The Risks of financing capital expenditure

There are real risks in financing capital expenditure ....... from your cash flow.  Business owners incur costs as a regular part of your company’s daily operations and they are unavoidable. This includes any maintenance or usage costs on equipment and machinery. However, you will also incur costs to acquire, build or improve assets you use for your business. The difference between these two is the difference between revenue expenditures and capital expenditures.

As a general rule, and to the extent that it is possible, if you are buying stock to sell in the short term, then finance it out of your day to day working capital. But if you are buying a large piece of machinery with a ten-year life, then you should look to finance it over ten years. Similarly, don’t fall into the trap of many small business owners where you have a good quarter and go out and buy yourself a flash new car straight out of the company’s cash flow. Unless you are confident that your strong sales will continue, you could find yourself in a cash flow bind if you empty the bank account to buy new assets every time you find you have a bit of surplus cash. Can the expenditure ride through any dips and troughs of cash flow? Have you left yourself short to continue to operate?

Form a strong relationship with a bank manager and keep them up to date with your plans. Banks will be happy to lend when times are good for your business and you should take advantage of that when financing any capital expenditure required in the expanding of your business. Similarly, the best time to secure an overdraft is when you don’t need it. The banks will be more willing and able to help you out and then if you hit a rough patch, you have a safety net. It’s a bit like an insurance policy but a great investment.

Capital expenditures are made for the purpose of capital investment and without such investment, it is difficult to grow a business. The purchase of large, long-term assets that depreciate over time is a capital expenditure. You make these purchases to provide the assets or infrastructure your company needs to grow its business and generate more profits. As such, you must use a sizable portion of your company's capital to acquire or install these assets. Many companies use debt financing or retained earnings to finance capital expenditures, but some use equity financing - hence the use of the term “capital” to describe the expenditure.

Capital expenditures are for new assets or major improvements that extend the life of an asset. For example, an extensive repair on a computer server is revenue expenditure. However, if you replace your computer server with a reconditioned server that now has two additional years in its life span that is a capital expenditure. 

Capital expenditure is still considered an investment in the business.  The expenses incurred by the new asset may be offset by the increase in revenue produced by it.  As a general rule, you may be wiser to take out a loan for the new asset (and receive the tax benefits) rather than reduce your cash flow to pay for it.

My advice:  Walk cautiously before you make a commitment.