Most organisations spend between 2% and 10% of overall revenue on capital projects – a huge investment that is rarely seen on the balance sheet because capital projects are owned by business units and never aggregated in their own right. If we don’t have transparency, how do we apply the right level of governance and process?
It’s challenging for many executives to grasp how the capital budget they are approving will actually be spent. In effect, some leadership teams approve a capital portfolio budget, rather than a portfolio of projects. Often, major spending is justified by a single line item in Excel, for example: “$5M warehouse”.
Capital projects are a critical means of translating corporate strategy into action. Top performers translate their strategic priorities into top-down guidance for resource budgeting, for example: 10% for sustainability projects, 30% for compliance, 50% for cost reduction projects, and 10% for growth projects.
This top-down guidance is important, but it doesn’t go far enough. Right now, it’s difficult for portfolio approvers to have a comprehensive understanding of the projects under consideration – and rarer still to see organisations with consistent governance mechanisms that they use to choose, support and track investments at the corporate level.
As a result, capital projects and portfolio management remain largely invisible to an executive audience – leading to capital leakage, poor capital investment returns and missed market opportunities.
Improve top-down guidance
How do executives know those projects are delivering strategic growth, rather than value destroying, growth?
Is the portfolio consistent with the company’s strategic priorities – and balanced according to key criteria? Is it focusing too much on “me too” rather than “disruptive” products? Is it favouring tactical investments with short pay-back times rather than supporting the higher-risk investments with longer pay-back times critical to supporting future growth? Are you overinvesting relative to your installed asset base?
Executives who don’t know the answers to these questions should be providing more targeted top-down guidance by going beyond the broad-brush percentages and providing specific and well communicated guidance relevant to each portfolio manager.
Evaluate projects using a centralised platform
Businesses proposing capital projects need clear strategic priorities translated into specific investment guidelines and budgets. Projects must be evaluated comprehensively against these guidelines.
The only way to carry out this task efficiently is to stop relying on spreadsheets. Not only are spreadsheets unwieldy, they are prone to human error and interpretation issues and often contain data that is out of date. Research shows that >90% of spreadsheets contain errors.
Spreadsheets make it very difficult to combine new and carry over projects during portfolio build. This is highly problematic given carry over projects can represent up to 40% of a portfolio.
To make project evaluation fast and simple, industry leaders are using cloud-based SaaS business intelligence platforms that can capture and visualise project “scores” on a dashboard.
On a platform, project teams can assess the attractiveness of a project using a common framework, including strategic alignment.
The outcome of the assessment is a numerical score. The higher the score, the higher the attractiveness.
This score becomes another tool to help portfolio managers create the initial portfolio build, which should then be reviewed by executives and assessed against revised top-down guidance, depending on changing market conditions, before being finalised.
Use dynamic resource allocation to smooth cashflow
Most capital project portfolios are managed according to the myth that projects start on the first day of the financial year and end on its last day. We see the consequences of this at year end when projects get pushed up against the fictitious financial year deadlines, leading to unintended consequences. Project managers have been known to pay to airfreight equipment in to they can achieve capital spend within the financial year! (The infamous hockey stick.)
In an ideal world, portfolio managers should be staggering projects throughout the year, starting and stopping strategically to smooth cashflow and remain aligned to changing strategic priorities. In this world, carry over projects would be seen as less of an issue and more of an opportunity to continue to shape the capital portfolio to meet strategic priorities.
CAPEXinsights makes this type of ongoing dynamic resource allocation substantially easier. It means portfolio managers can review projects with a focus on prioritisation, risk and spend across financial years. Dashboards help inform ongoing decision-making with real-time information to maintain the strategic intent of the portfolio and enable periodic portfolio health checks.
When assessing portfolio build, the platform makes it easy to see what carryover projects are in play, when they’re likely to finish and what that will do to cash flow. Then new projects can be put in place around these existing constraints, with portfolio managers able to manipulate different build scenarios to create the best strategic and cash flow outcomes.
When executives and portfolio managers have a means of evaluating, tracking and controlling capital projects, the annual portfolio build process becomes substantially more efficient. The result is a smart, strategic portfolio of projects that create both strategic and financial value.