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Living in denial

My favorite part of a new role is meeting my new finance team.

First in a large group, to make sure everyone hears the same messages. Then in smaller groups, by team/part of the business. Then, finally, I try and meet as many people 1-on-1 as possible. Even if that takes a year or more to get around to a large team.

Today I was meeting James and Mary. Two business analysts who had been rated by the business as having the highest potential. These were my favorite kinds of conversations. Seeing how we were using our rawest talent.

Both proudly told me how they were working on ‘Project Graham’...

OK, I’ll bite: “WTF is Project Graham?”

They explained that it was a major capital project. Over $100m. And they were the ones pulling the business case and capital approval form together.

The penny dropped, as I realized while the project name was unfamiliar, the project itself was not. This was one I had culled from the plan months earlier (as part of the anecdote I shared last week).

It was completely unaffordable for the next three years at least.

This was frustrating. It was clear that the divisional president sponsoring the project wasn’t ready to let it go just yet. Even though it had no chance of happening.

And it wasn’t just any resources he’d tied up. Two of the brightest analysts in the business were spending 50% of their time working on the business case.

It was not their fault, of course. The message hadn’t reached them. And they were gladly working on what was a big, sexy project. That they reasonably believed to be the biggest priority in their part of the business.

It was yet another example of how this business was woefully poor at communicating priorities and allocating resources. Letting politics and mediocrity get in the way of doing a good job.

The opportunity cost of their time was huge. We could have gotten far more useful output from them if they were working on the right things. And they would learn way more.

I had to figure out a way of communicating what projects were ‘inside’ the CapEx envelope and which were not. So we could 5x our focus on those projects, and 0.1x our focus on projects outside.

Burn the Boats: Making CapEx Approval Decisions

This is part 4 of a 5-part series covering the CapEx process.

• In the first week, we set out the correct mindset for a CFO when evaluating CapEx

• In the second week, we defined the total pot available to spend on CapEx. The CapEx ‘envelope.’

• Last week we started to allocate that pot to individual projects, so we could prioritize which projects to evaluate further.

So, let’s take stock. We have a defined total CapEx budget, and we have some projects we intend to use it for.

But we haven’t actually yet greenlit any projects. Today we will talk about the process for formally approving the projects.

This is the important bit. This is where the real commitment happens. The checks get written, and the team gets mobilized. We are about to squeeze the toothpaste out of the tube, and there is no putting it back.

So this can’t be a rubber stamp exercise, despite the work we’ve already done. Far from it.

Roles in Capex Evaluation

At this point, the business is financially and strategically committed to the project in principle.

But now we need to ensure the business is holistically committed to it and remove that ‘in principle’ qualifier.

Holistic business commitment is a bigger job than it sounds. If it’s a big project it could involve much more people. This means roles and responsibilities in that approval are important.

Let’s cover some basics:

Note one person could cover one or more or even all of these roles. Likewise, one role could go through multiple levels in a complex business (i.e. signing off the financials at different levels).

Project Manager - This is the person who is responsible for delivering the project. Whoever will be running the project on a day-to-day basis. This is also the person that will get promoted if the project goes well, and fired if the project goes to sh*t. Sounds brutal. But acute incentives are important, as the quality of the project manager is the single biggest success factor in the delivery of a CapEx project. More on that next week.

Project Sponsor - This is the person who is accountable for the project. This is whoever needs to go and explain the status of the project to the board. This can be the same person as the PM but in large businesses typically it is someone different. They are normally the line manager or CXO responsible for the PM.

Buyer - This is the person responsible for ensuring you get the best possible price on the materials and services when the money gets spent. i.e. you are not overspending on the investment itself. In a big business, there may be a dedicated buyer for CapEx or a VP of procurement. In a small business, this will be the project manager.

Business Partner - This is the finance person who is ‘running the numbers.’ They have validated the operational assumptions, converted that into a cashflow projection, run the sensitivities, and identified the risks. They are the person everyone looks at when someone asks “what sales volume uplift are we assuming in year 2?”

Master of Coin - This is the person who is responsible for the money. The one making the capital allocation decision. Are we ready to give this project manager and their project the money they are asking for? Do we have it? How are we funding it? This will be the CFO most of the time, but not always. It depends on the specific authority limits and size of the project.

Ultimate Approver - This is the person with the authority to actually approve the project. The ‘buck stops here’ person. Most often this is the CEO. But, in larger orgs this will be delegated to different parts of the business, depending on the size of the project.

Approving Stakeholders - These are the leaders of functions that are affected by the project. For example, a manufacturing project will need someone to sign off on health and safety. Anything with a significant labor impact should be signed off by the CHRO. If it’s a capacity increase that relies on growth, then you need your CRO to agree to new targets. IT, procurement, product, etc. There could be a long list of approving stakeholders on a complex project. These people can also help you decide if something is maintenance CapEx or not.

CapEx Committee - This is a group of senior people from the business who set the CapEx rules and govern the overall process, authority limits, etc. Normally chaired by the CFO or COO. Done right, it plays a vital role in cutting through internal bureaucracy in complex businesses. Done wrong, it’s another layer of useless corporate crap. As CFO you set the tone for this forum, so make sure it’s valuable. The CapEx committee can be used as a way of assembling individual signatories into one place. And it can also play the role of a collective ‘final approver’ on large projects.

Board - For the largest projects, the board will act as the CapEx final boss. Even the CEO can’t do whatever they want. The board will set a ‘delegation of authority’ which will say what the CEO and CFO can and cannot green-light without board approval. We talked more about this here. A critical feature of this is a sensible CapEx limit. This is a useful protection for the CFO. I’ve worked with a $15m limit most recently, meaning anything above that will automatically need board approval, in addition to myself and the CEO. It gives the whole process teeth and keeps the CEO in line too. The limit needs to fit the business size.

The CapEx Approval Form

So, how do you govern this nightmare workflow?

Historically, this has been through a CapEx Approval Form (CAF). Every business has one of these. They are normally referred to by some acronym. I’ve also seen them referred to by a color (a ‘yellow’ form), purely because someone decided years ago, they should be printed on yellow paper.

So what does a typical CAF include:

1. General Information

• Project Title

• Project Reference

• Submission Date

• Project Manager

• Department/Business Unit

• Sponsor

• CapEx Category (Maintenance CapEx, Growth/Efficiency)

2. Business Justification

• Project Elevator Pitch

• Project Description

• Business Need

• Expected Benefits

• Alternatives Considered

• Risk Assessment

• Impact of Rejecting the Project

3. Financial Justification

• Total Estimated Cost

• Timing of Investment

• Funding Source

• Financial Impact

  1. Impact on Revenue

  2. Impact on Margins

  3. Impact on Expenses

• Return on Investment

  1. NPV

  2. NPV Per $ Invested

  3. IRR

  4. Payback

  5. Cash on Cash Return

• Sensitivity Analysis and Scenarios

• Key Assumptions

• Breakdown of spend (and supporting quotes)

• Detailed cashflows and supporting workings

4. Implementation & Execution Plan

• Project Plan

• Key Milestones & Deadlines

• Dependencies & Required Resources

5. Stakeholders

• A section for each affected department to comment/risk assess (e.g. ESG, IT, H&S)

6. Approvals

• Project Manager

• Sponsor

• Buyer

• Business Partner

• Approving Stakeholders

• Master of Coin (CFO)

• Ultimate Approver (CEO)

While the top page summarizing the above might be 1-2 sides of paper, the detail that sits behind it can run and run. A great CapEx form will include all relevant supporting details, but no more.

This rarely gets done right. From my experience most project managers either share woefully little important detail, they share the wrong detail, or they share everything they have. All make for a painful process.

And all are signs that the project is underprepared, or doesn’t have the right oversight.

The less the project team has ‘tied the threads’ together, the more it will be incumbent on you, as the CFO, and the CEO, to do that thinking for them. So beware…

Automating the Process

This process sounds like it should be automated. But in most cases, it is not.

The old school manual Word or Excel form (and a metric sh*t ton of supporting files) has been surprisingly resilient. Like a turd that won’t flush.

This is clearly archaic and needs to change. The tools are out there, they are just hard to implement or low priority (and legacy ERPs notoriously do this part of the process badly).

Sounds like a great AI use case to me…

If you are building this, I would be interested in investing. Just hit reply.

Approval Limits

This sounds like a lot of bureaucracy, right? Yeah, it is.

Is it always necessary? No.

This is where your approval limits come in. They should be designed so that the level of process matches the risk, size, and complexity of a project.

This is most commonly done on investment size, i.e. projects above certain investment levels need different layers and levels of approval. And this makes sense, with investment size being a proxy for risk. But it’s not the only way of thinking about it.

Even small projects can be disruptive if they go wrong. Other ways you could set approval criteria:

• Risk-based limits

• Strategic importance

• In the envelope vs out of the envelope

• Complexity/Cross-functional impact

• Payback period

• Maintenance vs Growth

• Impact on customers

These do require some qualitative criteria, but it’s not insurmountable if it's important enough.

The benefit is that it ensures that projects that don’t need scrutiny don’t get bogged down. For example, anything with a payback of less than 12 months should have an accelerated route through the process.

And the projects that need deeper consideration get the slow thinking they deserve.

Having clear rules for which approving stakeholders get to sign off on which projects are important, too. You do not want to give departmental heads more power in this process than they deserve. They need to be involved in the projects that affect their functions but should not have the power to hold up projects unnecessarily. It happens ALL THE TIME. Yes, it’s a sign of a weak culture. But it’s also a sign of a weak process. Your process.

Leases

You might ask what role lease funded CapEx plays in all of this. There is a good question in Tuesday’s mailbag on this point. So I’ll tackle it there instead…

Capex Approval in Practice & Sign-Off

Getting a CapEx proposal to a stage where it is ready for approval is A LOT of work. It drinks resources.

This is why it is important not to waste time on projects that are never going to happen (like in the earlier anecdote).

You need to create teams and forums to make it easier for projects to go through that process.

A good CapEx committee spends a good deal of its time working out how to make sign-off thorough, but efficient.

Making the Decision

So, with all that work done. How do you actually decide whether to approve the project or not?

If the process is right, for a project to get as far as your desk for final sign-off it must have passed countless small tests along the way. So a big part of this stage is in making sure that you are comfortable with the tests the proposal has been through. And ensuring nothing has fallen between the gaps.

If something has made it this far and it’s not a good financial or strategic fit, not only are you kicking the project out, but you are also asking why it was allowed to hit your desk.

For big projects, you will likely have been involved at different points of the journey. It’s not like you should be seeing this for the first time when you are asked to get the checkbook out.

But even in a good process, you will face things that are more marginal calls. This is where your judgment and experience of the business kick in.

When I turn projects away at this stage, there are normally one of two reasons:

Firstly, because there is some disconnect between the functional workstreams. The sales growth plans haven’t quite aligned with the operational plans. Or something is off on the timing. And it needed someone to connect the dots to spot this.

Secondly, something has changed. It could be the economic environment, the cash position, or maybe a competitor launched a competing product. It could either be the circumstances around the project itself. Or just a change in your risk appetite, because the world has shifted.

I wonder how many CapEx projects have gone on ice in the last 3 months, because of the tariff uncertainty. Tens or hundreds of billions, I would guess.

When I have a truly marginal CapEx decision, I try and bring it back to the ‘real options.’ The true incrementality:

• If we do this, what does it mean we cannot do?

• If we don’t do this, what are the consequences?

• If it goes badly, how bad is it?

Monitoring Status

As I move forward I like to give every project that is approved a ‘monitoring status’ which signifies the level of risk it has. And determines the level of elevated governance over the project itself.

For example:

• Gold Status

  • High risk, and high financial impact

  • Requires brief weekly written project status updates to the CapEx committee

  • Monthly agenda item at CapEx committee

  • Full post-implementation review

• Silver Status

  • Important but lower risk

  • Monitored through the report to the CapEx committee monthly

  • Added as an agenda item if the project falls off plan

• Bronze Status

  • Low risk

  • Monitored through the annual process and by exception

By tiering it this way, you can ensure the business weights its executive attention to the projects that need it most. More on this next week.

Wedding Vows Moment

Success has a thousand fathers, while failure is an orphan.

The more complex the project, the more places and excuses to hide behind. And the more likely those excuses will be needed. It’s simply a function of the complexity.

For the most critical projects, you need to bind the whole team to its success.

Most call this accountability, but that isn’t strong enough. I prefer to think of it as ‘emotional ownership.’

You want every single person involved in complex projects to feel like they are personally responsible for the success of the whole project. And that if it fails, it would be a disaster for the team and them personally.

There is no substitute for looking someone in the eye and getting their personal guarantee that they are going to make sure that this is successful.

For the most important projects, immediately before approving the project, I like to pull all stakeholders from the business into a room (in person is better, but virtual is ok) to have what I call the ‘wedding vows moment.’

Where we all, (including me) agree that we shall from this moment forward be wedded to this project. And make sure it’s a success. A ‘speak now or forever hold your peace’ moment. I use the same tactic to bind an exec around budget assumptions.

This is the moment when you burn the boats. Get it right, and you’ll feel the accountability fill the room. We’ll talk more about this in an upcoming FP&A series.

Net-net

So now, we have approved the project.

Job done. Right?

Not even close. The fun is just beginning. Now we have to make sure that the project is delivered on time, on budget, and on spec.

That’s what next week is about.

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