By Alan Beaulieu on Oct 29, 2019 1:58:00 PM
The Business Cycle is a key factor as you make decisions on significant capital investments for your company. The economy, your industry, and your firm are constantly moving through a business cycle. Sometimes we are growing at a faster and faster pace, and the urge to make the capital investment can be almost overpowering. This is Phase B of the business cycle, and it is defined by acceleration. While businesses often move forward with capital investments at this time, it is, unfortunately, often the wrong time for such investments.
Here are three variables that should factor into your decision-making process as you consider a capital investment:
Find out where you are in the business cycle.
Business leaders should determine where they are in the business cycle before making a capital investment. The process is not complicated; we present it in detail on our website. Once a business knows where it is in the business cycle, it must determine where it fits into the economy. Is the company in synch with the larger economy? Or is the relationship countercyclical? These questions need to be answered in order to maximize the return on the capital investment. Please visit itreconomics.com to learn more about the four phases of the business cycle and how you fit into the economy.
When to make the capital investment.
When to make the capital investment depends on when the asset will be needed. That seems quite simple on the surface, but it is not. Answering the first question in terms of the business cycle is the crucial first step.
A business under the pressures of faster growth will naturally straight-line, or assume such growth will continue into the future; the business would therefore tend to make a capital investment to solve a problem they are facing today. For example, a manufacturer may need to increase throughout at a juncture in the manufacturing process. There is a bottleneck, and a new piece of equipment would solve the problem. A $300,000 capital investment is made, and, if all goes well, the new piece of equipment is delivered and installed three months later. The next thing you know, an economic slowdown is happening, and backlog and production demands are slowing down with it. The bottleneck was a three-month problem that could have been handled through overtime, perhaps, or outsourcing.
In this example, the capital investment was a reactionary decision, and the asset was put into service when it was not immediately needed. The manufacturing company will likely need it at some point in the future, when the economy picks up again, but the expense and disruption to operations could have waited.
The best time to put this type of asset into service is before you need it, not when you need it. Placing a productivity tool in advance of demand allows you the time to put it into operation with minimal disruption, allows time for training, and guarantees that the increased efficiencies will be in place when you need them, not when you don’t.
Knowing where you are in the business cycle, and when the next peak and trough are coming, is crucial to the timing of capital investments. There are several ways to arrive at this knowledge. Please see our website for everything from a self-directed analysis (see our free DataCast™ trial) to customized analysis completed by our expert economists and analysts.
The cost of the capital investment.
The use of business cycle analysis will allow you to control the cost of the capital investment. Phase B, the accelerating growth phase of the business cycle, is where too many businesses make the decision to invest. The timing of that decision all but guarantees that the business will be paying more than it should for the investment. A hot economy benefits the seller more than the buyer. Delivery times can be extended as providers struggle with their backlog. Margins are firm, and inflationary pressures – a generally accepted rationale for higher prices – may be a factor.
Buying on the back side of the business cycle provides for the opposite: Wait times are diminished, margins are flexible with sellers hungrier to make the sale, and pricing concessions can be more easily negotiated. Purchases made on the back side of the business cycle will reduce the cost of the capital investment, thus guaranteeing an improved ROI.
The points above apply to much more than equipment. They are just as applicable to upgrades to computer systems, new CRM systems, implementation of timely marketing programs, and employee training programs, to give a few examples.
A longer-term outlook, with dependable macroeconomic forecasts from ITR, enables the same forward view for strategic decisions regarding, for example, construction projects, the acquisition of another company, opening a new office in another state, expansion into a new product line, or any other longer-term capital investment. Use the business cycle to your financial advantage and maximize your return on capital investments.