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Remember as a child when your allowance never seemed to be enough?  Isn’t it ironic that capital expense replacement budgets are much like your allowance?  These budgets often come up short and are often established by others.

The good news is it doesn’t have to be this way.  Using long-term budget forecasting tools, management can be progressive versus reactive and ensure adequate funds for all capital expenses.  To mitigate budget shortfalls in critical years, it is paramount to properly project and reserve for capital replacement expenses, since expenses will vary significantly over the years.  The term of the capital replacement budget should include a complete replacement cycle of all major building and equipment systems; this typical requires a minimum of 20-year projections.

There are four basic components to this process:

1. Selecting a team
2. Setting goals
3. Assembling accurate data
4. Developing a Funding Plan

Selecting a Team:

In short, your choices are to either utilize internal staff or commission the service.  For multiple buildings and site locations, most organizations are not set up to do this work effectively.  Even the simplest building will prove to be complex when all aspects are being given consideration: identifying deferred maintenance and repairs; life safety, code violations and changes; inherent construction deficiencies; possible improvements; major equipment and system service and overhauls; as well as the fundamental task of identifying, evaluating, pricing and forecasting all the capital replacement budget items necessary for a comprehensive and complete budget.  It is with few exceptions where it can be recommended to complete the work internally, and, too, you forfeit the obvious advantages of reports prepared by independent and objective experts.

Setting Goals:

Selecting the team is integral with the goals you can achieve.  As noted in the above paragraph, a capital budget plan should consider much more than just the routine replacement of capitalized equipment and building systems.  It should be reflective of your business model and be executable; in other words, a capital budget plan should really be a strategic plan.  Summarized below is a checklist of requirements and objectives to be considered when commissioning this work:

• Select the most experienced independent consultants to conduct the field inspection services.  The more experienced the field inspector, the better the chance of identifying critical issues.  This applies to new buildings as well as older buildings.  In reality, it is much more difficult to identify a problem in a new building before it causes extensive damage than observing self-evident problems in older buildings.
• Your budget plan should be dynamic, not just a hard copy report used for a year or two.  It should be easy to update.  Ideally, the consultant will provide software and the data file with the service.  You will have a lot of time and expense invested so the best value is one which can be used for years.
• The plan should be reflective of your business model and be executable.  For example: is your approach progressive or reactive, what are your budget constraints, etc.?  This process will require your review and approval of the budgets.
• Specify a reporting format that will provide you with the analysis you need.  Data should be structured so you can filter and drill down to per unit costs in individual buildings and even areas or types of equipment and systems.  Ideally, you can model to assist with making critical decisions.  You should also be able to filter for pricing levels, repairs, improvements, capital versus operating expenses, to mention a few.  This, too, will help you take advantage of combining multiple contracts or projects over multiple years, or to negotiate unit price contracts, etc.
• Budget items should include any expense (capital or operating expense) in aggregate of $1,000 (or as low as $500) with a life beyond one year; in addition, any critical repair, life safety or code issue regardless of cost.  Finally, experienced consultants familiar with your business model should provide recommendations for efficiency improvements as well as to help make your facilities more marketable.
• Do not limit your study to a specified term of years, such as 10 or 20 years.  As a minimum, collect data on all major equipment and systems regardless of remaining life.  Assuming you get software with the data package, you can then print reports for any term of years.  Most importantly, when updating each year, it is risky to try to identify and add existing budget items not included because the items had a remaining life beyond the original report term.

Assembling Accurate Data:

Much of the data will already exist in the records of most facilities.  If your facility was recently constructed, the contractor files should have records of all major equipment and system costs.  For older facilities, much of the capital expense items, including effective useful life data, should be available in your accounting and maintenance records.  Your service contractors are a reliable source for data.  Experienced consultants will have good internal sources or can research any missing data.  Data from pricing books, such as R.S. Means, should be used only as a last resort and only by consultants experienced with this type of data.

Once detailed listings of repairs, improvements, major overhauls, and capital items are made, the next step is to determine the replacement cycle that applies to each distinct budget item.  This is where good historical data is important.  As there are industry standard data for life cycles, the best data are your own.  Forecasting replacement cycles need to take into consideration the various drivers that apply to your unique facility.  Some key drivers to consider are your business model, funding, scheduling, competition, quality of maintenance, availability, efficiency, obsolescence, and environment.  Market demographics and competition will often be the key drivers in determining replacement cycles of furnishings and finishes.

Developing a Funding Plan:

Most facilities, during a 20-year life cycle, will encounter 70 to 80 percent of the total capital expenses in or about years 10 and 20.  This is especially true for residential and commercial construction types; building exteriors and communal area interiors need paint every 7-10 years, carpet every 5-7 years, wall coverings every 7-10 years, and roofs and major mechanical and electrical equipment systems typically have 20-year life cycles.  Higher quality roof systems and capital equipment may have a life up to 30 years.

To get to a funding plan, you must have data to cover, at a minimum, one replacement cycle of all major equipment and systems.  Then identifying the peak year and adjusting for inflation, the data can be amortized to determine a funding plan.  The funding plan can be based on either depreciation or amortization of actual expenses encountered.

Summation:

By including all capital expense projections in your strategic plan, you can eliminate capital surprises and accurately align income with expenses.  When this is achieved, your allowance will be enough!