Are you proactive or reactive in your planning?
Having a long-term strategic investment plan is a key element of creating wealth. Are you likely to create a high value business by responding to pressing needs? There are many competing demands for capital investment in every business. These include:
- The need for more capacity
- The need to reduce costs of production/delivery (e.g. automation)
- The need to have a deeper knowledge of the drivers of profit
- The need to create new product/service lines
- The need to enter new markets
- The need to make acquisitions
If these demands are addressed only when they become pressing, they business is unlikely to achieve the best outcomes that it can.
Over many years working with SME businesses we have rarely seen a structured 5-year capital investment plan (or even a 3-year plan). Investment plans are discussed and are generally needs driven. Even the occasional strategy workshop will focus more on positioning, future directions and often include vague goals such “develop our teams”, “better understand our customers’ needs”, and so on.
Businesses need to have quantified capital investment plans. These will have a long-term budget, implementation timelines, clear return on investment objectives, and an understanding of what the business will look like in 5 years’ time. That would include its revenue, gross margin, NPAT and net assets. These are firm numbers against which the business can frame its plans.
Proactive investment planning will be determining the capital investments that are needed to achieve the long-term planning outcomes.
Great businesses are built on long-term planning?
The ceefo Wealth Engine program is based on the fundamental principle that achieving higher returns on equity (ROE) on an increasing equity base is the key to creating wealth. Achieving high ROE on a low equity base that remains low is missing the opportunity to harness the compounding impact of ongoing good ROE outcomes.
This means that management will need to spend a significant portion of their planning time reviewing investment options. Our observations over many years working with SME businesses is that the vast proportion of planning time is focused on profit related issues. Profit is critically important. But we believe that most SME businesses need to devote a lot more time to capital investment planning.
The planning needs to be done with a clear understanding of what is realistic. The 5-year planning period enables the business to generate a significant capital investment budget. When the capacity maintenance budget (depreciation & amortisation) and debt funding options are added to the retained earnings, the size of the capital investment budget can be a revelation to management.
Major investments cannot be implemented in a rush
The two big key risks in relation to implementing bigger capital investment plans are assumption risk & implementation risk.
Assumption risk refers to the assumptions used in the capex analysis on the major capital investment projects. Larger investments need time to review and test the assumptions. It is also important to fully explore that all possible outcomes are considered. Not considering outcomes in the planning stage that eventuate in the implementation phase can seriously harm the investment returns
To achieve this, plans cannot be rushed.
Capital investment planning also must be tempered by the capacity of the business to implement the plans. Experienced managers will not only be aware of this, but they may be overly wary about big plans because of the impact they could have on existing operations.
Once again, the key to mitigating implementation risk is more detailed planning of implementation. Where a business does not have dedicated project management staff, they would need to consider using consulting project managers.
Like almost all complex projects (and not so complex), putting more effort into planning is the key to mitigating the implementation risk.
Having a 5-year planning outlook period provides the timeframe for longer term planning and this enables a lot more effort to be put into the review, analysis & planning activities that are so critical to success.
How the Wealth Engine program supports building a great business
The ceefo Wealth Engine program is a structured program that provides the framework to undertake the 5-year capital investment planning process. This is a dynamic program that is reviewed and updated on a quarterly basis using the previous completed financials and the current forecast financials as the starting point to generate the budgets and target ROE outcomes over the 5 years of the planning period.
Ask your CFO or advisor to implement the “ceefo Wealth Engine Program” and support you to establish and maintain your own WEALTH ENGINE.