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Most budgeting is operational, fairly straightforward and deals with relatively modest administrative changes to existing departments as a new budget is put together.
For example, the procurement department determines its requirements for the next budget year and focuses on areas such as salaries, benefits, healthcare and office space. The department's growth should reflect the overall growth of the company and its corresponding need for procurement staff. Departmental operating budgets should offer few surprises.
Capital budgeting is different, and it involves large expenditures of cash for new investments. Capital budgeting software can be a great help in this invariably complex process.
To get an idea of the wide range of a typical organization's capital expenditures and why capital budgeting software is so useful in managing them, consider these simple examples.
The IT department might budget for a major increase in computing power that, if supported by top management, is likely to be approved. The risks involved are modest, and the costs and time frames are well known. The only significant issue going forward is how the increase in computing power will help the company.
Now consider a major capital appropriation for a new factory in Eastern Europe that will take three years to complete. Such lengthy projects are risky; the costs can be highly variable, and predicting future revenue streams from the investments is always problematic.
Budgeting for such project-centered capital expenditures is tricky since the investments are large, the time horizons add to variability, and both the cost and revenue streams can only be predicted. Later, I'll explain some of the important features of capital budgeting software and their role in managing these kinds of complexities.
Describing assets in capital budgeting software
For each business unit, it is useful to catalog all of the capital assets currently in use. Each capital asset should have a historical maintenance record -- maintenance of assets is part of the operational budget -- as well as a forecast of future maintenance requirements.
It may be a good time to replace the asset rather than incurring higher maintenance costs. Capital budgeting software can help companies create a portfolio of current capital assets and decide which to retire and replace. In any case, building a current catalog is a useful precursor to determining future maintenance costs.
Managing future capital expenditures
Other database tables in the capital budgeting software deal with future expenditures for new capital assets, and they include the following:
- a description of the capital asset and the relevant business unit;
- the future revenue stream to be derived from the new asset;
- the future cost stream to be incurred from the asset;
- all uncertainties about cost, revenue and project issues; and
- financial methods, including net present value, internal rate of return, discounted cash flow, etc.
If the capital expenditure is a project, the database entries should include a complete description of the tasks and contingencies within the project, and the software should provide an interface to any project management software being used for the project.
What kind of analytics will you need?
Microsoft Excel is clearly inadequate for the task at hand. At a minimum, the capital asset data should be stored in database tables, which means you need a real database, which capital budgeting software provides.
Even better would be to store the data in multidimensional tables, since the data is inherently N-dimensional (e.g., business unit, asset, time period). Multidimensional tables enable more sophistic analytics.
The system should come with a set of standard reports and a report writer that enables creating custom reports and extending existing ones.
The heart of your analysis should revolve around what-if analysis. Suppose 30 capital assets are under consideration. One what-if analysis might eliminate some of the potential capital expenditures to see if the company can manage with fewer assets.
Monte Carlo simulations deal with analyzing risk. Since a number of cost, revenue and time numbers can only be estimated, Monte Carlo simulations enable you to run hundreds of trials and examine the aggregate output.
Vendors of capital budgeting software
Corporate performance management (CPM) software has the capabilities you need for capital budgeting. Included in this category are Anaplan, Centage, Host Analytics, CCH Tagetik and others. CPM software provides the additional benefit of consolidating operational and capital planning in one place.
Some ERP vendors also provide capital budgeting software in the form of business intelligence packages that they sell. SAP BusinessObjects and Oracle Hyperion are prime examples. The vendors often combine their transactional ERP systems with their CPM systems, providing a good source of data for the capital budgeting software.
You should carefully examine how these capital planning applications are constructed and determine if you must buy both the CPM software and fixed asset software -- which is part of the ERP system -- for effective capital budgeting.
Two other vendors, Finario and PowerPlan Inc., bear mentioning. Both specialize in capital expenditures and provide the needed capital budgeting software and performance management tools.
D.C. government uses PowerPlan for capital expenditures
The District of Columbia, the municipal government of Washington, D.C., is a PowerPlan user. It is a rather unique government body, consisting of a municipality, a county and state-level government, and a school district.
Each entity manages an enormous amount of capital assets, all with differing degrees of maintenance requirements. The government agencies have maintained records of these assets with varying degrees of accuracy.
The first step in improving the process was to agree on a filing system to represent capital assets. The D.C. government chose a system called Capital Asset Replacement Scheduling System (CARSS), which runs on the PowerPlan software. Each agency was given a uniform template for loading its capital assets into the CARSS system.
Using PowerPlan's tools to analyze the CARSS system's database, D.C gained substantial insight into such key factors as the financial impact of deferred maintenance and how to prioritize capital projects to minimize risk. It was also able to improve the likelihood that capital projects would be well funded.
As a result of using CARSS and other software provided by an outside consultant, D.C. was able to fund its highest priority capital expenditures for the six years of its capital improvement plan through 2022.
By using capital budgeting software from its consultants and PowerPlan, D.C. can now catalog all of its assets efficiently, determine maintenance schedules and evaluate new capital projects. It is also more capable of funding new projects and rejecting projects that aren't important enough.
Integrate business plans with budgets
Use CPM analytics for budgeting
Understand the role of enterprise asset management software