The Impact of Capital Projects on the Operating Budget

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Type: 
Best Practice
Background: 

The operating impact of a capital project is an essential factor to consider when making an informed decision about proceeding with the project.  Capital projects can impose significant consequences upon the operating budget. While this is typically an additional operating budget burden, these impacts can also represent a positive impact on the operating budget.

Presenting operating impacts may be required by law or by the government’s own financial policies.1

The analysis of operating impacts from capital is often deficient in practice (i.e., in Budget Awards Program – many “not proficient” ratings).  This is an indicator that practitioners are (1) failing to understand the need, (2) not effectively making the argument within their jurisdictions to include it, or (3) lacking the tools and methodologies for calculating or showing the costs.

Recommendation: 

GFOA recommends that governments discuss and quantify the operating impact of capital projects in the budget document.  The impacts should be identified on an individual project basis, but may be summarized.  The following steps should be taken to ensure that operating impacts are identified.

 

  1. A specific policy on operating impacts should be included under the capital section in the financial policies of the government.  A rule might be established that the capital improvement program may not be submitted/approved until impacts are noted.2 
  2. In order to accurately reflect and describe these impacts, assumptions should be noted.  Staff involved with estimating operating impacts should be trained on how to set up the methodology.  Items to consider when making assumptions include:
    1. Timeframe to determine when costs, savings or revenue will start.  For example, first-year startup costs will likely differ from costs in successive years when savings may be realized.
    2. Various anticipated phases of the project.
    3. In-house or external operations.
    4. Type of work being done.
    5. Whether the costs, savings, or revenues are recurring or non-recurring.  For example, replacement and maintenance costs may occur on alternating or periodic years rather than annually over the life of a capital asset.  A government should analyze the cycles for such up-keep costs and plan accordingly.
    6. Defined cost structures, when applicable (see example).
  3. Operating impacts can be classified into one of three elements or a combination of the three.  These include increased revenues, increased expenditures or additional cost savings (see example on following page).
    1. Increased revenues may be the result of additional volume, like opening a new train line, a new swimming pool, or a sports facility.
    2. Increased expenditures are often the result of a new facility, like a school building, fire station, etc. This would result in additional headcount and associated expenditures.  Expenditures can be broken out by component.
    3. Savings may result from a number of items such as more efficient energy savings, more productive software, and lower maintenance and repair expenditures.
  4. Agency long-range financial plans should include anticipated operating impacts from approved or anticipated capital projects.
    1. GFOA recommends the development of long-range financial planning.  Such plans should include the operating impacts of capital projects.
    2. Similarly, the assumptions regarding the long-range financial plan should include clear descriptions of such operating impacts.
Project Year 1, Including Start-up Costs Recurring Salary & Benefits Recurring Other Operating Costs Recurring Annual Revenues
Library A $xx,xxx $xx,xxx $xx,xxx N/A
Library B $xx,xxx $xx,xxx $xx,xxx N/A
Hangar $x,xxx N/A $x,xxx $xx,xxx
Aniam Shelter Addition $x,xxx N/A $x,xxx N/A
Total $xx,xxx $xx,xxx $xx,xxx $xx,xxx

 

Narrative

Libraries - The additional personnel (3.5 FTEs) that will be needed at the two new branch libraries are an Assistant Branch Manager/Children's Coordinator, Library Clerk, Maintenance Worker, and one part-time employee. The additional operating costs are due to the fact that the Library A is increasing from an existing 1,500 square feet structure to an 11,000 square feet building, and Library B is increasing from 2,400 square feet to 13,000 square feet.  The  increased  operating  costs  may be broken down into start-up costs and on-going costs (some of which may not necessarily be annual, but periodic) Start-up includes hiring  of a  contracted  security  guard ($xx,xxx),  additional books and  materials ($xx,xxx), magazines  and  newspapers ($x,xxx), children's programming ($x,xxx), clerical, janitorial, and miscellaneous supplies ($x,xxx).  It is anticipated that the new branch libraries will open October 20XX and September 20XX, respectively.  On-going costs include books and computer software annual maintenance fees.  Salaries and benefits for the new personnel as well as any escalating costs of the retiree benefit package are increased annually from the initial base.  Maintenance and equipment upkeep ($xx,xxx) are included on a periodic basis.

Hangar - The  additional  10-unit  hangar  at  the  Airport  will  provide  for  annual  revenue  of approximately $xx,xxx. The Regional Airport maintains a waiting list for hangar space and the addition of ten additional units will help alleviate some of this backlog of applicants.

Animal Shelter Addition - The proposed Animal Shelter Addition allows for maintenance.

Committee: 
Governmental Budgeting and Fiscal Policy
Economic Development and Capital Planning
Notes: 
  1. For instance, per Nevada Revised Statutes (NRS) 354.601: Construction of capital improvement without funding for operation and maintenance included in approved budget is prohibited.  A local government shall not begin the construction of a capital improvement unless the funding for the operation and maintenance of the improvement during the current fiscal year, included personnel is included in an approved budget.
  2. For the Commonwealth of Massachusetts, as part of the annual development of the capital investment plan, the Executive Office for Administration and Finance evaluates the operating budget impacts for all requested projects.
References: 

GFOA Best Practice, “Presenting the Capital Budget in the Operating Budget Document,” 2008.

GFOA Best Practice, “Incorporating a Capital Project Budget in the Budget Process,” 2007.

GFOA Best Practice, “Multi-Year Capital Planning,” 2006.

Approved by GFOA's Executive Board: 
September 2015