What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Qualitative Factors in Capital Investment Decisions

Original post by Brian Hill of Demand Media

A company's capital investments are expenditures made with the expectation they will result in long-term benefits -- improved efficiency or productivity, cost savings and increased revenues. Many times they are expenditures on operating facilities and equipment. The finance department attempts to calculate the payback period for each proposed capital expenditure or project. This calculation shows how quickly the project's benefits, in numerical terms, will pay for the cost of the project. The pure financial impact is not the only determinant of whether an expenditure will be made. Qualitative factors are considered as well.

Contents

Environmental Impact

In response to consumers' growing concerns about protecting the environment, many companies have included expenditures in their budgets that serve this important cause, going beyond what is required by government regulations. Companies that are perceived as good stewards of the environment are viewed in a more positive light by both consumers and stockholders. This can have a long-term positive financial impact on the company, though the impact is difficult to quantify. Companies that win awards or receive recognition for environmental stewardship receive valuable positive publicity and increased consumer awareness. These benefits can translate into acquiring new customers and greater loyalty from existing customers.

Employee Morale

Companies sometimes spend money on capital improvements because they want to create a better work environment for their employees. Ordering new office furniture, for example, may not have an immediate, quantifiable payback for the corporation, but it can boost employee morale and result in greater productivity. The company's management is perceived as caring about whether the employees have an attractive, functional, comfortable place to work. The quality of the office environment is also important to presenting a positive image to customers and vendors who visit the office. The finance department may not be able to quantify the benefits of these expenditures. They have to look at the project in reverse -- if the office environment looked shabby or outdated, would the company's image suffer to the point that customers would do business somewhere else?

Ancillary Benefits

Large companies with enormous research and development budgets are constantly in the process of developing new technologies. The payback for some of these may be many years down the road, if at all, and extremely difficult to forecast. Creating a corporate culture dedicated to innovation often leads to unexpected and dramatic breakthroughs in technologies. An expenditure on Project A leads to a spin-off invention -- Project B -- that ends up having much greater commercial viability than the original Project A that received funding. The company's management had the courage to approve Project A even though its benefits could not be easily quantified, nor could the eventual profitable spin-off been foreseen. The company had faith in the creative process itself.

Strategic Factors

A capital expenditure may be made that doesn't fit into the company's current goals at all. A retailer might purchase a tract of land years in advance of any plans to build a location on the property. They take this step to prevent a competitor from acquiring the property, knowing that the traffic in the area is growing and someday it will be the ideal location for a new store. The immediate payback for the expenditure is not allowing the competitor to secure an advantageous location that could boost its revenues and market share.


                   

References

  • "Financial Management 101: Get a Grip on Your Business Numbers"; Angie Mohr; 2007

About the Author

Brian Hill's first writing credit was the cover story for a national magazine. He is the author of three popular books, "The Making of a Bestseller," "Inside Secrets to Venture Capital" and "Attracting Capital from Angels." Among his magazine article credits are the March 2005 and June 2008 issues of "The Writer." His interests include golf, football, movies and his two dogs.


Advertisement