A to Z of Capital – Capital Planning & Programming

A to Z of Capital – Capital Planning & Programming Mark Kenyon – FAN Advisor (mark.kenyon@cipfa.org.uk)

This Session will Cover………… • Planning for capital expenditure. - General Principles - Prudential Code - Capital Strategies - Asset Management Plans (AMP) - Capital Programmes • Constructing a programme. • Other issues to consider

Planning for Capital Expenditure – General Principles (1) • Capital expenditure, like revenue, should be driven by an Organisations’ Corporate Goals & objectives. • Expenditure should be directed to develop the asset base to ensure it is structured to meet the strategic priorities and operational and service needs of the organisation, supporting service improvement and transformation. • Ownership of the capital planning process by members, staff, partners and other stakeholders.

Planning for Capital Expenditure – General Principles (2) • Sustained emphasis on achieving priorities through shifting resources from low priority areas to high priority areas. • Plans need to be flexible to manage the changing needs of the organisation and external environment. • Requires robust project management and asset management processes and procedures, including staff skills base and detailed asset data. • Consideration of whole life costs.

Planning for Capital Expenditure – General Principles (3) • Affordable, prudent and sustainable (Prudential Code): • the total capital investment of the authority remains within sustainable limits, and in particular to consider its impact on the local authority’s ‘bottom line’ and hence council tax. • over the medium term net borrowing should only be for a capital purpose, therefore net external borrowing should not, except in the short term, exceed the total of the capital financing requirement in the preceding year plus the estimates of any additional capital financing requirement for the current and next two financial years. • treasury management is carried out in accordance with good professional practice.

The Prudential Framework ‘The Prudential Framework is an umbrella term for a number of statutory provisions and professional requirements that allow authorities largely to determine their own plans for capital investment, subject to an authority following due process in agreeing these plans and being able to provide assurance that they are prudent and affordable’ CIPFA Practitioners’ Guide to Capital Finance in Local Government

Prudential Code - Regulatory Framework Part 1 Primary legislation on which the capital finance system is based. Part 2 encourages good financial management, supporting the financial planning requirements of the prudential regime. The Local Government Act 2003 (Local Government in Scotland Act 2003) The Local Authorities (Capital Finance and Accounting) Regulations Provides the operational detail for the primary legislation and specifically states that authorities must have regard to CIPFA’s Prudential Code when setting and reviewing their affordable borrowing limit. CIPFA’s Prudential Code for Capital Finance in Local Authorities Professional code of practice developed by CIPFA in order to underpin and flesh out the system of capital finance

Prudential Code – Second Edition 2009 Introduction • Prudential Code plays a key role in capital finance – by regulation – organisations required to have regard to the code when carrying out duties. • Authorities determine their own programmes for capital investment. The code supports authorities in making these decisions. • Objectives of the code are to ensure that capital investment plans are affordable, prudent,sustainable and that treasury management decisions are taken in accordance with good professional practice. • Applies to all local authorities including police and fire. • Code sets out indicators that must be used and the factors that must be taken into account to demonstrate compliance with the code. • CFO responsible that all factors relating to the code are reported to the decision making body. Also establishing procedures. • CFR – look at this in the matching expend to resources.

Prudential Code – Process & Governance Issues Prudential Indicators:- • To demonstrate that capital investment plans are affordable, prudent, sustainable, the PC requires Authorities produce a set of prudential indicators. • Designed to support and record local decision making in a manner that is publicly accountable. • Not designed to be comparative performance indicators. • PC doesn’t include suggested indicative limits or ratios. • Definitions of indicators consistent with SOA definitions to promote transparency. • The indicators specified in the code are the minimum requirements. LA can develop more to assist themselves.

Prudential Code – Process & Governance Issues Setting and Revising Indicators:- • For a local authority it is usually full council that approves the indicators. • If indicators are revised they must revised by the body that originally approved them. • Indicators for the forthcoming year and following years must be set before the beginning of the forthcoming year. • Prudential indicators should not be set independently from one another – should be a strategic process.

Prudential Code – Process & Governance Issues Monitoring Indicators:- Chief Financial Officer is responsible for establishing monitoring procedures to monitor performance against indicators These should have particular regard to:- • Is the authorised limit for external debt likely to be breached? • In year monitoring should be undertaken regularly against key measures for example reviewing estimates of financing costs to revenue and capital financing requirement. • Significant variation, e.g. caused not achieving projected in-year capital receipts, should trigger management action.

Prudential Code – Process & Governance Issues Indicators -matters to be taken into account:- In setting or revising their prudential indicators, the local authority is required to have regard to the following matters: ● Affordability, e.g. implications for Council Tax and if applicable Council housing rents ● Prudence and sustainability, e.g. implications for external borrowing ● Value for money, e.g. option appraisal, asset management and strategic planning. ● Stewardship of assets, e.g. asset management planning ● Service objectives, e.g. strategic planning for the authority ● Practicality, e.g. achievability of the forward plan.

Prudential Code – Affordability (1) • Consider all resources currently and estimated for the future, together with capital plans, revenue income and expenditure. • Forthcoming year and the following 2 years. • Need to consider risk and uncertainty – take into account in risk management strategies. • Is total capital investment sustainable – what’s the impact on the bottom line. i.e. council tax levels, revenue consequences of investment. The following prudential indicators are key indicators of affordability: Looking ahead for a three year period: • Estimates of the ratio of financing costs to net revenue stream. • Estimates of the incremental impact of capital investment decisions on the Council Tax. After the year end: • Actual ratio of financing costs to net revenue stream.

Prudential Code – Affordability (2) Other prudential indicators that relate to affordability are:- Looking ahead for a 3 year period:- • Estimates of capital expenditure. • Estimates of capital financing requirement (underlying need to borrow for capital purpose). • Authorised limit for external debt. • Operational boundary for external debt. After year end:- • Actual capital expenditure. • Actual capital financing requirement. • Actual external debt.

Prudential Code – Affordability (3) • Operational Boundary: • most likely (not worst case scenario), prudent view of the level of gross external indebtedness (borrowing + long term liabilities). • key management tool for in year monitoring. Shouldn’t be breached regularly – if it is there needs to be further investigation. • Authorised limit: • upper limit on the level of gross external indebtedness (worst case scenario), which must not be breached without council approval. • provides headroom over and above the operational boundary, sufficient for unusual cash limits. • Both need to be consistent with the authority’s plans for capital expenditure, financing and treasury management. • Risk management and risks analysis needs to be taken into account.

Prudential Code – Prudence • Prudential indicators in respect of external debt must be set and revised taking into account their affordability. • To ensure net borrowing is only for capital purposes you need to ensure that (apart from short term) net external borrowing does not exceed the total of capital financing requirement in the proceeding year plus the estimates of additional capital financing requirement for the current and next 2 financial years. • Also prudent that TM is carried out in accordance with good professional practice. The Code requires authorities to adopt the CIPFA Treasury Management in the Public Services: Code of Practice & Cross Sectoral Guidance Notes.

Prudential Code – Local Authority with Housing Functions • If you have an HRA you need to consider the impact on rent levels when considering affordability of capital plans. • Do separate calculations for HRA and non HRA elements for the following indicators:- - Estimates and Actual the ratio of financing costs to net revenue stream. - Estimates of the incremental impact of capital investment decisions on housing rents. - Estimates and actual capital expenditure. - Estimates and Actual capital financing requirement.

Planning for Capital Expenditure – the key documents • Key capital planning documents (all ‘live’); • Capital Strategy - describes how the investment of capital resources will contribute to the achievement of the authority’s key objectives and priorities that are detailed in their community plans and strategies. • Asset Management Plan (AMP) – Converts the corporate aims and visions set out in the Capital Strategy (CS) into asset reality. Considers assets in the round. • Capital Programme – sets out the spending plans of the organisation and where these are to be funded from. It should be produced in line with the Capital Strategy & AMP and adherence to the Prudential Code.

The key documents – how they fit Partners Financial Context Corporate Operating & Governance Policies External Environment Operating Units’ Strategies Corporate Strategy Capital Strategy & Revenue Expenditure Strategy Annual (or 3/5 year Rolling) CapitalProgramme & Revenue Expenditure Programme

Capital Strategy – what is it? • The Capital strategy is one of the key overarching strategies of an organisation. • Describes how the investment of capital resources will contribute to the achievement of the organisation’s key objectives and priorities, including the visions set out with the local area (e.g. LAA). • Looks at determining priorities between the various services, opportunities for cross-cutting and partnerships/joined-up investment. • Medium/long term focus i.e. 3 to 10 years. • It forms the backcloth of the Asset Management Plan(s) and the Capital Programme.

Capital Strategy – Possible contents (1) • Key priorities and targets of the organisation – cross reference to other key strategies, e.g. Medium Term Financial Strategy. • Consideration of overall financial context in which the Strategy has been drawn up (current economic climate, financial position of the Authority and outlook for both). • Consideration of opportunities for cross-cutting, partnership working and joined-up investment, possibly giving examples of the steps being taken to work with other councils or agencies, where budgets are being pooled or where there is integrated service provision or joint procurement.

Capital Strategy – Possible contents (2) • The Authority’s approach to Asset Management, including:- • Process of consultation • Process for option appraisal of capital project proposals. • Process for the prioritisation of capital projects including officer and member arrangements for assessing potential schemes. • Process for managing, monitoring and evaluating approved schemes. • Process for Corporate review of existing properties • Consideration of revenue implications. • Capital Funding & Procurement, including the Corporate approach to generating capital resources e.g. bidding for additional capital resources.

THE CONTENT OF A CAPITAL STRATEGY London Borough Bromley • Introduction – included the intended use of the strategy. • Organisation’s Vision, Priorities, Targets links to LAA etc. By service vision, key activities and outcomes, planned capital investment. • Consultation processes of the organisation. • Asset Management in the Organisation. • Capital Programme (Summary) and inclusions in the appendix. • Identifying & Prioritising Schemes. • Key Partners. • Monitoring Capital Programme and Performance. • Capital Programme Funding and Procurement. • Conclusions.

Asset Management Plans (AMPs) – what are they? • Converts the corporate aims and visions set out in the Capital Strategy (CS) into asset reality. • Implementation document which operates over a shorter time horizon than the CS – generally 3-5 years (updated annually) and informs the Capital Programme. • Normally starts from the baseline of the current property stock. • Sets out how the Authority intends to close the gap between the asset base now and what it requires going forward, including assessment of the likely costs of this work and how it might be funded. • Should cover all the organisation’s assets.

Asset Management Plans (AMPs) – Possible contents (1) • Policies & Organisational arrangements, e.g. Roles and responsibilities, governance and decision making processes, data management processes including what core asset data is held, where and how it is used etc. • Detail of the asset portfolio - including results of condition surveys and the objectives for each asset. • Closing the gap – how the Authority is going to get the asset portfolio to where it needs to be to meet the requirements of the Capital and Corporate Strategies. This will include: • Identification of under-used assets and actions required, e.g. disposal, shared use.

Asset Management Plans (AMPs) – Possible contents (2) • Closing the gap (cont.): • Resources – capital receipts, available funding, revenue implications. • Performance and Monitoring - systems in place to ensure goals and objectives are being met, including critical success factors & milestones, performance indicators, details of current performance & key historic trends.

Capital Programme – what is it? • Budget for capital purposes (approved by Members) driven by the Capital Strategy and AMP, and in adherence to the Prudential Code. . • Likely to cover a number of years (generally 3 to 5). Key features include: • Development is a joint effort between officers from the finance, technical, and service departments. • Includes schemes that have already been approved but where spending is expected to continue into the following financial years, and new schemes where spending will not commence until the following financial years. • Regularly monitored in terms of cost and physical work against an approved programme.

Constructing a Programme - General Principles • Effective consultation with users of services, external stakeholders etc. • Programme should be sustainable, affordable and able to deal with issues such as slippage. • Enables members and staff to use their scrutiny role to ensure the organisation works strategically & effectively with local service partners, so resources are directed to local priorities in the best way. • Investment appraisal process which includes evaluation of risks and the relative costs and benefits. • Whole life costs, benefits and their impact on the local community and environment are considered. VfM. • Scenario analysis is used to evaluate options, consider risk, external factors and whole life costs or benefits.

Constructing a Programme – Process (1) Identification of schemes: • Driven by the authority's Capital Strategy and Asset Management Plan, i.e. schemes should be identified as a result of a perceived need to meet council and service objectives. Remember: • It is fundamental requirement of effective asset management that all new investments, whether capital or revenue, are subject to an investment appraisal process which includes evaluation of risk and the relative costs and benefits.

Constructing a Programme – Process (2) Setting out the business case for schemes: • Identifying the cost of the scheme over its life including the revenue costs and the capital expenditure required including the likely phasing and potential financing of the schemes. Remember: • Large schemes, in particular, may take five or more years to complete. • It can take a number of years to advance some schemes to the stage where construction works can commence.

Constructing a Programme – Process (3) Prioritisation of schemes: • The need for capital expenditure generally far exceeds capital resources. The Capital Strategy should set out the prioritisation methodology. Possible means include: • Developing a methodology for scoring proposed schemes against set criteria; or • assigning schemes to different classes, e.g. essential, priority or desirable.

Prioritisation Methodology Remember • There is no one way to evaluate bids. • Most authorities now use some form of weighted matrix. • The key is openness and transparency. • Officer groups or member/officer groups usually decide or make recommendations. • Should failed bids move into the programme for future years? • No-matter what criteria are used to evaluate bids the ultimate constraint is what the authority can afford in both revenue and capital terms.

Possible prioritisation factors • whether the council would fail to meet its statutory obligations if the proposed scheme did not proceed; • level of external funding attached to the proposed scheme; • how the proposed scheme helps meet stated council objectives; • whether a failure to implement the scheme would result in a reduction in the council's stated level of service; • whether a high level of public support can be demonstrated; • whether the scheme involves a partnership with other bodies thereby bringing resources (not necessarily financial) into the authority; • whether the scheme links to other plans and reviews, in particular, whether the scheme helps address problems identified in a best value review; • whether it meets national government priorities; • whether the proposed scheme will result in future revenue savings.

Example prioritisation document • Handout: example prioritisation methodology.

Constructing a Programme – Process (4) Content of a programme: • Encompasses much of information gathered on each scheme during the business case/selection processes. • In simple terms: total capital costs for the current and following financial year on all schemes, compared with the overall resources available to finance capital expenditure in each of those years, i.e. • for schemes in progress, actual capital expenditure up to the end of the last financial year, revised estimates of capital expenditure for the current financial year and future years, and a revised estimate of the total capital cost; and • For new schemes, total estimated capital costs, including those scheduled over future years. • For all schemes, how they are funded (i.e. useable capital receipts, borrowing, revenue contributions, capital grants etc).

Slippage • Major area of uncertainty in the monitoring of programmes. • Issues such as changes in design requirements, planning controls, compulsory purchase problems, and legal difficulties can all cause the start/end date or phases of schemes to slip. • Methods of dealing with slippage - : • Approve a programme of schemes which exceeds the level of available funding (problematic); or • Programmes with greater flexibility?

Constructing a Programme – Process (6) Completed schemes: • Purpose: to identify areas where the capital programming and monitoring process can be improved. • Undertake post completion (e.g. once scheme has been in full operation for a year) reviews on a sample basis? • Report by lead officer on completed schemes setting out information such as: • Procurement process • Timeliness of scheme • Final cost of scheme against estimate • Quality of scheme against standard • Outputs of scheme compared to targets in bid • This report to be considered by the capital monitoring group (or equivalent) and by exception CMT and cabinet. • Results fed back into capital programming & planning process.

Example Programme Process Production of Programme:

Issues to consider: Revenue implications • These can include: • Initial costs which can’t be capitalised, e.g. feasibility studies. • the cost of borrowing or loss of investment income if useable receipts are to be used; • MRP or loans fund principal; • the running costs associated with the asset, such as; • salaries of employees or management fee if outsourced; • security, heat and light etc; • repairs & maintenance; and • administrative support costs. • efficiency or other savings arising from the scheme. • Income generation (new/increased fees & charges, rents etc). • Capital strategy should demonstrate how the revenue implications would be taken into account in deciding priorities. E.g. priority may be given to schemes that generate revenue savings, such as investment in energy saving plant and equipment.

Delegate Information

Option Appraisals (1) • Evidence-based process for making investment decisions, using a systematic comparison of alternatives against set criteria. • Level of detail examined will depend on the size, complexity and strategic importance of the project concerned. • Principles: • being clear about what you are hoping to achieve – your objectives; • considering the different ways in which they could be achieved – your options; • assessing the costs and benefits of the different options; • identifying all the pros and cons of the options and quantifying them and valuing them wherever possible; • considering any risks and sensitivities; • considering the most appropriate and best value use of resources, not just focusing on the lowest initial costs.

Option Appraisals (2) Useful resources on option appraisal: • Treasury ‘Green Book’ - arguably excessive for routine appraisals, however provides valuable elements of guidance that can be used selectively. http://www.hm-treasury.gov.uk/data_greenbook_index.htm • RICS ‘Making the right choices’ includes brief and accessible guidance on option appraisal at the more typical scale of routine asset management choices. http://www.rics.org/site/scripts/download_info.aspx?downloadID=2753&fileID=3052 • The former Department for Education & Skills produced a detailed guide to option appraisal guide in May 2002. http://www.teachernet.gov.uk/_doc/13179/AMP_Option_appraisal_guide.pdf • Those who subscribe to TISonline’s Asset Management information stream can access its informative page on option appraisal at: http://www.tisonline.net/assetmanagement/default.asp?section=Option%20Appraisal&pagesize=all&pagemode=text

Business cases (1) Typically the following data would be held on each scheme: • title; • committee or cabinet portfolio, department and officer responsible for the scheme; • description; • priority rating; • total estimated capital costs, including those scheduled over future years: • analysed into design and supervision, land acquisition, siteworks, construction contract payments, ancillary services, equipment, furniture and fittings and other expenses; and • broken down into monthly or quarterly cash flows for monitoring purposes.

Business cases (2) • Total estimated revenue costs including those scheduled over future years: • analysed into employees, various running expenses, capital financing costs, and income; • How the scheme will be funded, e.g. useable capital receipts, capital grants, revenue contributions etc. • Other financing considerations, e.g. revenue savings such as energy conservation; • Timetable for progressing the scheme through the various implementation stages, site selection, design, planning permission, land acquisition, bills of quantities, contract tenders, start on site, and completion, etc;

Constructing a Programme – Process Monitoring the programme: • Regular monitoring; both in terms of cost and physical work against an approved programme. • Capital Monitoring Group (or equivalent) – every 6-8 weeks: • Looks at all schemes. • Reports on an exception basis to CMT / Cabinet. • Quarterly monitoring report (covering all schemes) to members. • Annual outturn report (covering all schemes) to members. • Monitoring needs to be able to identify and show the likely effect on schemes of a change in phasing of any individual scheme (slippage). • Consideration of cash flow implications of programme.

Example Programme Process (2) Monitoring: • Corporate capital monitoring group set up: • Group meets every 6–8 weeks; • Progress of all capital schemes reported to group by the relevant manager; • Group then reports on any issues or high-risk schemes to CMT or, if necessary, to cabinet. • Considers reports on completed schemes, reporting by exception to CMT or Cabinet. • Financial capital monitoring report on all schemes (including explicit consideration of external funding) produced after above meeting for CMT and cabinet 3 times per year (Q1, Q2 & Q3). • After year end (June/July), summary capital outturn (detailing major variances) for year reported to CMT and Cabinet.

Issues to consider: Whole Life Appraisal & Sustainability (1) • Whole life appraisal considers all relevant expenses, income and performance associated with the acquisition, procurement, ownership and potential disposal of an asset over its life. • Enables decision makers to evaluate the real consequences of differing initial scheme options over its full life, and consider key questions such as is it worth investing more initially to save money and improve building performance in the longer term? • Should be incorporated into the option appraisal process. • Note:whole life appraisal incorporates whole life costing which is referenced within the prudence and sustainability requirements of the Prudential code.

Issues to consider: Whole Life Appraisal & Sustainability (2) Need to consider: • Have all costs been planned for: • all aspects of the development and equipment costs; • initial capital costs including all aspects of procurement; • ongoing capital costs e.g. replacement of components; • revenue costs (covered in next slide); • costs of disposal, e.g. dismantling, decontamination etc. • Opportunity cost – would you be better investing in something else. • Is it future proof: • will there be a need for significant investment during the assets life; • how does service know it is fit for purpose in the medium to long term given factors such as demographic growth; • what about environmental considerations.

A to Z of Capital – Capital Planning & Programming