Impact of CAPEX and OPEX on Asset Management

SUMMARY

In any organization, one of the main objectives is to maximize profitability; therefore, it is very important to consider the costs that influence both the life cycle of owned assets and the projects undertaken, in order to make strategic decisions. Consequently, the different investments incurred throughout the cycle must be known and analyzed: investments in the acquisition or improvement of capital goods (CAPEX) and investments associated with maintenance and other operating expenses (OPEX). The company must plan these investments to correctly prepare its budget, so it is necessary to consider both the evolution of these investments in previous years and the needs of all departments. As a result, companies sometimes find themselves needing to substitute CAPEX for OPEX and vice versa. One way to reduce these capital costs by offsetting them with OPEX is the use of outsourcing or the rental of equipment and facilities. The most obvious advantages of this change are increased cost flexibility and reduced financing needs.

Keywords: Capex; Opex; Profitability; Costs; Investment

1. INTRODUCTION

As a result of the current economic situation, most companies in various industrial sectors have found it necessary to reorganize their strategic plan to become more competitive and, in this way, survive in the market (Porter, 2009).

As Goldratt (1984) states, the goal of any for-profit company is none other than to make money; therefore, maximizing the profitability of a business is, if not the main objective of every company, one of the most important.

To achieve this goal of maximizing profitability, companies will have to conduct a significant analysis based on how they manage their own assets. If they want to achieve the objective of increasing their profit margin, they must make changes to certain basic variables that affect utility, either by increasing revenue or optimally reducing costs.

When we refer to asset management, we are considering the programming and planning of the physical resources owned by the company, taking into account an exhaustive analysis of all investments made throughout their useful life, in order to understand the benefits each asset offers and thus carry out a correct decision-making process.

In this article, we will study how companies are affected by the investments they make and, based on these, the decision-making process they must undertake to manage their assets correctly.

2. ASSET MANAGEMENT

The existing competitiveness among different companies is characterized by implemented budget cuts, pressure on delivery times, and high quality requirements for products and processes. All of this, together with market globalization and the current financial crisis, has led modern industry to undergo profound transformations, optimizing its resources by establishing appropriate Asset Management policies (Amendola, 2012).

To regulate these policies, the Institute of Asset Management (IAM) was founded in 1993, bringing together various organizations with the aim of sharing best practices. These new practices consolidate a discipline known as Asset Management and represent a revolution in countries such as the United Kingdom, Australia, and New Zealand. Two years later, the IAM included a significant group of associated companies from England, Australia, and New Zealand. Subsequently, in 1998, the need to create solid foundations for Asset Management was established for different markets and industries, but it was not until 2003 that the British Standard committee for Asset Management began its journey (Amendola, 2015).

In 2004, the British Standard PAS 55 specifications were published, complementing and supporting ISO 9001, ISO 14001, and OSHA 18001 standards, establishing appropriate practices for asset management aligned with the company’s strategic plan (PAS 55, 2008).

Due to the widespread acceptance of PAS 55, the generation of the first ISO standard was proposed, which would consider everything that had been done so far, but in a more systemic way. In 2010, the ISO technical committee decided to create an International Standard for asset management based on the PAS 55 document, which they agreed to call ISO 55000 (2014).

According to the different definitions of Asset Management, it refers not only to a department of the company but encompasses all areas of the organization, as all of them impact and are necessary for value creation. In this regard, ISO 55000 (2014) defines Asset Management as:

“The coordination of an organization’s activities to create value through its assets.”

Works such as those by El-Akruti et al. (2013) highlight the close link between good asset management and the achievement of strategic objectives set by top management.

In this way, Asset Management has become the theoretical framework in which strategies, methodologies, norms, standards, and techniques necessary to generate value through optimized asset management coexist, making the organization sustainable.

3. ASSET LIFE CYCLE

In the business world, when we talk about Asset Management, we refer to the Asset Life Cycle (Amendola, 2015); which encompasses the different phases an asset goes through from its creation to its disposal.

As mentioned, one of the ways a company can improve its profitability is by managing costs, with the aim of minimizing them. In this sense, a significant portion of the costs incurred are related to maintenance, making this one of the few areas where profitability can be improved.

Amendola proposes an asset life cycle model associated with maintenance management, whose stages are:

1. Design and Acquisition Stage:

This is the first phase of an asset’s life cycle. In this initial stage, the necessary investments are made for its creation, design, development, and commissioning. Both the asset’s capabilities and characteristics are developed, and its installation proceeds.

Furthermore, in this stage, most of the investments that will be faced will occur: research, design, documentation, testing, quality, development, among others.

2. Operation and Maintenance Stage:

In this second phase, the asset has already been created and is operational, functioning normally. Therefore, all operational costs that may affect it are taken into account, meaning the investments that must be made for the asset’s correct functioning, whether through preventive, reactive, predictive, or proactive maintenance; also considering all materials, tools, spare parts, or indirect costs.

3. Disposal Stage:

This third phase refers to the end of the asset’s life cycle. At this point, the asset is no longer able to perform its activity efficiently. Therefore, it is at this moment that the company must analyze its situation to decide whether to retire the asset and replace it with another or make investments aimed at improving it, adapting it to current demanding needs. (Pérez and Cascarrilla, 2013)

Figure 1: Life cycle and disposal phase, Amendola, 2004.

Figure 1 shows how the different stages of an asset’s life cycle are distributed and, in turn, how costs vary depending on the stage.

Consequently, adequate maintenance management will lead to an increase in both the efficiency and the lifespan of a company’s asset.

4. TYPES OF INVESTMENTS

Given that analyzing investments made is fundamental for a company, it would be necessary to identify the different types of expenses and investments that can occur throughout the asset’s life cycle.

To understand the importance of investment analysis and how it will affect results, the term TOTEX (Total Expenditure) will be introduced. This term consists of the sum of CAPEX and OPEX, terms that will be explained in the following sections (Borgez, 2015).

4.1. CAPEX

CAPEX is the abbreviation for the Anglo-Saxon expression Capital Expenditure. This term is defined as funds spent, or rather investments made by a company, in both the acquisition and improvement of capital goods or physical assets.

Thus, CAPEX can be understood as the series of investments made in different equipment and facilities to maintain or increase production levels, or also, to maintain the operation of a particular business or system.

In relation to the asset life cycle, costs are associated with the investments made in the first stage of this study: design and acquisition, as it is in these initial moments that the company dedicates greater efforts to both the creation and innovation of its products.

Companies must plan their investments; therefore, a capital investment budget must be prepared, and several aspects must be considered to do so correctly. First, the CAPEX investment made in previous years must be quantified. Second, a distinction must be made between capital investments made for maintenance (OPEX) and those made for the acquisition of new capital.

Finally, once this analysis of previous years has been carried out, the current budget can be prepared, in which the needs of all company departments must be taken into account, as this will be the only way to ensure the budget is as realistic as possible, always faithful to the company’s financial reality.

4.2. OPEX

Conversely, as mentioned, the term OPEX (Operational Expenditure) must be differentiated. It is defined as the costs associated with equipment maintenance, including both consumable expenses and other expenses necessary to carry out the activity, as well as other items the company must face outside of its production, such as payroll or taxes.

In this case, it can be observed how these costs correspond to the second stage of operation and maintenance.

This part of the life cycle is when most failures occur (Amendola, 2015), which is why a large part of the costs referred to as OPEX are found in this phase. This fact is a drawback since failures occur randomly, making it difficult to accurately estimate a forecast of these expenses (Borgez, 2015).

To understand both concepts, consider the need to purchase a machine. The initial investment required to obtain it is considered CAPEX, while the cost derived from its maintenance in the production system is considered OPEX.

Understanding this, it can be concluded that calculating capital investments is simpler than calculating operational investments. This is because the former will truly be a disbursement, somewhat fixed, although it is true that for various reasons or unforeseen events outside the company, this calculation may increase or decrease; while the second type of operations presents greater difficulties in measurement.

4.3. DECOMMISSIONING COSTS

This section addresses the costs related to the last stage of the life cycle, which are disposal or decommissioning costs, as they also affect the company’s strategic and financial plan. (Pérez and Cascarrilla, 2013)

As the name implies, these costs refer to investments incurred at the end of an asset’s life.

Figure 2 summarizes the stages of an asset’s life cycle and the costs incurred at each stage.

Figure 2: Cost allocation to each stage of the life cycle.

To analyze life cycle costs, it is important to have the greatest possible knowledge of capital, operational, and decommissioning costs. However, a key point in the cycle is the optimal time for asset replacement. This is considered fundamental in a company’s strategy, as a poor decision caused by delaying or advancing replacement can lead to certain extra costs for the company, resulting in a decrease in profitability.

MODEL

Once the theoretical framework has been presented, we have sought to align the financial department with the decision-making process of an organization, all within asset management. By understanding the different stages of an asset’s life cycle and analyzing the various investments and costs incurred throughout it, it is observed how a lack of communication between departments can lead to a decrease in profitability, with special emphasis on the timing of asset replacement.

For this process to be carried out correctly, an analysis of different decision-making models has been performed, seeking and selecting those related to asset management. These models have been classified according to: their area of application, the phases to be carried out in each model, their development, the necessary tools, and also the level of implementation difficulty, considering the training of the personnel who will carry out their application. After this analysis, various decision methods oriented to different situations are available.

Some of the models analyzed include: Life Cycle Cost, Analytical Hierarchy Process, Systemic Analytical Process, Promethee. Through these, a series of variables are weighted, allowing for their prioritization.

By unifying the three aspects discussed: an asset’s life cycle, the types of costs incurred, and how and when to make a decision, the following model is proposed:

Figure 3: Strategic Asset Management Plan for Decision-Making

Figure 3 shows the elaborated model for carrying out the organizational decision-making process, which will be directly related to the PEGA – Strategic Asset Management Plan.

In this scenario, and from a financial department’s perspective, the viability of all decisions made in asset management must be analyzed from the outset. That is, different financial indicators must be used to help interpret information about cash flows and the profitability that assets will generate in the future.

The situation presented is as follows:

A company has an asset for its production process. After the first two stages of the asset’s life cycle, the need arises to decide whether the asset in use can continue its activity or if the time has come when its activity negatively impacts achieving positive profitability; that is, a decision must be made to eliminate/replace or make the necessary modifications (maintain) for its correct functioning.

Given this scenario, how should one proceed? Replace or maintain?

• Step 1: The different decision-making options will be presented, detailing the useful life of the owned asset with corresponding annual revenues and expenses, as well as all viable alternatives.
• Step 2: The different known costs at the initial moment of each alternative proposal will be analyzed, i.e., the initial outlays related to the acquisition of a new asset – CAPEX.
• Step 3: Once the previously known CAPEX costs have been studied, an analysis must be carried out for those costs that may arise randomly during the asset’s life – OPEX, always trying to obtain an approximation. This applies to both the owned asset and the alternatives.
• Step 4: This step consists of evaluating the future cash flows that these decisions will generate.
• Step 5: Once both the costs and revenues that will occur have been calculated, they must be capitalized to the present moment to carry out a fair valuation of all alternatives.
• Step 6: Finally, once all amounts are valued at the same point in time, a calculation of the profitability offered by each alternative can be made, allowing us to choose the most profitable option. To do this, it is advisable to use different financial indicators along with decision-making models, in order to obtain complete information and achieve a hierarchical ordering of the alternatives.

Once the previous steps have been completed, it will be known which alternative is most beneficial, and this must be adjusted to the budget.

Thus, the goal pursued with the implementation of the proposed model is to help generate a correct decision-making process aligned with organizational objectives. It must be taken into account that a company may not manage its assets well and incur significant losses. The moment an asset is decided to be replaced or not is one of the most important decisions a company faces.

MODEL CONCLUSIONS

Based on the study conducted, the following conclusions are drawn:

• Analyzing operational costs is difficult because, even if estimated approximately, they can vary considerably. Consequently, this can lead to preliminary results that are not representative of reality, which in turn can lead to an erroneous decision. Therefore, special attention must be paid to this step.
• Aligned with the previous conclusion, the financial department and the technical area must be in continuous feedback, as both parties must know the situation of both assets and the budget level at all times, to avoid making incorrect decisions again.
• Another potential drawback is that the alternative that could provide greater profitability to the company may not be feasible due to certain budget limitations. In this case, companies sometimes find themselves needing to substitute CAPEX for OPEX, forcibly maintaining an unprofitable asset. By increasing operational expenses in this way, one approach to reduce these capital costs is the use of outsourcing or the rental of equipment and facilities, as this can ultimately be a decision that benefits the company in the long term.
• On the other hand, if this method is consistently applied by all departments of a company, with their involvement from the beginning, the economic result will consequently increase.

As a general conclusion, we can affirm that for a company’s good performance, correct and fluid communication between departments is key so that CAPEX and OPEX do not negatively impact asset management decisions.