How do you decide if buying equipment is worth it? This question doesn’t focus on whether to buy or lease, or whether to choose new or used equipment. It’s about understanding if a capital investment makes financial sense. If you’re better off with the investment than without it, then it’s worth considering. However, the answer isn’t always simple and requires careful analysis.
Breaking it down: The key steps
1. Understand the total cost
The cost of new equipment goes beyond the price tag.
Purchase price: The upfront cost.
Other expenses: Initial tooling, freight, insurance, and exchange rates.
Hidden costs: Offloading, container fees, and rigging.
Installation: Changes to buildings, utility connections (electricity, air, dust collection), and removing old equipment.
Testing: Travel expenses and materials for test runs.
Training and hiring: Bringing your team up to speed.
Make sure you accumulate all these line-item costs when calculating the total cost.
2. Evaluate your alternatives or options
What are your options if you don’t invest? This is your baseline.
Do nothing: What happens if you keep the status quo? This could mean higher repair costs, lower sales, or lost opportunities.
Outsourcing: Would it be more expensive or less efficient to outsource?
Other equipment: Are there cheaper or simpler alternatives?
Lean Manufacturing: does it lead closer to one-piece flow, or does it lock you into batch-production?
3. Identify and quantify the benefits
The investment must bring measurable benefits.
Increased capacity: Removing bottlenecks to produce and sell more. These provide often the best benefits, as the gross margin of that product is going on the benefit side.
Lower costs: Saving on labour, materials, or overhead. These are most common line items in the benefit calculations.
Higher quality: Reducing waste or improving customer satisfaction.
New capabilities: Producing new products or reducing processing time.
Flexibility: Faster setups or quicker changes will allow you to operate on much smaller batch sizes. This will reduce factory through-put time. This will lead to reduced work-in-progress.
Reliability: Less downtime or reduced inventory needs. Redundancy in machines (i.e., having two machines) increases the overall reliability. Quantifying this benefit is very much based on assumptions as most companies don’t keep relevant records.
Working capital reduction: If a new investment allows/causes production to operate with less inventory, then basically the expected working capital reduction can be deducted from the investment amount. For example, if the investment allows you to change from batch manufacturing with a high level of work-in-progress and finished goods inventory to a short manufacturing lead-time, just-in-time (make-to-order) facility, then you can deduct the value of the permanent reduction from the investment cost. Theoretically if the inventory reduction equals the investment cost, then the equipment is paid off as soon as the inventory reduction has been realized. Practically, the equipment does not cost anything. I do not see this investment justification used often, and I have seen accountants argue against this point.
Tax saving/tax incentives/grants: In profitable years an investment will create additional tax write-offs, especially if there are some incentive programs by the government with accelerated depreciation. Also, direct government investment grants will impact the ROI of an investment. How to incorporate these benefits into the calculation needs to be agreed with your accountant. The simplest way is to deduct the grant amount from the initial investment sum.
Some benefits, like risk reduction or aligning with long-term strategy, are harder to quantify but still important.
There are several investments where benefits are difficult to quantify. For example, the dust collector, the compressor system, all are needed (and some are legally required) regardless of benefits. In these cases, the calculation will not lead you to a yes/no decision. However, such a calculation can be used to calculate the difference between different options considered.
Of all the steps listed here, identifying and quantifying the benefits is the most important one. This requires a good understanding of the production processes and the capabilities of the new investment.
4. Calculate the return
To justify an investment, compare your financial situation with and without the equipment.
For simple calculations, use the payback period method:
Divide the total investment by the annual benefit. This gives the number of years it will take to recover your costs.
For larger investments, consider advanced methods like Net Present Value (NPV) or Internal Rate of Return (IRR). These provide a more complete picture but may require the accountant’s help.
These return-on-investment calculations are just formulas. The result of the calculation is only as accurate as the accuracy of the input data. If some of the input data (i.e. benefits) are just guesses, the result will be guesses too.
In my experience the payback period calculation, if any, is the most frequently used.
5. Plan for scenarios
Create best-case, worst-case, and most-likely scenarios for your projections. This helps you prepare for uncertainty and reduces the risk of relying on overly optimistic assumptions.
6. Be wary of false savings
Don’t overestimate benefits: If you save floor space, but keep paying the same rent, it’s not a real saving unless you can use the space for something profitable.
Compare costs fairly. For example, if a bus ride costs $3 and a taxi ride $25, you can’t claim walking as a $25 saving when the bus was a realistic alternative. The benefit should be always calculated in reference to the most reasonable alternative.
If the new investment triples the output, but the market does not allow you to sell more, it would be false to use it as a benefit.
7. Think beyond the numbers
Not every benefit is financial. Ask yourself: Does this align with our long-term strategy?
Will it reduce risks or improve safety?
Can it improve employee morale or brand reputation?
8. Involve your team
Investment decisions shouldn’t happen in isolation. Consult your finance team, operations staff, sales and marketing, and end-users to ensure all perspectives are considered. Collaborative decision-making reduces the chances of overlooking key factors.
Larger companies typically have systems and methods in place on how investment calculation have to be done. Smaller companies and companies with little formality need to set their own course. Often these companies had the owner-operator deciding on gut feeling. Here the company’s accountant and the production staff have to come to an agreement on the methodology and the approach to investment calculations.
The role of intuition
Even with all the calculations, your gut feeling matters. If the numbers say yes, but something doesn’t feel right, take a closer look. Intuition should complement analysis, not replace it.
As Albert Einstein said: “The rational mind should be the servant to the intuitive mind, not the other way around.” Trust your instincts, but don’t skip the math.
A Checklist for justifying equipment
Use this checklist to guide your decisions: Calculate the total cost, including hidden expenses.
Compare alternatives (including doing nothing).
Identify measurable benefits, like increased sales or reduced costs.
Choose a suitable calculation method, such as payback period or ROI.
Create scenarios to account for uncertainty.
Consider non-financial benefits, like safety or strategy alignment.
Involve key stakeholders for diverse perspectives.
Balance rational analysis with your gut feeling.
By following these steps, you’ll make smarter, more confident investment decisions that support your company’s growth and success.
Do not forget the post-investment audit
It does not matter if the investment decision had been made on a handwritten notepad or a very formal capital expenditure request (CER); it boils down to a promise, that if the company invests the money, it will achieve a list of benefits.
Most companies I know do not conduct post-investment audits, but in my opinion, they are essential for several reasons. First, knowing that results will be reviewed creates accountability and encourages more thoughtful decision-making. Second, it provides an opportunity to verify whether the initial assumptions were accurate, offering valuable insights for future planning. Third, it helps the team learn and improve their approach for subsequent capital expenditure requests (CERs). Finally, if the promises made are successfully achieved, it boosts management’s confidence in the team’s work and decision-making process.
