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Investing in Your Business: Is Now The Time?

Posted Thursday, June 16, 2016 by Gerry MIchael, Falco Sult LLC.

Changing production technology is a fact of life in today’s economy. For Graphic Arts firms that are just returning to financial stability after the Great Recession, these challenges are common. New capabilities and new technology to existing capabilities continue to present themselves. Those presenting these options promise greatly improved financial results and success for those firms that invest in these options. But all too often, the actual results may not be what had been hoped for.

Capital Budgeting offers a framework for evaluating these situations. Although it can be complicated in some cases, it ultimately comes down to a simple question:Is now the right time for my company to make a significant investment to acquire new technology, and if so, what return can we realistically expect?

While the question is simple, the answer is not. Too often decisions such as this use the wrong data and are based on unrealistic assumptions. Companies tend to place too much emphasis on potential benefits or technological improvements rather than the results the specific company should expect. This is misleading, which leads to bad decisions and bad results in most cases.

The correct analysis should use the actual financial benefits that a company expects to realize. All such investments must ultimately be paid for by improved cash flows to the business, which means that either your customers must decide to pay you for the investments by spending more on products and services, or you must be able to maintain revenues while reducing total operating costs.

So, what matters is what changes, and this is called “Marginal Analysis:’

There may be many other elements in the analysis, but in its most basic form, the only real question that matters is this:

Will the net cash flow produced by this new invest­ment, over its expected useful life, be more than the total cost of the investment, after considering the time value of the benefits and costs?

Key concepts here include the following:• What is the total initial cost or investment? This is not as easy as it appears. For instance, will the new technology require changes in other parts of the business, and what will those cost? Will your existing workflow support this change? Will staff training,or even possible staff replacements, be required? How will the investment in this technology increase investment in inven­tory? Will you need to inventory supplies or other consumables to support this invest­ment? These are all costs that need to be included.

• Is our sales/marketing staff knowledgeable enough to bring it to market? Will that involve additional costs or staffing?

• What does “net cash flow” mean here? Is it total cash flow, or just the difference that will result from this investment? Does it include growth in demand that we have no plans to create, beyond the investment itself? How will that growth be generated? Is this a “if we build it, they will come” strategy?

• What will the marginal costs of new sales be, if that is the goal for the investment? This cost is not the same as what you use for estimating or costing .. .in fact, it’s something you probably don’t have anywhere in your current information system. How will you estimate this?

• Are there ongoing indirect costs that will change as a result of this investment?

• What about the effects of how we finance this investment? Do they matter?

• What are the tax effects of this investment?

• How do we evaluate the benefits we expect to receive in the future with costs we incur today? Is there a way to estimate the present value of all cash flows, regardless of when they occur?

• Finally, how should we factor in risk when evaluating this investment? What risks will be involved?

Very few decisions are more critical to the success of your business than a decision about capital expenditures. Be sure when you face such a choice, that you use “best practices” when evaluating both the costs and the benefits.