Budgeting for Operating Competitiveness

Capital budgeting can be an important aspect of relations between systems integrators and operating companies that rely on internal logistics to remain competitive. It’s often difficult to determine what course of action will most benefit a company's long-term business objectives. Even more difficult is the acquisition of funding for speculative improvements in the way of financial and market uncertainty. As a consequence, some of the complexity involved in choosing among capital projects requires a consultative approach to planning and providing systems equipment through competitive processes.

Management preferences are often insurmountable. Discounting, growth rates, and various other financial considerations can be adjusted to satisfy these preferences. In doing so, sensitivity analysis allows the company a “last look” to see how resulting costs will vary from expectations set forth during the appraisal process. These costs are namely equipment and operating costs.

Starting Point Established
A facility's growth requires a careful look at available technology and systems processes that result in flexible and reliable means of achieving measures such as productive capacity, unit storage capacity, and unit shipping capacity. An operating company's objectives will normally touch on all three measures, but more often will concentrate on quality and customer service. Levels of quality and customer service address order accuracy and order cycle times in a distribution setting. Order accuracy and cycle times relate directly to shipping capacity and for this reason, shipping capacity is generally the most important measure of performance.

The capital budgeting approach offers a “systems solution” to a prospective customer in a manner that allows him or her to understand the financial impact of the buying decision on the business. A lower-priced solution is compared to one or more higher-priced solutions. This is often thought of as a “step-up” method for evaluating each potential project. In the capital budgeting world, this process is referred to as incremental analysis. Incremental analysis compares the differences in costs and benefits of each project to provide a series of evaluations for which the customer can see a starting point and ending point. Utilizing this “number trail” leaves little doubt in the customer’s mind that the project selected will provide the greatest financial benefit to support the long-term business objectives of the company.

Before a comparison of projects can begin, capital budgeting requires that each project stand first on its own merits. Any project may prove its worthiness if it can outperform the operating practices the company currently employs. A growing company is considering other means of handling and storing materials because current methods have become outdated or simply inadequate. An operation that relies on manpower to conduct daily business has a difficult time managing the ups and downs of its business cycle throughout the year. Growth compounds this problem further as inventories increase and customer needs become more complex. In capital budgeting terms, a facility's current operating methods, procedures, and level of technology are referred to as its operating baseline. Some operations rely on manpower seen in many manufacturing settings. For internal logistics, however, manpower usually must be minimized to improve quality and customer service. This is especially true in areas of decision-making and repetitive processes such as product sorting and order consolidation.

Understanding this relationship between a facility's business objectives and lower operating costs, alternative means of conducting daily business will often include levels of technology or automation that can be easily compared to a company’s operating baseline. In many instances, the current logistics operation is indeed labor intensive (costly) and often has its belly exposed through uncoordinated, disjointed, or frequently interrupted material flow referred to as a bottleneck to production managers and operations analysts.

Looking at Cash Flows
As we apply capital budgeting techniques, cash flow is essentially the “answer” we’re looking for when comparing today’s operation with tomorrow’s. Every time one investment is compared to another a series of cash flows is generated for each year the investment remains in operation.

Whether one competes in a market large or small, accounting for uncertainty is difficult at best. Some financial techniques are useful and help build confidence when forecasting economic conditions. One is the use of variable discount rates that increase as the project life is extended. To complement this adjustment is that of increasing the minimum accepted rate of return (MARR) as projects become larger in scale and negatively impact cash flows. Maximizing a project’s total profit by extending its life is more difficult, however, as it is so dependent on a company’s rate of growth and level of technology. Depending on its industry sector, often companies are afforded tax incentives by governmental agencies to build up infrastructure and compete on a wider scale. This is accomplished through allowances for facilities that inherently bear greater risk when assessing capital investment opportunities.

Scaling Up
Larger operations are generally confronted with more than one alternative means of increasing capacities and lowering operating costs. However, some processes are difficult to improve upon. Capital budgeting often shows that processes should stay in place due to a lack of order activity or due to product constraints that prevent the application of more automated methods. Logistics capabilities must be aligned to support this growth. In general, service is of high business value to our company regardless of the material mix of our customers.