Blog · Territory, capacity and quota planning
A capital budget plans spending on long-lived assets, chosen project by project; an operating budget plans a year's revenue and running costs. This page compares the two in one table, works five capital proposals through NPV, IRR and payback against a 1,500,000 limit, and shows how the chosen projects flow into next year's operating budget through depreciation and savings.
A capital budget is the plan for spending on long-term assets, such as equipment, buildings, vehicles and systems, chosen project by project with net present value (NPV), internal rate of return (IRR) and payback. An operating budget plans one year's revenue and day-to-day running costs. The two meet a year later: approved capital projects enter the operating budget as depreciation, running costs and the savings they were approved to deliver.
| Capital budget | Operating budget | |
|---|---|---|
| Covers | Purchases of long-lived assets: plant, equipment, buildings, vehicles, major systems | Revenue, cost of sales and operating expenses: salaries, rent, marketing, IT, travel |
| Horizon | The life of each asset, often 5-25 years, approved in an annual round | One fiscal year, usually by month |
| How items are approved | Project by project, on NPV, IRR and payback, within a total limit | Line by line, by department or cost center, against last year or from zero |
| Where it lands | Balance sheet, as property, plant and equipment, then depreciated | Income statement, in the period |
| Usual owner | CFO and an investment committee or the board | Budget holders, consolidated by FP&A |
The accounting test for a single cost, expense it now or capitalize it, is the subject of OPEX vs CAPEX. This page is about the two budgets and how projects are chosen for the capital one.
A capital project is spending on an asset the business will use for more than a year. Under US GAAP the rules sit in ASC 360, Property, Plant, and Equipment; companies reporting under IFRS apply IAS 16. The tax test is similar: the IRS says depreciable property "must be expected to last more than 1 year" and must have a determinable useful life. Most companies add a capitalization threshold, a minimum cost below which items are expensed regardless.
Each proposal needs four things: the initial cost, the expected cash flows year by year (savings, extra margin, less any new running costs), the useful life, and the risk. Proposals fall into two groups. Maintenance capex replaces what wears out, and is often approved with little appraisal because the alternative is stopping. Growth capex adds capacity or capability, and competes for the money left.
NPV = −Initial cost + SUM(Cash flow in year t / (1 + r)^t)
IRR = the discount rate r at which NPV = 0
Payback (years) = Years before full recovery + Unrecovered cost / Cash flow in the recovery year
NPV per dollar invested = NPV / Initial cost
NPV is the value the project adds today, in dollars, at the company's required return r. Positive NPV means the project earns more than r. It is the method to rank by, because it measures value in money.
IRR is the return the project itself earns. It is easy to compare with a hurdle rate, but it ignores scale: a small project can have a higher IRR than a large one that adds far more value.
Payback counts how fast the cost comes back, ignoring everything after that and the time value of money. It is a liquidity and risk check, not a measure of value.
NPV per dollar invested, a form of the profitability index, ranks projects when capital is limited: it shows which projects add the most value per dollar of the budget.
Five proposals, a 10% discount rate and five-year cash flows, net of each project's own running costs. The capital limit is $1,500,000.
| Project | Cost (USD) | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | NPV at 10% (USD) | IRR | Payback (years) | NPV per $ |
|---|---|---|---|---|---|---|---|---|---|---|
| Second packing line | 600,000 | 150,000 | 200,000 | 220,000 | 220,000 | 220,000 | 153,808 | 19.0% | 3.14 | 0.256 |
| New ERP module | 400,000 | 90,000 | 120,000 | 140,000 | 140,000 | 140,000 | 68,727 | 16.0% | 3.36 | 0.172 |
| Warehouse automation | 900,000 | 260,000 | 260,000 | 260,000 | 260,000 | 260,000 | 85,605 | 13.7% | 3.46 | 0.095 |
| Delivery vans (6) | 360,000 | 110,000 | 110,000 | 110,000 | 110,000 | 60,000 | 25,940 | 13.0% | 3.27 | 0.072 |
| Solar roof | 500,000 | 85,000 | 85,000 | 85,000 | 85,000 | 85,000 | −177,783 | negative | not within 5 years | −0.356 |
Payback for the packing line: cumulative cash flow is 150,000, 350,000 and 570,000 after three years, leaving 30,000 to recover from year 4's 220,000, so 3 + 30,000 / 220,000 = 3.14 years.
Two sets fit within the limit and stand out:
| Set | Cost (USD) | Total NPV (USD) |
|---|---|---|
| Packing line + ERP module + delivery vans | 1,360,000 | 248,475 |
| Packing line + warehouse automation | 1,500,000 | 239,412 |
The smaller set wins. It spends $140,000 less and adds $9,063 more value, although it leaves out the single biggest project. Ranking by NPV per dollar gets there directly: take the packing line, then the ERP module, then the warehouse automation would not fit, so the vans. No other combination within the limit beats 248,475.
The solar roof deserves a second look. It was judged on a five-year horizon, but a roof lasts about 25 years. Over ten years at 85,000 a year its NPV is +22,288. The horizon rejected it, not the project. Run long-lived assets over their real life before turning them down.
The operating budget is the plan for next year's income statement: revenue, cost of sales and operating expenses, by month and by department or cost center. It is built from drivers (volumes, prices, headcount, rates), either rolled forward from last year or rebuilt from zero, as in zero-based budgeting. The same driver logic sets sales capacity: capacity is arithmetic works it for a sales team.
Capital spending never appears in the operating budget as a purchase. It arrives three ways:
The net effect on next year's operating profit is 350,000 − 212,000 = +138,000. If the operating budget is approved without these lines, the first variance report will show unplanned depreciation and running costs, and the savings will be invisible because nobody budgeted them.
Three checks close the example.
NPV recomputed in Excel. With the negative initial cost in B2 and years 1-5 in C2:G2:
=NPV(10%,C2:G2)+B2
Microsoft's NPV function assumes every value occurs "at the end of each period", and says that if the first cash flow occurs at the beginning of the first period, it "must be added to the NPV result, not included in the values arguments." For the packing line the formula returns 153,808. The IRR function, =IRR(B2:G2), does include year 0 and returns 19.0%.
Payback from cumulative cash flow. A running total row, =SUM($C2:C2) filled right, must cross the cost in the year the table says.
The chosen set within the limit. 600,000 + 400,000 + 360,000 = 1,360,000, below 1,500,000; NPVs 153,808 + 68,727 + 25,940 = 248,475.
=NPV(10%,B2:G2) discounts year 0 by a year: the packing line comes out at 139,825 instead of 153,808.Once both budgets are approved, the work is tracking spend against them. Covirage's cost variance tools join ledger actuals to budget, headcount and purchase orders, and build the variance bridge by cost center and vendor; for large capital programs, project cost control does the same by work package. The external AI model explains the variances and never does the arithmetic. See cost and variance analysis, and how to read a forecast bridge for reading the walk from budget to outturn. For templates, see the business budget template and budget vs actual; for reforecasting during the year, budget vs forecast.
A capital budget is a company's plan for investment in long-term assets such as property, equipment, vehicles and major systems. Each project is appraised on its cost, expected cash flows and risk, typically with NPV, IRR and payback, and approved within a total spending limit.
The capital budget covers spending on assets that last several years and are recorded on the balance sheet. The operating budget covers a single year's revenue and running costs that go through the income statement, including depreciation of past capital spending.
Net present value (the value today of future cash flows less the cost), internal rate of return (the discount rate at which NPV is zero), payback period (how long until the cost is recovered) and the profitability index. NPV is generally preferred because it measures value added in money.
Forecast revenue, cost of sales, and operating expenses such as salaries, rent, marketing, IT and travel, by month and by department or cost center, plus depreciation. It is usually built alongside a cash budget and a capital budget for the same year.