Capital Budgets - A Step-by-Step Approach

March 26, 2010
Abide by these principles when developing a capital plan to ensure that budget is more thorough, accurate, and meaningful  

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Few organizations can lay claim to having a well-developed, efficient, and practical capital-budgeting plan. Due to various constraints, improving the capital-budgeting process is often overlooked, rushed through, or pushed aside altogether. The procedure can be frustrating for any facilities professional: No one division owns the capital budget, and anticipating costs for upcoming projects and systems is easier said than done. Despite these obstacles, capital planning and budgeting is absolutely essential. So, you might as well do it right. (Right?)

Capital planning and budgeting go hand in hand: “Capital planning is a way of defining how you’re going to spend money to get the most impact for your organization and its mission,” says Ray Dufresne, vice president of consulting services, VFA Inc., Boston. “Capital budgeting is knowing what you’re going to spend your money on in the next year (or two or three). In many organizations’ budgets, [facilities spending is] second only to labor.”

An all-inclusive capital budget covers the entire property and serves as a means to evaluate its physical condition, pinpoint existing and anticipated needs, determine upkeep/modernization costs, and find ways to address these needs within financial limits.

Abiding by these principles when developing a capital plan can help ensure that your capital budget is more thorough, accurate, and meaningful:

Define the needs of your facility, preferably over a period of 3 to 5 years.
Identifying facility needs is best done via a comprehensive evaluation of all facilities and their systems - otherwise known as a facilities condition assessment. Some facilities professionals choose to outsource this task to an independent firm; others choose to take on the assessment themselves. “Outsourced facility audits are always an option,” says Charlie Dismore, training director, Capstone Real Estate Services Inc., Austin, TX.

However, dependence on outsourced services can ignore the expertise you have with both the organization’s mission and its physical premises. But, he points out, “There is no substitute for experience in being able to accurately predict costs for capital projects. If you don’t have it, try to hire it.”

“It should be a very property-specific inventory of what exists, including an assessment of current conditions, a projection of remaining useful life, etc.,” says David Whiston, president, On-Site Insight Inc., Needham, MA. Condition assessments can also create the foundation for an effective preventive maintenance program, help make decisions regarding short- and long-term needs, and differentiate between actions that should be handled by the operating budget vs. those that require new capital. (The worksheet featured in a link below may help you get started with your own condition assessment.)

As data is gathered during a condition assessment, it’s sometimes collected without a clear understanding of its objectives. Keep your goals and intentions in mind: What do you want to establish with this data? If you know how you’re going to use the information, it may influence how (and in what format) you collect it.

Databases can be useful in this process: “They can be analysis tools. They can look at the effects of the decisions you make. They can create scenarios and play out those scenarios to see - based on the decisions you make today - what the future’s going to look like,” says Dufresne. However, Whiston cautions facilities professionals against the widespread, excessive enthusiasm he has seen for automated solutions. “Before worrying about slick manipulations of automated data, you should care about the quality of the baseline assessment,” he emphasizes. Do you understand the real physical circumstances of the facility over time? Have you found opportunities to make equipment more cost effective?

Distinguish between costs for operational and capital expenses; estimate the costs and timing of the work.Whiston says he often sees a much more limited scope to the capital-planning process than makes sense. “[Facilities professionals] want to concentrate on 10 or 15 big-ticket systems and think about the costs and remaining useful lives associated with them. But, if you’re only focusing on big-ticket items, you’re missing an opportunity to optimize the assets.” A perfect example: The boiler. If you think about a boiler but nothing else in the boiler room, you’ve missed the opportunity to operate the system more efficiently. Paying attention to the relationship between the “big” things and the “little” things really warrants notice. Dufresne agrees: “Seeing capital budgeting as, ‘I’ve got a budget of X million dollars for next year; what am I going to spend my money on?’ and focusing on that - without looking at the big picture and how needs are going to change over time - is a big mistake. It’s not the initial cost that’s going to kill you, it’s the cost you put in on a periodic basis that [ends up being] the majority of the money you’ll spend from capital.”

Dismore says that life-cycle costing is one of the least understood (but most significant) aspects of a capital budget. “The wise manager will understand and apply the concepts of not only acquisition costs, but the necessary expense of design, installation, maintenance (both preventive and anticipated corrective), training, projected longevity, and any recovery opportunities at the end of the life of the equipment or product.”

Prioritize capital projects and identify those that should be addressed in the order of need or perceived value.
Many experts suggest that facilities professionals prioritize capital-equipment purchases and projects in this order:

  1. Start with projects that pose health, safety, or code-related issues.
  2. Move on to the items on the list that will have adverse consequences if they’re deferred.
  3. Next, undertake the tasks that will help you reduce future capital and operating costs.
  4. Lastly, think about the marketability of your properties and the projects that will add perceived value to the organization.

When making decisions about which capital projects and equipment purchases to tackle first, remember that there are standard useful-life assumptions for virtually everything in commercial real estate. “Certain kinds of roofs have a 25-year useful life, for example,” explains Whiston. “But, we’ve seen 2-year-old roofs that are effectively bathtubs; they won’t achieve anything close to an industry-standard useful life. If you rely on industry rules of thumb in the capital-budgeting [and prioritization] process, you’ll miss the mark far more often than you hit it.”

Define the annual capital program for the next fiscal year with guidance from senior management.
Ideally, capital planning should be a year-round process. In reality, most organizations don’t have that luxury. As much as possible, think about the budget as an ongoing course of action - even if it’s something that really only happens once per year.

Dismore recommends a continuing, long-range capital planning program that’s validated and re-estimated every year: “Anticipated projects [should be] evaluated and either moved into the coming fiscal year to be addressed, moved further into the future, or scrapped if no longer viable.” He emphasizes that evaluation notes should be compiled throughout the year for consideration by the capital-planning team.

He also recommends that facilities professionals plan for between 5 and 10 percent of estimated total project costs to be available for contingency. “The single most difficult aspect of [a budget] to control is change orders. These have a way of blowing the budget out of the water.” If you can plan in advance (as much as possible) for these events, your budgets will be more realistic.

Solicit bids from qualified contractors or vendors for new equipment, projects, etc.
This step in the process can make your capital budgets even more true to life. Whether you’re talking a simple lighting-system purchase or an office renovation, make certain that the contractors and vendors you’re working with have ample time to respond to bid requests; rushing this process can increase the amount of the estimate if the firm doesn’t have enough time to deliver the needed product or services.

Enlist professionally qualified assistance to help you determine the actual needs and relative costs of design, construction, and oversight of large projects. “Attempting to save soft costs up front may result in higher overall expenses for a capital improvement project,” says Dismore.

Throughout this process, pay attention to the details: What’s it going to cost to remove your existing roof before you install the new one? How difficult will it be to get the existing boiler out of its space before you replace it? Include the answers to these questions in your budget. “Be rigorous about the uniqueness of your property in terms of the quality of materials, how well it’s maintained, environmental impacts, how the systems are used, etc.,” says Whiston.

Leah B. Garris ([email protected]) is senior associate editor at Buildings magazine.

Sample Quality Criteria Evaluation Form (pdf)

If the information presented so far hasn’t inspired you, consider these real-life case studies:

  • Oakland, CA-based Kaiser Permanente, a not-for-profit managed healthcare provider, had no central system to deal with facility information or to support its capital-planning process. The organization also had problems linking its capital-planning initiatives to its mission of “providing high-quality, affordable, integrated healthcare.” To achieve results, Kaiser conducted a detailed assessment of its facilities, generated a central facility database, and developed a method for prioritizing requirements. The outcome? It has identified short- and long-term critical issues, optimized capital plans that balance technical and strategic business goals, and has an executive comprehension of condition disparities across its portfolio.
  • BankBoston, acquired by super-regional Bank of America in 2004, has many branches that were acquired through mergers or acquisitions. It needed to centralize inconsistent facility data and leverage its facilities to support acquisition and retention. The organization instituted a program to assess facility conditions and standards, and developed a comprehensive database of detailed building information. As a result, BankBoston now benefits from accurately budgeted requirement costs and reduced waste in capital projects and emergency repairs.
  • U.S. Army MEDCOM, which manages over 27 million square feet of healthcare facilities, had no reliable approach for evaluating facility conditions. It also lacked a prioritization timetable for remedial projects and deferred maintenance. By implementing capital-planning software, establishing consistent assessment methodologies, and employing analysis tools to explore funding options, the organization can now demonstrate how capital expenditures support the quality-care mission of the military. It was also commended by the U.S. House of Representatives for its capital-planning approach.


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