What Questions Does a Financial Check Up Answer Before a New Capacity Investment

Financial check up

When a capacity investment comes onto the agenda, the first subject discussed is usually the demand side. Order trends, the utilisation rate of existing lines, delays in delivery times and volume requests coming from customers form the rationale for the investment. That rationale often rests on solid ground. Carrying out the investment, however, also depends on the conditions under which the company's financial structure can support the process.

A financial check up is an assessment that sets out the company's financial position as of a specific date using a defined methodology. When it is carried out before an investment decision, the purpose of the work shifts slightly: The aim is not only to describe the current picture but to make visible the relationship between the company's present structure and the new burden the planned investment will create in cash, debt and reporting terms.

This approach places the investment decision on a numerical footing. In discussions at board or shareholder level, the question of whether the company can carry the investment becomes a subject that can be addressed through defined indicators rather than estimates. As a result, the timing of the decision becomes as discussable as the decision itself.

Below we address the questions answered by a financial check up carried out before a new capacity investment under three headings: Which criteria determine the scope of the work, which questions come to the fore on the cash and financing side, and through which indicators the post-investment period becomes measurable.

What Scope Does a cc Before an Investment

A standard assessment covers the cash cycle, the debt structure, profitability broken down by product and customer, receivable risk and the reporting infrastructure together. In work carried out before an investment decision these headings remain; a number of investment-specific subjects are added to the scope.

The first of these is the financing composition of the investment. The portion of the total investment amount to be met from equity, the portion to be provided through credit or leasing and the portion to be financed through supplier terms are each defined separately. Once that separation is made, the months in which the investment's cash outflows fall become clear. Investment expenditure does not occur in full on the contract date; it is distributed as an advance, interim payments and a balance after commissioning. Basing the work on that distribution determines the accuracy of the subsequent cash planning.

The second subject is the cash requirement of the operation that continues during the investment period. A capacity increase often creates a permanent increase in inventory, raw materials and personnel. When the new line is commissioned, production volume rises; collection, however, arrives with a certain delay depending on sales terms. The period between these two movements is where the working capital requirement becomes apparent. Treating that requirement as an item separate from the investment amount may prevent the additional financing need that otherwise arises later.

The third subject is the maturity distribution of the existing debt structure. A new investment loan is added on top of existing obligations. The share of short-term debt in the total, seasonal concentration and the status of assets used as collateral all affect the conditions under which new financing can be obtained. When this picture is set out at the start of the work, preparation for financing discussions proceeds alongside it. We addressed the details of that preparation separately in our article on preparation before bank and financing meetings.

The fourth subject is the relationship the investment will establish with existing operations. In some cases new capacity replaces existing lines, and in others it is added to them. Once that distinction is made, it becomes clear whether the investment will generate additional revenue or a change in the cost structure. Where the existing line remains in service, the effect of fixed costs on the personnel, energy and maintenance side is calculated separately. In a replacement scenario, the cash inflow arising from the disposal of the old asset and any difference in value are included in the scope of the work.

The fifth subject is dependency on the supply side. A capacity increase raises raw material requirements. The terms on which existing suppliers can meet that volume, whether alternative supply channels exist and the items in which currency exposure is concentrated can be addressed together with their effect on cash. In structures where the share of imported inputs is high, this heading feeds directly into the investment's cash plan.

When determining scope it is useful to take the company's decision-making structure into account as well. If the investment decision is taken by the shareholders, the output of the work is prepared in a format that can be discussed on their agenda. In structures where the decision is taken at board level, the output is built in line with the indicator set used in board presentations. Once that alignment is achieved, the findings of the work enter the decision process directly.

The choice of date also matters in determining scope. When the date on which the assessment is based is one where the period-end closing has been completed and the inventory count carried out, the data set is consistent. In the same way, the definitions used need to be clarified from the outset. Whether the definition of cash includes blocked deposits, the cost method used to calculate inventory value and whether intra-group receivables are separated all directly affect how the results are interpreted.

The duration of the work can also be planned from the outset. Compiling the data set, clarifying definitions and reporting the findings are generally completed within a defined calendar. Placing that calendar before the investment discussions allows the decision to be taken on a prepared basis.

Cash Cycle and Financing Capacity: What a Financial Check Up Adds to Investment Timing

A question that frequently arises in investment decisions concerns the date on which the investment will start, alongside whether it will be made at all. A financial check up addresses that question through the company's cash generation pattern and financing capacity.

The cash cycle is a measure formed by collection periods, supplier payment periods and inventory turnover periods together. The length of that cycle shows how much of the cash generated from operations the company holds for its own operating requirements. When the cycle is long, setting aside the equity-funded portion of the investment from operating cash requires a certain amount of time. Calculating that period supports a realistic investment calendar.

The commissioning period of the investment is part of the same calculation. In the period between machine delivery, installation, trial production and the start of series production, expenditure continues while additional revenue has not yet been generated. The length of that period and the source that will cover the cash gap arising within it are among the concrete outputs of the work.

The headings addressed on the cash and financing side in a pre-investment assessment can be listed as follows:

→ Distribution of investment expenditure across months: The calendar of advance, interim and balance payments,

→ Commissioning period: The length of time during which expenditure continues and additional revenue has not yet been generated,

→ Working capital increase: The permanent requirement arising in inventory, raw materials and receivables,

→ Maturity alignment: The relationship between the repayment calendar of the investment loan and the date the investment begins generating cash,

→ Collateral capacity: The status of the existing collateral structure and of assets under mortgage,

→ Resilience of operating cash: The ability to meet the repayment burden in a scenario where demand falls below expectations,

When these headings are read together, the room for manoeuvre created by starting the investment on a particular date becomes visible. The maturity alignment heading comes to the fore at this point. When the principal payments of the investment loan are concentrated before the date on which the new capacity begins generating cash, an additional burden arises on the operation's existing cash. Structuring the repayment calendar with a grace period covering the commissioning phase may contribute to balancing that burden.

Collateral capacity is likewise a heading that is useful to know in advance. Once the scope of assets used as collateral in existing loans and the remaining free collateral area are set out, the structure through which new financing can be arranged becomes clear. That information defines the scope of financing discussions from the outset.

Calculating the working capital requirement occupies a separate place at this stage. The additional inventory, raw material and receivable amounts created by the capacity increase can be calculated using existing cash cycle periods. If sales increase by a certain proportion, the level the receivable balance will reach is a calculable result when the collection period is assumed to remain constant. Planning that amount as a financing item separate from investment expenditure provides comfort on the cash side in the period after commissioning. Performing this calculation at the outset may reduce the need to seek additional financing later.

The level of cash generated from operations is also part of this calculation. The cash generated from operations in the last three periods and its course across those periods indicate the resource that can be allocated to the equity component of the investment. If that amount changes noticeably during the year, it may be preferable for the months in which investment expenditure is concentrated to coincide with the months in which cash is strong. The timing question becomes concrete at precisely this point.

The effect of financing costs on the total investment is also among the outputs of the work. Loan interest, commissions, collateral expenses and currency differences are added to the total cost of the investment. When these items are defined from the outset, the payback calculation is built to include the financing burden. Otherwise the calculation is made on the machine price alone and the realised picture may diverge from the plan.

A scenario approach provides a useful framework at this point. A situation in which capacity utilisation is realised at the planned level, one in which it remains a certain proportion below plan and one in which input costs run above expectations can each be calculated separately. Once the extent to which operating cash covers the repayment calendar is set out for each situation, the conditions under which the investment can comfortably be carried become visible. That calculation offers a range at the decision stage and allows discussion over a defined band rather than a single estimate.

Part of the preparation on the cash side is the definition of reserve resources. The level of credit limits not used during the investment period, allocated but undrawn amounts and assets convertible into cash in the short term can be addressed as a separate heading in the work. Defining these resources in advance keeps the cash effect of any delays during commissioning at a manageable level.

The effect on cash of deviations that may arise on the demand side can also be addressed in the same work. How the repayment burden would be met in a situation where capacity utilisation remains below the planned level is a subject that can be defined before the investment decision. That assessment can be considered together with the level of pricing and cost structure after the investment.

Making the Post-Investment Period Measurable

One output of the work carried out before the investment is the creation of a baseline reference. Once the cash cycle, debt structure, margin level and capacity utilisation rate as of the assessment date are recorded, the post-investment period can be read alongside that reference.

Without that reference, separating the portion of the change arising in the post-investment period that stems from the investment from the portion that stems from market conditions may become difficult. Measurement carried out with the same definition set, on the other hand, prepares the ground for interpreting the difference between periods. We also addressed the intervals at which investment returns are measured in our article on post-investment monitoring and measurement intervals.

Defining a small number of indicators at the outset may be sufficient to establish a monitoring system. The capacity utilisation rate, the course of unit cost alongside volume, the additional cash inflow generated by the new line and the realised level of the working capital requirement can be among those indicators. The frequency with which the indicators will be reported and the unit that will produce the data are determined at the same stage.

It is important that the reporting infrastructure is in a position to carry that load. When a new line is commissioned, cost allocation keys are updated and the product-based margin calculation is rebuilt to cover the new structure. Identifying the requirements on the reporting side during the assessment supports the usability of post-investment data in decision processes.

Sharing the baseline reference at board and shareholder level also supports the process. When the level of each indicator at the time the investment decision is taken is recorded, assessments made in subsequent periods proceed on the same footing. That arrangement helps the results of the investment to be addressed independently of individual interpretation.

If the financial check up is repeated at defined intervals, the effect of the investment can be monitored across periods. The change arising in the cash cycle in the first year after completion, the movement in the maturity distribution of the debt structure and the course of the margin level form a meaningful series when measured using the same method. That series also provides a body of knowledge that can be used in preparing subsequent investment decisions.

Another benefit of the monitoring system emerges in communication on the financing side. Institutions providing credit may request periodic information on the progress of the investment. Having the indicators defined from the outset allows that information to be prepared regularly and consistently. The same data set becomes usable both in internal decision processes and in discussions with external stakeholders.

The choice of time interval also matters in interpreting the indicators. In the first months of the commissioning period, unit cost generally runs above the targeted level; trial production, scrap rates and the learning period affect that picture. Defining that period as a separate phase supports the correct reading of measurements in subsequent periods. In the same way, in business models with seasonal concentration it may be preferable to make comparisons against data from the same period of the previous year.

Specific decision points can be defined at board and management level in the period following the investment decision. Reviews carried out in the third and sixth months after the commissioning date allow the difference between plan and outcome to be seen early. Determining the measurement set to be used in those reviews before the investment supports the orderly operation of the process.

The preparation carried out before the investment decision supports internal communication throughout the process as much as it facilitates the decision itself. When the production, sales and finance units look at the same data set, the link between the capacity plan and the cash plan is established. The sales side's volume projection is considered together with the finance side's collection assumption; the production side's commissioning calendar is matched with the payment calendar. Once that matching is done, the investment ceases to be the agenda of a single unit and becomes a plan belonging to the company as a whole.

Setting out these headings also makes the positive aspects of the investment concrete. The effect of the capacity increase on unit cost can be calculated alongside the spreading of fixed costs across volume. The improvement in delivery times achieved once the new line is commissioned can be assessed as a gain that may be reflected in payment term and price discussions with customers. When the numerical equivalent of those gains is included in the work, the rationale for the investment can be conveyed on the same footing in financing discussions.

In this way the financial check up ceases to be a one-off status document and becomes a study that provides a footing before the investment decision and a comparison reference afterwards.

At NT Finans Partners, through our financial check up model, which assesses your company's financial structure with an independent perspective, we set out the cash, debt and reporting equivalent of your investment decisions and support you in planning the calendar and financing structure of your capacity investment on a measurable footing. You can contact us to review the process together.