Capital expenditures (Capex) are crucial for sustaining and growing business operations. Properly projecting Capex in financial models and valuations is essential for accuracy. Here are a few tips for estimating CapEx effectively:
Percentage of Sales Method
Capex is commonly projected as a percentage of sales, reflecting the investment needed to drive growth. Consider these approaches:
Historical Averages: Use the company's historical capex as a percentage of sales, averaging data from the past 3-5 years.
Industry Benchmarking: Compare against capex as a percentage of sales from peer companies within the same industry.
Percentage of PPE Method
Alternatively, Capex can be projected as a percentage of the opening balance of Property, Plant & Equipment (PPE) i.e. Fixed Assets on the balance sheet every year. This percentage can be based on historical averages or industry benchmarks as applied for the Percentage of Sales Method above.
Checkpoints for Reasonableness
To ensure that Capex projections are realistic, consider the following:
Stage of Growth: Early-stage companies generally require higher Capex as a percentage of sales to build their asset base, compared to more mature companies.
Fixed Asset Turnover: Changes in the fixed asset turnover ratio can indicate whether the Capex level is suitable for the company’s operational capacity. A very high turnover might suggest that the Capex is too low to support projected revenue growth, whereas a very low turnover could indicate excessive Capex.
Growth Strategy Considerations
Align Capex projections with the company’s strategic growth plans, which might include:
Expansion of production capacity.
Entry into new markets.
Enhancement of workforce and resources.