Cutting capital spending can be short-sighted
Should capital expenditure be the first corporate cut or the last thing to go? Investment in plant or buildings is the basis for tomorrow’s profits, but delaying it is an easy way to boost today’s cashflow.
A survey from the Chartered Institute of Management suggests companies are taking the axe to capital spending rather than looking to emerge from the recession with efficient new machinery. But when capital projects are big-ticket items and borrowing is difficult, especially for small and medium-sized firms, it is tempting to include them in the cost savings.
The same survey found that half the companies have frozen recruitment, 44 per cent have frozen pay and a third are making redundancies. If there are to be fewer people working on the shop floor, what is the point of re-equipping it with new plant? And if a shrinking economy means reduced demand, why would a firm working at below capacity want to add new machines?
Indeed, if the recession is causing deflation, there is a price advantage in deferring purchasing new plant or undertaking building.
But reductions in the workforce may be exactly why a company needs efficient plant and buildings, and delaying purchasing new equipment could leave companies unproductive when demand turns up. A firm that failed to renew its transport fleet for, say five years, would be running a clearly outdated operation, for instance. And while lorries and vans can be acquired quickly, many capital projects have long lead times and need to be commissioned now to be ready for the recovery.
Companies should thus be very careful and selective in deferring capital spending. And while borrowing remains difficult, most companies continue to have positive cashflow even without cancelling capital expenditure.
The test of whether companies are being too cautious in deferring investment spending will be seen if the revival in takeover activity continues. Bids are big-ticket items too that strain borrowing. If a company can afford to buy a rival it can afford to invest in capital projects.
