i.2.2 Decision #2 – What is the right source of financing?
Once the public agency has developed a CIP listing essential capital projects, it must determine how to finance them in the CIB. Paying for a capital improvement as the financial resources are available is called “pay-as-you-go” funding (PAYGO). If the agency lacks the financial resources to use this approach it may consider borrowing the funds needed to construct the capital improvement and repay those funds over time. This is called “pay-as-you-use” funding, or debt financing.8
The decision to use PAYGO or debt financing is a function of many factors including those described below.
- How quickly is the project or facility needed?
The construction or acquisition timeline is essential in deciding whether to use PAYGO or debt. If the facility is needed immediately and the agency lacks sufficient resources to construct or acquire it, debt is the most reasonable alternative. Some projects may be driven by legal or regulatory mandates or court judgements; these are likely to move sooner than other discretionary projects.
- Will the public agency have enough funds on hand when it needs them to pay for a capital improvement on a PAYGO basis?
Is paying for a capital improvement on a PAYGO basis feasible? The public agency must consider when it will need funds to construct or acquire the capital improvement as set forth in the CIP and whether the needed funds will be available at that time. Special care should be taken to avoid unrealistic assumption about growth in revenue and interest earnings.
- Does the public agency have access to the capital markets to fund a capital improvement using debt?
In order to pay for a capital improvement using debt, an agency must be able to raise sufficient money from investors to pay for the capital asset and provide reasonable assurances to these investors that the debt will be repaid as promised.9 This typically depends on sound financial operations and effective reporting.
- Does the public agency have enough ongoing funding to pay debt service without jeopardizing services?
In order to pay for a capital improvement using debt, an agency must provide reasonable assurances to investors that borrowed money can be repaid as promised. Similarly, the agency must assure its stakeholders that it can continue to deliver promised services and still allocate necessary resources to debt repayment in the foreseeable future, even during economic downturns.
- Given the nature of the asset, will available funding cover the total cost of ownership?
Every capital improvement has a life cycle cost. This is better understood as the “total cost of ownership,” which includes periodic costs such as maintenance, major renovation, or replacement of component parts of the financed improvement during the life of the asset, especially during the term of the indebtedness. If the agency is using most of its available funding to repay the debt used to finance a capital improvement, there is a risk that the agency will be unable to maintain or operate the improvement over time.
- Does funding for the project pose any intergenerational equity implications?
Intergenerational equity attempts to align the useful life of the capital improvement with the period during which those benefiting from the improvement are paying for it. How much should one generation pay for public services and facilities as opposed to future generations?