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What Is Capital Planning, And Why Should You Care?

Posted by IKO Community Management on October 6, 2016 at 11:30 AM

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According to Oxford University Press, “capital planning is an integral part of an agency’s strategic planning process” that provides a blueprint “in order to meet the goals and objectives in the agency’s strategic and annual performance plans.”

So, since this concept is normally for corporate businesses in government and finance, what exactly does it mean for community management companies? IKO Community Management breaks down the what, when, and how behind capital planning:

What is capital planning?

In more basic terms, it is the process of budgeting resources for the future of an organization’s long-term plans, according to BusinessDictionary. The capital planning process is used to determine whether or not an organization’s long-term investments are worth funding through the firm’s “capitalization structure,” also known as basic accounting.

In short, businesses ask, “Do we have the money to commit to this long-term project, and will this project benefit our business for the better for many years?”

 

What is the difference between independent and mutually exclusive capital planning projects? 

The former is an individual project whose monetary flow is not affected by the final accept-or-reject decision of other projects. It is usually accepted, should it meet the company’s capital planning criterion. The latter is a set of projects that are all used to accomplish the same task, thus only one will be accepted. It is typically the project that closest meets the criterion.

 

Do businesses call capital planning anything else?

It is also often referred to as investment appraisal, capital budgeting, and budget planning.

 

What is the purpose? 

One of the primary goals of capital budgeting is to increase the value of the organization for those who are invested in it. This can include anyone who is a primary stakeholder, has part ownership rights or stock, and the like.

 

When should businesses use capital budgeting?

Companies should use it only when necessary. This could be when a large amount of funds that influence the profitability of the company is on the line. The more likely scenario is when a long-term investment, like erecting a new community center or outsourcing to help plan a new pool, is essential to the success of your community for years to come.

 

What is considered a long-term investment?

Like we mentioned earlier, capital budgeting is typically for a corporate business, and, depending on the nature of the industry, this could include budgeting for new or replacement machinery, research and development, new product production, marketing, and other major expenditures.

For most communities and other developments, a long-term investment is something along the lines of the addition of an amenity, like a community pool or fitness center. It could also be revamping a common area, or hiring a local company to introduce a neighborhood-wide recycling program.

 

How do businesses use capital budgeting?

Many methods are used for capital budgeting, including techniques such as:

  • Accounting rate of return
  • Average accounting return
  • (Discounted) Payback period
  • Net present value
  • Profitability index
  • Internal rate of return
  • Modified internal rate of return
  • Equivalent annual cost
  • Real options valuation

For more information, check out OpenGov’s blog that highlights how to create a solid Capital Improvement Plan, the benefits of capital budgeting, and more.

And there you have it. IKO Community Management breaks down the ins and outs of capital budgeting with a few simple questions and answers. If you want to learn more about what we do, how we can help your community or office parks, or tips on how to be the best homeowner, click below:

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Topics: Company, community