What is an AFE – Authorization for Expenditure – in Capital Planning?

What is an AFE – Authorization for Expenditure – in Capital Planning?

The AFE (authorization for expenditure) process is notoriously complex. It often involves input from various stakeholders across a wide range of departments, and approvals can take months to turn around.

But it’s also essential for capital planners to understand. So, in order to help you get a handle on how it works, we’ve put together answers to frequently asked questions.

For more on the AFE process in the oil & gas industry specifically, check out our blog post.

What is an Authorization for Expenditure (AFE)?

Well, that depends on your role in the company.

For those in finance, it’s a process for companies to evaluate estimated project costs, then approve funding for individual or portfolios of projects from the central Capex budget.

  • Finance teams can rely on input from various parties — including engineers, accountants, and lawyers — along the way to weigh in from their unique perspectives.
  • Once the project is finished, actual costs are tallied up, and the variance from the original estimates is calculated. When these calculations are done manually, finance staff must review the variances and determine if anything within the process needs to be changed in order to improve the outcome of the project and incorporate into other business planning documents/systems.
  • For those in finance, it’s a process for companies to evaluate estimated project costs, then approve funding for individual or portfolios of projects from the central Capex budget.
  • Finance teams can rely on input from various parties — including engineers, accountants, and lawyers — along the way to weigh in from their unique perspectives.
  • Once the project is finished, actual costs are tallied up, and the variance from the original estimates is calculated. When these calculations are done manually, finance staff must review the variances and determine if anything within the process needs to be changed in order to improve the outcome of the project and incorporate into other business planning documents/systems.

For those in accounting, it’s a document that contains estimated expenses from those involved with a requested project, which requires approval before central Capex funds are allowed to be deployed.

  • For example, in the oil & gas industry, geologists, surveyors, and lawyers all provide estimates of the costs they’re responsible for. The costs are summed up, reviewed by the accounting team, and sent to the CFO and other relevant parties for approval.

Where do AFEs come in during the capital planning process?

For most companies, the AFE process begins when a department manager determines the need for a new project or large capital purchase. The process then unfolds along these lines:

  • Once the project scope is outlined, estimated costs are gathered from each relevant party. This can include estimates of legal costs from lawyers, construction costs by engineers, etc.
  • A total project cost forecast is then determined, and approvals are requested from the CFO and others; oftentimes, who is required to sign off on a project request is dictated by the nature of the project itself, the amount of money being requested, strategic concerns such as ESG, etc.
  • Once senior executives give their sign-off, the project is greenlit to start spending Capex dollars; actual costs and revised estimates are expected to be included in recurring forecasts
  • Finance teams will typically allow for a margin of error when budgeting for the project, which can vary by as little as 5% and as much as 20%, depending on the industry and the systems used to generate the estimates
  • CFOs rely on cost estimates/forecasts when projecting future quarterly earnings
  • Many companies analyze Capex forecast accuracy on a quarterly basis, and adjust cost assumptions based on real-world outcomes

How does the AFE approval process work?

The AFE approval process can vary widely based on project size, industry, and complexity, though there are commonalities:

  • Before the process officially begins, the company should have a general idea of what the project is trying to accomplish, and clear most legal/regulatory hoops
  • Once each stakeholder in the approval workflow has compiled estimated costs in their area, an initial draft of the AFE is sent to accounting
  • The accounting team matches up the estimated costs with general ledger (GL) codes, and the AFE is sent up the chain for approval. This is considered the “creation and approval” process, and can take up to several months – particularly if the organization is dependent on manual processes such as emailing spreadsheets
  • To optimize the approval process, consistent ROI and risk metrics are key; without a consistent project grading process, it’s much more difficult for approvers to compare and contrast projects that might be competing for the same piece of the budget “pie.” It can be easy for bias from senior management or others to creep into their forecasts, and be much harder for essential strategic considerations to be fairly evaluated.
  • For more complex projects that may span one or more years, a stage gate process is required in which key milestones in the project require a new round of approval taking into account progress that has or hasn’t been made against the forecast or changing marketplace dynamics

How do AFEs get tracked?

Depending on the size of the project, AFEs can get incredibly complex, and – for those companies still dependent on manual processes – require spreadsheets with thousands of rows.

  • Manual workflows leave a lot of room for error: in the oil & gas industry, for example, average AFE estimates tend to miss the actual forecast by 20%
  • The best companies are able to reduce this variance to 5%, and get a much clearer picture of their capital plans by automating the process and adding real-time reporting; the bigger the project, and the more parties involved, the higher the likelihood that an automated workflow will improve estimate accuracy
  • Other than accuracy, automated workflows also eliminate information silos that can make data hard to track, dynamically reroute approval requests according to set business rules, and help companies adapt when changes occur such as a department reorganization, changes in leadership, etc.

How does a capital request follow up work?

The best performing companies do not consider the AFE process complete when funds have been allocated and approved; they monitor forecast accuracy, ensure that actuals have been sent to their ERPs for better cash flow management, and – perhaps most importantly — do “project lookbacks,” also known as post-completion reviews.

  • Effectively evaluating project performance is highly dependent on consistent data; after all, it’s difficult to assess an ROI metric for comparable projects if they are utilizing different calculation models
  • Post-completion reviews are essential to creating a culture of continuous learning and improvement, yet are often neglected for various reasons, including the lack of a central depository of project assumptions and details, forecasts, strategic rationale and performance
  • “Mandating” a post-completion review as the final step in the AFE process can be an effective way of improving compliance for this essential activity

What types of AFE software are there?

Most companies in the large enterprise space that continue to rely on manual processes and generic software solutions, are keenly aware that their status quo is suboptimal – which, given the size of their Capex budgets, can have a material impact on their earnings. The executive summary to address this includes:

  • Generic software solutions lack the agility and intelligence that help companies reduce inaccuracy in their estimates and make better Capex allocation decisions
    • The simple task of passing spreadsheets or simple templates/forms from one party to the other, then synchronizing them at some later point, is time-consuming, labor intensive, and error-prone
    • Additionally, it’s easy for bias to creep into AFEs that rely on generic systems, since – given inconsistent metrics and less oversight – individual parties may be prone to pushing cost estimates higher or lower based on faulty assumptions, political pressures, and the like
    • Without a purpose-built solution, the AFE tracking process becomes fragile; if an engineer leaves the company along with his spreadsheet that contains vital AFE data, for example, that information may be lost
    • Simple form builders lack any financial intelligence and dynamic routing ability
  • Purpose-built solutions such as Finario GO provide a single source of truth that eliminates data errors and uncertainty
    • Finance and accounting teams can spend more time on value-added tasks rather than chasing down inconsistencies
    • A purpose-built solution allows you to analyze critical variables such as ROI, strategic initiatives like ESG, and risk factors utilizing best-in-class models, custom models, and other criteria of importance
    • From the get-go, Finario GO allows your company to set up an AFE process based on your unique priorities and processes; once it’s implemented, all future projects are evaluated in a consistent, data-driven manner
    • While streamlining the entire process is a critical benefit, the ability to make quicker and smarter decisions can have a profound impact on an organization’s return on Capex investment