Capital program considerations in challenging times.

• Author: Fishbein, John
• Position: Capital expenditure

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Governments across the country are tightening their budgeting belts. Since capital expenditures make up such a large part of the budget, the capital program is not immune to this contraction. Developing a capital program strategy in challenging economic times requires special attention in eight areas: fiscal constraints, expenditures, plan review, operating impact, prioritization, citizen involvement, planning/timeline, and closeout. These factors cover both financial implications and program considerations.

FISCAL CONSTRAINTS

In a slowing economy, fiscal constraints force local governments to review expenditures, particularly large ones such as capital projects. Governments should be conservative when analyzing the availability of capital revenue sources, especially those tied directly to the economy

Revenue Sources. All funding sources used for capital projects should be reviewed regularly, particularly during times of economic uncertainty. Governments can use a checklist that includes several factors: How stable are the revenue sources? Are they economically or politically dependent? During an economic downturn, elastic revenues such as sales tax generally slow down. However, in the current recession, even stable revenue sources are declining. If certain fees are dedicated to capital projects, they should be analyzed to ensure they are still sufficient. If not, will elected officials approve an increase in the fee to raise necessary revenue? Onetime revenues are available for only a given period of time, so if they are being used for a long-term project, alternative funding should be considered and available. If a bond offering is planned as a possible capital revenue source, the current credit market turmoil could affect previous assumptions.

Funding Options. In analyzing funding options, governments need to consider the pros and cons of different sources. Managers can make more informed decisions if they look at potential problems as well as likely gains. Making a list of the advantages and disadvantages of particular funding options is a good approach (see Exhibit 1). Be conservative in forecasting the amount of revenue a specific capital revenue source may bring in. Also, be aware of the impact or burden each decision may have on citizens. For instance, if a real estate transfer tax is being considered as a capital revenue source, would this hurt real estate further? Does the government have legal authority to raise such a tax? Do voters have to approve it?

Project Justification. When resources are limited, it is a good idea to do a cost-benefit analysis on major capital projects. Doing so allows government officials to consider the specific reasons why a project is needed, along with clear statements regarding the impact of not proceeding with the project. (See Exhibit 2 for a cost-benefit analysis from the City of Edmonton, Alberta.)

Return on Investment. Fiscal constraints may limit project selection to those with the highest return, cost savings, or payback.This approach allows for a more objective selection of capital projects.

Partnerships. Some governments seek partners to help them fund projects. Potential partners include other governments, non-profits, or private-sector companies. Partnerships should particularly be considered in cases where the other party can provide additional expertise or funding. (See Exhibit 3 for a list of regional partnerships the County of Arlington, Virginia, takes part in.)

CAPITAL EXPENDITURES

As capital resources become scarce, governments tend to cut back on expenditures--although one positive outcome of the economic downturn is that construction costs have declined. But when revenues are tight, it is especially important to have accurate capital project cost estimates. A number of techniques can be used to make these calculations more precise.

Conceptual Costing. Some governments establish parameters that can be used to estimate total project costs for each phase of a project, from concept through construction. (See Exhibit 4 for the parameters used by the County of Spotsylvania, Virginia.) Estimating all phases of the project as accurately as possible during the early planning phase ensures a reliable cost model. Managers can use this model to determine whether the scope of the project needs to be scaled back because of budgetary concerns, and changes can be made in the design phase, when it is most cost-effective to make alterations.

Accuracy of Estimates. The accuracy of estimated costs contained in a capital improvements program varies, depending on the degree of detail included in the project proposal. Three categories of estimate levels are used to determine project cost estimates. The conceptual estimate is the least accurate and is used when the conceptual idea or plan has been prepared without precise details. An example would be a new police or fire building that is being considered, but for which no plans have been completed. This kind of estimate would also be used for projects where a final location is unknown and right-of-way or land costs are involved. The second level, the detailed estimate, is based on an approved design plan or conceptual plan that the city has accepted. Street projects where city staff has used actual bid prices to prepare estimates based on typical street structural and geometric details fall into this category. The highest level of estimating is the design estimate, which is based on a completed set of design drawings and specifications that are ready for bidding. This level could also be called a bid or engineer's estimate.

Risks in Estimates. Cost estimates include some uncertainty, and decision makers need to be made aware of these risks. This kind of communication can take place in a variety of forms, but it is frequently included on individual capital project sheets in a budget document.

Cost Monitoring. Costs should be monitored over the life of the project. Many governments have established detailed databases containing important information about their capital projects, allowing the creation of timely reports. A good example is the Illinois State Toll Highway Authority project management database. It is used to keep track of the status of capital programs, identify problems before they become too big to deal with easily, allow alternative analysis, and get information to all parties as needed. Database users have real-time access to timely information on budgets, commitments, expenditures, cash flows, forecasts, and performance status, allowing them to control costs by making decisions quickly. The toll highway authority provides regular reports on project variances from the plan (e.g., expenditures or timeframe).

Financial reports generated to assist in variance analysis include the following:

* Monthly project status reports, which focus on schedule and cost status, proposed or pending changes, and current project issues. They include detailed financial and schedule performance for each project, including change orders, forecast-at-completion costs, and expenditure tracking.

* Exception reports, which are used to disclose project issues that could cause delays or budget overruns. They allow managers to address problems quickly by bringing the expected future...