Capital Planning: The Ultimate Guide

Rick Bell | Content Strategist | August 29, 2024

In This Article

Even with massive cash infusions to repair roads and bridges, modernize airports, and revitalize and build other new forms of infrastructure on a global scale, there’s still a budget attached to every project.

Effective capital planning lays out the process for spending that money to receive maximum short- and long-term benefits, while also strengthening financial governance of each project. In this article, you’ll learn how your organization can improve efficiency and promote financial transparency across a single program or a portfolio of public and private construction projects.

What Is Capital Planning?

The goal of capital planning is to allocate a finite amount of budget and resources to “the right projects”—the projects that best align with the owner’s strategic goals and objectives. Project owners, regardless of what they’re building, do three things: They plan, construct, and operate critical assets and infrastructure.

With unrestrained access to capital, an owner could, in theory, green light every project, but the reality is that owners must make hard choices. Some projects will move down the pecking order in the capital plan and/or they’ll receive fewer resources than originally envisioned. Others might be canceled entirely.

Key Takeaways

  • Capital planning identifies the projects that best align to an owner’s strategic goals and objectives.
  • Organizing the capital planning process into an appropriate framework helps ensure that it’s fair, equitable, impactful, sustainable, and actionable.
  • Capital planning programs are more effective when teams and stakeholders are connected and using modern technology tools and platforms.
  • Lax oversight and manual processes can lead to favoritism and approval of pet projects. Cloud-based capital planning tools help give every project a fair chance and build transparency and accountability into the process.

Capital Planning Explained

A project owner receives funding. If it’s a government entity, that’s likely public money collected through bond measures and taxes. A private company typically funds construction projects using loans, equity, investments, and other private funding.

Capital planning establishes the right projects to take on, allocation of the available funds, and how much should be spread across those projects to align with long-term organizational objectives. The capital plan generally is reviewed and approved by operations, finance, and executive leadership stakeholders.

With so many complexities and variables, including staff shortages and rising supply costs, what you're really trying to do in the capital plan is pick the projects that align with the unique strategic goals and objectives of your organization. The evaluation and prioritization (scoring) of projects will be subject to the criteria an owner cares most about. These could be both qualitative (resiliency, environmental impact) and quantitative (return on investment, net present value).

Capital Planning Process

The capital planning process is one of the most important and complex aspects of managing a project or project portfolio—a concerted effort that requires diligence, patience, and constant communications.

By organizing the capital planning process into a standardized intake, evaluation, and selection framework, capital planners can simplify what is often a series of disconnected forms and spreadsheets.

A typical construction capital planning process covers the following ground.

  • Preparation and Analysis: Capital planning and finance departments prepare with an intake process (project proposals) that helps them understand the scope, schedule, resources, costs, and risks of a potential project. Ideally, this intake process is made available to the operations leads within the project management office (PMO), who are best suited to provide the details that capital planners will need to evaluate and prioritize all proposals together.
  • Strategy Development: Strategy development establishes the criteria that are most important to an owner’s strategic goals and objectives. Criteria often are a combination of both qualitative and quantitative measures unique to each owner. For example, arriving at a project score could be a combination of measures that are individually weighted against one another. How sustainable is the project? Is the project part of a regulatory requirement? What is the project’s ROI? What are the risks in delaying it? By including these measures in the initial intake form, capital planners can begin the rank and stack analysis of which projects should ultimately receive funding and be authorized to move forward.
  • Implementation and Monitoring: Implementing policies and procedures to support effective oversight improves financial accountability over the capital plan’s duration. So it’s important to monitor the progress of capital projects and evaluate their success based on the established metrics of quality, cost, and schedule targets. Budgets created by the finance team are shared with the operations team, which then continually shares updated forecasts with finance. If budget adjustments are required, finance must authorize them to ensure the project can continue.
Capital Planning: The Ultimate Guide image
Successful capital planning requires preparation, developing a strategy, and monitoring progress.

Tools and Techniques in Capital Planning

Capital planners often rely on various tools and techniques to make key decisions. The fact that many capital planners still do their work on spreadsheets and send multiple versions through email is hard to believe in this digital age—but it still happens. Meantime, operations teams tend to use their own project management systems as part of the project management office (PMO) delivery organization. It’s therefore critical that both budgets and forecasts be integrated across these organizational boundaries.

With complex projects often valued in multiple billions of dollars, optimizing capital planning lies in project management software designed to make planning and forecasting easier, more accurate, and more effective. Ideally, the tool you’re working with supports all seven of the following:

1. Financial modeling and analysis

With financial modeling and analysis, you should be able to run different financial scenarios and models and/or look at risk and get a risk score—both qualitative and quantitative. Financial models quantify the impact of capital investments. Compare the numbers against historical performance and provide decision-makers with easy-to-read financial reports of planned versus actuals. Budget planners rely on various finance methods and techniques to make informed decisions, including net present value (NPV), internal rate of return (IRR), and discounted cash flow (DCF).

2. Scenario planning and sensitivity analysis

Capital investment decisions are based on a set of assumptions and inputs. The lack of certainty brings about investment risk.

  • Scenario analysis: The process of estimating the expected value of a portfolio after manipulating a number of key variables. This method can be used in both investment strategy and corporate finance.
  • Sensitivity analysis: A method to identify how much variations in the input values for a given variable will impact the results for a mathematical model. While there isn’t a single formula for sensitivity analysis, the general approach is to select an input, modify it by a specified amount, and ascertain the impact on the output. Analysts typically vary inputs up and down by a fixed percentage, such as 10%, to assess sensitivity. The simplistic formula is:

    New output = base output x (1 + change in input)

3. Risk assessment models

Risk assessments quantify uncertainty in capital planning. A qualitative risk assessment is subjective (a basic score), while a quantitative risk assessment calculates potential outcomes. The goal of any risk simulation is to evaluate the confidence you have in the project plan, which areas of that plan expose the project to the most risk, and what responses you will take to mitigate those risks.

  • Monte Carlo simulations: A type of computational algorithm that plays a crucial role in analyzing risks. Monte Carlo simulations are increasingly used in conjunction with AI models. The core concept behind the Monte Carlo simulation is a multiple random sampling from a given set of probability distributions.
  • Value at risk (VaR): A statistic used in risk management to predict the greatest possible losses over a specific time frame. Although there are several methods of calculating VaR, the historical method is the simplest:

    Value at risk = vm (vi / v(i - 1))

4. Portfolio management techniques

Reliable portfolio management enables you to direct and adjust capital planning to help maximize return, whether a project is under consideration, under construction, or nearing closeout and handover. If done well, a data-supported portfolio management strategy helps organizations meet their capital planning goals today and tomorrow.

Investors use both the efficient frontier and the capital allocation line (CAL) to achieve different combinations of risk and return based on what they desire. With CAL, the optimal risk portfolio is found at the point where the line is tangent to the efficient frontier. This asset weight combination gives the best risk-to-reward ratio, as it has the highest slope for CAL. See the image below.

  • Capital allocation line (CAL): A line that graphically depicts the risk-and-reward profile of assets that can be used to find the optimal portfolio. The line E(Rc) = Rf + Spσ(Rc) is the capital allocation line.
  • Efficient frontier: It comprises investment portfolios that offer the highest expected return for a specific level of risk and graphically represents portfolios that maximize returns for the risk assumed, showing the benefit of diversification. It helps investors understand the potential risks and returns in their portfolios and analyze how they compare to the optimal set of portfolios considered to be efficient. The efficient frontier rates portfolios (investments) on a scale of return (y axis) versus risk (x axis).

5. Project management and governance tools

These tools are used in the transition between identifying the right projects to do and handoff to a project management execution team. A comprehensive project management application is valuable to manage schedules, contracts, and documents and provide a governance framework for compliance oversight. However, for many project owners the finance capital planning department and project management office use different systems. And that’s not ideal because the execution side is using project management tools to understand the details of what the plan really needs, collecting actuals, and providing forecasts that should go back to and inform the capital planning group on how it’s doing. Furthermore, capital planning can’t wait on slow, spreadsheet-driven processes to evaluate a project’s status. Immediate, data-driven visibility allows that team to quickly and accurately manage the budget.

  • Project management software: Automated solution that gives users full control of all workflows. It connects the right people to the right projects, supporting the organization’s goals with a clear view of financial performance across a project portfolio.
  • Governance frameworks: Critical to control and standardize the way projects are delivered. Such frameworks also increase efficiency, promote decision-making accountability, and reduce risk through streamlined and standardized processes that provide visibility and support compliance.

6. Performance measurement and KPIs

Ideally, owners measure performance across the entire “plan, build, and operate” lifecycle as assets move from concepts into operations and maintenance. Owners should develop measures and KPIs that reinforce what success looks like and how to achieve the expected result. A good start is to focus on high-level outcomes/targets they care about most—bringing quality assets into production on budget and on schedule while minimizing risk. Measures and KPIs tend to be a mix of quantitative and qualitative outputs. While finance teams may prefer quantitative measures such as ROI, working capital, cash flow, and profit margin, project teams may also include softer measures of team communication, conflict resolution, health and wellness, and team morale.

Measures and KPIs should also be relatable to the audiences that review them. Project teams tend to track performance at a finer level of detail than is generally shared with executives or public stakeholders.

  • Return on investment (ROI): A simple and intuitive metric of the profitability of an investment. ROI is a key metric used by business analysts to evaluate and rank investment alternatives. There are several versions of the ROI formula. The two most commonly used are:

    ROI = net income/cost of investment
    or
    ROI = investment gain/investment base

  • Economic value added (EVA): A way to measure the economic profit of a company or project. EVA is calculated by taking net operating profit minus a finance charge. The finance charge captures the required rate of return on capital invested by the company.

    The EVA formula can be expressed as:

    EVA = NOPAT – (WACC invested capital)

    Where NOPAT = net operating profit after tax; WACC = weighted average cost of capital; invested capital = shareholders’ equity + net debt at the beginning of the period. (Alternatively, invested capital can be calculated by taking total assets minus cash minus non-interest-bearing liabilities.)

7. Advanced analytics and big data

Data from past construction projects is valuable in helping organizations understand how to build out new projects more efficiently. For example, an energy company has built numerous refineries, and there’s general knowledge of what it will take to build the next one. Advanced analytics can help that company analyze mountains of data from the last 20 refinery projects to make better-informed decisions on the right projects to take on, how to allocate available funds for a given project, and how to spread the money across projects.

  • Predictive analytics: The use of statistics and modeling techniques to forecast future outcomes. Predictive analytics determines a likely outcome based on an examination of current and historical data. There are three common techniques used in predictive analytics: decision trees, neural networks, and regression.
  • Big data analysis: The process of collecting, examining, and analyzing large amounts of data to discover market trends, insights, and patterns that can help companies make better business decisions.
Predictive analytics helps us manage risk on a jobsite. I applaud the efforts of our entire supply chain who want to collaborate with us and with innovators like Oracle to find solutions to help us drive that approach.

Nitesh AlaghBusiness Lead, Digital Engineering, Sustainability and Emerging Tech, Severn Trent

9 Capital Planning Best Practices

Construction project owners know that managing capital investments wisely leads to better cash flow and faster growth. When organizations struggle with managing their spending, they miss out on the opportunity to expand development and profitability. They can improve overall capital investment performance by adhering to the following nine practices, along with using a comprehensive capital management application.

1. Align capital planning with strategic goals

Capital planners are uniquely challenged with ensuring that all projects which receive funding are properly aligned to an owner’s strategic goals and objectives. The importance of this formal alignment can’t be understated. Planners must consider the external and internal factors that could affect an organization's ability to pursue strategic goals without fear or favor, estimate the capital needed for each project, and evaluate and rank the projects that will receive funding.

2. Implement a rigorous project evaluation process

A standardized process in which each project is evaluated, scored, and prioritized helps eliminate pet projects and favoritism. Projects can be ranked according to urgency, feasibility, risk, and strategic alignment. The projects with the highest positive impact and the lowest opportunity cost generally get the nod.

3. Establish a strong governance framework

A strong governance framework provides proof over time that you’re getting what you paid for—timelines are being met and risks are being managed and mitigated. A clear connection between finance, which releases capital budgets, and the PMO, which receives those budgets and provides monthly forecasts back to finance, keeps each department in constant alignment should reauthorizations be required. A strong governance framework should include the policies and procedures that each group is responsible for, a reference system architecture that outlines both when and how specific data and information crosses departmental boundaries, and the frequency interval of stakeholder decision-making and reporting.

4. Foster cross-functional collaboration

It’s important to foster cross-functional collaboration between key departments, especially between capital planning/finance and the project management office execution group. They will share information at specific intervals and times, ideally at least every month.

But such collaboration may not just be internal. Owners often hire delivery teams (contractors/suppliers) as part of the execution process. Ensuring that these delivery teams can both access and share critical project documents, schedules, risk, and cost information with the PMO is vital. No engineering or construction project happens in a vacuum, and all must contribute to and collaborate on a shared and unified plan.

5. Embrace flexibility and adaptability

Yes, owners want predictability from their capital planning strategies to ensure that deadlines are met and costs remain under control, but it’s important to be flexible. Planners must build flexibility into capital budgets to adapt to ever-changing conditions, such as when the price of materials suddenly skyrockets or there’s a freak weather event.

6. Leverage technology and data analytics

The technologies you choose should start with the end in mind. Are the technologies making project information readily available to those who need it? Do they make it easy to keep decision-makers and stakeholders at all levels informed?

Capital planning technologies should ideally help planners evaluate, prioritize, and select the projects that align to the organization’s strategic goals and objectives. They should also be interoperable with the project management technologies of the PMO and delivery teams who provide the necessary forecasts planners need to make adjustments across their project portfolio.

Once all projects in the portfolio can be seen together, you can easily find new opportunities to unlock and surface insights. Data analytics dashboards built into integrated portfolio capital planning and project management technologies give planners and PMO/delivery teams the insights they need to make the most informed decisions.

7. Prioritize risk management

Project risk occurs in two phases: during the proposal, prioritization, and selection phase and during the project execution phase. Capital planners focus on the former, operations/delivery teams on the latter. Putting a risk management framework in place across both phases is crucial.

8. Ensure transparency and accountability

As capital projects become increasingly complex, it’s critical to create clear service-level agreements and provide all stakeholders with regular updates at every stage to help ensure transparency and accountability. Those stakeholders include not only owners, planners, and delivery teams, but also regulators.

9. Emphasize continuous improvement

Continuous improvement involves refining ongoing processes based on lessons learned from past project errors and failures. It also involves constantly adjusting existing project processes to meet changing demands.

Capital Planning Challenges

The world is an uncertain place. There was a global pandemic. Weather events are becoming more extreme and unpredictable, requiring a plan to prioritize the aging infrastructure most in need of renovation. Money is tight. Whatever you're planning to build, capital planning should help ensure reliability while optimizing investments. Here are some of the biggest challenges that capital planners will need to overcome.

  • Uncertainty and Volatility: Volatility in interest rates, the price of raw materials, the stability of vendors and suppliers, geopolitical landscapes, and the impact of climate change are just several of the factors that can create challenges for capital planners on construction projects.
    Other contributors to uncertainty include supply chain disruptions, unpredictable weather, and labor unrest. Diversifying investments and the sources of financial capital is an effective way to protect against volatility. It’s also important to maintain a long-term perspective and not be swayed by short-term market movements.
  • Regulatory Changes: Regulations governing carbon emissions, building safety and design, zoning, contracts, and other areas are commonplace in the construction industry, and they’re constantly changing at every level—federal, state, and local. Capital plans need to be adjusted accordingly. For example, in the case of legally binding federal targets to reach carbon neutrality by 2050, energy efficiency and alternative sources of power and heating are now a top priority for builders.
  • Resource Allocation: Resource allocation involves balancing competing needs and priorities. Resource demands constantly fluctuate over a project’s lifecycle. Scarcity of labor, machinery, and other resources established in a capital plan often leads to project delays and wasted time and money as workers and equipment sit idle. Overallocation of resources—too many employees designated to a single project, for example—also will negatively affect efficiency and productivity.
  • Technological Disruption: Manual processes and spreadsheets are giving way to smart applications purpose-built for construction and engineering projects, enabling organizations to analyze the large volumes of data they already own or are collecting to gain insights and help mitigate risks. Those firms that don’t embrace the latest project and capital management applications risk missing opportunities, over-allocating or under-allocating resources, missing deadlines, and falling behind competitors.
  • Risk Management: Identify risk early and evaluate often. Risk management requires the integration of dynamic and diverse sets of information, including budget, cost, and schedule data. In some cases, a specific risk factor can’t be avoided or controlled. For example, an urgent project must move ahead during a specific time of year and in a region where inclement weather is unavoidable.
    Risk management isn’t a process suited to a siloed, spreadsheet-based environment and requires collaboration and centralized data management.
  • Stakeholder Alignment: Each project stakeholder has their own special interests and priorities that don’t always align with strategic goals. Whether you’re the owner managing a broad cross section of financial and strategic decision-makers or the general contractor overseeing trades, unions, and jobsite inspectors, effective stakeholder alignment is critical to your success. Stakeholder alignment identifies who they are, determines their level of participation, and gets them all on the same page. Stakeholder alignment requires constant communication and information sharing across organizational boundaries, from the project’s inception to its handover. If you reinforce and constantly communicate the strategic goals and objectives, you’ll likely have all your stakeholders aligned and singing off the same sheet of music.

Build Budget and Cash Flow Accuracy Across Your Portfolio with Oracle

Project owners and their capital planners are constantly asked the question, Are you working on the right projects? The market-leading Oracle Primavera Portfolio Management platform lets organizations easily create an intake process to evaluate, prioritize, and select the right projects. Managers can evaluate portfolio scenarios and arrive at an optimal plan for allocating budget and other resources across multiple projects in line with strategic goals. The cloud platform also enables users to monitor portfolio health and track performance.

Oracle Primavera Portfolio Management enables planners, executives, stakeholders, and project managers to propose, inventory, prioritize, and select projects in a collaborative fashion and take corrective action when necessary. The solution provides comprehensive long-range tools for capital planning and budget approval across project portfolios. Configurable performance scorecards also monitor the lifecycle of portfolios based on key measures.

Organizations manage a portfolio of important capital projects. Why leave that up to legacy systems because, “That’s the way we’ve always done it” when there are better options to build fast and stay on budget? Oracle Primavera Cloud lets organizations get started quickly and change as needs arise or strategic goals shift.

Capital Planning FAQs

What is the difference between capital budgeting and capital planning?
Capital budgeting is identifying and tracking where the money is coming from. Capital planning is identifying what will be done with that money.

What is capital management planning?
Capital management planning creates a systematic way to track how capital budgets are being spent.

What are the principles of capital planning?
The main principles of capital planning are to evaluate, score, and prioritize projects; align them with strategic goals and objectives; ensure the seamless transition from one stage to the next; and continually share information on project performance.

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