Fixed assets are assets such as land, buildings, and equipment that are not likely to be consumed, sold or otherwise converted into cash in the normal course of business. These are assets you don’t expect to part with any sooner than a year’s time. Another definition is an item with a useful life greater than one reporting period. For most fixed assets, the useful life is much longer, three to seven years or more.

Because they require a large investment, these assets will impact the operation of a business well into the future. So before you make a decision about making such a large purchase, you should consider:

  • Its long-term usefulness
  • The business that will be generated from its use
  • The return on that business

Businesses vary in their capacity for accumulating fixed assets, but that capacity is always limited, so it’s important to carefully evaluate capital expenditures.

Here are 3 questions to consider when making those decisions:
1.

What other opportunities will be eliminated or delayed significantly by the use of cash (or debt) for this expenditure? Are there other items that would provide a higher or faster return on the investment? Would a different decision increase operating efficiency more quickly or effectively?

Remember, there are opportunity costs with every decision. You can only spend the cash once and then it must be replenished.

2.

How does this item support the future objectives of the organization? Capital expenditure decisions will have an impact on the operation for years into the future. Ask how purchasing the particular asset fits into the company’s strategic plan for application of resources.

3.

What is the possibility that an item will become obsolete before it has reached its useful life? Obsolescence is the loss of usefulness of an asset occurring through progress of technology or by changing laws or social customs. It is a reduction in the value of the item resulting from revolutionary inventions, unusual growth or development, radical economic changes or other factors that force retirement before the end of its useful life.

The last thing you want to do is invest a large amount of cash in an asset only to find that its effectiveness has been significantly diminished because of the evolving needs of the company or business in general. Computers, telephone systems and other technologies are especially susceptible to this phenomenon.

Periodically review your company’s fixed assets to determine if they are under-performing, or even worse, non-performing. Dispose of any such assets as soon as possible. Unless there is a probable future use for it, there is no logical reason to retain it. Holding items that have no useful purpose consumes otherwise usable floor space, increases maintenance costs unnecessarily, and ties up cash – your most important asset.

Calculating Capital Expenditures

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