Financing Capital Expenditures

A big part of the success and value of a business is in the cash flow management.  Which is significantly impacted by Capital Expenditure, commonly referred to as CapEx.

Many businesses require a Capital Expenditure Investment in Equipment or other machinery (FF&E) that needs refreshing on a regular schedule.

So, the question comes down to how to manage these expenses.

Financial Reserve Account

One option is to set aside a Financial Reserve on a yearly basis.  Doing this is equivalent to building up a ‘rainy day’ fund.   This does reduce the on going cash flow to the bottom line in terms of profit, but it is a practical way to prepare for major capital expenditures.  Since profits are being diverted to the Reserve account, this method has a negative impact on the on going profits of the business.  However, this does reflect positively on the company’s balance sheet, as the Capital Expenditure Reserves are listed under the assets column.

Positives:  Capital Expenditure Reserves Accounts reflect favorably on the balance sheet
Negatives:  Reduction of Bottom Line Profit

Line of Credit

Another option is to carry a line of credit to use when Capital Expenditure arises.  Since no profits are being diverted to a Capital Expenditure Reserve account, this does not affect the on going profit of the business, which means it would show a higher profit than a business that is setting aside reserves.   However, a line of credit does impact the company’s balance sheet  negatively, due to the fact that it shows up in Liabilities column.

Positives:  No adverse effect on Bottom Line Profit until the Line of Credit is Used
Negatives:  Line of Credits adversely affect the Balance Sheet

Which method of financing capital expenditures makes the business more valuable?  Neither one does, per se, since there are many Business Valuation formulas that go into a Business Valuation.  Each formula accounts for the effects of a Capital Expenditure Reserve Account in different methods.  In some methods having a strong cash reserve in the Capital Expenditures account is factored in strongly, and in others much less.  Thus, your situation isn’t as simple as just multiplying some number times your profit.

Looking for assistance with financing your Capital Expenditures?  Curious how much your business is worth, Just Elementary, Inc, Business Brokers can help you with Valuation Matters, contact our Client Care Manager Sonia Chhabra at  (888) 926-9193 or email cs@justelementary.com for an assessment of your company’s situation.