Capital investment is part and parcel of running a manufacturing and processing business. More than in any other industry, the reliance on advanced automated equipment means processors are involved in a near continuous cycle of upgrade and replacement, driven by natural machinery life spans and rapid changes in technology.
Budgeting for equipment upgrades and replacement is tricky, especially in the volatile economic climate we are living in. Gaining a positive return on investment, i.e. making sure the the contribution to output and profit outweighs the total cost of ownership, is essential, otherwise equipment overheads will drag a company into unmanageable debt.
But forecasting ROI on capital expenditure requires a long term view. And with Brexit looming and the pound weak, it is difficult for anyone to predict with any degree of certainty what the markets will look like in a year’s time, nevermind five. This kind of uncertainty increases the risk in capital investment, because it is harder to predict the outcome of budgeting decisions.
However, economic uncertainty does not free processors from the need to invest in essential equipment. Decisions still need to be made regardless of the difficulties. In these circumstances, it pays to be meticulous in considering all of the factors at play, as well as understanding the various financing options available to you.
Pin down your objectives
The key to any investment is that it should start from a clear business objective. Even if you have an old piece of machinery which is nearing the end of its operational life and needs replacing, there are broader factors to consider. Do you want to simply replace like-for-like, or is this an opportunity to improve efficiency and output? If so, how? What other changes are likely to be made, and how will that fit in?
The point is, if you start from a definite goal – we want this new piece of equipment to increase productivity by x amount – you can then work backwards to assess whether a) it is realistic and b) it is financially viable, i.e. the returns will outweigh the costs. For large investments, seek advice from a professional consultant to help you work through this process.
Take a whole business view
As touched on above, investing in a new piece of equipment is never a single, isolated act, because the new machinery will have an impact on wider business operations. A common mistake is to approach upgrades and replacements in a piecemeal fashion, one at a time. This is never likely to lead to the most efficient and effective overall system.
In a challenging financial environment, the one thing you can control and predict is the quality of your processes. Every investment you make should be working to an overarching business strategy of improvement, whether that is streamlining production or increasing output. If you view every individual upgrade as a cog in a larger process, you are much more likely to create and maintain a system which does give you a positive ROI in the long term.
Understand your financing options
When forecasting future returns is difficult because of market volatility, you need to look to mitigate risk in capital investment as much as possible through flexible financing arrangements.
An obvious example is using hire purchase arrangements to spread high upfront costs, especially if you do not have the liquid capital available. Leasing is another option which can offset much of the risk involved with equipment purchases. Finance leasing provides an extra layer of protection compared to hire purchase by removing the obligation to own outright. If, at the end of the lease term, you realise the equipment is not giving you the returns you expected, it can be returned. Otherwise, you can opt to extend the lease or pay a lump sum to complete purchase.
Operating leases, on the other hand, remove the purchasing element entirely. If you really don’t want to take the risk with capital expenditure, an operating lease provides equipment on short to medium term contracts as an off-balance sheet item, with all service and maintenance charges included in the fee.
Peregrine Leasing is one of the UK’s leading providers of asset finance, with more than 25 years’ experience in the manufacturing industry.
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