Nonprofit Accounting Basics

Capital Budgets Play an Important Role in Nonprofit Planning

Note: Articles published before January 1, 2017 may be out of date. We are in the process of updating this content.

Author: 

A. Michael Gellman

Sustainability Education 4 Nonprofits

Annual operating budgets for nonprofit organizations will always be center stage, drawing the attention of senior management, Board, and staff. The pressure to have the best annual operating budget is unrelenting. However, this pressure can focus too much attention on short-term operations, often to the detriment of longer-term sustainability, capacity, and cash flow planning. Capital budgets are a synergistic complement to annual operating budgets and will help current and future planning.

There is a general misconception that unless you are a large organization with substantial capital assets such as a building, there is no need for a capital budget. This is an incorrect assumption. All organizations will benefit from installing and annually updating a capital budget.

Capital budgets include a list of material (large dollar as defined in your capitalization policy for fixed assets) future required acquisitions of capital assets that have a useful life of more than one year, such as computers, equipment, vehicles, furniture, etc.

Capital asset acquisitions are generally not included in most accrual-based annual operating budgets and are handled partially by amortization of capital assets through depreciation expenses. This can lead to capital asset acquisitions being overlooked and left out of future planning. A capital budget will close this planning gap by showing a clear picture of the capital assets an organization will need to acquire in the future.

There are three key benefits from having capital budgets which will improve long-term planning and help your organization to avoid being caught by surprise.

First, capital budgets enhance sustainability. Organizations need to plan to replace capital assets before they become obsolete, hard to maintain, or stop functioning. For example, an older van critical for delivery of meals to seniors can become cost prohibitive to maintain. Likewise, a computer that is still working might not have enough memory, storage capacity, or computing power to handle new software and computing tasks. An aging hot water heater could fail and cause water damage and might not be repairable. These are just a few examples. The one commonality in these examples is the potential for immediate disruption to current operations if these assets are still in service past their useful life.

Second, capital budgets can help nonprofits address future capacity issues that result from growth, new programs and activities, automation, and modernization. Most operating budgets are built without thought to providing resources for expanding or changing future infrastructure. As one example, there could be future anticipated changes in occupancy needs because of moving, adding new office locations, consolidating office locations, or enabling remote working to continue or expand.

Finally, the most important benefit of capital budgets comes from helping to improve long-term cash flow planning. Capital budgets are an excellent planning tool and visual aid to show when cash will be needed for future capital asset acquisitions and replacements. Without capital budgets it becomes very difficult to manage long-term cash flow needs.

Planning Tip Pair the approval of annual operating budgets with approval of updates to your capital budget. The two actions together will be synergistic, helping to ensure that both short-term and longer-term planning needs are being addressed. The emphasis for capital budgets is on updates. A new operating budget is prepared each year while capital budgets are living documents that are updated each year. Make sure to clearly delineate in your capital budget new additions, capital assets taken out of service or disposed, and, most importantly, deferral actions where a scheduled capital asset replacement or acquisition was not completed and moved to a later date. Deferral actions are usually signs of distress and should be approved separately.

Make sure your capital budget includes a year-by-year summary of capital asset funds needed for new acquisitions and replacements so timing of future cash availability requirements can be seen. For example, a five-year capital budget cash requirements summary showing a total $150,000 might break down as follows:

  • Year 1: $10,000
  • Year 2: $30,000
  • Year 3: $90,000
  • Year 4: $10,000
  • Year 5: $10,000

In this example, year 3 reflects a significant capital asset acquisition such as the replacement of three delivery vehicles. Including this summary in your capital budget helps to ensure that your organization is always aware of these significant future cash requirements.