Ever signed off on a big purchase and regretted it a month later?
More than anyone will confess, it occurs. Money is pulled from the account, assets arrive and within days sits in a corner doing nearly no productive work. What actually needed repair never gets funded.
Capital expenditures are where small businesses either grow their foundations… or slowly hemorrhage money for years.
Here’s the problem:
For most owners capital expenditures decisions are more like shopping. Huge sums are spent based on intuition, a slick sales presentation or because the guy down the street did it last year.
And it’s not uncommon spending, either. According to research, 57% of SMBs anticipated capital expenditure this year. The average spend per business was about $109k. That’s a lot of capital getting spent on decisions often made in under an hour.
Let’s fix that.
Table of Contents
What you’ll take away:
- What capital expenditure actually covers
- The capex decisions small businesses get wrong most often
- A simple way to sanity-check any big purchase
What Capital Expenditure Actually Covers
Capital expenses are funds used to buy assets that will last for years. Operating expenses are day-to-day costs like rent, payroll, software licences, coffee.
The difference sounds like accounting trivia. It isn’t.
One pays for this month’s activity. The other invests in the next five years. Capital Expenditures, or Capex for short, typically consists of:
- Vehicles and machinery
- Computers and technology
- Office fit-outs and furniture
- Property and building improvements
- Tools and equipment
For example, take something as simple as provisioning a remote employee. A laptop is a capex. A chair is capex. A standing desk for home office ergonomics falls into a weird grey area between healthcare decision and equipment purchase. Right there in that Venn diagram overlap is why these decisions tend to get messed up. Adjustable standing desks are a helpful illustration because research has shown they can have a significant impact on productivity. One study from Texas A&M discovered call centre employees using sit-stand desks were approximately 46% more productive than their peers using traditional desks. If you spend $800 on a standing desk to keep a productive employee comfortable, it’s an investment. If you spend $800 on a standing desk because the colour looked good online, it’s an expense.
Same item. Completely different decision.
Why Capex Mistakes Hurt So Much
Very few small businesses go under because of one catastrophic event. They die a slow death, as the money dries up.
Approximately 29% of dead startups attributed their failure to “running out of money.” About 82% of small business failures note poor cash flow management as a cause. Large purchases are one of the quickest ways to deplete your cash flow.
Think of it this way…
A bad operating expense costs you one month.
A bad capital expense costs you many years.
Here’s another kicker. Capex is frequent. 55% made capital outlays in a recent six month period. Most business owners are making these decisions all the time and most have no process to guide them.
The Capex Decisions Small Businesses Get Wrong
Buying For The Business You Wish You Had
This is the most expensive mistake of the lot.
An owner purchasing $30,000 per month capacity buys tools that were designed for a $200,000 per month business because he knows growth is inevitable. Growth comes too slowly (3 years instead of 6 months) and now the business is stuck with excess capacity.
Purchase for where the company is today plus a realistic one year projection. Not the 5 year fantasy scenario.
Ignoring The Full Cost Of Ownership
The price tag is never the price.
Every asset drags a tail of costs behind it:
- Installation and setup
- Training
- Insurance
- Maintenance and repairs
- Consumables and spare parts
- Downtime when it breaks
It’s easy for an inexpensive machine with costly components to cost more than the expensive machine over a five year period. Calculate cost per year of useful life, not what’s on the invoice.
Treating A Tax Deduction Like A Reason
“It’s a write-off” has killed more small business cash flows than any other phrase in the English language.
A deduction lowers taxes on money you’ve already spent. Only deduct $20K if you really needed the asset and were going to spend $20K anyway just to save a few grand in taxes.
There’s a simple test: If there was no tax break whatsoever would you buy it? If not, then don’t buy it.
Buying Cheap, Then Buying Again
The flip side is just as costly.
Skimping on something you use every day…desks, chairs, essential machinery, your primary computer…often results in you having to replace it sooner. Cheap buy vs cheap buy looks great on paper, but gets crushed in actual practice.
Simple rule that holds true: Spend wisely on everyday items. Pinch pennies on luxuries.
Getting The Timing Wrong
Plenty of good purchases are made at terrible moments.
Purchasing a $40,000 asset in the slowest month of the year…right before taxes are due. Invoices that are coming in late. That’s how a company who turned a profit can’t pay payroll.
Match the purchase to the cash calendar first. An asset can be right but if not at the right time…It’s still wrong.
Never Checking If It Worked
Almost nobody goes back and reviews a big purchase.
The money’s spent, the asset shows up, everyone forgets. Thus the same errors occur every year because nothing was quantified.
Six months after every large purchase, review it. Did you get what you thought you were getting? That one thing will make every decision clearer.
A Simple Way To Sanity-Check Any Big Purchase
Before signing anything, run through these five questions:
- What problem does this solve? If the answer is vague, stop right there.
- What if it doesn’t get bought? Sometimes the truth is “nothing much”.
- What’s the total cost over its useful life? Not the sticker price.
- Can the business afford it? Will it hurt the cash position? Look at the next 90 days.
- How will anyone know it worked? Pick a number that can be measured.
Five questions. Ten minutes. Stops most of the poor choices above from costing anything.
Tying It All Together
Capital expenditure isn’t about spending less. It’s about spending on purpose.
Successful companies don’t have the largest procurement budgets. Successful companies ask mundane questions prior to funds transferring. They purchase what they operate, they account for the true cost, they overlook the tax-writeoff excuse, and they spend wisely where it matters.
A quick recap:
- Capex shapes years of cash flow, not just one month
- Buy for today, plus a realistic 12 months
- Total cost beats sticker price every time
- Never buy something purely for the deduction
- Review every major purchase afterwards
Buy those and your next investment will be something that still looks smart in five years.
