The Capital Improvement Ratio (CIR)

As the higher education industry absorbed the impact of SFAS 93, followed by 115 and 116, many balked at the funding of depreciation expense. Prior to those landmark pronouncements, various “funds” were deployed to capture activity within the capital spending and financing arenas. It was common to call the payment of principal on debt and capital spending “expenditures” and write them off as if they were annual expenses. That was twenty years ago.

I think we all see the value today in an expense called “depreciation”, designed to match the using up of assets over the years they provide service to the institution. We also tend to be believers in the idea of investing for capital purposes within a budget that is separate from operations. And, a reasonable pay-down of debt over time is critical for an institution that is attempting to improve its financial health.

In light of this, I created the Capital Improvement Ratio or “CIR”. The goal is to demonstrate the stewardship of the institution in its renewal efforts. The emphasis is on how much in operating cash is invested on a net basis in capital improvement each year. Here is the breakdown of the CIR:

+ Net Capital Spending (new fixed assets minus retirement and sales of fixed assets)
– (Change in Long-Term Debt)
= Net Capital Improvement (A)

(A) / Depreciation Expense = Capital Improvement Ratio

Ideally, the CIR is 1.2 or greater, recognizing that replacing depreciating assets typically requires current dollar spending in excess of what was spent when the retiring asset was new.

Note that a year when long term debt increases and capital investments are minimal (a refinancing perhaps) can yield a negative CIR. Also, if a bunch is borrowed in anticipation of a capital spend, it can skew the process. In that case, you may want to offset the change in LTD by whatever is in an escrow fund awaiting spending on a project.

Give it a try and tell me how it works (or doesn’t) for you.