Most companies own equipment or property used in producing products, providing services, or conducting business. If they meet certain requirements under Generally Accepted Accounting Principles (GAAP), those items are accounted for as Capital Assets and their costs are depreciated over time. When purchased, their acquisition costs are referred to as Capital Expenditures (CapEx).
In the Mergers and Acquisitions world, CapEx is important as an element of the cash flows of a company. Usually found in the firm’s Cash Flow Statement, its proper inclusion in management’s financial projections will be key to allowing potential buyers to perform a discounted cash flow valuation of the company to prepare their bid. Conversely, failing to forecast CapEx properly will be uncovered during due diligence, causing buyers to lose confidence in the seller’s projections and resulting in a lower price.
The rationale for CapEx projections usually falls into one or more of the following categories:
- Replacement – property, plant, and equipment that has become worn out or obsolete; its purchase simply allows the firm to continue performing the function of the replaced equipment. This is not the same as an asset becoming fully depreciated on the books of the company, which may occur before or after the asset ceases to be useful. Nor is it to be confused with property and equipment maintenance, which may be capitalized under some conditions, but is usually expensed.
- Growth – if a company plans to increase output beyond the capacity of its current facilities, growth CapEx must be included in the projections. Note that some expansion strategies may not require CapEx, such as the addition of a 2nd or 3rd shift in which incremental employees will simply use the same equipment, increasing its utilization.
- Technology – if a firm plans to switch materials, such as building aircraft wings from composites rather than aluminum, CapEx may be needed to support new production processes. In this example, metal fabrication may be accomplished using common, inexpensive equipment, while composite fabrication might require custom molds and expensive new equipment. Failure to properly project these costs can create substantial problems during due diligence.
In our 21 years of selling mid-market aerospace and defense companies, we’ve experienced numerous instances where sellers had initially underestimated CapEx in their projections. To avoid problems in buyer due diligence, we work with our clients to ensure CapEx is correctly forecasted and included before we initiate discussions with potential buyers.
Have a great day everyone.
Managing Director, Aerospace