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Planning and Budgeting Tools

Planning and Budgeting Tools. Andrew Graham School of Policy Studies Queens University MPA 827 2019. Today. Capital Budgets. Share of Core Public Infrastructure by Level of Government 2013. Average Age and Age as a % of Useful Life of Core Public Infrastructure, 2017.

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Planning and Budgeting Tools

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  1. Planning and Budgeting Tools Andrew Graham School of Policy Studies Queens University MPA 827 2019

  2. Today

  3. Capital Budgets

  4. Share of Core Public Infrastructure by Level of Government 2013

  5. Average Age and Age as a % of Useful Life of Core Public Infrastructure, 2017

  6. Federal, Provincial and Municipal Investments in Infrastructure

  7. Using Ratios to Determine Good Management of Infrastructure From the OAG Commentary on the 2015-16 Financial Audits

  8. Edmonton’s Infrastructure Renewal Ratio

  9. The Challenge of Capital Budgeting • Think of a continuum of spending to impact • If I hire a teacher, I get an output immediately • If I budget to build a school I get a school in say two years time • If I budget to build a power plant, I get power in seven years time • If I under-maintain an asset, I see a deterioration in public services in ten to fifteen years time • This introduces an inherent bias against capital spending • Benefits not visible immediately or costs of not investing only visible in the long term • Tougher to cut recurrent spending • Easier to cut maintenance spending than fire teachers

  10. Where Capital Fits In • Conventionally, we think that recurrent spending plus capital spending delivers a service •This is wrong •Public asset base plus recurrent spending delivers service

  11. Capital Budgeting • Capital Budgeting is a process used to evaluate investments in long-term or capital assets. • Capital Assets • have useful lives of more than one year; • analysis requires focus on the life of the asset; • low-cost, long-lived assets are not usually subjected to the Capital Budgeting process; • cost often makes it necessary for the organization to finance the asset using long-term financing from capital campaigns, mortgages, long-term loans, leases, and equity offerings.

  12. Unique Features • Capital budgeting decisions have long-term implications. • These decisions involve substantial commitment of funds. • These decisions are irreversible and require analysis of minute details. • These decisions determine and affect the future capacity of the agency.

  13. Capital Acquisitions Capital Improvements/ Betterments Maintenance Types of Capital Budget Actions

  14. Capital budgeting:Analyzing alternative long-term investments and deciding which assets to acquire, eliminate or renovate Risk in Capital Investment Decisions Investment involves along-term commitment. Outcomeis uncertain. Decision may bedifficult or impossibleto reverse. Large amounts ofmoney are usuallyinvolved.

  15. Why Prepare a Capital Plan? • Investments are large, • Mistakes can be costly. • Capital acquisitions lock the organization in for many years, • Capital assets have long lives, • The organization uses to buy the capital asset flows over time and at different costs..

  16. Steps in the Development of a Capital Budget

  17. Inventory of Capital Assets • Life cycle assessments – replacement plans • Depreciation schedules: accrued value or replacement value • Provides information on the capacity of the infrastructure in place

  18. Capital Investment Plan • Primarily a planning document – not necessarily fully funded • Relating it to the agency’s or government’s overall objectives and priorities • Danger of ‘hidden’ capital costs not attracting public or political attention: replacing computers, buildings, sewers • Danger in ‘all to obvious’ capital renewal costs getting priorities: potholes

  19. Developing a Multi-Year Plan • Reinforces the cyclical nature of capital costs – recurring expenses • Permits inclusion of maintenance and preventive costs of capital • Permits some entities to consider various longer-term funding strategies

  20. Development of a Financing Plan • Complexity varies dramatically • Ranges from drawing on appropriated funds completely right through to public-private partnerships, bonds issues, specialized financing strategies such as user fees (airports) • Increasing trend to look at creative options

  21. Financing Capital Projects: Options • Special capital reserves • General expenditures • Special fees, levies, charges • Borrowing • Private financing

  22. Problems in Capital Budgeting • Full costing versus buy and build new only – renewal, maintenance, staff, skills, secondary capital (power source, support systems) • Accrual pushes for fuller costing

  23. Challenges in Capital Budgeting • Failure to look at secondary and opportunity cost impacts • Capital projects are long term: politics in short term • New means of financing: PPPs, new financing schemes, build-buy-operate

  24. Cost Estimation

  25. Danger of Optimism Bias in Costing • Departments may under-budget for costs because they think that if they are honest with the costs, money will not be allocated • Poor risk analysis or using only preliminary costings • Project overruns are a nightmare for spending control, yet they are endemic in the public sector

  26. Procurement: A Major Issue in Capital Acquisition In theory, procurement is supposedto go somethinglike this… Department Courtesyof TBS

  27. And then things don’t go asplanned… Department

  28. JSS = Joint Support Ships: Non Combat vessels being built at the Vancouver Shipyards of Seaspan as part of the National Shipbuilding Strategy What Can Possibly Go Wrong? JSS • Project went from 3 ships, $2.1 billion in 13 years to 2 ships, $2.8 billion in 16 years • Why? • Poor scheduling estimate • Ramp up of expertise • Procurement process badly managed

  29. What Could Possibly Go Wrong? Wildly Divergent Cost Estimates

  30. A valid cost estimate should reflect who we are, not who we wish to be.

  31. Cost behaviour

  32. Key Characteristics of Variable Costs • Total variable costs change in direct proportion to changes in volume • The variable cost per unit of activity (v) remains constant and is the slope of the variable cost line • Total variable cost graphs always begin at the origin (if volume is zero, total variable costs are zero) • Total variable costs can be expressed as:

  33. Total Variable Costs

  34. Key Characteristics of Fixed Costs • Total fixed costs stay constant over a wide range of volume • Total fixed cost graphs are always flat lines with no slope • The flat (horizontal) line intersects the y-axis at the level equal to the fixed cost • Fixed costs per unit of activity vary inversely with changes in volume • Fixed cost per unit of activity increases when volume decreases • Fixed cost per unit of activity decreases when volume increases

  35. Total Fixed Costs

  36. Key Characteristics of Mixed Costs • Total mixed costs increase as volume increases because of the variable cost component • Total mixed costs can be expressed as a combination of the variable and fixed cost equations: • Total mixed costs = variable cost component + fixed cost

  37. Mixed Costs

  38. Simple Illustration: Fixed and Variable Costs

  39. Which are fixed and which are variable costs? A Box Store A Hospital Patients' food Lawn mowing & grounds keeping Laundry Bandages & dressings Nurses’ salaries Utilities Ambulance services • Store rental • Utilities • Sales commissions • Wages & salaries • Cleaning • Goods sold • Manager’s salary • HR department salary • Advertising

  40. From a business success point of view, is it better to have more fixed or more variable costs?

  41. Costing and analytical tools • Time Value of Money • Sensitivity Analysis • Cost Benefit Analysis

  42. Core Question in Making Capital Spending Decisions: Will the future benefits of this project be large enough to justify the investment given the risk involved?

  43. Time Value of Money Principle Since capital projects provide benefits into the future and since we want to determine the present value of the project, we will discount the future cash flows of a project to the present.

  44. Time Value of Money Principle Money in hand now is worth more than the right to receive money in the future because money in hand now can be invested to earn interest.

  45. Time Value of Money: Measuring Present Value • Major impact on intergenerational equity issues • Where it really matters for the public sector is in its use in forward costing and cost benefit analysis of projects that derive actual costs and benefits of a project • Also, how cash will flow becomes crucial in terms of final value

  46. Net Present Value (NPV) is a means to calculate whether the public sector organization will be better or worse off if it make a capital investment. It does so by adding the present value of outflows and the present value of inflows. It shows the value of a stream of future cash flows discounted back to the present by some percentage that represents the minimum desired rate of return, often called the cost of capital. Net Present Value NPV = PV Inflows – PV Outflows

  47. Time Value of Money

  48. General decision rule in applying NPV

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