A Structured Approach to Making Capital Investments
Leadership teams that have a consistent process to consider and to evaluate growth opportunities improve the likelihood of success. Following is a framework for how to think about capital projects. We define capital projects as incremental investment that aims to transform a process or a capability. For example, should a company automate a productions line given the required investment and reworking of the work flows?
Correctly thinking through new capital projects involves a structured approach that includes an evaluation of financial, strategic and risk considerations. Here is one approach to evaluating capital projects
1. Define the project and scope
- Clarify the objective and define what the project aims to achieve and how it aligns with the organization’s goals
- Define the scope and determine the project’s boundaries. Does this include a single product or all products? One plant or all the plants?
2. Articulate the feasibility of the capital project
- Analyze the market to understand current market demand, future trends, emerging customer needs and the competitive landscape
- Appreciate the technical feasibility by assessing the technical requirements, resources and capabilities to deliver the project
- Assess the legal and regulatory factors that may impact the project
3. Analyze the financial implications
- Estimate the real costs of the project including initial capital expenditure, operating costs and other financial commitments
- Forecast the revenue and/or ancillary benefits that project is likely to generate
- Develop multiple scenarios or cases to account for varying degrees of demand, complexity and timing
- Understand the financial impact by evaluating the project’s net present value and return on invested capital. Be sure to compare projects consistently
4. Assess the risks
- Identify key risks including financial, operational, market and environmental. Then quantify or estimate the potential size of those risks
- Analyze how to mitigate those risks. Assess the impact and likelihood of each risk and develop strategies to mitigate those risks.
5. Analyze the impact to stakeholders
- List all stakeholders impacted by the project, including investors, employees, customers, and communities
- Determine how the project impacts these stakeholders and how their interests and influences affect project success
- Communicate the impact of the project to the stakeholders
6. Evaluate and select
- Establish criteria based on the strategic fit, financial returns, risk profile and alignment with corporate goals and sustainability targets.
- Introduce a decision-making process to score and to weight each project based on consistent criterion and weightings to reflect their importance
After having thoroughly assessed the capital projects, the Company should be informed and prepared to make a well-reasoned decision. Once the decision is made the Company would continue by:
- Allocate necessary resources
- Create an implementation plan
- Obtain approval, then launch
Once the project is rolled out, it is important to review the process and adapt future plans based on key learnings. The Company should document lessons learned and integrate this knowledge into future project planning and decision-making processes.
This framework provides a systematic approach for managers to evaluate new capital projects, balancing the potential benefits against the risks and costs. By following this framework, managers can make informed investment decisions that align with the strategic objectives and financial criteria of their organizations.
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