Four Planning Considerations for Every Capital Project
Newark is changing. A commercial real estate boom has brought interest, energy, and money to the area, and some of the city’s nonprofit leaders are working to ensure that the vulnerable communities they serve don’t get lost in the shuffle. Many charitable organizations exist in the crossroads of Newark’s real estate gains and its residents’ needs and wants. In the current economic climate, some nonprofits seek to take advantage of the market by investing in capital projects, such as purchasing or renovating a building so the organization can expand critical services. While it may seem like an easy decision, large-scale facilities projects can be complicated, with unseen pitfalls and unexpected expenses.
From July 2016 through March 2018, Nonprofit Finance Fund (NFF) worked with 15 Newark-based nonprofits as part of the Newark Resilience Initiative (NRI), a project underwritten by Prudential Financial to combine customized consulting services and flexible grants to support organizational health and adaptability. During NRI, several of our clients navigated facility management decisions. NFF worked shoulder-to-shoulder with their leadership to ensure those projects supported their mission, while also making sense for the organization financially. For a nonprofit leader considering a facility project, it’s necessary to address the question: How will this purchase or renovation affect our financial situation? To help evaluate, I’ll share some financial health considerations from NRI participant, Vivian Fraser, the President and CEO of Urban League of Essex County, and insight from NFF’s 35 years of experience in the sector.
- Evaluate the implications of one-time capital expenditures and ongoing operating costs
Urban League discovered that running programs out of a newly-purchased building required additional staff to meet increased demand. On top of the one-time capital cost of buying the building, Urban League also needed to upgrade the phone system to serve clients efficiently .
In another example, imagine you run an after-school program that wants to convert an office building into program space to serve a new age group. Not only will you have one-time construction costs, but you likely need to hire additional program staff, purchase supplies, technology upgrades, and spend money on marketing. When planning a facilities project, the distinction between capital costs for construction and ongoing operating expenses of the after-school program should be carefully considered, especially because the organization may have higher operating costs post-project, and funding these costs requires different resources.
- Anticipate both capital and ongoing revenue needs associated with the project
Property and equipment (P&E) investments are funded through capital resources which may be available through acquiring debt, using reserve funds, or running a capital campaign (a dedicated fundraising drive, usually to raise money for a facility, endowment and/or reserves). And simultaneous to these capital needs, operating revenues are necessary to maintaining regular programs and services, creating a tenuous balance between the need for one-time versus ongoing funds. For example, donors may contribute to the capital campaign instead of making program or operating gifts. In addition to the new building, Urban League is also considering a capital campaign to make improvements to its P&E. As part of the capital campaign readiness assessment, Urban League evaluated potential donor fatigue for those who could be asked for capital campaign and annual contributions in the same year.
This need for capital and revenue may mean managing two concurrent fundraising efforts, which can also be a drain on staff capacity. If the capital project results in increased programs and services, this probably requires increased annual earned and contributed revenue targets to cover expanded operations.
- Consider the potential effects to the bottom line
When a facilities project is funded through a capital campaign, nonprofits can sometimes show a year or two of what look like large surpluses because capital is raised up-front and can be mistakenly commingled with regular revenues. This period of theoretical surpluses may be followed by deficits when the project is completed, and the organization experiences either higher-than-expected operating costs and/or lower-than-expected revenues. Although the Federal Accounting Standards Board does not require the separation of revenue and capital in audited financial statements, making this crucial distinction provides greater clarity on what funds are available for operations and what’s earmarked for the campaign.
Among the increased operating expenses associated with a facility project is depreciation – a non-cash expense that approximates the accounting value of a fixed asset’s useful life. NFF encourages nonprofit leaders to track surplus/deficit both before and after depreciation to clearly show the impact of this non-cash expense.
- Understand the influence on liquidity
It is important that the capital project is financed in a way that doesn’t fully deplete the organization’s liquid resources. When nonprofits are “house rich and cash poor,” it limits their ability to respond to unforeseen risks or pursue new opportunities that may be mission critical.
An organization’s liquidity is defined as adequate access to cash to meet operating needs. And liquidity can also be affected by fixed asset additions. If an organization has reserves, it may plan to use a portion of them to fund all or some of its capital project, making the organization’s balance sheet more fixed and less liquid. With increased P&E, the portion of all net assets which are truly accessible and liquid may be smaller as more assets are invested in fixed assets.
Moreover, anticipating how a capital project will change a program and/or operating costs can help an organization determine and prepare for future demands on its cash. Projecting cash levels before, during, and after a capital project provides decision-makers critical information as to whether the project’s cash need will be too great or volatile to manage or if additional resources will be needed.
Assess capital projects holistically
By understanding the capital expenditures and operating costs, preparing for ongoing revenue needs, examining the bottom line, and recognizing liquidity implications, nonprofit leaders will be able to assess capital facilities projects holistically. This is critical to navigating the opportunities and challenges of capital investments, especially in a rapidly-evolving real estate market like Newark.
As Vivian Cox Fraser notes, “Nonprofits are always ready for capital; the question is more about the kinds of capital they need and anticipating its impact to the organization.”
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