.

The root causes are:

  • Rigid spreadsheet-based templates.
  • Disparate data sources.
  • Inconsistent assumptions.
  • Variable data quality.
  • Manual integration and report preparation consuming the time of your key resources.

Capital project financial planning and analysis processes are in urgent need of digital transformation.

The key remedy is a capital budgeting solution that provides a single source of truth, dynamic online business case templates, and seamless process workflows. An integrated capital budgeting software solution will significantly enhance your capital FP&A effectiveness. Empower your FP&A team and executives with timely capital expenditure management insights so that your organization can achieve its strategic plan. Read more about our FP&A solution here: