Tools and Techniques of

Capital Expenditure Control

Sheetal Wagh
 A capital expenditure is the use of funds or assumption of a liability in order to
obtain physical assets that are to be used for productive purposes for at least
one year.

 This type of expenditure is made in order to expand the productive or

competitive posture of a business.

 The reverse of a capital expenditure is an operational expenditure, where the

cost is incurred strictly for current operations.

 Always charge operational expenditures to expense when incurred.

 Since they are charged to expense in the period incurred, they are also known as
period costs.

 From a financial analysis perspective, a business should at least maintain its

historical level of capital expenditures.

 Otherwise, it will be suspected that management is not adequately reinvesting

in the organization, which will eventually lead to a decline in the business.
 Objectives of Control of Capital Expenditure:

(1) To make an estimate of capital expenditure and to see that the total cash outlay is
within the financial resources of the enterprise.

(2) To ensure timely cash inflows for the projects so that non-availability of cash may
not be a problem in the implementation of the project.

(3) To ensure that all capital expenditure is properly sanctioned.

(4) To properly co-ordinate the projects of various departments.

(5) To fix priorities among various projects and ensure their follow up.

(6) To compare periodically actual expenditures with the budgeted so as to avoid any
excess expenditure.

(7) To measure the performance of the project.

(8) To ensure that sufficient amount of capital expenditure is incurred to keep pace with
the rapid technological developments.

(9) To prevent over-expansion.

 The 4 tools of Capital Expenditure Control are as follows:

1) Performance Index

2) Technical Performance Measurement

3) Post Completion Audit

4) Earned Value Method

1} Performance Index:

Often it is necessary to present information from several related areas

simultaneously.

This is done to provide a statistical measure of how performance changes over

time.

The performance index is a management tool that allows multiple sets of

information to be compiled into an overall measure.

There are two Performance Indexes in Performance Cost Management.

These are:

(a) Schedule Performance Index

(b) Cost Performance Index
(a) Schedule Performance Index (SPI):

• It is the ratio of total original authorized duration versus total final project duration.

• It tells us about the efficiency of time utilized on the project.

• It is a measure of progress achieved compared to the planned progress.

• Schedule Performance Index (SPI) = Earned Value/Planned Value

• SPI = EV/PV

 Conditions:

a) If SPI > 1, this means that more work has been completed than the planned work.
b) If SPI < 1, this means that less work has been completed than the planned work.
c) If SPI = 1, this means that work completed is equal to the planned work.
(b) Cost Performance Index (CPI):

• It is measure of the value of work completed compared to the actual cost spent
on the project.

• It tells us about the efficiency of cost utilized on the project.

• It is a measure of cost efficiency.

• Cost Performance Index (CPI) = Earned Value/Actual Cost

• CPI = EV/AC

 Conditions:

a) If CPI > 1, this means earning more than spending.

b) If CPI < 1, this means earning less than spending.
c) If CPI = 1, this means earning is equal to spending.
2} Technical Performance Measurement:

• This is a key indicator of progress, parameter or a metric that can be used to

monitor the progress or performance of selected requirements.

• A technical performance measure is monitored to ensure that it remains within

tolerances as an indicator of the progress of design.

• It is one of the most commonly used Systems Engineering Tools.

• These measures are identified at a very early stage in the System Engineering
Process during the Conceptual Design and their progress is continually
monitored throughout the Acquisition Phase.

It is a control and analysis technique that is used to:

a) Project the probable performance of selected technical parameter over a

period of time.
b) Record the actual performance observed of the selected parameter
c) Through comparison of actual versus projected performance, assist the
manager in decision-making.
3} Post-Completion Audit:

• An audit that takes place at the conclusion of a project requiring capital

expenditure, or other business initiative, intended to evaluate the final costs and
benefits to the company.

• Post-completion audits are typically performed by objective third-party auditors,

in order to remove any inaccuracies due to bias or preference.

Post completion auditing (PCA) of capital investments is a formal process that

checks the outcomes of individual investment projects after the initial
investment is completed and the project is operational.

• It is an objective and independent appraisal of the measure of success of a

capital expenditure project in progressing the business as planned.

• The appraisal should cover the implementation of the project from

authorization to commissioning and its technical and commercial performance
after commissioning.

• The information provided is also used by management as feedback, which helps

the implementation and control of future projects.
4} Earned Value Method:

• Earned value management (EVM), or Earned value project/performance

management (EVPM) is a project management technique for measuring project
performance and progress in an objective manner.

• Earned value management is a project management technique for measuring project

performance and progress. It has the ability to combine measurements of the project
management triangle:

 Scope
 Time
 Costs

• In a single integrated system, Earned Value Management is able to provide accurate

forecasts of project performance problems, which is an important contribution for project
management.

• Early EVM research showed that the areas of planning and control are significantly
impacted by its use; and similarly, using the methodology improves both scope definition as
well as the analysis of overall project performance.

• EVM implementations for large or complex projects include many more features, such as
indicators and forecasts of cost performance (over budget or under budget) and schedule
performance (behind schedule or ahead of schedule). However, the most basic requirement
of an EVM system is that it quantifies progress using PV and EV.