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When implementing ESG disclosure reporting with a target setting to meet the sustainability objectives, a new phenomenon comes into play. How should you evaluate new strategic initiatives and capital expenditures (CapEx)? We are familiar with financial evaluation based on e.g. return of investment, return on assets, net present value or payback period. But now, how should you include sustainability factors in the evaluation? 

Considering sustainability in a capital spending evaluation makes sense for the business:  

  • Material cost savings can be achieved 
  • Capital projects can be made more resilient, or future-proofed, against emerging sustainability risks 
  • The costs of inaction are potentially material 
  • Taking sustainability issues into account drives innovation in your supply chain 
  • Demonstrating your sustainability commitment can build trust and reinforce or enhance your license to operate 
  • Adopting sustainability practices can help reduce financing costs and increase access to capital 

Most companies already have sophisticated capital investment appraisal processes focusing on managing project risk*. Sustainability is simply one type of risk to be managed. The questions asked at each stage of the appraisal process, traditionally designed for testing and assessing financials, are equally applicable to sustainability: 

  1. Go / No Go approval: Does this project support our corporate strategy, values, targets and commitments?  
  1. First stage approval: How can we optimise business value through project design?  
  1. Final authorization and delivery: How can this project be refined to maximise long-term value creation for business, the environment and society?  
  1. Post-investment review: Did we achieve our financial and sustainability objectives? 

Ultimately, enabling investment in more sustainable capital assets is a question of strategic priorities: what does the company want to invest in and how will this be funded? 

There are four common elements to integrating sustainability into the CapEx evaluation processes:  

Who to involve and governance 

Establishing accountability (through leadership) and changing mindsets (through culture) are the foundations for embedding the change. Involving the right mix of people with appropriate roles and capabilities is crucial.  

What to assess 

To identify and prioritise sustainability issues for consideration in the capital investment decision, it is useful to think about:  

  • Types of sustainability issues (social, environmental, economic) 
  • The whole lifecycle (from construction to operation to end-of-life) 
  • The value chain (from suppliers to own operations to customers) 

How to assess 

To assess the sustainability issues identified, there are four main approaches:  

  • Qualitative, e.g. high / medium / low rating; 
  • Quantitative, e.g. KPI scorecards; 
  • Monetary, using shareholder (or company) value, e.g. energy costs; 
  • Monetary, using stakeholder (or societal) value e.g. cost of pollution to society or the benefits for society. 

How to decide 

For decision-makers to make sense of a sustainability assessment, they need frameworks. Key considerations when developing such a framework include:  

  • Setting decision-making criteria: These may be non-financial or financial criteria, depending on the type of sustainability assessment undertaken.  
  • Choosing between investment options: Holistic evaluation frameworks and structured decision-making methods can help to formalise the consideration of sustainability as a core part of the investment case.  
  • Exploring funding options: The way in which funding is sourced can influence how capital is allocated between investment options, from simply using your mainstream capital budget as the sole source of funding to identifying new sources of specialist funding.  

Also, consider doing CapEx and operational expenditures (OpEx) budgets together. Maintaining a strict divide between CapEx and OpEx budgets can disadvantage capital projects, which result in lower operating costs, e.g. energy and water efficiency projects. Some companies set up special funds that allow a higher initial CapEx budget to be offset by a lower OpEx budget in the long run. 

Fully integrating sustainability into the CapEx evaluation process is a long-term ambition, taking years rather than months. Maturing in this space is about finding approaches that work for your organisation. 

A modern Enterprise Performance Management platform can support this data-driven process by providing models with financial and sustainability metrics, including the data and process governance with documentation and an approval process with an audit trail. In addition, when targets are set, scenarios can be used to evaluate the impact on the financial and sustainability targets set through this integrated planning approach. 

*This blog post is based on the Essential guide to CapEx from A4S CFO Leadership Network 

Marco van der Kooij

Consulting Director at inlumi 

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