What factors are likely to drive a firm's outlays for new capital (such as plant, property, and equipment) and for working capital (such as receivables and inventory)? What ratios would you use to help generate forecasts of these outlays?

Answer 1

First, corporate managers decide the outlays for new capital, based on their expectation of future growth of the company. For example, when large sales growth is expected, a manager may decide to expand the firm's plant and equipment. Second, the company may increase investment in plant and property in order to lower future (potential) competition. In some industries, capacity expansion is a strategy that a company can make to deter potential competitors from entering the market.
Since capital expenditure is a strategic decision, it is difficult to forecast without some guidance from management. In the absence of such guidance, a good rule of thumb is to assume that the ratio of plant to sales will remain relatively stable and that outlays for new capital will be whatever amount is needed to maintain that ratio.
Managers may decide to decrease the outlays for working capital when
1 . they expect that the sales will shrink in the future;
2 . they expect that operating efficiency will improve, and thus require less working capital (e.g., implementation of just-in-time manufacturing); or
3 . the way of doing business is likely to change (e.g., change to OEM business).
Just like the forecast of capital expenditures, it is difficult to estimate future outlays of working capital without understanding management's plans. The rule of thumb, however, is to assume that the ratio of net working capital to sales will remain the same and that investment for working capital will be the amount which is needed to keep that ratio constant.