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Indian economy is on the back foot as compared its Global peers. Indian economy entered the pandemic period with an injured foot. One of the biggest impediments to India’s economic growth has been the muted level of investment activity in the last decade. Fixed capital formation (in lay man’s term Capex) grew at 8 % during the FY 10 to FY 20 as compared to more than 15% in the immediate previous decade. The legacy issues could severely impact our path to a quick economic recovery.
Capital Expenditures in any industry show confidence of the entrepreneurs to generate profits from the business. Increased Capex show that the entrepreneur believes that the products/service in which he/she is getting into will have sufficient demand to achieve profitability. The COVID 19 Pandemic has punctured many organizations ability to execute capital projects. The path to recover from the crises and resetting the capital expenditure cycle remains a long one, thus companies should evaluate the impact of the pandemic on the demand of their product and services before getting into long bets of Capex.
Deferring Capex for a while will give time to the entrepreneurs to assess the situation in a better way and also will free up substantial cash reserves.
FACTORS TO BE CONSIDERED BEFORE CAPITAL EXPENDITURE
The Main Objective of Capital Expenditure is to:
- To Expand the business to different location, increasing product line
- Technological upgradation
- To replace existing machinery
- Increasing the capacity
Demand for the products and service (Domestic or International) is the main factor on taking the decision of any of the above activities. Entrepreneurs should regularly take market leads to assess the demand for their products/ services
Important things to evaluate before incurring Capex
- Payback Period
- Cost of Finance and Return on capital invested
- Liability tenure
- Availability of Destressed Assets
- Options of using a Asset light business model
It is important that Companies liability mirrors the payback period of the underlying asset. Many companies face the challenges of asset liability period mismatch and start showing signs of stress. In most of the cases the payback period is greater than the liability tenure that means you have to pay your entire liability (loan) before the cost of asset is recovered. Chinese companies have been able to do a better job at matching their liability profiles with their investments’ payback periods in comparison to Indian Companies. This leads to choking up cash flows of Indian Companies and the availability of working capital thus reducing the competitive advantage in the Global market.
Companies looking for investing should evaluate the option of buying stressed assets at a cheaper cost and reviving the unit. This will reduce the cost of the company and also utilisation of idle capacity.
Tweaking the existing businessmodel to an asset light model is also another way to save capital cost. Companies can take advantage of excess utilization in the economy and outsource the orders to other firms.
WHEN SHOULD THE MSME START CONSIDERING INVESTMENTS
The Government has by far taken measures to incentivize the supply side. In order to recover demand an aggressive Government Spending on Infrastructures is the need of the hour to boost employment and revere the adverse impact of COVID19. Companies will take a cue from government spending to start their investments. Recovery of Construction, real estate and manufacturing sector will give a green shot that demand will revive. Increased spending by governments (both by center and states) will start the Capex cycle; this will lead the big companies to start investing consequently generating employment and reviving demand for products and services. The resetting of Capex cycle will give opportunities to MSME to start investing.
In conclusion entrepreneur should keep an eye on Government and big corporate spending to start their investment cycle. The impact of slowdown will be there for some time so entrepreneur should give special attention on the Payback Period and their Liability Tenure
Next week we shall continue the discussions. Till then please apply and let me know your feedback at email@example.com .
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I wish to personally thank CA Abhay Nair for his valuable contributions & Inputs by taking part in all the discussions pertaining to contents of this article.
(Dr. Anil R. Menon is a business coach and a Prof at S .P .Jain school of Global Management. He has own youtube channel MenonMantras where many videos are uploaded for the benefit of business community owners and entrepreneurs)