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Weekly UpdatesCapital budgets are used to allocate funds for physical assets that are to be acquired, constructed, renovated, and rehabilitated. In order to develop a capital budget, a jurisdiction must assess its infrastructure needs, prioritize among projects, integrate long-term capital plans into the service-delivery responsibilities of the government, evaluate a range of funding options, and schedule the regular repair and replacement of the capital stock. (1) This is most often achieved through the adoption of a formal capital improvement program (CIP), which sets forth a jurisdiction's construction and maintenance plans over a five- or six-year period. The National Advisory Council on State and Local Budgeting (NACSLB) recommends that state and local governments undertake a series of steps to manage their capital assets. (2)
A government's goals of providing efficient and effective services to its citizens for an equitable price can be enhanced by separating its budget into at least two parts: the operating budget and the capital budget. A dual budget system allows for a balanced operating budget and for the possibility of borrowing funds for a financed capital budget. (3) It also enhances awareness of the capital budgeting process and, therefore, leads to closer managerial control over the implementation of the capital budget. While operating budgets provide funds for a host of expenses, such as salaries and police uniforms, capital budgets are restricted in scope to provide funding for only physical projects or fixed assets. The revenue sources for capital budgets include own-source revenues (taxes and fees), debt, and intergovernmental revenues. The feature that makes a capital budget's revenue structure different from an operating budget's is the use of long-term debt. State and local governments can borrow funds from investors and use those funds in a capital budget to cover the costs of construction, rehabilitation, and major repair. Although local government policies vary on items or projects that are eligible for funding in the capital budget, typically a facility or structure is expected to be consumed or used up over a period of time that minimally exceeds one year or for many governments exceeds three or five years. Governments may also have dollar thresholds for items to be included in the capital budget, and the threshold depends on the size of the government's budget.
This article provides an overview of the capital budgeting process. More specifically, it addresses:
* The role of capital budget managers in coordinating the CIP and preparing the annual capital budget
* The capital budgeting cycle
* The principles of financing capital facilities
* The relationship between the capital budget and the operating budget
MANAGING THE CAPITAL BUDGET
The locus of capital budgeting frequently is found in the finance department, the budget office, or the planning and development department. The capital budget process is most often housed in the budget office with close consultation with the planning and engineering agencies. An important decision is whether the capital budget approval process will be done concurrently with the operating budget or separately Coordination of the two budgeting processes permits policymakers to analyze the total operating, maintenance, and construction costs of capital projects. Since monies from the operating budget are generally used to fund the ongoing maintenance of capital assets, it is crucial to coordinate the operating and capital budgeting processes to ensure that new capital asset construction will not overburden the operating budget in the future.
THE CAPITAL BUDGETING CYCLE IN STATE AND LOCAL GOVERNMENTS
In general the capital budgeting cycle incorporates six important stages: 1) asset inventory, infrastructure needs assessment, and cost analysis; 2) project prioritization; 3) financing plan development; 4) CIP and capital budget preparation and adoption; 5) capital budget execution; and 6) CIP evaluation and updating. (4)
Stage I: Asset Inventory, Infrastructure Needs Assessment, and Cost Analysis
NACSLB Recommended Practice 2.2 calls on governments to "have a process for inventorying its capital assets and assessing the need for, and the condition of, these assets." A sound needs assessment requires collaboration among capital budget managers, engineers, planners, and finance specialists. The goal of such collaboration is to provide decision makers with a realistic appraisal of the condition of existing capital assets, reasonably accurate demand estimates for current and future facilities, verifiable costs of maintaining, repairing, or replacing capital assets, and an analysis of long-term opportunity costs.
Once the needs assessment is complete, a list of candidate capital projects is developed, including renovated and new facilities. The list of candidate capital projects for the CIP can originate from numerous sources, including governmental agencies, advisory groups, citizen and business groups, chief executives, and members of the legislative branch. Public hearings are often held from which additional projects may be placed on the capital budgeting agenda for consideration.
Stage 2: Project Prioritization
The second stage of the capital budgeting cycle is the identification and prioritization of projects for inclusion in the CIP. The NACSLB recommends that projects be prioritized based on explicit criteria agreed upon prior to the planning process. Each criterion should be weighted to reflect its relative importance to the jurisdiction compared to all other criteria. For example, weighted criteria should help a jurisdiction decide whether a project to protect the health and safety of the citizens or a project that creates or protects jobs in the area is more important to the community. Exhibit 1 presents an example of a project priority ranking worksheet.
Stage 3: Developing a Financing Plan
It is important that a government identify potential funding sources for each of the projects included in the CIP. Such a requirement greatly increases the likelihood that resources will be available for each year of a multi-year project, and discourages decision makers from perpetually pushing unfeasible projects into the out-years of the plan.
Funding for infrastructure projects is derived from three sources. One source is cash contributions that are generated from the government's authority to collect own-source revenues during the current fiscal year as well as from accumulated savings or reserves from previous years. The second revenue source consists of contributions from other levels of government (i.e., intergovernmental aid). A third is borrowed money, or debt issues.
Stage 4: Preparation and Adoption of the CIP and Capital Budget
The fourth stage of the process is the preparation and adoption of the CIP and the capital budget. In most governments, the capital budget is the first year of the CIP. A capital budget should include:
* A detailed description of each project to be considered in the current budget year
* A statement of the purpose of each project
* A description of the method for financing each project and the sources of funds
* A schedule for the completion of multi-year projects.
After the schedule of completion and citizen evaluation are completed, the capital budget--as a separate fund for accounting purposes--is then submitted to the legislative branch for approval. Capital budgets are usually placed in a separate fund that self-balances all capital projects and funding sources.
Stage 5: Execution of the Capital Budget
This fifth stage of the capital budgeting process involves close cooperation and communication between finance staff and line agencies responsible for executing capital projects. Whether a project is contracted out or performed in-house, the line department is typically expected to maintain strict oversight of the project. This project oversight role is important to keeping a project on time and on budget, as well as to make sure that contractors comply with applicable laws and regulations. The "watchdog" role for agencies is important to prevent abuses, to curb cost overruns, and to make sure that contractors and the government agency comply with applicable federal, state, and local laws and regulations on issues such as child labor, building codes, and affirmative action.
Stage 6: Evaluation and Updating of the CIP
The final stage of the capital budgeting process involves evaluating and updating the CIP. NACSLB Recommended Practice 11.5 advocates that all governments monitor, measure, and evaluate capital program implementation. An important reason for conducting an evaluation or audit of a capital asset after its acquisition and/or construction is to determine whether scheduling and financing goals outlined in the CIP were attained. During the acquisition and/or construction of capital assets, delays or cost overruns are not unusual. The post-completion evaluation highlights problems encountered from initiation to completion of the project. The identification of problems is important so that efforts can be initiated to prevent the same problems from arising in the future. The post-project evaluation should review the accuracy of cost and benefit projections made prior to selection and construction of projects. The evaluation should include explanations of any differences between pre- and post-project costs and benefits and, if warranted, estimating procedures should be adjusted.
A government's CIP should be reviewed on a yearly basis and updated as necessary. At minimum, as the first year of the CIP becomes the next fiscal year's budget, a new final year should be added to the CIP annually (Governments that have biennial budgets typically also choose to revise their CIPs every two years.) Changes in economic forecasts, revenue estimates, citizen demand, legal mandates, priorities of the legislature, or other factors may necessitate additional adjustments to the multi-year CIP.
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