All businesses have fixed assets. They are defined as items which are not for resale and have an economic life which is greater than one year. Fixed assets are allocated to categories such as: office equipment, furniture fixtures and fittings, computers, motor vehicles, leasehold improvements, freehold land and buildings, etc. Each of these categories is assigned a set depreciation rate (e.g. normally 3 years for computer equipment and 5 years for furniture fixtures and fittings).
Once purchased the fixed asset is recorded in the fixed asset register and the general ledger. It is depreciated at the rate of the asset category it has been assigned to. The depreciation is calculated monthly and the depreciation charge is charged to the profit and loss account and offset against the cost of the asset on the balance sheet.
So why are we talking about depreciation? Well we need to include depreciation in our budget profit and loss account (as it affects the bottom line) and balance sheet and therefore we need to project the depreciation for each asset over the coming year. Depreciation is known as a “non cash item” so it is never included in the cash flow forecast but it is offset against the cost of the asset so the asset is valued in the balance sheet at its net realisable value i.e. its open market sale value.
To compile a capital expenditure budget you need to list all the items which are likely to be bought over the coming year and allocate them to the month they are to be purchased. It is best to have a minimum limit for each item e.g. £100 to £250 otherwise the list could be endless. To be safe it is probably best to add a contingency as you never know what you may have to buy e.g. a new computer. The depreciation should be calculated for the items included in the capital expenditure budget on a monthly basis. The capital expenditure budget will then be inserted into the balance sheet and the cash flow forecast and the budget depreciation in the profit and loss account and the balance sheet.
Having included the capital expenditure budget into the budget model you may find there is not enough cash in the cash flow forecast to pay for the capital expenditure. At this point it may be worth considering if leasing certain assets might be a better option as it will spread the cost over time, which means your cash lasts longer, rather than being spent in one go.
