Most often we think in terms of capital investment as being driven by the ability to produce more widgets/units of time or cost, but there are many more considerations that should compete for our available capital dollars. The elements can include:
- Inventory reduction
- Reduced lead time
- Increased customer satisfaction
- Future business expansion
- Expanded capability and/or product scope
- Improved quality
- Improved safety and ergonomic issues
- Improved energy efficiency
- Reduced waste disposal or environmental compliance costs (cost avoidance projects)
** A quick note on item five: Exercise freedom in how you view yourself and your company. You might view yourself as a kitchen cabinetmaker — I suggest at the very least you are a manufacturer of case goods, and that is a far broader description. Do not miss opportunities for new business simply because they do not fit into an unnecessarily restrictive definition of your capabilities. **
We normally look at capital investment analysis as a justification process; I think it more useful to think of it as a comparative evaluation. Any healthy and growing business will have more viable projects with attractive Return on Investment (ROI) to pursue than can be funded within the limits of the normal capital budget.
There are accepted formulas to determine capital investment rates that are beyond the scope of this article; we will focus on determining the best use of that money.
Software Investments
Prior to looking at the machinery side of investment, let's talk a little about software investment and, more specifically, investment justification.
Software justification, in my experience, can be far more elusive than machinery justification. The supporting numbers that generate the ROI of software are often more difficult to determine with real certainty of their accuracy. The implementation costs are just as elusive; thus these ROI calculations are often based on "soft" figures.
There are two primary areas of risk in software justification and investment. The first is the often limited grasp of the scope of the project and therefore the true cost. Second is our rather limited definable understanding of the benefits and, thus, our limited ability to define the expected returns.
To minimize the exposure to both underestimating the scope (cost) and harboring unreasonable expectations of return, be particularly objective in defining both of these areas while evaluating a project. Be diligent in understanding exactly what you are committing to in cost and resources and what you are expecting (and being promised) in return.
A special note on resources: Any significant software implementation will require a major commitment of time and effort of your own people, including an internal champion for the project. You may need to consider additional people to support the implementation effort. Shortcuts here will lead to a failed project and nonrecovered costs.
There are a number of books, which can help avoid some of these pitfalls, that you might want to consult prior to committing to a major software investment. Making the Software Business Case: Improvement by the Numbers, by Donald J. Reifer is one, and Making Technology Investments Profitable: ROI Roadmap to Better Business Cases, by Jack M. Keen and Bonnie Digrius is another. The latter is a more holistic treatment.
One unavoidable reality is that without the appropriate investments in software the ROI of machinery and process projects will be quickly handicapped. Inevitably, the key element that positions great companies apart from good companies is their ability to manage, disseminate and utilize information.
Hardware Investments
Hardware investment decisions are normally more definable than are software investments. The exceptions to this are projects being evaluated on the basis of future business potential; these can pose challenges similar to software.
The evaluation of any potential project must be based on sound and unbiased data. Do not allow your own preference of one project over another to influence the data used to make the evaluation. I acknowledge that especially those of you who are owners might make a decision based on "gut feel" — and that is your prerogative — but I encourage you to go through the same analysis that should be done by any responsible publicly owned company. Further, I encourage you to make that analysis with truly objective inputs. You might find that your "gut" is confused.
Often projects include optional peripheral costs. Examples of these include automated material handling or special "add on" features to a machine. Be cautious in these evaluations. It is possible that the "base" project yields an attractive return, but the optional peripherals, if evaluated on their own merit, do not.
The most dangerous case is when the "base" project is evaluated solely with the optional and financially unjustified peripherals included and meets a reasonable ROI. The net result is an investment with diminished ROI compared to the "base" project. Projects that incorporate peripherals generating a negative return simply place a silent thief in your pocket.
Keep in mind that the primary purpose of financial evaluations is not to meet a minimum standard of return but to determine the most beneficial projects fundable within the capital budget. Spending money on a "neat" peripheral with negative return and not funding another project with a positive return is simply bad business.
Another pitfall that silently impacts profitability is assuming that any machine not fully depreciated and running well remains a good investment. Present and future value cannot be based on past performance. Control technology and software advancements for many CNC machines are advancing at a pace that can justify replacing machines not yet fully depreciated.
The Financial Case
The only bona fide reason to invest in your business is to be more profitable in the future. Often tax implications enter into the decision, and certainly they can impact the timing of an investment, but a "bad" investment will not be rendered "good" by favorable tax implications. The determination of the most beneficial investment will seldom be swayed by tax implications.
Investments must be evaluated the old-fashioned way; based on sound financial analysis resulting from sound engineering analysis.
I do not suggest that nonfinancial managers ignore the input of the financial and accounting professionals. I do suggest, however, that nonfinancial managers be conversant in exactly what the financial professionals are looking at and how they evaluate investments. One of the best online sources I have found is
www.solutionmatrix.com. They offer an excellent downloadable (free) financial metrics program that evaluates ROI, payback, cumulative cash flow, net cash flow, net present value and internal rate of return. While we tend to focus on ROI, it is certainly not the only measure and, at times, not the most important measure of a project's potential return. This is particularly true for new and future business applications.
The movement to just-in-time has prompted a changing and broader approach to evaluating the financial return of projects. These include inventory reduction implications and floor space implications, to name only a few; these are real cost factors and should be incorporated into your project evaluations. These concepts are often alien to traditional accounting principles. No discipline involved in manufacturing today can be allowed to continue in the "we always did it this way" mode. There are many good books and seminars available for your financial folks to better understand and support these broader approaches to financial evaluations in just-in-time and lean environments.