All companies have multiple investment opportunities, in all areas of the company there are many opportunities for expansion and improvement. Simply ask each area leader what is needed and you will find requests like these:
Production: “We need to replace the yellow machine that is causing the bottleneck with a more modern one that needs less personnel, consumes less energy and produces twice as many units each shift with fewer quality problems. The new machine costs € 800,000 Euros if we buy it in Germany or $ 300,000 if we buy it in China “: Which will generate the best return on the investment?
Logistics: “If we had 3 additional trucks, we could improve customer service through timely and more personalized deliveries to supermarkets.”
Fixed Assets: “If we build our own warehouse we will stop paying rent in 3 warehouses that we currently have, we would obtain great logistical savings, better control and more comfort. In time we will finish paying the leasing used to finance the project and we will be able to generate greater profits. ”
Some of these investment opportunities are classified as capex and others as Opex:
The opportunities classified as capex or capital expenditures refer to the acquisition of fixed assets that will later be depreciated, among these are properties, machinery, computers, vehicles, furniture and fixtures.
When we talk about capex, these investments are usually of significant amounts and must be evaluated financially as projects, where financial modelling is carried out to know what the capital needs will be, the sources of financing, the expected benefits of making the investment and where they evaluate all the risks.
In this type of project, it is important to know what the financial risks are if things go wrong, the financiers usually analyze aspects such as:
- Internal Rate of Return (IRR)
- Period of payback.
- Operational breakeven point, operational + financial breakeven point.
- Current income without the project, expected income if the project is executed.
- EBITDA with and without the project.
- Economic Added Value (economic profit) with and without the project.
- Net present value (NPV), sensitivity analysis of NVP using different discount rates (cost of capital), prices and sales levels.
It is based on all these aspects that we recommend if a project should be executed or not, or if it should be executed with some variations on the initial idea.
On the other hand, those investments classified as Opex or operating expenses refer to operating expenses such as payroll, public services, fees, property rental, etc.
On these occasions, decisions impact operational spending (OPEX), such as when deciding to hire salespeople and opening commercial branches in other areas of a country, in these cases it is also important to evaluate what the impact on profits is if things go right or wrong, as well as its impact on cash flow.
I have seen in my career as a consultant how some companies invest three and four million dollars in a project (for example, expansion in production capacity) without making a correct evaluation of the project, it is these types of decisions that can put a company at risk when things do not go as expected, costing more than the initial budget (eg. Reficar) or take longer than budgeted (eg. Hidroituango).
I have also seen owners that buy the shareholding of their peers in a company without evaluating the price to be paid and the way to finance the payment, sometimes this has led companies and their partners to bankruptcy.
In conclusion, despite the fact that there are many investment opportunities in all businesses, these must be carefully evaluated by the company team and/or external expert advisors in project financial evaluation. This way you can prioritize financial resources that are finite in the projects that generate greater value for shareholders and the company in general, this will allow you to make fewer mistakes and will accept projects that generate greater value with a known and accepted level of risk.
Simón Restrepo Barth, Investment Banker, lecturer of finance, Partner of ONEtoONE Corporate Finance and member of several Boards of Directors.