Understanding capital planning

Across industries, many people are familiar with the terms OPEX (operating expenditure) and CAPEX (capital expenditure.)  Over the next six posts, we’ll look at the more complex of the two types of business costs and see how they are planned and managed. This will provide and understanding of why CAPEX planning is important for the business. We’ll also look at considerations for improvements to Capex Planning and why they’re important to the mining industry.

First, let’s define what the two types of costs are.  OPEX is the cost of producing income to the company. It covers the costs of generating income like wages, energy, consumables, contract services. These costs are treated as immediately deductible when calculating tax and profit.  CAPEX is investment in goods or services which support the company generating income in the future. Things like plant, buildings and equipment are included. For tax purposes, these costs are not immediately deductible, but are depreciated (their value reduced) over each year of their life. The time dependent tax treatment of the two expense types has influence on how they are viewed and employed in practice.

Operating costs relate to expenses here and now, where capital relates to future benefits, one or more years on.  We can get an appreciation for why capital expenses require more planning and approvals.  This is handy to know when we see improvements we want to recommend and why our ideas aren’t always met with rapid action.

CAPEX planning considers the lifecycle of the investment, which may be a short 2-year life (like computers or portable radios) or 30 years for a conveyor gearbox (including planned maintenance rebuilds.) Because of the longer lifecycles of the items, the planning process considers that lifecycle value to the company.  After all, if a conveyor gearbox fails, how many production hours will  you lose and what’s the impact on costs?

There are several phases used to divide the planning and operational lifecycle of the asset being considered (asset means the capital ‘thing’ the company is investing in.) Alternate names don’t change the need for up-front detailed planning and decision making. We’ll use a real example of a recent safety related project to show how the project is evaluated during this phase:

Starting with the initial phase of considering a capital investment, we’ll call it the Identify Phase. These things need to be addressed in this phase:

  • Identify the need for the project.
  • Explain the objective of the project outcome and describe the benefits to the company for investing in it.
  • Identify any constraints or assumptions relating to the proposal.
  • What suggested solutions or options, does the initiator think will solve the need?
  • What risks are there in this proposal?
  • How does the proposal fit in to the company’s strategic or operating plan/s?

Let’s consider the early planning conducted by a major metal producer.  The company’s process safety policy states that personnel are not to be placed in hazardous situations, where they may be at risk in the event of a major failure of the plant.  A risk analysis of the plant and processes was done to understand the outcomes of possible failure.

The central control room was found to be within range of hazards in the event of several possible process failures.  The consequence of some of these events included likely fatalities.  This situation was unacceptable.  Something had to be done to reduce this risk and have the working environment meet the safety policy.  This was the defined need for action.

In the Project Initiation Report, the stated objective was to meet the company safety policy and reduce the current level of risk of personnel working in the control room, in the event of any of the identified process failures.  The suggested solution was to relocate the control room to another part of the plant, not likely to be affected in the event of process failure.

Knowing the longer-term considerations of CAPEX and the detail required to assess the need, benefit and risk of these investments, we’re building an understanding of why the company takes CAPEX planning more seriously.

In the next post, we’ll look at the next phase of the process, the Assess Phase. Please add your questions, views or experiences in the comments below.

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