In Extreme Makeover: Home Edition, a well-coifed, nattily dressed crew of designers, carpenters, plumbers, and electricians remakes a stunned family's home in a week—but this isn't “reality” TV. Major building projects generally require a substantial time and resource commitment in the planning stages. While the design and engineering work should be left to professionals, your financial staff has an important role in the planning process. Based upon many years of experience in providing capital to nonprofit organizations undertaking major projects, it has become quite obvious that the financial leadership's early involvement in the planning process is essential for a successful project.
In the early stages, financial staff's input is essential to determine the project's appropriate, and affordable, scope and cost. A clear delineation of available financial resources provides operational planners, architects, and engineers with definitive parameters for planning and designing a workable concept, thereby saving time and money. Setting financial parameters early also allows executives to better manage the expectations of clients, funders, board members, and employees.
Developing a financial blueprint for a capital project, whether a new building, a major renovation, or even a new information system, involves numerous internal and external variables. Developing and refining a financial model can be tedious and time consuming, but they're worth the effort.
A useful model will take into account the project's impact on the organization's income statement, balance sheet, and cash-flow statement, described in more detail below. Once the modeling process has been developed, the financial projections can be evaluated by calculating standard financial ratios and comparing the results to industry targets (table). This comparison process will help management determine both the project's financial viability and the likelihood that the necessary amount of outside capital can be raised to finance the project.
Table. Key financial ratios for nonprofit behavioral healthcare organizations
Revenue projections should reflect the revenues from new or expanded programs; capital costs' impact on reimbursement rates, if any; and reductions in investment income if reserves are used to fund the project. Expense projections might include adjustments in staffing costs, occupancy costs (i.e., increased insurance costs and adjustments to utility costs), and capital costs (i.e., interest expense and depreciation expense) that result from the project. Key measures to track include earnings before interest, taxes, depreciation, and amortization (EBITDA), the debt service coverage ratio, and operating and excess margins.
Implications for the balance sheet likely will include using both cash reserves and debt to finance the project. Using cash reserves will impact liquidity as measured by days of cash on hand and the cushion ratio. Using debt financing will increase leverage as reflected in the debt to capitalization ratio. The balance sheet's asset side will reflect the addition of the newly acquired fixed assets and any use of cash reserves.
Developing projections of the cash-flow statement is essential to ensure that the timing and levels of cash available remain at a manageable level during the project's construction and implementation phases. By projecting cash-flow needs, a plan for meeting working capital needs, such as an increase in the availability of a line of credit, can be anticipated before such a need occurs.
Developing a financial model to assist in the project's financial planning will be invaluable in analyzing various design and budget scenarios. In the end, a deliberative and well-designed financial blueprint is an essential tool for ensuring a project's success and the organization's future financial stability.