Do you know how to calculate the Payback Period? How about Return on Investment? Have you completed a cost/benefit analysis? What about Life Cycle Costing?
As a facility manager coming from a background in engineering or operations, preparing and presenting a funding proposal probably does not come easily. This is why we put together this guide to break down today's most sought after financial analysis models so that you can demonstrate your financial expertise to the CFO and other key stakeholders who hold the power of project approval.
In this blog we discuss:
- Simple capital budgeting analysis methods such as Payback Period and Return on Investment
- Demystify the complex budgeting concepts of Life Cycle Costing and Total Cost of Ownership
- Explain how to develop a proposal in terms that will resonate with key financial decision makers
Armed with a solid understanding of these financial concepts, you will be able to strategically plan for long-term capital projects and be empowered to confidently request funding for the capital projects you want to complete.
What is Capital Budgeting?
Capital budgeting is the term for the planning process used by organizations for evaluating, appraising, and determining which project expenditures and/or investments are worth pursuing. For facility mangers this includes investment in new construction, machinery, plants, and other long-term ventures. High-dollar expenditures also include the purchase of fixed assets like land, buildings, new equipment, rebuilding or replacing existing equipment, as well as research and development.
The large amounts spent for these types of projects are known as capital expenditures. At it's core, Capital Budgeting is a tool for maximizing the future of an organization. Because most companies can only manage a limited number of large projects at any one time, Capital Budgeting is an essential tool for optimizing funds.
Typically a Capital Budgeting plan takes into account the calculation of each project’s potential accounting profit by period, cash flow by period, the present value of cash flows after time value for money, the number of years it takes for a project’s cash flow to pay back the initial cash investment, a risk assessment of risk, and other factors.
What is the Goal of Capital Budget Analysis?
In general, the goal of capital budget analysis is to put various numbers into perspective. It provides context to the costs of physical assets against your organization's overall budgetary requirements.
This type of analysis will help you to make decision about which projects to fund and which to defer. It is based on project rankings that are measured against benchmarks as well as each other. If your projects pass the benchmark then they are worth pursuing.
Intelligent software, like FOUNDATION.Plans, can make the Capital Budget decision making process much easier. Our platform includes a system that associates costs with building deficiencies, ranks prioritization of construction projects, and performs in-depth analysis reporting. These reports are an essential element in helping facility managers prove to the CFO or other key financial executives that the projects they want approval for are critical for the long-term health of the facility.
For example, we have worked with the New York Department of Education (DoE) and the School Construction Authority (SCA) since 1998 to implement a system that performs comprehensive costing for the annual school construction budget. Our solution, FOUNDATION.Plans, allows the DoE to generate comprehensive reports based on specific SCA requirements, and our costing calculation software enables report generation based on inspection deficiencies.
Their Five-Year Capital Plan, which regularly encompasses $14 to $16 billion in project planning, requires that assessments are performed across the entire network of the City’s 1,700 public schools. After receiving inspections, the agency determines which problems to fix, how much each project will cost, and how long they will take to implement. Prior to working with Intellis, this process was arduous, inefficient and often inaccurate.
Deficiencies found through the inspection process (using facility condition assessment software, FOUNDATION.Conditions, also developed by Intellis) are costed and prioritized using the Deficiency Costing Prioritization system. This system allows the DoE and SCA to manage the extraordinary task of prioritizing the deficiencies of 1,700 public schools using built-in algorithms and reporting.
After the implementation of our FOUNDATION Solution, the agency was able to produce a more accurate and transparent 5-Year Capital Plan Amendment, which included an increase of over $1 billion for enhanced educational services and better facilities for the City's more than one million students and the teachers and staff who serve them.
With the help of FOUNDATION, the DoE and SCA has seen an average increase of $1 billion per year in funding. We are proud to continue working with the DoE and SCA to produce these amendments that to optimize and enhance the capital planning process, so that facility managers can provide enhanced educational services and better facilities, thus securing safe and modern learning environments for students and teachers!
The Basics of Capital Budget Analysis
Now we will discuss the more simple capital budget analysis methods such as the Payback Period and Return on Investment.
Management’s expectations of facilities have changed, and the measurement of success that facility executives use has also changed. This switch is due in part to the volatile economy. Although facilities are often viewed as a cost center that can be controlled by eliminating a line or two on a budget, the current financial conditions have pressured the facility department into demonstrating real business value across the entire enterprise. Upper management want to know how much of a return it is receiving on its long-term facility investments.
In order to gauge the true value of a capital plan, facility executives must look beyond cost savings.
Defining the Payback Period
The Payback period refers to the length of time it takes to recoup project-investment costs from the savings obtained from the capital budget. The payback period of a given investment or project is an important determinant in terms of deciding whether to fund a particular project. In general, longer payback periods are not desirable.
Defining Return on Investment
The term Return on Investment or ROI is thrown around a lot by CFOs and other financial executives. It's a simple concept. Let's break it down, so the next time you're meeting with financial stakeholders, you can impress them!
ROI measures the gain or loss generated on an investment relative to the amount of money invested. Typically it is expressed as a percentage in order to compare a company's profitability or to compare the efficiency of different investments in projects.
In short, ROI is a simple measure of profitability that is expressed as a percentage. The percentage returned is based on the initial capital invested. The rate of return, or ratios or money gains or lost on an investment is relative to the amount of money invested. You'll need to compare magnitude and timing of gains to investment costs and measure the cash generated due to the investment.
Metrics that measure ROI are geared at aligning the goals of long-term facility projects with the business goals of an organization, whether it is a single department or an enterprise. An intelligent facilities management system, such as FOUNDATION.Plans, can simplify the collection and analysis of data for capital projects. More importantly, with FOUNDATION.Plans it is easier that ever to generate and share reports with financial executives. This will empower you with the right tools so that you can tell a compelling story about why your project should be funded because your proposals will be back by hard data.
Demystifying Life Cycle Costing and Total Cost of Ownership
Now we will demystify the more complex budgeting concepts such as Life Cycle Costing and Total Cost of Ownership.
Life Cycle Costing (LCC) and Total Cost of Ownership (TCO) are some of the more buzz-y financial terms right now in the facilities management sector. They are also commonly referred as whole-life costing, cradle to grave, or womb to tomb. Further they refer to the same cost measurements.
Total Cost of Ownership and Life Cycle Costing are closely related analysis methodologies that are meant to reveal various lifetime costs that are a result of the ownership of certain types of assets. Along with purchase costs, TCO also incorporates substantial costs for deploying, operating, upgrading, as well as maintaining the assets.
Total Cost of Ownership refers to the sum of all costs incurred throughout the lifetime of owning or using an asset; they typically go beyond the original purchase price. TCO enables decision makers to look at asset procurement in a more strategic way (beyond the lowest bidder) and to level the playing field when choosing among competitive bids where the lowest priced bid may or may not be the least costly asset to procure.
Life Cycle Costing is a technique to establish the total cost of ownership. It is a structured approach that can assist management in the selection process. It can take into account any costs that the selection team feels are appropriate. Maintenance, asset disposal, training, cost of upgrades, energy consumption, resources used in manufacture and cost of duplicate service during installation are all examples of costs that could be included in an LCC analysis.
In short, TCO and LSS are methodologies for calculating the whole cost of a system from inception to disposal. It includes the financial cost, which is relatively simple to calculate, as well as the environmental and social costs, which tend to be more challenging to quantify. Typical areas of expenditure which are included in calculating the LCC include planning, design, construction and acquisition, operations, maintenance, renewal and rehabilitation, depreciation and cost of finance and replacement or disposal.
How to Sell Your Project
In order to successful sell your capital improvement project it is essential to present a compelling business case that is backed by intelligent data. With a facilities management system like FOUNDATION.Plans, it is easy to convert your vision into operational objectives and to link your capital project plan to individual performance, strategic planning, while highlighting the outcomes for ongoing improvement.
- Quick Tips
- Present Business Case in 3 slides or less
- Utilize financial analysis
- Sustainability initiatives
- Protecting environment
- Social initiatives
- Maintaining good relations with neighbors
How to Present Your Business Case
When developing your business case think in terms of how this capital project will benefit the CFO. It's essential to convey information to the CFO in their language by using the financial models discussed in this blog.
- Quick Tips
- Phrase your introduction in the form of a problem statement
- Propose your solution
- Present your Financial Analysis
- Use Payback Period and ROI analysis
- Explain sustainability benefits using Total Cost of Ownership and Life Cycle Costing
- End with a specific and compelling example of how this capital project benefits society and in turn supports your organization's strategic initiatives
Don't forget to practice your pitch and keep your proposal to about 30 seconds—think of the classic elevator pitch.
Today, establishing the right metrics and explaining your capital projects using the right financial analysis terms is critical to ensuring your projects get funded and approved. Without the right financial models, it can be difficult to accurately explain to financial stakeholders why certain projects need to be funded.
Using these essential financial tools and sharing them with executive leadership will go a long way when it comes time for you to present your capital budget plans and get those projects funded!
Ready to learn more?
Research and Resources
Accounting Tools Blog, " Overview of Capital Budgeting," https://www.accountingtools.com/articles/2017/5/17/overview-of-capital-budgeting.
EduPristine Blog, "Capital Budgeting," https://www.edupristine.com/blog/capital-budgeting.
Estes, Jonathan, "Measuring the Real ROI," Building Operating Management Magazine, https://www.facilitiesnet.com/energyefficiency/article/Measuring-the-Real-ROI--7547.
Investing Answers Blog, "Technical Analysis," https://investinganswers.com/financial-dictionary/technical-analysis/return-investment-roi-1100.
Investopedia, "Payback Period," https://www.investopedia.com/terms/p/paybackperiod.asp.
Wales, Phil, "Making the Business Case: Define the ROI," Building Operating Management Magazine, https://www.facilitiesnet.com/facilitiesmanagement/article/Making-the-Business-Case-Define-the-ROI--12217.
Zimmerman, Greg, "How to Prepare Better Proposals for Facility Projects," Building Operating Management Magazine, https://www.facilitiesnet.com/facilitiesmanagement/article/How-to-Prepare-Better-Proposals-for-Facility-Projects--12718?source=part.
Zimmerman, Greg, "Proven Tactics Facility Managers Use to Get Funding Approved," Building Operating Management Magazine, https://www.facilitiesnet.com/facilitiesmanagement/article/Proven-Tactics-Facility-Managers-Use-to-Get-Funding-Approved--12715.
Zimmerman, Greg, "Working With the Financial Department to Get Funding Approved," Building Operating Management Magazine, https://www.facilitiesnet.com/facilitiesmanagement/article/Working-With-Financial-Department-Will-Show-How-to-Get-Funding-Approved--12716?source=part.