Last updated on Mar 24, 2024
- All
- Cash Flow Analysis
Powered by AI and the LinkedIn community
1
Historical capex ratio
2
Industry capex ratio
3
Strategic capex plan
Be the first to add your personal experience
4
Depreciation plus maintenance capex
Be the first to add your personal experience
5
Here’s what else to consider
Forecasting capital expenditures (capex) is a crucial step in discounted cash flow (DCF) analysis, as it affects the free cash flow (FCF) and the terminal value of a company. Capex represents the amount of money a company invests in its fixed assets, such as property, plant, and equipment (PP&E). In this article, we will discuss some of the best practices for forecasting capex in DCF analysis, based on historical trends, industry benchmarks, and strategic plans.
Top experts in this article
Selected by the community from 5 contributions. Learn more
Earn a Community Top Voice badge
Add to collaborative articles to get recognized for your expertise on your profile. Learn more
- 6
- 3
- 1
1 Historical capex ratio
One of the simplest and most common methods for forecasting capex is to use the historical capex ratio, which is the percentage of capex to revenue or EBITDA. This method assumes that the company will maintain a similar level of investment relative to its sales or earnings in the future. To apply this method, you need to calculate the average capex ratio for the past three to five years, and then multiply it by the projected revenue or EBITDA for each forecast period.
Help others by sharing more (125 characters min.)
-
(edited)
- Report contribution
Thanks for letting us know! You'll no longer see this contribution
See AlsoWhich of the following is not true capital budgeting?Incremental cash flows are consideredOpportunity costs are excludedRelevant cash flows are consideredSunk costs are ignoredWhat is Capex? | Definition from TechTargetCapEx vs. OpEx: What’s the Difference?Capital Expenditure (CapEX): Meaning, Types, Examples, Formula - HappayThis method has the limitation of ignoring price volatility of end product . For eg: crude oil is subject to very high volatility . In years of very high prices the ratio of sales or EBITDA to capex can be highly skewed and impact the ratio assessment. One can volume of sale as a better factor relative to capex and depreciation is linked to usage . Keeping these factors in mind , we should adjust the base of comparison. In certain situations seeing the trend of capex as a percentage of Net fixed Assets can serve as a better ratio.
UnhelpfulLike Like Celebrate Support Love Insightful Funny 6 -
(edited)
- Report contribution
Thanks for letting us know! You'll no longer see this contribution
This is probably the most intuitive approach, however, this approach is really good for the short-term but fails to take into account the lifecycle of the business. It can be the case that the historical period has either been of high growth or declining growth. It fails to take a forward looking approach and in a way ignores the cyclicality, nonetheless, it works really well for short-term horizon.
UnhelpfulLike Like Celebrate Support Love Insightful Funny 3 -
(edited)
- Report contribution
Thanks for letting us know! You'll no longer see this contribution
"Analyzing capex trends using historical ratios offers a reliable forecasting method. By calculating average capex ratios over 3-5 years and applying them to future revenue or EBITDA projections, we can estimate future investment levels accurately. This approach is both informative and practical, aiding in strategic planning."
UnhelpfulLike Like Celebrate Support Love Insightful Funny 1
2 Industry capex ratio
Another method for forecasting capex is to use the industry capex ratio, which is the average capex ratio of the company's peers or competitors. This method can be useful when the company's historical capex ratio is not representative of its future needs, due to factors such as growth, expansion, or obsolescence. To apply this method, you need to identify a relevant set of comparable companies, and then calculate their average capex ratio for the past three to five years. You can then use this ratio to estimate the capex for your target company, based on its projected revenue or EBITDA.
Help others by sharing more (125 characters min.)
-
(edited)
- Report contribution
Thanks for letting us know! You'll no longer see this contribution
Where possible , relevance of comparable set of companies should take into account the stage of the company under evaluation relative to the peer group. Clearly, growth stage companies tend to have more new capex than just maintenance capex. This can change the forecasted capex substantially.
UnhelpfulLike Like Celebrate Support Love Insightful Funny 3
3 Strategic capex plan
A more detailed and realistic method for forecasting capex is to use the strategic capex plan, which is based on the company's specific projects, initiatives, and goals. This method requires more information and analysis, but it can capture the nuances and dynamics of the company's investment strategy. To apply this method, you need to identify the major capex items that the company plans to undertake in the future, such as acquisitions, expansions, upgrades, or replacements. You also need to estimate the timing, cost, and benefits of each item, and then allocate them to the appropriate forecast periods.
Help others by sharing more (125 characters min.)
4 Depreciation plus maintenance capex
A final method for forecasting capex is to use the depreciation plus maintenance capex formula, which is based on the assumption that the company will invest enough to maintain its existing asset base. This method can be useful when the company has a stable or declining growth rate, and does not have any significant capex projects in the pipeline. To apply this method, you need to estimate the maintenance capex, which is the amount of capex required to keep the PP&E at the same level of efficiency and functionality. A common way to do this is to use a percentage of depreciation, such as 100% or 120%. You then add the maintenance capex to the projected depreciation for each forecast period.
Help others by sharing more (125 characters min.)
5 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
Help others by sharing more (125 characters min.)
-
- Report contribution
Thanks for letting us know! You'll no longer see this contribution
It is always useful to see the impact of the capex DCF forecast on other items on the balance sheet and P/L to ensure that it does not lead to a vast deviation in previous trends unless supported by the markedly different future growth or expansion or hive off plans For eg : An upward bias in capex can lead to lowered profitability , which in turn will impact many other ratios. Seeing the full picture is always a useful final tool to deploy in the number crunching art of capex projection.
UnhelpfulLike Like Celebrate Support Love Insightful Funny 3
Cash Flow Analysis
Cash Flow Analysis
+ Follow
Rate this article
We created this article with the help of AI. What do you think of it?
It’s great It’s not so great
Thanks for your feedback
Your feedback is private. Like or react to bring the conversation to your network.
Tell us more
Tell us why you didn’t like this article.
If you think something in this article goes against our Professional Community Policies, please let us know.
We appreciate you letting us know. Though we’re unable to respond directly, your feedback helps us improve this experience for everyone.
If you think this goes against our Professional Community Policies, please let us know.
More articles on Cash Flow Analysis
No more previous content
- What are some common investing cash flow ratios and benchmarks that you use or follow? 7 contributions
- How do you incorporate capital expenditure into a discounted cash flow (DCF) analysis? 5 contributions
- How do you evaluate the trade-off between paying dividends and reinvesting in the business? 3 contributions
- What are some red flags or warning signs of poor cash flow management? 8 contributions
- What are some alternative methods to IRR for evaluating mutually exclusive projects? 1 contribution
- How do you use IRR to measure the value creation of a project or a business? 3 contributions
- What are the advantages and disadvantages of using IRR as a project selection criterion? 1 contribution
- How do you calculate the incremental IRR and when is it useful for project ranking? 1 contribution
- How do you account for changes in working capital and capital expenditures in FCF analysis? 7 contributions
No more next content
More relevant reading
- Capital Budgeting How do you handle non-conventional cash flows in NPV analysis?
- Performance Measurement What are the advantages and disadvantages of using payback period as a performance measure?
- Technical Analysis How can you use relative vigor index in capital budgeting analysis?
- Cost Management What are the best practices and tips for improving your cost forecasting accuracy and reliability?
Help improve contributions
Mark contributions as unhelpful if you find them irrelevant or not valuable to the article. This feedback is private to you and won’t be shared publicly.
Contribution hidden for you
This feedback is never shared publicly, we’ll use it to show better contributions to everyone.
