The role of CapEx budgeting in CapEx planning
Explore how CapEx budgeting underpins successful capital expenditure planning.
Capital expenditure (CapEx) involves significant outlays and have a substantial effect on the financial health of an organisation, impacting growth, productivity, and competitiveness.
Therefore, setting the annual CapEx budget requires the ability to plan, allocate, and control long-term investment, with a focus on maximising return on investment and strategic alignment.
In this blog, we outline the step-by-step process of setting a CapEx budget and examine potential pitfalls and best practices.
What is a capital expenditure budget
A capital expenditure budget outlines the planned expenditure allocated to CapEx investments over a financial period. A budget template will typically include:
- Business unit/department name
- Categories such as land, building, machinery, IT, leases, vehicles, and equipment
- Priority level e.g., high, medium, and low
- CapEx type such as automation, expansion, replacement (with the last purchased date), and compliance
- Spend descriptions with a brief justification e.g. age, condition, need, and location
- Amount estimate (in the local/global currency) and spending by month/quarter/year
Benefits of CapEx budgeting
Align with corporate strategy
What is the justification for the investment, and how does it support your strategy?
A good capital expense budget ensures that capital allocation aligns with long-term business objectives such as expansion, sustainability, or compliance.
Supports proactive asset management
The annual capital expenditure budgeting process encourages business units and departments to proactively assess the performance of current assets and budget for the repair, upgrade, or replacement of existing equipment, technology, and infrastructure.
Improve cash flow forecasting
Capital budgeting encourages detailed cash flow forecasting, allowing companies to align investments with cash inflows and outflows throughout the financial period.
Increases transparency and accountability
The CapEx budgeting process assigns ownership to each capital project.
This will increase accountability for delivering the project on budget and on time, supporting a culture of ownership. It will also reduce the potential of project/cost overruns and unnecessary or politically motivated spending.
Supports post-investment review (PIR)
PIRs provide insights into capital projects, comparing forecasted and actual performance and assessing ROI, timelines, benefits realisation, and expenses.
The feedback from a PIR enables the capital expenditure process to be continually refined and improved, utilising lessons learned from both successes and failures to inform future capital expenditure budget cycles and enhance future projects.
Claim capital allowances
Organisations can often benefit from tax relief on capital expenditures.
In the UK, some (or all) of the value of an item is deducted from profits before tax . Businesses can claim capital allowances on plant and machinery, research and development, patent rights, and intellectual property. For example, an annual investment allowance (AIA) allows organisations to claim up to £1 million on plant and machinery such as equipment, machinery, and business vehicles (vans, lorries, company cars).
Pitfalls of poor CapEx budgeting
Budget overruns and delays
A McKinsey study found that 79% of CapEx projects experienced cost overruns compared to initial budget estimates . The same report found 52% of projects suffered delays compared to original estimates.
Price fluctuations, inflation, and supply chain disruptions create a challenging environment for setting capital budgets, especially for large-scale CapEx projects spanning multiple years.
At the same time, underestimating costs, poor CapEx planning, and/or unforeseen circumstances can result in unexpected/unbudgeted costs as well as overcapacity or shortages.
Both scenarios can lead to a heightened risk of budget overruns and extended timelines.
Poor strategic alignment
Without strong governance, projects may move forward despite offering weak strategic value. If a proposal does not contribute to long-term objectives, the investment should not receive funding.
Inadequate governance
Without governance, capital decisions may be influenced by internal politics or personal bias. In addition, organisations may lose control of CapEx spending without sufficient oversight and reporting capabilities.
Stage-gate processes support good governance, reduce risk, and deliver better outcomes. Their incremental nature means that organisations avoid allocating capital to projects that no longer meet strategic objectives, or where better solutions have become available in the time since a preferred vendor was identified.
Siloed planning across departments
Another challenge is siloed working.
Siloed teams can focus on their own agenda. This can have a negative effect on the capital budgeting process, which requires cross-functional collaboration to agree on budgets.
Without collaboration, capital expenditure requests risk missing expected synergies and duplicating effort.
Inaccurate cash flow forecasting
Capital expenditures support business growth but require substantial upfront costs, which can impact cash flow.
A good CapEx budget will spread costs over the financial period and increase free cash flow (FCF).
Poor cash flow planning can cause liquidity issues, forced cost-cutting, and project delays.
Reduced ROI
A poor budgeting process can lead to reduced ROI due to cost overruns, delays, and strategic misalignment.
Balancing competing priorities
Another potential drawback is failing to balance your CapEx portfolio between:
- Short-term and long-term projects
- Growth vs maintenance projects
- Strategic objectives (e.g., market share, sustainability, compliance, efficiency)
- Project category (e.g., growth, maintenance, regulatory, and technology)
- Risk appetite (e.g., risk averse, risk seeking, and risk neutral)
A diversified portfolio will balance high-risk/high-reward investments with more stable projects. This will reduce exposure to significant risks and prevent over-commitment in one area.
How to create a capital expenditure budget
An effective CapEx management process starts with setting a capital budget. The budget process is completed towards the end of each financial year and outlines the planned expenditure for the next period.
In many organisations, top-down budgeting is common. With this approach, senior management will allocate a set amount to individual departments. For example, a hotelier will commit around 3% of a hotel’s annual turnover to capital expenditures.
However, some organisations adopt a bottom-up budgeting approach where individual departments are required to list proposed projects and associated costs on a spreadsheet and submit their budget to senior executives for approval by email.
At the same time, they will need to submit an initial business case containing brief details (strategic fit, scope of work, risks, timescales, costs, etc.) of each proposed project outlined in the budget spreadsheet. A more detailed business case is required later in the process.
Bottom-up budgeting involves the following steps:
The budgeting process commences with a bottom-up needs assessment to solicit input from departments, who will assess current and future needs by analysing:
- Asset condition and lifecycle
- Performance and production data
- Maintenance records
- Strategic priorities
- Operational inefficiencies
The budget process should consider the potential replacement/repair of current capital assets in the forecast period (maintenance CapEx) and projects that will grow the business (growth CapEx).
The proposed budget (and outline business case if relevant) will be submitted to department heads, who will review/comment, edit and approve the budget before submission to the board of directors for sign-off. The following areas should be considered:
Funding availability
Significant funds are required to finance capital expenditures.
Finance evaluates available capital using financial statements, projected income and expenditure, and free cash flow. The finance team will also consider historical capital spending plans.
An additional factor is borrowing capacity and the availability of external finance.
External Loans and leases are alternative funding sources for capital projects, while phased investments can ease pressure on cash flow and budgets.
In setting the capital budget, finance teams must balance long-term business growth with cash flow management and shareholder dividends.
Once finalised, finance will share the information with senior management, who will set the maximum budget for each business unit.
Strategic alignment
The capital budget should allocate funds to capital expenditure projects that align with the organisation’s long-term strategic goals. Therefore, department heads need to ensure the proposed initiatives support the long-term vision.
For instance, if you’re a hotel owner/operator and a corporate objective is to increase revenue per available room (RevPAR), refurbishing guest rooms should be a high-priority project.
Additionally, an in-depth analysis of key market trends and competitor activity is important to anticipate consumer demands and exploit emerging opportunities.
Financial analysis
Every organisation should conduct a financial analysis to understand the potential ROI for each proposed project. These are likely to include metrics like:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback period
- Weighted scoring models
Executive management will assess if the potential project is feasible based on the financial models. They will also compare the financial viability with competing projects.
Risk assessment
Every capital investment is high stakes and carries risk. Key management will want to evaluate:
- Potential risks
- Impact
- Likelihood
- Mitigation plans/actions
The most acceptable risk profiles will move forward and receive funding.
Each project is prioritised and ranked.
Approved projects are added to the budget for each department, which outlines all planned CapEx for the upcoming financial year, including amounts, priority level, new/replacement, and expected completion dates. The budget will also include committed CapEx (e.g., projects previously approved/in progress) and deferred CapEx (e.g., projects delayed).
Before the start of the new financial year, the approved CapEx budget is distributed to each business unit. At the same time, a contingency budget is made available to the business unit, which can be allocated as required during the fiscal year to address ad-hoc projects.
All planned capital expenditure for the upcoming financial period (usually one year) is included in the budget. However, the inclusion of a project in the approved budget does not give authority for a business to spend or commit to capital expenditure budgeted. A separate CapEx request is still required for each individual project in accordance with the authority matrix.
The capital expenditure request is more detailed than the initial business case and will include:
- Strategic justification
- Cash flow forecasts
- ROI, payback, IRR, or NPV projections
- Quotations and timelines
- Risk assessments
Once approved, the project moves to the implementation phase: procurement, contracting, installation, and commissioning.
Clear governance and project management are essential to avoid delays and cost overruns.
Continuous monitoring ensures the project stays on track and delivers expected benefits.
The budget should be reviewed and adjusted in the event of competitive threats and/or opportunities.
CapEx software helps track:
- Actual vs budgeted costs
- Project progress and cycle times
- Risks and bottlenecks
- Vendor performance
- Invoice and payment status
Once the project is operational (or the asset has been purchased and is in use), the organisation will conduct a PIR to assess ROI, benefits realisation, and lessons learned. This feedback loop improves future capital expenditure management.
Best practices for budget setting
Use zero-based budgeting (ZBB)
With zero-based budgeting, every new budget cycle starts from a zero base.
Closely related to bottom-up budgeting, ZBB requires each item to be justified and approved from the outset.
With ZBB, CapEx projects are evaluated and prioritised based on their ROI, strategic alignment etc.
Limit year-end spending
In many organisations, year-end is the last chance to utilise the allocated CapEx budget. This can lead to “use it or lose it” reactive spending, bad procurement and poor project execution.
To optimise CapEx spending, reallocate funds, carry over the remaining budget into the next fiscal period, or avoid a “hard stop” by implementing a rolling, multi-year budget. This is useful for long-term investments that have lengthy lead times or staged delivery.
Incorporate scenario planning
Use scenario planning to test how unexpected events (e.g., exchange rate fluctuations, inflation, and supply chain disruptions) will impact project feasibility. This stress test ranks each project in terms of best case, base case (most likely), and worst case.
Similarly, sensitivity analysis compares how changes in key variables (e.g., investment costs, discounts, and depreciation) affect CapEx outcomes like NPV, payback period, or IRR.
Separate CapEx and OpEx
Create separate budgets for day-to-day operational expenses and longer-term capital expenditures.
Prepare a contingency budget
Establish a contingency budget for each department to use as required during the financial period to address ad-hoc projects and unforeseen expenses.
Leverage technology
Traditionally, finance teams have relied on Excel spreadsheets to manage the annual budgeting process. However, technology solutions like eCapEx are available to support the capital expenditure process from project prioritisation and budget setting to request submission/approval and post-investment review.
Conclusion
CapEx budgeting is a strategic imperative and can help companies make more informed investment decisions.
Whether you’re in hospitality, manufacturing, or any other capital-intensive industry, budgeting software alongside a bottom-up needs assessment and a rigorous commercial evaluation can help organisations assess opportunities, prioritise investments, and set budgets accordingly.
Please call 03300 100 000 or contact us to book your eCapEx demonstration or discuss your requirements.