Is Your Capital Management A 'Capital Crime'?

In many organizations there is a formal capital management process for applying for and receiving 'capex'. Business cases have to be generated and approved, funding needs to be planned and allocated. Increasing levels of financial modeling sophistication are used to compute the promised ROI or NPV. All very formal and controlled, in theory.

In practice, it's a game.

Executives see the process as a ‘dash for cash’. They see obtaining their allocation of capital as a mark of their effectiveness (no executive wants to admit they have not won any capital allocations all year). As a result, figures are fudged, decisions “influenced” and an attitude of “whatever it takes” is brought to bear.

Interestingly, research by McKinseys and others[1] has quantified the long-term impacts of this cavalier attitude to capital management. In “How to put your money where your strategy is” Messrs, Hall, Lovallo and Musters have shown that the companies that effectively manage their capital end-to-end, and don’t play games, increase their share price and profitability, and outperform their peers by around 40% over time.

Forty percent is a large number and quantifies why capital management is so important and poor project investment management is a 'capital crime'.

Meanwhile back at the game, the fact that capital management is an end-to-end process is largely ignored. The returns on the project investments are often not tracked or measured, Indeed, less than one third of companies even try to measure the benefits and value realized from their capital investments. Two thirds allocate the funds and then…hope for a return. Hope is not effective capital management.

More games.

Those that do attempt to measure the returns on investment tend to measure budget achievement – by deducting promised benefits from future budgets – rather than measuring the actual benefits realized. This is an important difference as there are several ways to achieve a future budget figure but there is only one way to achieve a project’s value – through the effective delivery of the project, the business outcomes and the benefits!

Are you playing games or managing capital effectively?

Now few organizations will admit to playing a game with capital. They’ll point to the documents, processes, approval steps and accounting procedures as proof that their organization is serious. But are they? Here are five questions every board and executive needs to be able to answer with an emphatic and realistic “Yes” to verify that they are truly serious about capital management (the management of shareholder funds).

1. Do you know which projects are delivering your strategy and how?
2. Do you measure the ROI from each of your project investments?
3. Do you know by how much your average ROI has improved year-on-year?
4. Have your measured your organization’s capability to realize returns on capital invested?
5. If your ROI has improved, do you know how this improvement was delivered?

We will discuss each of these five questions and their ramifications in these linked capital management effectiveness blogs.