Principles of Effective Capital Planning
and Property Accounting
Kent Allen
November, 2013
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Key Subjects
•
•
•
•
•
•
Reasons for Capital Investment
Key Elements of Capital Investment
The Capital Planning Process
Predicting and Measuring Investment Effectiveness
Capitalization Issues
Depreciation and Other Accounting Principles
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Main Financial Components
CAPITAL ASSET
PLANNING
PROPERTY
ACCOUNTING
&
PROPERTY
MANAGEMENT
Highly Interrelated
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Capital Asset Life Cycle
Planning &
Analysis
Budgeting
Implementation
Oversight &
Reporting
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Capitalization,
Control
& Utilization
Disposition
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I TOOK THINK-A-TRON APART…
--- IT WAS JUST A SIMPLE CARD READER –
NOT A REAL COMPUTER, AFTER ALL…
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The Ongoing Cycle of Asset
Management
Property
Management
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Dynamics of Capital Investment
• Technological Advances
• Changing Markets or Service Populations
• Process Changes
• Legal and Regulatory Changes
• Aging of Existing Assets
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Capital Planning - Points to Consider
 Not limited to Private Sector businesses.
 Seeks to maximize the efficient use of
financial resources.
 Major impact on profitability and
effectiveness.
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Related Funding Categories
• Capital Budget
•
Funding associated directly with the asset’s
intrinsic value.
• Associated Burden
•
Funding for other costs not directly related to the
asset’s value.
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Key Characteristics of Burden
Items Below Cost and Longevity Thresholds
• Administrative Expenses
• Support of Requirements Not Adding to
Asset Value.
• Examples:
•
•
•
•
•
Demolition Costs
Architect and Accounting Fees
Insurance Premiums
Closing Costs
Damage Payments
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Capital Project Features
• Capital Project is defined chiefly by two
characteristics:
• Larger Cash Requirements (Greater than a Defined
Cost Threshold).
• Longer Asset Life as Compared to Burden (Expense)
Items.
• These are precisely defined in the
Disclosure Statement .
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Capital Project Thresholds
> 12
10
CAPITAL
VALUE
8
6
4
EXPENSE
2
0
-
2
4
6
8
10
> 12
ASSET LIFE
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Other Resource Requirements
• Budget for Unanticipated Costs
•
Overruns of Total Project Cost
• Both Capital and Burden budgets are affected.
• Inadequate EAC cost estimates cause shortfalls.
•
Scope Creep
• Over time, many projects tend to expand in terms of
purpose, application and cost.
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Other Resource Requirements
• Time
• Realistic Schedules
• All projects require adequate time to complete.
• Cash Cost and Availability
• Expenditure patterns must be accurately forecast.
• Unanticipated cash requirements cost money.
• Business practices may include reliance on shortterm credit for funding of day-to-day cash needs.
• Unexpected demand drives the cost of money.
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Legal Environment
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Reducing Resource Requirements
• Alternative Funding – Contract-Direct vs. Capital
• Wherever possible, seek to obtain items as directcharge contract assets
• “One Purpose” items with no use other than contract
support.
• Must have customer approval.
• Results in better financial results.
• Fewer assets to track and account for.
• Improved returns on assets employed.
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Capital Projects - Broad Categories
• Strategic Needs
• Anticipated Markets or Service Challenges
(Capacity)
• Use and Development of Emerging
Technologies
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Capital Projects - Broad Categories
• Operational Needs
• Safety, Legal and Environmental
• Productivity Improvement
• Maintenance, Repair or Replacement of
Aging Assets
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Uses of Capital Funding
• Provide equipment to support current contracts.
• Maintain existing technology levels.
• Establish strategic capabilities.
• Meet all regulatory obligations.
• Maintain, modernize, and expand infrastructure.
• Buildings
• Grounds
• Support Systems.
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Strategic Perspective
• Investments in land, equipment, buildings and other
assets for future economic gain are part of an
organization’s strategic direction which must be
periodically revisited.
• Business investment decisions cannot be made lightly,
because a significant commitment of funds is made over the
long term.
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Strategic Perspective
• Limited resources require that various alternatives must
be narrowed down.
• The process of identifying, analyzing and selecting
capital investment opportunities is known as capital
budgeting.
• The capital budget is comprised of those projects
selected to provide economic returns that meet the goals
set by management.
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Key Aspects of Capital Budgeting
Timing:
• Define an effective time interval for budgeting.
• Standard Process:
• Establish consistent and effective practices for
gathering and processing capital requests.
• Apply process across the board for all requesters.
•
Categorization
•
Employ well defined categories based on type of need.
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Key Aspects, continued
Prioritization:
• Have well-defined methods for ranking competing
requests by criticality.
• Allocation of Funding:
• Establish clear affordability levels and distribute
funding proportionately.
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Key Aspects, continued
Budget Review:
• Develop a hierarchy for coordinating requests.
• Preliminary Budget Approval by Top
Management
• General Presentation of Preliminary
Budget.
• Coordination of Resultant Changes
• Prioritization
• Timing
• Inclusion vs. Exclusion
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Review of Capital Requests
•
•
•
•
Consistency with Strategic Plan
Elimination of Duplication
Technical Effectiveness
Correct Asset Category
• Legal and Regulatory
• Maintenance and Sustainment
• Technology Development
• Process Improvement
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Selecting the Best Capital Project
• Given the cash frequency of need and the spectrum of investment
categories, a system must be established for distributing cash most
effectively by:
• Determining total affordability limit
• Aligning competing projects with operational and strategic
objectives
• Ranking projects within each investment category.
Legal / Regulatory
Operational Needs
Strategic Initiatives
Productivity Improvement
Other
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Selecting the Best Capital Project
AFFORDABILITY
• The type of investment largely determines its eventual
selection for the budget proposal.
INVESTMENT TYPE
PRIORITY TIER
PORTION SELECTED
Legal / Regulatory
ALL
Operational Needs
MOST
Strategic Initiatives
SOME
Productivity Improvement
DISCRETIONARY
Other
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Property Accounting Responsibilities
 Services Provided:
• Asset Capitalization
• Asset Transfers
• Asset Retirements
• Depreciation
• PP&E Reporting
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Property Accounting Responsibilities
Assets Under Construction (AUC)
• Capital Project Types :
• Capital Fabrication
• Straight Buy
• Capitalization
• Closure of Capital Projects
• Initiation of Depreciation
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Definitions of Depreciation
• Physical Depreciation - Decline in the economic potential
of assets originating from normal wear and tear,
environmental exposure, and technical obsolescence.
(Asset deterioration).
 Financial Depreciation - Spreading of original cost
over the estimated life of an asset. Different
methods are employed based on a given asset’s
typical patterns of use and its ability to maintain a
stable value over time.
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Financial Depreciation Process
PROCUREMENT &
CAPITALIZATION
PROCUREMENT
ASSET USEFUL LIFE
(DEPRECIATION PERIOD)
CAPITALIZATION
DEP.
EXPENSE
CASH
CAPITAL
ASSETS
YEAR 0
CAPITAL
ASSETS
YEAR 1
DEP.
EXPENSE
CAPITAL
ASSETS
DEPRECIATION CURVE
YEAR 2
DEP.
EXPENSE
CAPITAL
ASSETS
YEAR 3
AUC (CASH TIED UP WITH NO BENEFIT)
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Basic Depreciation Methods
Straight-Line vs. Declining Balance
ACQUISITION VALUE
6
5
COST
4
STRAIGHT
LINE
DECLINING
BALANCE
3
2
1
RESIDUAL VALUE
0
0
1
2
3
4
5
6
7
8
9
YEAR
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Depreciation Based on Asset Class
 To ensure consistent accounting methods, asset
classes are assigned to different types of assets,
based on the asset’s estimated useful life and the
general pattern of physical depreciation.
Asset Class Description
Land
Buildings
Buildings - Temporary/Portable
Office Machines
Factory Machinery & Equipment
Heavy Trucks
Autos
Furniture & Fixtures
Electronics Equipment
Aircraft & Aircraft Equipment
Computer Equipment
Leasehold Improvements
Assets Under Construction
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Depreciation Method
No depreciation
39 Year Straight Line
15 Year Straight Line
10 Year Variable Declining Balance
18 Year Straight Line
10 Year Double Declining Balance
5 Year Double Declining Balance
12 Year Straight Line
4 Year Declining Balance
6 Year Variable Declining Balance
3 Year Double Declining Balance
Straight Line spread over remaining term of the lease
No depreciation
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Investment Analysis
• A wide choice of capital investments are typically
available:
Some examples:
– Invest in new facilities for expansion (new volume)
– Upgrade outmoded facilities (improve cost
effectiveness, cost savings)
– New equipment for potential new opportunities
• Various alternatives/choices must be
narrowed down (limited resources)
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Measures of Capital Investment
Effectiveness
Capital projects can be assessed by their Return on Investment (ROI),
generally achieved through one or both of the following processes:
•
Cost Reduction
• Better Use of Limited Resources (Limiting or Reducing
Cash Outflows).
• Does not include cost avoidance.
•
Cash Generation
• Realizing Greater Cash Inflows due to Increased
Markets and/or Service Populations.
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Cash Inflows Should Exceed Outflows
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Investment Analysis, Continued
• Two basic measures of projected investment value:
– Return on Investment (ROI)
• Best applied on an individual project basis,
typically before investment.
– Return on Net Assets (RONA)
• Usually a measure of many combined projects.
• Typically measured on the basis of all-up fixed
asset values.
• May be a forecasting tool, but generally used as an
ongoing metric following project implementation.
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Application of Simple Payback Method
4-Year Cost Recovery Scenario
Year 0
Year 1
Year 2
Year 3
Year 4
$25K
$25K
$25K
$25K
($25K)
PAYBACK
($50K)
($75K)
$100K
BALANCE OF COST OUTSTANDING
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Discounted Payback Method
5-Year Cost Recovery Scenario
Year 0
Year 1
Year 2
Year 3
$25K
$22K
($53K)
Year 4
Year 5
$20K
$18K
$15K
($33K)
($15K)
PAYBACK
($75K)
$100K
BALANCE OF COST OUTSTANDING
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Cumulative Cash Flow and ROI
80
Cash Flow
CapEx
Completion &
Asset
Capitalization
60
40
Cash Generation
Cash Return
on Investment
20
0
-20
Cash Use
Capital Investment
-40
“Simple”
Cost
Recovery
Point
Cash Generation
Positive ROI
Discounted
Cost Recovery
Point
-60
-80
Time Value of Money
-100
Year 0
Year 1
Year 2
Year 3
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Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
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Comparative Return-On-Investment
DISCOUNTED ROI
1.4
2nd
CUMULATIVE CASH FLOW
1.2
1
265% (29% IRR)
Project A
1st
0.8
0.6
Project B
3rd
0.4
0.2
390% (48% IRR)
156% (9% IRR)
Project C
0
-0.2
$M
-0.4
-0.6
1
2
Year
3
4
5
($K)
CASH OUT
CASH IN
IN/OUT
ROI
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6
7
A
500
1800
360%
265%
8
B
200
1000
500%
390%
9
10
11
12
C
500
950
190%
156%
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RONA Formula
RONA =
=
Return on Sales
(Profitability)
Asset Turns
(Asset Utilization)
Sales
NOPAT*
X
Net Assets
Sales
NOPAT
X
(Net Operating Margin less tax rate)
=
Net Assets
Net Income
=
Net Assets
* NOPAT = Net Operating Profit After Taxes
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Capital Planning Effect on RONA
Good
Net Income
Net Assets
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Poor
Net
Income
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Investment Effectiveness Over Time
UTILITY
VALUATION
INVESTMENT EFFECTIVENESS =
Capital Project Value
4.5
4
UTILITY
(TOTAL BENEFIT FROM USE OF ASSET)
3
CAPITALIZATION
VALUE
3.5
2.5
2
1.5
AUC
COST
1
0.5
POSITIVE
INVESTMENT
IMPACT
DISPOSITION POINT
REDEPLOY
SELL
DONATE
ABANDON
SCRAP
NET
BOOK
VALUE
RESIDUAL
VALUE
0
1
2
3
4
TIME
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5
6
7
8
NEGATIVE
INVESTMENT
IMPACT
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Assets Under Construction (AUC)
• Accumulated Cash Expenditures Against
Projects Not Yet Completed/Received and
Therefore Not Yet Capitalized
• Drains Assets (Cash)
• Generates No Benefits or Depreciation
• Increased Revenue
• Cost Savings
• Improved Profit Margin
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Limiting AUC Cost
Most Common Approaches:
• Accelerate Procurement
and Construction Processes
• Ensure that Capitalization Process is Efficient:
• Speed
•Accuracy
• Where Possible, Apply Progressive/Partial
Capitalization
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Limiting AUC Cost –
Progressive Capitalization
YEAR 4
YEAR 3
YEAR 2
YEAR 1
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Improving Investment Effectiveness
• Ensure capital investments align with strategic
objectives.
– Better use of assets to generate revenue and
expand business base.
• Minimize capital commitments and expenditures.
– Challenge requests for capital funding.
– Conduct project analysis (ROI, etc.) to objectively
assess projects’ potential profitability/positive
cash balance.
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Property Management’s Central Role
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Questions
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JIC
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Reinvestment Rate vs. Shareholder
Value
CAPITALIZED
New CapEx
Current
Depreciation
Current CapEx
Prior-Period
CapEx
CAPITALIZED
Current
Depreciation
Balanced Ratio
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