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Weekly UpdatesWHY ANALYSIS OF CAPITAL PROJECTS IS IMPORTANT
Decisions regarding capital projects can have important impacts on the fiscal health of communities for a variety of reasons. By definition capital projects are big-ticket items that represent major financial commitments. Because communities often finance capital projects through long-term borrowing, these financial impacts are felt over a long period of time. Further, capital projects frequently result in long-lived physical assets that may carry with them annual operating costs for maintenance, and eventually, major renovation costs.
Capital projects present particular analytical challenges for budget staff and are often not as well understood as regular operating budget requests. Onetime capital projects may require a sharp learning curve for analysts. Analytical challenges may be exacerbated by submittals from requesting departments that are incomplete and lack detail.
KEY QUESTIONS
Despite these challenges, budget staff must provide a thorough analysis and develop defensible recommendations on capital project requests to be presented to policy makers and the public. Several key questions should be addressed as part of this analysis:
* Does the project make sense strategically?
* What is the desired outcome of the project?
* Is the proposed project the best way to achieve the desired outcome?
* How much is the project really going to cost?
CAPITAL INVESTMENTS SHOULD BE STRATEGIC
Capital projects can have long-range impacts on both community development and government operations. Site and design of new and replacement infrastructure can influence location decisions by residents and businesses. Investments in government facilities can affect service delivery decisions for years to come.
A thorough analysis of a capital project request should include a discussion of whether or not the project makes sense strategically. Capital projects should reflect community values and priorities and be consistent with the government's strategic plan and objectives. Many communities require departments to identify how each project contributes to one or more strategic objectives as part of the budget request process. Budget staff needs to analyze these statements for logical consistency and ideally, supporting data.
The strategic impacts of how projects are completed need to be analyzed as well. If the strategic plan includes an objective to increase community green space, are road construction projects designed to maximize grassy borders and do they include funding for tree planting? The location and design of government facilities can stimulate nearby private sector development and help to stabilize at-risk neighborhoods. Do facility location and design plans consider not only the efficiency of department operations, but also potential positive and negative impacts on the surrounding community?
WHAT IS THE DESIRED IMPACT OF THE PROJECT?
A thorough analysis of a capital project request also should define the desired impact of the project and identify key measures to indicate project success. Capital project requests are sometimes submitted as reactions to an unexpected problem or some sort of external pressure and are inconsistent with the long-term direction of the organization. Other capital project requests may not adequately take into account changes in the government's operating environment and risk making an investment in "fighting the last war."
Taking the time to explicitly define the problem(s) that the project is intended to solve can help assure that capital investments will produce desired results. During this process it its important that budget staff take an objective perspective and ensure the discussion includes adequate focus on external impacts on the community in addition to internal impacts on government processes. Frequently referring back to the organization-wide strategic plan and objectives can help governments use capital projects more effectively to fulfill their mission.
IS THE PROPOSED PROJECT THE BEST WAY TO ACHIEVE THE DESIRED OUTCOME?
Once the desired project impact has been defined and key outcome measures identified, the analysis can turn to a review of alternative methods of achieving the expected results. Are there ways to produce the desire impact other than the requested capital project? Budget staff should make sure that the alternatives reviewed in this step are not limited to bricks-and-mortar solutions or based on a perspective that is too government-centric. Analysis of capital project requests should include, at a minimum, a high-level review of the relative costs and effectiveness of feasible alternatives. Based on this analysis a recommendation for the best alternative or the best combination of alternatives may be formulated.
For example, a municipal government looking to improve water quality in local rivers and lakes, could consider investing in additional or improved sewage treatment infrastructure, implement best management practices for storm water runoff, or seek to reduce pollution by educating citizens on the proper use and disposal of pesticides, cleaning solvents, and other household hazardous waste. Only a thorough analysis of the relative magnitude of the sources of water pollution and the cost effectiveness of the various alternatives will lead to the best utilization of limited resources.
HOW MUCH IS THE PROJECT REALLY GOING TO COST?
Determining how much to budget for capital projects is one of the most difficult and frustrating tasks assigned to government budget officers. Dealing with unexpected project cost overruns seems to come with the territory for most governments that regularly include capital projects in their budget. However, a rigorous analysis of the project in the following areas can help to minimize the unexpected.
* How will the money in the project budget be used?
Scope changes are a frequent cause of project cost overruns. The scope of the project should be formally defined by the requesting department and explained to officials and policy makers who are responsible for approving the budget. All parties should have a common understanding of what the project will and will not accomplish and agree on a process for making changes.
Perhaps because of the format in which they are submitted, capital project requests sometimes do not receive the same "scrubbing" as line-item operating budgets. However, budget staff should know what expenses are included in the project budget. Reviewing this information at the beginning of the project can help to prevent surprises during later stages of the project.
* Understand key capital project cost drivers.
Key cost drivers for capital projects should be identified as part of the analysis. Some common cost drivers for capital projects are:
** Staff time--Will staff be allowed to charge time to capital projects? If so, which staff and how many hours?
** Land acquisition--Will land need be acquired as part of project? How many owners are there? Are they willing to sell?
** Design and engineering--Will design, engineering and bid documents be completed by internal staff or external consultants? How much will design and engineering cost?
** Construction costs--How "concrete" are estimates?
** Environmental remediation--Have any necessary environmental analysis been completed? What are the risks?
** Scope creep--What will stakeholders want to add to the project?
** Close-out--Are there any potential project close-out expenses that can be anticipated? How much should be set aside to resolve these issues?
** On-going maintenance--What will the impact be on the O&M budget?
* Understand the nature of engineering cost estimates.
The accuracy of engineering cost estimates varies dramatically depending upon the amount of data available to the estimating engineer and the level of analysis completed. The Milwaukee Metropolitan Sewerage District places cost estimates into the following categories to help ensure that policy makers are aware of the potential for significant differences between estimated and actual project cost.
* Conceptual--cost estimates are based on a general concept of the project and often rely on rough calculations using experience from other similar projects or standard cost/unit tables. Actual costs can vary significantly from conceptual estimates as project scope is formally defined and specific project specifications are understood.
* Preliminary design--cost estimates are based on an initial definition of project scope and a basic definition of project specifications. Preliminary design cost estimates are typically more accurate than conceptual estimates but actual costs may still vary significantly as project scope is refined and detailed specifications are analyzed.
* Final engineering--cost estimates are developed based on a final project scope, detailed project plans, and data contained in the actual request for bids documents. Final engineering cost estimates are usually much more accurate than conceptual cost estimates and preliminary design cost estimates. However, actual costs can still be higher or lower depending on costs for raw materials like steel or concrete and the number of projects out for bid in the regional construction market.
* In construction--cost estimates are based on actual bid prices and are usually relatively accurate. However, conditions that might not be foreseen in the request for bids documents such as environmental contamination, unexpected underground soil conditions or changes in project scope can result in changes in project cost.
* Close-out--expenses may be incurred even after the project is substantially complete. For example an ancillary project not covered by existing contracts may be necessary, or claims for damages resulting from the project may need to be paid.
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