Persuading the Finance Committee
Here are some tips on making the financial case for capital expenditures
By Randy Broadwater
Miller Electric Mfg. Co.
When all business projects compete for the same pool of capital dollars, how can manufacturing managers and engineers make their request for new equipment stand out?
It can be done by learning to speak the financial language used by the persons responsible for business profit and loss, including general managers, financial officers, controllers, senior management, or even bank loan personnel. Before moving to the capital approval process, however, manufacturing-oriented personnel need to establish a baseline that enables them to measure improvement. The improvements so measured will finance any new expenditure.
Modern manufacturing and high-volume fabrication operations must focus on continuous improvement to remain profitable and competitive. Continuous improvement in manufacturing companies can take many forms. In recent years, manufacturers have applied lean manufacturing to their operations with good results. Subsequent improvements obtained through the use of digital control technologies in modern production systems have helped increase throughput, reduce warranty cost, reduce scrap, lower cycle times, and improve quality. Digital control technology can also lower costs associated with inspection, testing, engineering evaluation and disposition, and subsequent rework. These technologies can even help overcome the shortage of qualified personnel.
To determine the impact of activities aimed at enhancing the productivity and efficiency of a manufacturing operation, the current state of the operation must first be measured to establish a baseline for any potential performance improvement. Note that the real impact of improving a manufacturing process may be felt beyond the production cell in upstream or downstream operations. Upstream areas in a welding operation, for example, include the tooling, forming, stamping, bending, fixturing, and even the associated piece-part tolerances and weld prep (grinding or shot blasting to remove mill scale, degreasing, applying anti-spatter solution, etc.). Downstream areas include rework and repair stations, inspection, and paint prep (removing weld spatter, grinding, polishing).
Measuring the impact of new processes or equipment may require input from other areas that they touch. Often, companies form purchasing or project teams that include a technical person who specifies the manufacturing equipment (typically the supervisor/engineer/manager), a financial approval person (usually from management), a representative from the purchasing department, a safety manager, a maintenance manager, and someone who represents the machine operators.
Note that labor may account for a significant portion of your total manufacturing costs, but it's equally important to understand material costs, utilization costs, and cost-avoidance opportunities, especially if production rates are increasing. Each situation may differ. To help you understand your costs and to gain a valuable outside perspective, work with equipment suppliers, integrators, and distributors who are prepared to take a consultative approach.
A good vendor/supplier partner wants to explore and understand your operation by asking a lot of open-ended questions that will allow you to explain your issues in depth. Be wary of the stereotypical sales guy who does all the talking and offers a quick solution. Rather, the vendor should ask questions to help discover your needs, and uncover cost-saving opportunities.
Good questions from the vendor should be along the lines of: "What are your production problems and their implications?" or "If we changed factor X, how would it affect your organization?" A good consulting partner probes for your needs in depth, and listens most of the time. He/she should want to get out of the conference room or office, and walk the production floor with you. Only through a deep understanding of your manufacturing processes can a consultant determine if he/she can offer solutions that will solve your problems, benefit your organization, and be economically justifiable.
A supplier partner must truly seek a solution to your problem rather than simply try to sell you a product. In manufacturing, or any other business for that matter, no one should want you to acquire equipment just because the equipment is new or technically interesting. What you really need is a way to lower costs in your operation over time.
When purchasing new equipment, manufacturing engineers and maintenance superintendents need to understand the time value of money. To start, consider that your company can probably receive a 10% return at relatively low risk by investing in mutual funds and stocks. When it comes to capitalized expenditures, any equipment that doesn't produce a return greater than 10% may actually deplete company resources (assuming you can continue to get by with your current machines). The same holds true for equipment that doesn't have a payback time of 24–36 months or less.
To differentiate your request, from others when you present your project to decision-makers, translate its benefits into financial metrics such as return on investment (ROI) percentage, and payback time. You need to understand your company's capital-expenditure policies, and find out what other key measurements management might use.
To increase the likelihood of winning approval for your project, refer to the simple Economic Evaluation Summary shown in Table 1.
What factors do managers with financially responsibility and accountability look for?
- ROI = Savings/Investment expressed as a percentage; look for ROI ≥ 20%.
- Payback = Investment/Savings expressed in time; look for ≤ 24–36 months
Other key measurements include: lower warranty costs; reduced rework; improved customer satisfaction rates; faster order-fill rates; better safety measures; increased efficiency; reduced labor costs; a chronic qualified-personnel shortage; and lean manufacturing.
Spending policy is an important factor. What is the dollar limit at your company before a company must be capitalized (cost depreciated over time)? Is cost to be expressed in smaller increments? Be aware that different depreciation methods make a difference when justifying a purchase.
Equipment cost can also be expensed; you can take the hit now, make the purchase, and the cost is absorbed at the time of the purchase. There's no asset on record with residual value, the impact on the bottom line is immediate, and this type of purchase is typically easier to justify.
When communicating with the financial stakeholders of a business, there is no substitute for understanding their terminology, spending policy, and driving forces. Doing the math to calculate ROI and payback on what you know or have measured about manufacturing process improvement is fairly straightforward. Reaching the point where you can actually calculate cost savings can require several incremental steps.
One of the best actions you can take as a manufacturer is to allow performance trials on your own shop floor. This quantifies actual verses ideal results, and helps build a coalition of internal champions who will support the project.
Credible consulting sales partners who have confidence in their solutions will usually commit to a performance-based purchase order to allow this trial process to take place. It pays to thoroughly examine your current process, and then strive to identify all of the actual costs associated with it. This cost number will be the baseline from which any improvements are calculated. You can then document the demonstrated and measured results of the performance trials done in your plant. Improvements offered by, for example, new welding equipment and processes, will be compared to the existing "baseline" process.
When it comes to welding, our company's Advanced Manufacturing Systems (AMS) group representatives focus on the different needs and types of manufacturing applications. They are trained to help high-volume fabricators and manufacturers negotiate this financial jungle and translate welding benefits into bottom-line dollars.
Consider saving this article and passing it onto the next sales person who knocks on your door and knows everything about their products and nothing about how to save you money—there are still a lot of them out there.
This article was first published in the December 2006 edition of Manufacturing Engineering magazine.