There are two methods that can be used to allocate costs in a process costing system. They are weighted average or FIFO (First In First Out). Accountants and business owners can decide which method to use based on their preference for simplicity or accuracy. Of course, there are differences between the two methods. But, they also share similarities…
The FIFO and weighted-average methods each always use these same inputs:
Ending WIP units
Percentage complete for materials & conversion
Amount spent on materials & conversion
Here’s a look at some of the differences between the weighted-average and FIFO methods (by step):
Unit Reconciliation
Cost/Equivalent Unit
Cost Allocation
Weighted-average method
Considers begin WIP 0% complete
Allocates the value of begin WIP
Begin WIP + Monthly expenses = Amt completed & transferred + End WIP
FIFO method
Considers begin WIP partially complete
Allocates expenses incurred
Monthly expenses = Amt to complete begin WIP + Amt started & completed + End WIP
Both methods are, generally speaking, similar. Which you should use depends in large part on preference. It also depends on your ability to conceptualize what is taking place.
A process costing system is primarily used by manufacturing companies that mass-produce a bunch of the same product. A process costing system can be contrasted with a job order costing system. A job order costing system would be used by companies that offer custom products and/or services.
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Process costing – FIFO vs weighted-average
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The weighted-average method might be considered simpler. But, the FIFO method might be considered more accurate. That being said, once the groundwork is laid for a FIFO process costing system, calculations should be made automatically and require a minimum of effort on your part. That is…if everything’s set up correctly.
Below, I’ll compare the calculations from the weighted average and FIFO methods. Each will refer to the same inputs – Item1, Dept A, from the Process Costing workbook. That way, you’ll be able to compare the two methods side-by-side, apples-to-apples, and decide which makes the most sense for your company. Then, you can move on to more pressing matters.
The purpose of unit reconciliation is to determine the total number of units to allocate costs across in a given month.
Obviously, those units that were completed will be included. But, also factored in, are “equivalent units.”
Equivalent units
Equivalent units = WIP units × Pct complete
These units are calculated for direct materials (DM), direct labor, and overhead individually. Why? Because these value-added costs are not applied uniformly.
For simplicity’s sake, overhead is assumed to be applied on the basis of direct labor hours. These two costs are, therefore, combined in this example and called conversion (costs).
Pct complete examples
For example, a particular product might have all its materials added immediately when it enters a department. The labor and overhead, however, might be added at a slower pace as those materials are assembled, mixed, machined, or whatever… In this case, the percentage (Pct) complete might be high for DM, but low for conversion.
Conversely, the most costly direct materials might be added during the last operation in a department. Since a lot of conversion costs have been applied, but the most expensive DM are not added until the end, the Pct complete might be high for conversion, but low for DM.
Hopefully, that makes sense. Reread it if you need to.
It all depends on the product being produced and the nature of the value-added in a given department.
Beginning WIP units
You’ll notice that Beginning WIP units aren’t factored into the unit reconciliation calculation for the weighted-average method. With the weighted-average method, Beginning WIP is considered to be started & completed in the current month.
No matter if last month’s Ending WIP units were 99% complete for DM and conversion costs. This month, Beginning WIP units are considered 0% complete. Under the weighted-average method, that is.
With the FIFO method, Beginning WIP units are included in Total units reconciled. Specifically, the equivalent units that weren’t included in last month’s calculation. For example, suppose last month’s Ending WIP units were considered 30% complete. Then, this month 70% of the Beginning WIP units will be used in the Total units reconciled calculation this month.
In fact, if you change the Pct complete for DM and conversion to 0% for the FIFO method, you’ll see that the Total units reconciled are the exact same amount for both methods.
DIFFERENCE 1: THE WEIGHTED-AVERAGE METHOD CONSIDERS BEGINNING WIP TO BE 0% COMPLETE. THE FIFO METHOD DOES NOT.
Completed & transferred vs started & completed
This subtle difference in verbiage makes a big difference in calculations between the weighted average and FIFO methods.
As mentioned above, Beginning WIP is always considered to be 0% complete with the weighted-average method. Ending equivalent units are added to Units completed & transferred to determine the Total units reconciled with the weighted-average method.
With the FIFO method, that is not the case. Since Beginning WIP units are already considered partially complete, Units started & completed are quantified separately. As the title implies – these are units that were both started and finished in a given month.
Total units reconciled
The weighted-average method adds the Ending WIPequivalent units to the Units completed & transferred to arrive a quantity for units reconciled.
The FIFO method does something similar. Ending WIP equivalent units are added to Units started & completed. Beginning WIPequivalent units (1 – Pct complete) are then also added to that quantity.
Cost per equivalent unit
Unit reconciliation only focuses on units. No costs were considered. Now, it’s time to tally costs for the month and to calculate a Cost per equivalent unit.
Cost per equivalent unit = costs to be allocated ÷ Total units reconciled
Comparing total costs between months, years, or even days doesn’t give you the whole picture. In order to have the whole picture, total costs must be compared using some sort of common denominator.
Hence the need to break costs down on an equivalent unit basis. Equivalent units take into consideration how many units were started, completed, transferred, and left in WIP at the end of the month. Every unit and every dollar is accounted for. So that accurate comparisons can be made.
Total costs to be allocated with the weighted-average method includes the value of Beginning WIP + Monthly expenses incurred. So, since Beginning WIP units were considered 0% complete and added to the Total units reconciled, the Beginning WIP amount (last month’s Ending WIP amount) is also included in the numerator to offset these units.
DIFFERENCE 2: THE WEIGHTED-AVERAGE METHOD ALLOCATES THE VALUE OF BEGINNING (LAST MONTH’S ENDING) WIP. THE FIFO METHOD ONLY ALLOCATES EXPENSES INCURRED THIS MONTH.
Total costs to be allocated under the FIFO method only includes the Monthly expenses incurred. Only costs from this month are used to calculate Cost per equivalent unit. Because, unlike the weighted-average method, only units from this month are reconciled.
Because the weighted-average method includes the value of Beginning WIP and the FIFO method does not, the weighted-average method will always have higher Total costs to be allocated. Whether that translates into a higher Cost per equivalent unit depends on the Beginning WIP units and the Units started & completed.
Cost allocation
Whereas the Total costs to be allocated include costs that the company started the month with (weighted-average method) and those that were added. The Total cost allocation includes costs that were passed to the next department (or finished goods) and those that the company ended the month with.
The Total costs to be allocated should always equal the Total cost allocation. Costs can’t just disappear into thin air.
In the weighted-average method, the equation balances as follows:
In the FIFO method, the equation balances as follows:
Monthly expenses = Amount to complete beginning WIP + Amount started and completed + Ending WIP amount
Weighted-average or FIFO for process costing?
Conventional wisdom says that the weighted average method is simpler than the FIFO method. I suppose this is said because Amount to complete beginning WIP need not be calculated for the weighted-average method.
But, since you will be determining the Pct complete for DM and conversion costs for Ending WIP units (which will become your quantities for next month’s Beginning WIP units) it shouldn’t matter. The calculation is already made.
Better to go with the method that produces a more accurate Cost per equivalent unit. Rather than one that blurs the lines between what was done last month and what was done this month. Particularly if you are in a super-competitive environment where accurate costs are needed to price appropriately.
Yes, I know that the Spreadsheets for Business Process Costing example workbook uses the weighted-average method. Confession: it wasn’t until I wrote this post that I really explored the difference between the two methods. If it ever makes sense to redo the process costing example workbook, I will use the FIFO method.
What do you think? Are there any circumstances where the weighted-average method makes more sense?
Is there something I missed? Or, do you have any questions?
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Categorize and list detailed expenses
Forecast revenue needed to cover expenses
Review the pro forma income statement and ratios
Plan for the best and worst-case scenarios
Download the church operating budget template
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Operating budget example for small churches, big churches, and every church in between
This is the second post on church budgeting and the fifth overall on church strategic planning.
Previously, the capital budget for the church was covered in depth. This post will focus on the operating budget. The capital budget, if you’ll remember, is the budget that the church completes for every potential project it plans to take on in the coming year. The operating budget consists of a forecast of revenue and expenses for the coming year. The culmination of the operating budget is a pro forma (or expected) income statement.
After completion of the capital budget and the operating budget, the church will be ready to tackle the financial budget. The financial budget will be covered in the next post.
What is an operating budget for a church?
An operating budget allows a church to be proactive regarding its revenues and expenses for the coming year. It allows the church to plan accordingly and to be ready for any scenario that might come its way. Doing so will allow the church to better meet its mission.
Information gleaned from the mission statement, SWOT analysis, strategy formulation, and capital budgeting will all play a part in preparing the Operating Budget for the coming year.
Creating an operating budget can be as simplistic as writing down a guess about how much revenue the church will make in the coming year and the number of expenses it will incur. This is better than nothing.
Dedicating some thought to each revenue source and each type of expense, plus estimating how they might rise or fall over the course of the year helps to paint a more accurate picture of the church’s financial position. Additionally, using the Spreadsheets for Business church operating budget template will give you the ability to not only estimate what the most likely scenario to play out next year will be, but will also help you to plan around a best case scenario and a worst case scenario.
Download the template by filling out the form at the top of the post.
How much time and effort should be dedicated to a church operating budget?
Any amount of planning is better than no planning. There is, however, such a thing as over-planning – AKA, paralysis by analysis. The sweet spot is somewhere in the middle – enough planning for you to feel confident that your church is in a position to thrive in the coming year.
The amount of thought you dedicate to each item in this church operating budget example is up to you. I urge you not to overthink it. However, after going through the following steps, I think you’ll find yourself rather confident about your church’s future going into the new year. With some of the worry off your plate, you can focus on other areas that will help your church achieve its mission.
How might an operating budget for a church differ from a for-profit business?
Fortunately, creating an operating budget for a church is much less complicated than for, say, a manufacturing company.
When creating an operating budget for a manufacturing company, you start with revenue and work your way through budgets for materials, labor, overhead, production, and a lot of other inputs.
When creating an operating budget for a church (which is essentially a service) some of that complication can be avoided.
Should you start with budgeting for revenue or expenses?
Personally (and maybe this is due to my background in budgeting for manufacturing organizations), I still think it’s smart to start budgeting with revenue. That way, you know how much you expect to make in the coming year and can plan your expenses around that information.
However, there’s also a school of thought, particularly by Aubrey Malphurs and his organization, that claims you should plan your expenses first. Then, you know how much you need to bring in to cover those expenses. Aubrey is much more of an expert on church operations than I am, admittedly. I can see the rationale behind this school of thought.
You should start with whichever you’re more comfortable with – expenses or revenue. I imagine as you get deeper into the process of forecasting, that you’ll be bouncing back and forth between the two anyway. So, ultimately, what you start with won’t matter. Unlike a manufacturing company, the levels of your revenue and expenses won’t necessarily affect each other. All that matters is what you end up with.
Look, your budgets are never going to be exactly right. That’s fine. What’s not fine is going into the coming year with a church that is at risk because you haven’t dedicated adequate thought to what the coming year may bring.
An operating budget won’t guarantee that your church will be successful. That’s why you shouldn’t spend every waking second working on it. It’s just a matter of giving appropriate thought to the matters of revenue and expenses.
The Pareto Principle states that 80% of outputs come from 20% of inputs. If you buy into this – 80% (or so) of the benefits of creating an operating budget for your church will probably come from the first 20% of the time that you spend on it. What this means, of course, is that by merely dedicating a tiny bit of thought to these matters, your church will reap big benefits.
How to create an operating budget for your church
Operating budgets look complicated, but at their core, they’re fairly simple. All you’re going to be doing is estimating your expenses, estimating revenues, and then filling in a couple of other details. There are no wrong answers. As a steward for your church, you’re in a better position to answer these questions than anybody else on Earth.
Let’s get started!
Your church’s expenses
Obviously, your church has costs that it incurs to provide needed support to its membership. Again, I have to give credit to Aubrey Malphurs for the framework of how expenses are grouped together.
Expenses are grouped into four broad categories: evangelism/missions, personnel, ministries, and facilities.
Within each broad category, each Expense is broken down into more specific categories and beyond that, into greater Detail.
So, depending on how organized your accounting is, you should be able to (hopefully) begin by breaking your existing expenses down into these four broad categories. Once you’ve done that, then you can begin to group similar expenses by subcategories. Then eventually, of course, you want to budget for every detailed expense.
Classifying expenses as fixed or variable
Along with every Expense in a subcategory, you’re going to classify it as fixed or variable. This sounds like a pain in the rear, but it’s good to understand the nature of each cost.
Fixed expenses, as the name implies, don’t change with revenue. They’re going to be the same whether you have a very busy year or a year where you just sit around twiddling your thumbs. For example, salaries are fixed and insurance is fixed. Any other expense which will be the same month after month, over the course of the year, is fixed.
Variable expenses, on the other hand, change. They typically change based on the level of revenue. If revenue goes up, variable expenses also go up. If revenue goes down, variable expenses would probably go down. For example, expenses related to outreach and local mission work might depend, in large part, on the amount of revenue received. So they can probably safely be classified as variable.
There’s no right or wrong answer when it comes to classifying your costs as Fixed/Variable. Some will be obvious, while others…not so much. Again, don’t dwell too much on this classification. Give it a little thought and select what you think is appropriate. The only real effect is on some of the ratios that are calculated once the budget is completed. You can always go back and change your classification.
Use the past to plan for the future
You can refer back to historical amounts, of course, to help with the forecasting of future expenses. In fact, that’s probably a very smart thing to do. Looking back at historical amounts paid will also help you to determine if an expense is fixed or variable.
If this is your first time completing an operating budget such as this, then I would suggest that you still break each expense down into broad categories (evangelism/missions, personnel, etc.). But, maybe don’t break them down into too many subcategories (district & synod support, convention assessment, etc.). And, definitely don’t overdo it breaking expenses down into detailed categories (detail expense 1, detail expense 2, etc.). You can always go into more detail next year.
On each of the broad category budget worksheets, you’re going to start at the top and list each Expense subcategory. Also, pick either Fixed or Variable from the drop-down menu.
In the bottom section – this is where you’ll break the subcategories down into detailed expenses. All of the detailed expenses will sum for the month and that amount will be carried back to the top
Let’s look a little deeper into each broad category.
Evangelism/Missions Budget
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The Evangelism/Missions Budget is where you’ll classify expenses related to efforts directed externally from the church to reach individuals who likely aren’t members.
Next, go to the detail section and itemize the subcategory expenses. Additionally, start forecasting month by month for the whole year. Each subcategory will automatically add all the detailed expenses.
You’ll see that a Total for each month and for whole the year is calculated. These amounts will carry over into other worksheets.
Personnel Budget
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The Personnel Budget is pretty self-explanatory. This is the money planned to be spent on the individuals who help run your church.
Expenses such as salaries, fringes, utilities for housing, and guest pastors/speakers would be entered here.
Ministries Budget
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The Ministries Budget is where you will enter expenses directed toward the individuals that are already a member of your church.
You know the drill by now – enter the appropriate subcategories and then the names and amounts for the detailed expenses.
Facilities Budget
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The last category of expenses is also pretty self-explanatory. A Facilities Budget includes those expenses that are required for your church, as a whole, to function.
How do you differentiate if expenses are for personnel or facilities? Easy, if the expense is, more or less, for one employees’ benefit then it’s probably a personnel expense. Conversely, if an expense is for everybody’s benefit then it’s probably a facilities expense.
As mentioned before, this is all somewhat subjective. There are no right or wrong answers, per se. Trust your gut, trust your experience, and classify expenses in whatever way makes the most sense to you.
If you’ve been following along closely, you’ll notice a special expense listed under the maint and repairs subcategory.
In the capital budget, we examined the feasibility of adding on to the church’s parking lot. Ultimately, based on the expected cash inflows and cash outflows, it was determined that making an addition to the parking lot was in the church’s best interest. So, in our hypothetical church, that project will be undertaken and will need to be included in the coming years’ operating budget. You’ll see detailed expenses related to the parking lot under the maint and repairs subcategory and the depreciation subcategory.
Don’t solely rely on what you spent in the past to create a feasible budget going forward into the future. Make a note of anything that might change and of any new expenses that might be incurred in the coming year due to projects approved in the capital budgeting phase.
How much revenue will you need to cover those expenses?
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Estimating expenses is a bit depressing. But now we get to tackle the fun part, and that is estimating revenue.
Revenue also has subcategories, but they are not broken down into detail.
By now, you know the routine. In the Revenue Budget, enter the start date for your budget in the cell D9.
You’ll see that the Revenue Source column is already populated but you’re welcome to change the descriptions as you see fit.
For each month and each Revenue Source, enter the forecasted amount of revenue. A Total for the months and for each Revenue Source will automatically be calculated.
Maybe you’re baffled as to how to forecast revenue. Offerings and donations are probably at least somewhat consistent. But, other sources of revenue like facilities use charges and trusts, investments and bequests are difficult, if not nearly impossible, to accurately predict.
First of all, I’ll say the same thing I did when it came to forecasting expenses, and that’s to just come to terms with being wrong in the first place. The value in this, again, is to dedicate a little bit of thought to it.
Spreadsheets for Business has a free tool that can help you forecast revenue (or expenses, or anything really…) accurately and it can also help you gain insights into what drives revenue.
Once the information is entered into the Revenue Budget, then you are very nearly done with the operating budget.
The church’s Pro Forma (expected) income statement
After completing all of the expense budgets and the Revenue Budget, you should see a nearly completed Pro Forma Income Statement. All that’s left to enter is information about interest.
If your church keeps funds in an account that pays a reasonable amount of interest, enter what you might expect to earn this year in the Interest Income field.
On the other side of the coin, if your church borrows money, then you will likely have Interest Expense over the course of the year. That amount in the Interest Expense field should be added as a negative amount.
Now you should have a pretty reasonable idea of what the coming year will look like from a revenue and expense standpoint. Notice that each of your expense categories has the amount as a percentage of Total revenue listed next to it. This gives you an idea of how your expenses are weighted.
For reference, Aubrey Malphurs recommends the following weightings:
Evangelism/Missions 10%
Personnel 40%
Ministries 25%
Facilities 25%
Obviously, your church doesn’t have to have this exact percentage for each expense category. But it simply gives you a benchmark to measure your church against.
All the calculations in the Pro Forma Income Statement are pretty straightforward. Operating Profit is Total Revenue –Total Expenses.Net Profit is what’s left after Interest Income and InterestExpense are accounted for.
Ratios and chart
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Now we’ll look at some very basic ratios to put the Operating Budget into perspective. These ratios were designed for, and are primarily used by, for-profit businesses. But even though a church operates differently than a for-profit business – especially a manufacturing company – they still might provide a little insight and perspective for the church leaders to use in decision making.
Profit margin
Profit Margin is pretty straightforward. It’s just Net Profit ÷ Total revenue. It shows you, in percentage terms, how much revenue you bring down to the bottom line.
Times interest earned
Times Interest Earned is a ratio that focuses on your ability to cover your interest payments.
Obviously, if an organization borrows money it needs to be able to meet the additional obligations placed upon them. So Times Interest Earned shows you, by taking Operating Profit ÷ Interest Expense, how many times over your church can cover its Interest Expense.
Degree of financial leverage
The Degree of Financial Leverage shows the amplification that borrowing money can provide to profits and losses. So, for instance, in the example operating budget, the Degree of Financial Leverage is 1.4. This means, at this level of borrowing, that for every 10% change in Operating Profit, Net profit would increase by 14% (10% × 1.4).
That sounds great, but the opposite is also true. If Operating Profit declined by 10%, then this level of borrowing would cause Net profit to decrease by 14%. That’s the nature of leverage. It amplifies gains and losses.
Most people can pretty easily grasp the nature of financial leverage.
If you borrow money and get to keep the gains from the borrowed money, then financial leverage is great. If you borrow money and your investment loses value, then you not only have the loss to deal with but you also still owe for the money you borrowed.
Degree of operating leverage
What’s not so easy to grasp is the benefits and detriments of other fixed costs, besides interest payments. The Degree of Operating Leverage quantifies the benefits and detriments of incurring fixed costs.
Why are fixed costs so important? Well for lack of a better answer – because they’re fixed. You are going to pay them anyway. So, if fixed costs really help you ramp up your operating profit, then that’s great. Because fixed costs aren’t going to increase on you.
The inverse is also true. Since fixed costs don’t change, you still have to pay them even if they are dragging operating profit down.
The Degree of Operating Leverage tells the same story as the Degree of Financial Leverage in the sense that it tells you how much greater Operating profit (not Net profit per se) would have been in the absence of fixed costs. This ratio really starts to get into detailed management accounting. That amount of detail is probably beyond the scope of this post, but since it’s included in the Executive Summary, I wanted to touch on it briefly.
In the example workbook, the Degree of Operating Leverage Is 10.2. This means then that a 10% increase in Total revenue, everything else being equal, would translate to a 102% increase in Operating Profit. Obviously, you know what that means if Total revenue went the other direction. It means that a 10.2% decrease would put Operating Profit in the red.
More about degrees of leverage
There is no good or bad Degree of Financial Leverage or Degree of Operating Leverage. It’s simply a reflection of the way your costs and borrowing affect your income statement. Leverage is great if Total revenue and Operating Profit are increasing. Leverage is bad if the outlook for the coming year is bad. So if your leverage is high and you’ve got concerns about your ability to bring in revenue for the coming year – then you’d better start looking to reduce fixed expenses and Interest Expenses.
Finally, at the bottom of the Executive Summary, you’ll see a handy chart that will illustrate the level of revenue and expenses (broken down by broad category) for every month in the upcoming year. This allows you to visualize how all these factors, which affect the financial health of your church, are expected to fluctuate throughout the year.
Plan for every scenario your church might face
Say that creating a simplistic operating budget is working at level 1 out of 10. Completing the Spreadsheets for Business operating budget template takes you up to 7 out of 10. This next section is what will push your church up to a 10 out of 10.
On the Likely-Best-Worst Scenario worksheet, you’ll see all the information pulled in from your Pro Forma Income Statement and the subsequent ratios under the Most Likely Amount column. But, what you will have the opportunity to do here, is to imagine multiple scenarios – some good, some bad. You’ll get to picture what your Pro Forma Income Statement will look like in the best-case scenario and the worst-case scenario.
Better or worse than expected revenue and expenses
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To use this valuable worksheet, all you need to do is start with a multiplier for the best case and worst case. Obviously, the best case for revenue is going to be a positive percentage, and for expenses, a negative percentage.
On the other hand, of course, the worst case for revenues is going to be a negative percentage, and for expenses, a positive percentage. Here, you are going to have the opportunity to play around with positive and negative future outcomes, and see what feels right in terms of multipliers for revenue and expenses.
But beyond simply entering a Best Case Multiplier and a Worst Case Multiplier for revenue and expenses, you can also refine the scenarios even further. You do this by entering specific amounts in the Best Case Override Amount and Worst Case Override Amount.
What are override amounts?
It means that you can tweak the dollar amounts for revenue and expenses even further. For instance, maybe you hope that your church might be blessed with an extraordinarily high amount of revenue from trusts, investments or bequests. You can thus enter a specific amount in the Best Case Override Amount for whatever would constitute the “best case” for your church.
On the flip side, say you know that, potentially, the worst case scenario for facilities expenses is that you need to replace the church HVAC system. So, you enter an adjusted amount in the Worst Case Override Amount for facilities that reflects this added expense.
You can also tweak the override amounts for Interest Income and Interest Expense.
At the very bottom, you’ll see the effect on the ratios from the Executive Summary based on what you entered for the Best Case and Worst Case Multipliers and Override Amounts.
There’s an old saying that goes, “hope for the best, but plan for the worst”. With this scenario planner, you’re able to do just that. You’re able to protect your church from contingencies while being prepared to act accordingly if the coming year is full of blessings.
Church operating budget
Maybe all of this seems overwhelming. That’s understandable if you’re not accustomed to planning with this level of detail. Again, I urge you (as the creator of this “overwhelming” budgeting template) to not overthink it.
What I do urge you to do however is to download the template at the top of the post – and to boldly use it.
Go over it once, quickly filling in the information you have handy, then walk away from it. After that, come back to it, look at it, reflect on what you’ve already entered and make any changes you feel are necessary. Then walk away from it again.
This is (for lack of a less cliched term) “a living document”. It is designed to take the relatively simplistic information of your forecasted revenue and expenses and to do the hard work of providing valuable output. That will allow you to be proactive for the coming year and give you confidence as a leader of the church. It can help your church not only stay financially solvent but also fulfill its mission and achieve its goals.
What other (sub) categories of revenue and expenses would you include?
What percentages and amounts would your church enter to prepare for worst and best-case scenarios?
A church capital budget helps you assign values to projects and prioritize which projects should move forward
The costs of assets, expected benefits (revenue), and ongoing cost (savings) help determine the viability of a project.
Net present value (NPV) and the profitability index (PI) are the primary outputs of church capital budgeting. Other outputs can help paint a picture of project desirability too.
Church capital budget explained
Now we’re getting into my wheelhouse.
Like I said before, I don’t pertain to be the greatest guru of the soft skills (mission statement, SWOT analysis, strategy formulation) covered previously. But now…now we’re breaking out the spreadsheets, and I can promise you that I can help you solves some problems when it comes to finances.
Church capital budget template download
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What is a church capital budget?
You might not know what capital budgeting is. That’s fine. When the average person hears the word “budget” they think of what money comes in during the month (sales, income, contributions) and what money goes out that same month(expenses). That’s an operational budget and we’ll cover that in a little bit.
Capital budgeting is the process by which an organization chooses which long-term projects to invest in. In a business setting things such as the time value of money, depreciation, and taxes are taken into consideration.
Capital budgeting for churches vs for-profit businesses
When conducting capital budgeting for business, projects are typically ranked based on their forecasted profitability. The projects that are thought to be the most lucrative are usually prioritized.
However, since churches are nonprofit, we’re going to have to attack this from a slightly different angle. Some projects might bring in more members and therefore more money. Other projects might help to achieve the church’s mission, but not bring in a dime. If that’s the case, we’ll have to consider other types of value besides cash money.
Capital budgeting is designed for for-profit organizations. However, with a little creativity, we should be able to tweak the process so that your church can use this powerful tool too.
You’ll be able to quantify what you foresee the expected returns to be on the big projects you want to undertake. You’ll be able to rank projects and choose how you employ your scarce resources. Best of all, you’ll be able to make wise decisions that will lead you closer to achieving your mission.
How to create a church capital budget
Big goals sometimes require big projects
Taking into consideration all of the previous steps you’ve completed in the strategic planning process (mission statement, SWOT analysis, and strategy formulation), think about what large-scale projects will need to be undertaken in light of your future plans.
Some things have probably already come to mind. Don’t systematically dismiss a particular project just because it seems infeasible. The point of the capital budgeting process is to make it obvious what projects you should pursue. So, all you’re sacrificing by running a project through this process is a bit of time.
Ultimately, you’ll want to select your projects and move on, so you can’t let this step drag on forever. But, if a project potentially plays an important part in your strategy or would help you achieve your mission, then, by all means, give it its time in the sun and then decide if it’s feasible or not.
With a list-in-hand of the projects you want to explore, let’s move on to crunching numbers.
By the way – all of the numbers you input into this workbook can be changed. So don’t overthink/over stress about any of this!
What church project will we be using as an example?
For the example used in the screenshots, we’ll keep it simple. The project will be a parking lot addition.
Our hypothetical church is seeing that membership has outgrown its existing parking resources. Many members are forced to park on the street during service. Additionally, the church leaders hope to keep the recent rate of growth up and they want to provide their members with plenty of room to park.
In light of this, they have decided to use some of their undeveloped land to add an additional 52 parking spaces.
Disposing of assets – is something being replaced?
If you’re replacing an old asset with a new one then you’ll have to input some information about the old asset. Why? Because even though an asset is being replaced, cash flow in the present and future can be affected. It’s cash flow that gives us your net present value (NPV) and NPV is how you (mostly) prioritize new projects.
*If this is starting to get too technical for your taste – hang in there. These terms will be explained in a simplified manner. Leave a comment if you have any questions.
Fortunately, for a church, the only thing we need to know about the old asset is what it can be sold for today. Since churches don’t pay taxes, none of the other information matters. Not even the original cost. Why? Because it’s a sunk cost.
So, if the old asset can be sold for cash, enter a value in the Current market value of old asset(s) field.
Disposing of assets – church parking lot
In our example, something new is being created. There’s nothing old to dispose of. Even if we were replacing an existing parking lot – old parking lots don’t have much value to anyone else.
So, in this example, the Current market value of old asset(s) is $0.
If, when you’re analyzing your church’s capital projects, you have an existing asset that might be worth something – enter the market value here. Whatever you can sell the old asset for will help offset the cost of the new asset. This will help increase NPV.
What is a sunk cost?
Sunk costs can be tough for people to grasp and even tougher to act upon.
A sunk cost is one that’s already been incurred and should have no bearing on future decision making. Meaning – the cash has left your hands and there’s nothing can be done about that anymore.
That’s not always how people feel emotionally, but from a strictly logical standpoint – it’s true. Money spent in the past is already gone. It cannot be unspent. Only cash flows in the present and future matter.
So, if you find yourself making decisions (in your personal life or on your church’s behalf) based on the money you’ve spent in the past – you need to stop and check yourself. Realize that nothing you do now can fix those mistakes. Base your decisions on what you can control now and in the future.
Initial cash outlay
First and foremost, what’s the new asset going to cost?
Include every expense that will need to be incurred to get this asset into service. Taxes, fees, shipping, labor…everything. These extra costs can add up and can significantly affect your decision making, so be sure to include them all.
Enter the grand total into the Cost of new asset(s) field.
Initial cash outlay – church parking lot
In our example, we’re estimating the total costs to be $208,000.
This will be enough to cover not only the parking lot itself but the design and ancillary costs too.
What will the salvage value of that new asset be?
Thinking about what your brand new asset might be worth when you’re done with it might seem silly. It’s so far in the future – and so hard to guess at, why bother?
Well, it is far into the future and you really can’t know what it’ll be worth. But, it will matter. Especially if it’s a higher-cost asset. Even if it will have no value in and of itself, will the scrap be worth something? Will your church be able to get anything out of this asset when it’s reached the end of its useful life?
You’re not going to be exactly right about what it’ll be worth, and that’s fine. Here’s a little trick to get you in the ballpark – start out with a number that’s absurdly high. Then, come up with a number that’s absurdly low. Start working your way back from the high number and up from the low number. When you feel like you’ve reached something feasible – go with it.
If you can’t settle on one good number then average the two numbers out if you need to. Just make sure you’re comfortable with the number when you’re done. It’s always best to be more conservative with forecasting than liberal. This gives you a margin of safety.
Once you’ve got your number, enter into the Salvage value of new asset(s) field.
Salvage value – church parking lot
Again, parking lots aren’t really worth anything to anybody else. So, unfortunately, we’ll have to enter a salvage value of $0.
What is the new asset’s useful life?
An asset actually has two different life spans. A depreciable lifespan and a useful lifespan.
What’s the difference?
An asset’s depreciable lifespan is the number of years an asset will take to be “written off.” Depreciation is a concept created by accountants. What it does is spread the cost of an asset over many years rather than having it hit only one year.
For example, say a company bought an asset for $50,000 with a depreciable life of 10 years. Rather than having that expense hit the year of the purchase, they would charge $5,000 to their income statement for the next ten years. The cost is spread out – not swallowed all at once.
Confused? No worries. Since you’re doing capital budgeting for a church, and aren’t subject to income taxes, you don’t have to worry about depreciable life (at least as far as the capital budget is concerned).
Okay…what about useful life? Well, depreciable life is for accounting in income statements. It’s roughly accurate but doesn’t really have any correlation to how long an asset can really be used. An asset’s useful life might be shorter or much longer than its depreciable life.
It can be hard to say how long an asset might really be useful. But, you have to put forward your best guess. I usually recommend that forecasts err on the conservative side.
Since a longer useful life will mean a higher value, I suggest you enter a value in the Useful life of new asset(s) in years that is on the low side. Start at 1 year (if an asset has a useful life of less than a year, it probably doesn’t belong in the capital budget) and work your way up. Once you hit a number that isn’t on the absurdly low side, you’re probably pretty close to a nice and conservative estimate.
Useful life – church parking lot
A quick Google search reveals that the expected useful life of a paved parking lot is 10-15 years. Since our example church wants to get the most out of its investment, we’ll enter a useful life of 15 years. This will require a commitment to proper maintenance and will cause the church to incur additional costs – which we’ll address later.
How much of a return does your church want on its capital projects?
Time, money, and other resources are limited. Not just for you and your church, but for everyone.
In order for a project to “make sense,” it has to eclipse a minimum acceptable rate of return.
For instance – if your church was presented with the “opportunity” to invest $1,000 and you were promised $1,050 in ten years, you would probably pass. Why? Because it’s just not worth it to tie up that $1,000 for a decade and to only receive 5% (about .5% per year) back for doing so. That money could be used for something more worthwhile now.
So, you might not know exactly what your hurdle rate (minimally acceptable rate of return) is, but you probably know it’s more than .5%.
If your church borrows money, keep in mind what you’re interest rate is – you’ll want your hurdle rate to be at least that much. Otherwise, you’re not getting a good return on investment on that borrowed money.
Other than that, I can’t say what your hurdle rate should be. This is a very subjective thing. Every church will be different.
I would recommend that you undertake the same exercise I suggested for determining the useful life of the asset – start at 1% and work your way up. Once you say “okay, I suppose I could live with that return,” then you’re probably in the neighborhood of a practical hurdle rate.
If you want to be a little extra conservative (and I would recommend as much) then go ahead and tack on a little extra to your rate. For instance, if your hurdle rate is 5%, maybe up it to 5.5%. If it’s 8% consider increasing it to 8.8%.
This tiny increase puts just a little more pressure on your projects to perform better in order to be accepted.
When you’ve finally settled on a hurdle rate enter it into the Hurdle rate field.
Hurdle rate – church parking lot
The rule-of-thumb is – the riskier the project, the higher the hurdle rate.
A parking lot might not seem like a particularly risky project. But, as you’ll see, justifying its construction is contingent upon church membership continuing to increase. That might seem likely for our example church, but it’s no sure thing.
An 8% hurdle rate seemed reasonable under the circumstances. However, that was bumped up to 8.8% to provide a little more room for error on the part of the projected cash flows.
The most important part of a church capital budget – the forecasted cash flows
As I’ve mentioned before – investments are defined, ultimately, by three variables. Cash in, cash out, and time. Notice I said “cash.” Not sales, not promises, not receivables.
Cash.
This step involves all three variables. Cash flow out, cash flow in, and the timing of each.
Cash outflows
Most projects will incur more costs than those required up-front. Many times costs are necessary as a part of the ongoing project.
The types of costs can vary. Here are some ideas for ongoing costs that a church may incur as a result of undertaking a new project:
wages and fringes
maintenance
utilities
supplies
insurance
interest
leases
advertising
And on and on…
I cautioned you to not overthink any of these steps earlier, and I stand by that. However, make sure you think this part through thoroughly. Overlooking expenses and not including them in your church capital budget can make a project look more attractive then it actually is. You don’t want to be ten years into a project and realize that there were expenses you never accounted for.
Next, think about the timing of the expenses. Are they monthly, weekly, yearly, or erratic? The capital budgeting worksheet is set up to look at cash flows yearly; not monthly or weekly. So, if monthly or weekly cash flows are expected, you’ll have to multiply them by 12 or 52 respectively.
Finally, keep in mind that costs tend to rise over time. A capital budget forecasts many years into the future. What cost $100 today could cost $125 or more fifteen years from now. Be sure to account for inflation – which traditionally runs 1% to 3% per year.
The future cash flow worksheet
The Future CF Worksheet is a scratchpad you can use to itemize costs, revenue and cost savings. None of the information entered here will affect the rest of the workbook.
Use the Comments field to enter your own notes about the expected future cash flows. This is useful because you can refer back to this information if you ever have a “what was I thinking…” moment.
Once you feel you have a sound (conservative) forecast of the cash outflows, enter these amounts in the Additional costs column. Keep in mind that these values need to be entered as a negative number. Don’t worry about messing that up, though. The workbook has data validation rules that will prevent you from entering a positive number in this column.
The capital budgeting workbook is set up to only accept Additional costs for as many years as you said the asset would have a useful life. So, if you entered “15” as the Useful life of new asset(s) in years, you can enter 16 years worth of expenses, but Year 16 won’t be included in any of the calculations.
Cash outflows – church parking lot
More parking lot means more parking lot maintenance. For starters, I assumed that there would be additional costs for snow removal every year. This was estimated to be $450 in Year 01 and increase by 2% every year thereafter.
If this were a real church performing this capital budgeting, I would caution them to not enter their entire expected snow removal expense here. The costs tied to the existing parking doesn’t matter in this analysis. They’re going to pay that anyway. Only expenses (and revenues and savings) tied to this project should be considered.
Parking lots also need to be restriped to keep them looking good and resealed to keep them from deteriorating.
Restriping was estimated to take place every three years starting in Year 03. This cost was also expected to grow at 2% annually, or 6.1% every three years.
Resealing was expected to take place every three years starting in Year 04. The cost was expected to be $2,850 at that time and then, you guessed it… increase at a 2% annual rate.
Okay, we got the negative cash flows (the costs) out of the way, let’s move on to the cash inflows.
