How to Plug Your “Capital Expenditures” Cash Flow Leak

December 12, 2012

Is cash leaking out of your “capital expenditures” back door? Lots of companies allow capital expenditures to drain their cash with little thought put into how to control it.

Why? The problem starts with the fact that you don’t see capital expenditures (the purchase of a vehicle, equipment, buildings, etc.) in your income statement when the expenditure is made. The expenditure is recorded on the balance sheet. Then the cost of the asset you purchased (and capitalized) is depreciated over the life of the asset.

KEY POINT: You can’t manage the cash you are using for capital expenditures by looking at your income statement.

A Real Life Example

In my book Never Run Out of Cash, I provided a real life example that happens in companies everywhere. One company in particular did a pretty good job during the year keeping expenses in line with the budget. They reviewed actual expenses to budget at the end of each month. In other words, they were paying attention to their income statement.

When I began my consulting work, one of the first things that stood out for me was the amount of cash they had used during the year for capital expenditures. It was about $200,000 for the year compared to less than $100,000 the previous year. And this company was doing just under $10 million in revenue. The number stood out to me because this business was not capital intensive and the number was a big increase from the prior year.

What happened? Management was so focused on the income statement and keeping expenses down that they let over $100,000 of cash leak out of the company through the "back door." They were a smart management team. They were financially oriented in many ways. But they still let over $100,000 of cash walk out the door.

And they didn’t even realize it until I pointed it out!

Nobody was paying attention to capital expenditures. There was no capital expenditures budget. There was no accountability for using cash if it was coded on their books as a capital expenditure.

A Capital Expenditure Plan

Step 1 in controlling this use of cash is to create a capital expenditures plan before each year begins. Here’s what the plan might look like.

Annual Cap Exp Plan

I like to keep the plan very simple and straightforward. Even with its simplicity it provides a number of important benefits.

  1. It gets your management team thinking about capital expenditures before the year begins
  2. It puts a focus on the cash to be used for capital expenditures
  3. It lets everyone know you are paying attention (that’s half the battle)
  4. It makes it easy to compare actual expenditures during the year so you can see how the plan is unfolding
  5. When someone wants to buy something they have to explain how it fits into the plan

The key is to monitor capital expenditures monthly.

I have seen this approach work wonders regardless of the industry a company operates in. And it’s not difficult once you understand that it takes more than a focus on your income statement to manage cash flow.

Here are a few other tips to keep in mind in managing your capital expenditures:

Don’t wait for your outside CPA firm to review expenditures at the end of the year and tell you which ones to capitalize and depreciate. Your CFO should have a process in place to ensure

  • Transactions are properly recorded every month, not just once a year. Otherwise you will be flying blind during the year (and providing inaccurate financial statements each month).
  • Most loan agreements have a covenant regarding the amount of capital expenditures allowed in any given year. Make sure you consider that when you finalize your spending plan for the year.
  • Include a discussion each month about how capital expenditures are shaping up against the plan. Putting this front and center with your management team every month will create a level of accountability that pays big dividends.

Your Plan

Improving cash flow is hard enough already! Allowing cash to sneak out the back door only makes it even harder.

An annual capital expenditure plan will help you shine the light on this very important component of your cash flow. It’s a great tool for managing (and controlling) the use of cash in your company.

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Topics: Accounting & Finance, Content Type

Philip Campbell

Consultant, Author

Philip Campbell is a CPA, consultant, and author of the book A Quick Start Guide to Financial Forecasting: Discover the Secret to Driving Growth, Profitability, and Cash Flow Higher. This new book provides a straightforward, easy-to-understand guide to one of the most powerful financial tools in business: a reliable financial forecast. He is also the author of the book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. The book is a step-by-step guide for business owners and managers who want to better understand and manage their cash flow. Since 1990, Philip has served as a financial officer in a number of growing companies with revenues ranging from $5,000,000 million to over $1,000,000,000. He has been involved in the acquisition or sale of 33 companies (and counting) as well as an IPO on the New York Stock Exchange. Philip loves helping entrepreneurs and business owners think strategically about the financial side of their business. His consulting work is focused on providing the financial insights that leaders need to increase profits, improve cash flow, and enjoy the fruits of financial success in business. What really sets Philip apart from the average financial person you meet is his passion and excitement about helping entrepreneurs and CEOs take control of their cash flow. In fact, early on in his career, he focused and “preached” so much about the importance of cash flow that people now call him CASH. Philip is the founder of Financial Rhythm, a website devoted to people who are serious about creating financial health, wealth, and freedom in their business. If you're an entrepreneur or business owner, Financial Rhythm is a place to get simple, actionable strategies for creating a financial future that is bigger and brighter than your past. Philip lives in Austin, Texas. You can email Philip at pcampbell@pdq.net.
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