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Importance of Effective Capital Planning

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While most successful ethanol producers conduct strategic planning exercises to lay out the future priorities for the business, comparatively few effectively tie in a formal capital planning process to ensure the appropriate capital strategy and structure are in place to support the achievement of the defined strategic priorities.

 

As a result, a company’s capital structure is often not aligned with the company’s strategic business priorities. At a minimum, a poorly aligned capital structure can result in unnecessary capital expenditures or the inability to fund strategic investments or meet shareholder expectations for distributions. At worst, it can leave the core business vulnerable to an unexpected liquidity squeeze, which can be devastating.

 

The challenge is in striking the right balance among competing capital priorities, including protecting the core business, investing for the future, and meeting shareholder expectations for distributions. As the industry matures, this challenge only becomes more acute. Competition is relentless, and increasing capital investment will likely be required to sustain competitive operations. At the same time, investors continue to seek a return on their investment, typically in the form of dividends. Add to this mix changing capital markets, increasing market volatility, and the reality that for most plants depreciation is rolling off, implying an increasing tax burden going forward, which effectively reduces cash flow availability. 

The capital plan is simply a means to an end designed to align the company’s capital strategy and structure with the strategic objectives and priorities of the business. An effective capital plan will first address the need to have adequate capital resources in place to protect the core business going forward and then address a plan to fund strategic priorities and/or meet shareholder expectations for dividends. The plan should define the optimal capital structure for the business (levels of debt and equity) that is designed to balance capital costs, tax structure, leverage and related risks.

  

The capital planning process is fairly straightforward; although like anything worthwhile, it will take some time and resources to complete, especially the first time around. Some key elements of the process include:

  

  1. Ground your plan in reality through a thorough assessment of the prior five-year financial and operating performance to understand liquidity needs and key drivers of future performance as well as the impact of business/commodity cycles.
  2. Define the company’s five-year strategic plans and priorities along with expected capital requirements over that period of time.
  3. Prepare an interactive financial model with which to quantify the impact of capital structure under multiple scenarios, grounded in your historical performance, and incorporating the expected capital needs going forward given strategic priorities.
  4. Use the model to simulate and quantify alternative capital strategies and sources and quantify the implications for the shareholders and the organization going forward.
  5. Determine the optimal capital structure for your organization, document and implement the plan, and then monitor the plan to adjust as necessary going forward.

 

In summary, an effective capital plan offers a number of benefits: enables your company’s strategic plans and priorities, ensures shared understanding and alignment among key decision makers, and provides a platform for communication to shareholders regarding the financial needs and priorities of the business going forward.

 

As you can tell, we love to talk about this stuff. For more information about effective capital planning and how it might benefit your organization drop us a note and we’ll follow up.
 

 

 

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Guest Wednesday, 16 August 2017