Reconsider capital investment plans
Excerpt reprinted with permission from The Credit Crunch: a Practical Guide, Grant Thornton LLP, 2008
What’s the issue?
Investing in new assets in a downturn can bleed you of cash when you need it most. Carefully consider your capital investment plans and question the proposed value and timing.
What can you do?
Take into account the timing of investments. If they aren’t mission-critical, consider delaying or deferring them. For a mission-critical asset, negotiate to acquire it under the most favourable terms, including (but not limited to) the use of debt financing to the extent available. It’s essential to weigh the operating and tax benefits of the investment against the financing costs, especially in a lending environment that’s become considerably more challenging. Cash flow budgeting should properly account for increased borrowing costs as well as constrained credit availability.
Attempt to fully understand changes to working capital that may result from a particular investment. The project may require increases (or decreases) in cash, accounts receivable, accounts payable or inventory. These changes in working capital should be included in the calculations we discussed earlier, as should economic value at the end of the life of the project.
Also be mindful of how recent changes in economic conditions and challenges in the lending climate are affecting your customers. Caught between the credit crunch that has made loans harder to get and more expensive on the one hand, and a weakening economy on the other, many Americans are expected to spend frugally in the coming quarters—bad news for Canadian companies selling to the US and insight into what we may be facing should our economy follow suit. Capital budgeting metrics (such as Net Present Value and Return on Investment) should incorporate realistic assumptions based on current economic conditions. This will aid practical decision making regarding whether or not to move forward with prospective investments.
What to avoid?
The easiest thing to do is to just stop investing in capital during difficult times. Don’t default to this position automatically. Failure to make necessary investments or maintenance capital expenditures can put you on a slippery slope. If an investment is vital to keep your business operating properly, don’t suspend or postpone the investment decision just because financing is more expensive and complicated.