CFOs look to old, new capital budgeting methods to keep profits high

money
Capital is king right now as companies are creatively pulling in profits.

Chief financial officers are getting creative about deciding what to invest in at a time when many U.S. companies are producing profits. To maintain those numbers—which stand at $2 trillion currently—while answering to activist investors, shareholders and financial analysts, CFOs are using a blend of old and new techniques, according to a CFO article.

“In a domestic economy that is potentially overripe and expanding at less than 3% a year, CFOs can’t just stick to standard operating procedure,” the article states.

They’re also grappling with changes to the ecosystem of capital investment, which is moving away from new machinery, manufacturing plants and other “hard” assets and toward research and development, staffing and software, the article adds. As a result, “budgets are less about updating old equipment and more about improving customer service, launching new products, securing corporate networks, and bolstering worker efficiency,” the article states.

To study potential investments, CFOs still use traditional capital planning techniques such as net present value (NPV), or the value in the present sum of money versus the future value, and internal rate of return (IRR), which also helps determine potential profitability by making the NPV from a project equal zero.

But they’re beginning to rely on new approaches, too.

Mark Partin, CFO at BlackLine, told the publication that “long-term capex decisions have gone the way of packaged software.” The accounting software firm has moved into a cloud-based software-as-a-service (SaaS) provider, the article adds. “Traditional capex has now been concentrated on cloud operations,” Partin said in the article. “I’m making short-term decisions on cloud applications—is this particular solution the right one to help us grow and invest in the right kind of people? Will it give us a return on our investment?”

Each of the company’s cloud providers signs up for annual terms as BlackLine shifts away from long-term commitments. Now, the company uses metrics such as the net promoter score, customer testimonials and reputation, not NPV at IRR.

The need to think fast is growing. To arrive at decisions quickly, Centage, which provides automated budgeting and forecasting software, uses a recurring revenue model with a predictable revenue stream, according to the article.

“If we strategically want to grow 40% this year, we look at the investments we need to make to support that; if we can’t afford the investments, we lower our growth goals,” Centage CFO John Orlando told the publication. That eliminates the need to look at each one’s IRR or NPV, “just the ROI,” he added.

To see this in action, consider the company’s adoption of Concur, an expense-reporting solution. Before using that, the Centage consulting team spent three to four hours a week reconciling expense reports, and now it happens in less than 30 minutes, saving 25 hours per week for people billing $250 an hour, the article states.

Long-term outlooks still matter, though. In looking at an enterprise resource planning system, which requires upfront capital investment, it’s hard to say what the market will look like in 10 years, making a SaaS product the clear choice, said Pegasystems CFO Ken Stillwell in the article.

“In making those decisions, Stillwell still performs a 15-year discounted cash flow (DCF), an analysis that projects the investment’s free cash flow into the future and then discounts this amount to arrive at a present-value estimate,” the article states.

The catch to all of this is that the investments that are hardest to measure—and riskiest—can be the most beneficial, the article adds.

“We don’t always pick the project the DCF says makes the most bottom-line sense,” Stillwell said. “If three potential capital projects break even from a DCF standpoint, meaning we shouldn’t invest in any of them, but one of the projects has considerable strategic upside, we’ll take it on. Even though we know we’ll lose money initially, we have to do it.”

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