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MRSC has joined with Toni Nelson, Small Cities Specialist, State Auditor's Office, Tracey Dunlap, Director of Finance & Administration at the City of Kirkland, and Mike Bailey, Administrator of Finance and Information Services, City of Renton, to bring you the "Finance Advisor" column. The "Finance Advisor" will feature a new article each month with timely local government finance information and advice you can use.*
Budgeting for Capital Improvements
July 2008
By Mike Bailey, Finance Director, City of Redmond
A few weeks ago at the Association of Washington Cities Annual Conference, I did a workshop on this topic. It generated a lot of questions from councilmembers in the audience (many of whom were new to their role on the council). So we decided it might be helpful to make our next Finance Advisor article on the topic of “Budgeting for Capital Improvements.”
First let’s review a few basic budgeting principles. A budget is a plan that allocates scarce resources to a much larger set of choices for services. The plan is based on the goals and policies of the organization that serve as the “ground-rules”. The plan must fit within the resources available, not only for today, but ideally for the future as well. The services provided should address the needs and the expectations of the community. That is they should be the right services and delivered in a way that the desired results are achieved. The decision making process to develop such a plan is the budget process. It occurs every year (or for those who are on a biannual budget – every two years). The mix of services can change with each new budget cycle.
Budgeting for capital improvements is essentially the same with a few significant differences. The services are in the form of capital improvements (we will define this in a moment) and the planning horizon is much longer. In addition, there are some state laws that are unique to capital improvement budgeting.
Capital Improvements
The definition of capital improvements can vary among agencies. Typically it is of a larger monetary value (say $50,000 and above) and has a longer “life” (it won’t be “consumed” in less than one year). So a building is a classic example of a capital improvement. Other examples are roads, bridges, parks, etc. Some less obvious examples involve systems. For instance, a single traffic light standard would not fit the definition, but a system of traffic lights would easily exceed $50,000 in value. As a result, significant improvements necessary for these large systems (traffic lights, paths, fiber optic cables) are considered capital improvements. In the accounting world, we “capitalize” these capital improvements. This means that we consider them an asset on our balance sheet that will be used over time rather than an expense within a single year. If we capitalize assets, then we account for their usage over time through depreciation – but this article is supposed to be about budget, not accounting (and for those of you on a cash basis of accounting, you don’t get into balance sheets, capitalization and depreciation anyway – but still budget for capital improvements).
Planning Horizon
The planning horizon for capital improvement budgeting has traditionally been five years. However, the Growth Management Act (GMA) adopted by the state legislature set a planning horizon of six years. The longer planning horizon allows the organization to plan well in advance for the major expense required to fund a capital improvement. It also allows for the grant process where it can take years for a project to obtain full funding from grant agencies.
Typically a six year capital facilities plan will focus the organization’s attention on the first few years of the plan. It is these improvement projects in the next year or two that are in immediate need of funding and project management. The remaining years of the plan (say years three through six) are important as well, but more as a context for the future needs of the agency rather than active projects being managed. As projects work their way closer to the front of the line – more focus is needed on how they will be paid for and managed.
State Laws
As we mentioned above, there are significant state laws to take into consideration when planning for capital improvements. The most significant of these (from a budgeting standpoint) is the Growth Management Act (GMA). The GMA is a community planning law that deals to a large degree with the comprehensive planning process. However, the GMA requires that comprehensive plans contain a “Capital Facilities Plan” (CFP). Not all communities in Washington are required to comply with the GMA, but the concepts found in the GMA with regard to budgeting for capital improvements are good.
Levels of Service
The GMA says that the local agencies must set policies about what levels of service (LOS) they believe the community requires. This quickly becomes complicated (and hard to explain briefly on paper) so we will use the provision of park facilities as an example. For instance, the policy making body may feel that the community requires 10 acres of developed parks for every 10,000 people. If this is a minimum LOS and our community has 15,000 residents, you could argue that the threshold requires us to have 10 acres of parks (we haven’t reached 20,000 yet, the next threshold). Once we reach 20,000 people, we now have doubled the parks threshold. So our CFP needs to include a plan on how to get from 10 acres to 20 acres during the same time we anticipate the population reaching 20,000. The illustration below might make this clearer:
This community is above their parks target LOS until 2010 when they reach 20,000 population. They then are working to catch up to the new LOS of 20 acres, which they reach in 2012. Therefore the theory of the GMA would say that the community has adequate park facilities (based on the local LOS policy) with the exception of the years 2010 through 2011.
With this theory as the backdrop, the CFP for this community should include the acquisition and development of park acreage to keep pace with the population and LOS policy. The actual projects (acquisition, design, and development of park acreage) would be described in the six-year CFP. The same would be true of other types of capital facilities (transportation systems, general government facilities, etc.)
The CFP
While the comprehensive plan is required to include a CFP section, this is often a pretty general policy discussion. The actual CFP is produced annually (or every other year in some jurisdictions) and is more like a budget. It is based on the policy discussion found in the comprehensive plan, but often includes the types and amounts of resources that are available for capital improvements (these include real estate excise tax, grants, dedicated local revenues, bond proceeds, development impact fees, etc). The CFP is often broken into sections that reflect the types of systems (transportation, utility, parks, general government, etc.). Summaries of the planned projects often illustrate both the nature of the project, the funding sources anticipated to be used and the year(s) in which the project will be developed. Some agencies break projects into phases (acquisition, planning, design, construction, etc). The projects are then described in greater detail. These descriptions should address the need for the project (if driven by LOS issues, this should be clear), the phasing, the specific funding sources, location, impacts on future operating budgets, etc.
I should also note that terminology changes from one jurisdiction to another. For instance, while many local governments refer to the actual capital budget as a CFP, other common names are the Capital Improvement Plan (CIP), Transportation Improvement Plan (TIP), etc. In some cases, the term CFP is used, but it refers to a slightly different document and process (such as a more general view of future needs or economic development related projects). So “check you local listings” to see how the terminology translates in your local government.
In my experience, the volume of needed improvements results in a CFP that can be a bit overwhelming. It is important to summarize the key points well and focus attention on the key policy elements. These include what the major investments are, how they will be financed and how the agency is doing in maintaining the level of service to its community. A good budget message is key both in the operating budget and in the CFP.
The Government Finance Officers Association (GFOA) and the Municipal Research and Services Center (MRSC) are two excellent resources for additional information. GFOA publishes recommended practices on many topics and recently created a focus on capital planning and economic development. MRSC has resources both on-line and in their library available for checkout.
Toni Nelson is the "Small Cities Specialist" for the Washington State Auditor's Office, providing both on and off site financial training and assistance to smaller cities and towns throughout the state. Ms. Nelson has been working with the Auditors office for 6 years and prior to that was the Clerk/Treasurer for a small town for 9 years. She has co-authored the "Small Cities Manual" a detailed reference guide for new clerk/treasurers on governmental accounting procedures and presents numerous training workshops throughout the state for AWC, WFOA, WMTA, WMCA and local/regional organizations such as EWFOA and SCWMCA. Ms. Nelson is also a member of and conference track coordinator for the WFOA Education Committee.
Mike Bailey is currently the Finance Director for the city of Redmond. Previously he worked as Administrator of Finance and Information Services for the city of Renton and as the Director of Finance for the city of Lynnwood. Mr. Bailey also served as president of the Washington Finance Officers Association and is the Vice Chair of the GFOA Budget Committee. An experienced CPA and GFOA budget reviewer, Mr. Bailey co-founded the annual Budget and Fiscal Management Workshops held each summer. Mr. Bailey conducts numerous workshops and has authored various articles on local government finance, including Effective Budgeting in Washington State Cities published by the Association of Washington Cities.
Tracey Dunlap, P.E. is the Director of Finance & Administration at the City of Kirkland. Prior to joining Kirkland in 2006, she was a principal and shareholder in FCS Group, a regional financial and management consulting firm (14 years). An industrial engineer registered in the state of Washington, she has worked with jurisdictions throughout the Northwest to develop and implement cost recovery and fee strategies, set utility rates, and improve organizational efficiency and effectiveness. Tracey's experience also includes working for a large defense contractor (5 years) and a major financial institution (3 years). She has presented on a wide array of topics for organizations including WFOA, APWA, APA, WABO, and AWC.
*The Articles appearing in the "Finance Advisor" column represent the opinions of the authors and do not necessarily reflect those of the Municipal Research & Services Center.