Capital Budgets Play an Important Role in Nonprofit Planning and Budgeting
Annual operating budgets for nonprofit organizations will always hold center stage, drawing the attention of senior management, Board, and staff. However, this focus can often lead organizations to neglect longer-term sustainability, capacity, and cash flow planning issues. This is why capital budgets have an important role, serving as a synergistic complement to annual operating budgets that will help current and future planning.
There is a general misconception that unless you are a large organization with substantial capital assets such as a building, there is no need for a capital budget. This is an incorrect assumption. Most organizations will benefit from installing and annually updating a capital budget.
Capital budgets include a list of “capital assets,” i.e., material assets (larger dollar acquisitions as defined in your capitalization policy for fixed asset purchases) that are expected to have a useful life of more than one year, such as computers, office furniture, vehicles, etc.
Capital budgets work best when they are segmented into like-kind purpose categories such as building improvements and betterments (new roof, elevators, HVAC system, hot water heater, etc.), technology equipment (computers, servers, optical scanners, printers, copiers, etc.), office furniture and equipment (desks, cabinets, cubicles, and chairs, conference room furniture, shelving, etc.), and transportation equipment (delivery vans, trucks, school buses, fleet vehicles, etc.).
This Template Basic Capital Budget Spreadsheet provides a good example of how these categories are often segmented.
These fixed asset categories are also usually segmented into useful life periods corresponding to how long these types of assets are generally expected to last before needing replacement, such as 3 to 5 years, 6 to 9 years, and 10 to 20 years. The longer period categories (10 to 20 years) are reserved for purchases that will last for many years into the future, such as replacing a roof on a building, adding a paved parking lot and driveway, and expanding facilities (for example, a university or hospital modifying a building to accommodate a new specialized research laboratory).
Capital asset acquisitions are generally not included based on the expected time of acquisition, in most accrual-based annual operating budgets and are only partially addressed by amortization of capital assets through depreciation expenses. This can lead to capital asset acquisitions being overlooked and left out of future planning. A capital budget will close this planning gap by showing a clear picture of the capital assets an organization will need to acquire in the future.
There are three key benefits to having capital budgets which will improve long-term planning and help your organization to avoid being caught by surprise.
First, capital budgets enhance sustainability. Organizations need to plan to replace capital assets before they become obsolete, hard to maintain, or stop functioning. For example, an older van critical for delivering meals to seniors can become cost prohibitive to maintain. Likewise, a computer that is still working might not have enough memory, storage capacity, or computing power to handle new software and computing tasks. An aging hot water heater could fail and cause water damage and might not be repairable. These are just a few examples. The one commonality in these examples is there is great potential risk for immediate disruption to current operations if these assets are still in service past their useful life.
Second, capital budgets can help nonprofits address future capacity issues that result from growth, new programs and activities, automation, and modernization. Most operating budgets are built without the thought of providing resources for expanding or changing future infrastructure. As one example, there could be future anticipated changes in occupancy needs because adding new office locations, consolidating office locations, or providing remote work options.
Finally, the most important benefit of capital budgets comes from helping to improve long-term cash flow planning. Capital budgets are an excellent planning tool and visual aid to show when cash will be needed for future capital asset acquisitions and replacements. Without capital budgets it becomes very difficult to manage long-term cash flow needs.
Planning Tip – Pair the approval of annual operating budgets with approval of updates to your capital budget. The two actions together will be synergistic, helping to ensure that both short-term and longer-term planning needs are being addressed. The emphasis for capital budgets is on updates. A new operating budget is prepared each year while capital budgets are living documents that are updated each year. Make sure to clearly delineate in your capital budget new additions, removal of capital assets taken out of service or disposed, and, most importantly, deferral actions where a scheduled capital asset replacement or acquisition was not completed and thereby automatically moved to a later date. Capital budget deferral actions are usually signs of distress and should be formally recognized as such with deferral actions approved separately as part of the annual operating budget preparation process.
Make sure your capital budget includes a year-by-year summary of capital asset funds needed for new acquisitions and replacements so timing of future cash availability requirements can be seen. For example, a five-year capital budget cash requirements summary showing a total $150,000 might break down as follows:
Year 1: $10,000
Year 2: $30,000
Year 3: $90,000
Year 4: $10,000
Year 5: $10,000
In this example, year 3 reflects a significant capital asset acquisition, in this instance, the replacement of three delivery vehicles. This illustrates how capital budgets by nature are often not linear, with the same outlay amounts planned for each year.
Including a capital budget that is updated annually as part of the annual operating budget building process will help to ensure that your organization is always aware of significant future cash requirements and potential cash flow deficiencies before they happen.
