Appendix A: How Customer Managers Budget Capital Expenditures

Overview

When a capital expenditure is proposed, the project must be evaluated and the economic consequences of the commitment of funds determined before referring it to a budget committee for review or to management for approval. How are the economic consequences described best? This is done in two steps:

First, set up the project in a standard economic model that can be used for all projects, no matter how dissimilar to each other they may be.

Benefits - costs = cash flow

To describe the formula in accounting terminology:

Benefits:	Projected cash revenue from sales and other sources
Costs:	Nonrecurring cash outlays for assets, plus recurring operating expenses
Cash flow:	Net income after taxes plus noncash charges for such items as depreciation

Thus, if the model were stated in a conventional accounting form, it would appear as:

Add:	Cash revenues projected (benefits)
Less:	Cash investment outlay and cash expenses (costs)
Total:	Cash flow

The "benefits less costs" model is usually developed within the framework of the company's accounts and supported with prescribed supplementary schedules that show the basis of the projection.