PUBLIC SECTOR FINANCIAL MANAGEMENT: PART 5: BUDGET MODULE: INTRODUCTION

Andrew Graham School of Policy Studies

Queens University www.andrewbgraham.ca

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“ Every agency wants more money; the urge to survive and expand is

built in.” Aron Wildavsky

What is a Budget?

A Plan

A Limit

A Schedule

A Reality Check

An Allocation

Another definition

A budget process is a system of rules governing the decision-making that leads to a budget, from its formulation, through its legislative approval, to its execution.

Karl-Martin, Ehrhart, Roy Gardner, Jürgen von Hagen, and Claudia Keser Budget Processes: Theory and Experimental Evidence, November 2000

The Budget as an Instrument of Public Policy and Management • Planning Instrument • Political Instrument • Social Instrument • Economic Instrument •  Legal Instrument

Source: Jerome B. McKinney and Lawrence C. Howard, Public Administration: Balancing Power and Accountability (Oak park, IL: Moore Publishing, 1979)

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Budget

Can

Need Want

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Control Steps taken by management to

ensure that objectives are

attained.

Planning Developing objectives for

acquisition and use of resources.

A budget is a financial plan for achieving the financial and

operational goals of an organization. It expresses what is to be undertaken in the defined period and authorizes

the financial authorities needed.

What is a Public Sector Budget?

•  Result of intense planning process, short-term decisions, roles of the dice and political nuance

•  Budgets from Ministers of Finance, i.e. high level political documents not the sole source of program funding: •  Statutory funding •  Self-funded programs

•  Management budget sets limits, targets and authorities to get on with the work

•  Legal instrument to allow spending = Appropriations

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Budget Perspectives

•  Budget applies differently at different levels •  Government-level: broad, policy-driven, focus on change

and announcements, combines revenue with expenditure •  Department: will focus on overall results, generalized

allocation to program pockets, more detail •  Unit: budget is tightly defined, focus on inputs, highly

specific, focus on defining resources available

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Our focus is departmental and unit-based.

Budgeting in time Context Historic Information

Evaluating Performance

Controlling operations

Forecasting & Planning

Plus Effects of Outside Environment

Current Operating Data

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Budget Architecture

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Types of Budgets •  Operating Budget:

–  also called recurrent budget –  funds designated to continuing operations “Plan for the day-in and day-out operations of the organization.

It is generally prepared for one year.” •  Capital Budget:

–  budget for permanent works: defining permanent –  tends to combine current year and future year plans –  current year often transferred into Operating Budget “Plan for the acquisition of buildings and equipment that will be

used by the organization in one or more years beyond the year of acquisition.”

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Types of Operating Budgets Budget Type Characteristics General Use

Line Item Expenditures and revenues are related to commodities

Control

Performance Expenditures and revenues are related to workload

Management efficiency

Program/Results Based

Expenditures and revenues are related to public goals

Planning and Impact

Not mutually exclusive.

Types of operating budgets 15

•  Input Oriented : Expenditures related to inputs. • Control Line

• Goals/Unit Oriented • Activity Based: Expenditures related to workload. • Mix of Financial and Program Control

Responsibility Centre/Program

• Linked to Planning • Outputs/Outcome Orientation: Expenditures related to outputs. • Less Control-Oriented

Performance/Results-Based

• Adaptive • Market Oriented Flexible

Not mutually exclusive.

Line Item Operating Budget

•  Simplest form of budgeting •  Budget information organized according to types of expenses, expenditure

or cost categories •  Often detailed in object codes – little detail. •  Primary orientation is expenditure control and accountability: permits inter-

budget cost comparisons, creates common reference points •  Relatively easy to prepare •  Does not provide any information regarding activities and functions of a

program

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Line Item Operating Budget Example

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Budget of the Killaloe General Hospital for Fiscal Year 200X

Object Code Budget 100. Salaries 8,000,000 200. Supplies 2,000,000 300. Rentals 250,000 400. Professional Fees 750,000

Total 11,000,000

Line Item Budgeting Limitations: • Rigid, unable to cope with

•  rapidly changing priorities and circumstances •  creation of new government services

• Budget evaluation mechanism difficult without mechanism to link things to be bought with things to be done.

• New budgets based on previous budget with increments for price increases

• No evaluation of whether objectives are still met or cost-effective

Line Item Budgeting • Advantages: • Easy to make • Micro-level expense control • Where the rubber hits the road: this is the details that

bedevil • Reliance on past data

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Responsibility Centre/ Program Budget •  Distributes budget to internal units: Responsibility

Centre •  Program could involve several responsibility centres •  Important means of assigning resources to program

objectives, specific offices and specific locations •  Seldom see this on its own for operational purposes •  Usually in combination with a line item approach •  Designed to follow the money.

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A responsibility centre is part of the organization, such as a department or unit, for which a manager is assigned responsibility, usually with spending authority for the assigned budget as well as

responsibility for its proper use.

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Responsibility Center Budget - Example

Budget of the Killaloe General Hospital for Fiscal Year 200X Responsibility Centre Budget

01. Operating Room 4,000,000 02. Laboratory 1,000,000 03. Radiology 1,000,000 04. Patient Care 2,500,000 05. Outpatient Care 1,500,000 06. Administration 1,000,000 Total 11,000,000

Program Budget - Example

Bureau of Public Safety and Leisure Services FY 201x-1y

Program Program Element Amount

05 -Public Safety 0501-Fire Protection 3,500,000

0502 - Police 5,000,000

Subtotal 8,500,000

06 – Leisure Service 0601 – Parks 2,000,000

0602 – Library 1,000,000

Subtotal 3,000,000

Total 11,500,000

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Program and Line Item Budget - Example

Bureau of Public Safety and Leisure Services Detailed Budget Information FY 201x-201y

Program Program Element

Responsibility Centre

Line Expenditure

Amount

05- Public Safety

0501 – Fire Protection

050101- Central Office

Staffing 250,000

Supplies 500,000 050102 – Upper Level Station

Staffing 1,250,000

Supplies 150,000 050103 – River Street Station

Staffing 1,200,000

Supplies 150,000 Total 3,500,000

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Functional Budgets

•  Result of combining a line item (input) and program approach

•  Functional Budgets focus on the major functions performed by an organization.

•  Combine elements of Line-Item and Responsibility Centered budgets

•  This format is often used for external reporting •  Note the line item detail

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Functional Budgets - Example

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Budget of the Killaloe General Hospital for Fiscal Year 2015 RC 100.

Salaries 200.

Supplies 300.

Rentals 400.

Professional Fees

Total

01. Operating Room

3,250,000 250,000 50,000 450,000 4,000,000

02. Laboratory

550,000 350,000 25,000 75,000 1,000,000

03. Radiology 450,000 450,000 0 100,000 1,000,000

04. Patient Care

2,000,000 400,000 0 100,000 2,500,000

05. Outpatient Care

1,050,000 125,000 25,000 50,000 1,250,000

06. Admin 700,000 425,000 50,000 100,000 1,250,000 Total 8,000,00 2,000,000 150,000 850,000 11,000,00

Program Budgets/ Results-Based Budgets

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• Budgets meant to link funding to expected results

• Program formulation and resources justification involve a set of predefined objectives, expected results, outputs, inputs and performance indicators which constitute a logic framework

• Performance in achieving results is measured by predefined performance indicators.

Performance Budget – small and unpretentious Example

Road Maintenance Budget FY 2016-2017

Activity Cost Formula Amount

Paving Roads Miles to be paved: 10 Cost per mile: $400K

4,000,000

Resurfacing Roads Miles: 5 Cost per mile: $150K

750,00

Total Road Maintenance Costs

4,750,000

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Performance budgets/results based budgets

• Strengths: •  Budget based on outputs •  Emphasis on performance and results •  Greater autonomy and flexibility meant to follow •  Greater accountability and reporting •  Departments more aware of outputs and cost of producing outputs •  Puts decisions on deployment of resources in the hands of people

at operations

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Performance budgets/results based budgets • Shortcomings:

•  No clear link to desired outcomes – the attribution issue •  Lack of focus on key internal processes •  Generally poor costing of inputs to results – the path is not clear •  With tighter fiscal position, need for greater emphasis on inter-

ministry allocations •  Diminishes need for cost control and basic probity.

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Flexible budget

■  Organizations often experience more or less volume than budgeted. ■  Flexible budgets look at expected revenues, expenses,

and net income under different volume assumptions. ■  The key to flexible budgeting is the identification of:

➨ Fixed Costs - which do not change with volume. ➨ Variable Costs - which do change with volume.

■  Flexible budget results are normally shown in a side-by-side columnar format.

■  A flexible budget is a form of "What if?" analysis.

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Volume of Breakfast Provided[1] 300 450 600

Expenses

Salaries 50,000 50,000 50,000 Supplies[2] 180,000 270,000 360,000

Rent 14,400 14,400 14,400 Other 5,000 5,000 5,000

Total Expense 249,400 339,400 429,400 Revenues

Municipality 200,000 200,000 200,000 Fund raising 75,000 125,000 125,000

Total Revenue 275,000 325,000 325,000 Surplus/(Deficit) 75,000 (14,400) (104,400)

[1] Assuming that the service is provided 200 days a year [2] Assume the cost per meal is $3.00 with little flexibility for economies of scale.

Hot Meals for School Flexible Operating Budget for 201X

Off-Budget Expenditures • Off-budget expenditures refer to financial transaction that

are not accounted for in the budget • Most public budgets exclude certain governmental

activities • Generally (but not always) refers to activities of public

enterprises, credit provided or guaranteed by government or subsidies channelled through the tax system

•  Increasing trend to include them in the financial statements of government

• Weaker control of these, but there is control nonetheless

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Off-Budget Expenditures • Introduction of accrual also highlights financial obligations of a non-cash nature that create potential liabilities for the government, e.g. loan guarantees • The main forms of off-budget expenditures are:

•  off-budget funds; •  direct loans; •  guarantees; •  Public Private Partnerships (PPPs) •  Public sector entities that are commercial and legally excluded from

the budget, e.g. Post Office.

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A fund is defined as a fiscal accounting entity with a self-balancing set of accounts

recording cash and other financial resources, together with all related liabilities and

residual equity or balances, and charges, which are segregated of the purpose of

carrying on specific activities or attain certain objectives for which special regulations,

restriction or limitations apply.

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Funds in Budget Architecture

Funds in Budget Architecture

•  Often funds are managed and reported separately – leading to a separate set of financial statements.

•  The use of funds restricts budgetary flexibility but displays allocation for specialized purposes in a transparent way – funds are often mandated in accounting standards or law, e.g. for municipal governments.

•  Often, special funds are created to segregate monies for programs for special purposes or as a result of unique designated revenue sources

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Funds in Budget Architecture

• Use of funds varies with governments • Municipal governments tend to be built almost entirely

around funds. •  The federal government and provinces will create special

funds for a variety of purposes, some that are linked to unique sources of funds through fees or special taxes, some of which are administered at arms length from normal practice.

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Fund Types Government Funds Proprietary Funds Fiduciary Funds

General FundSpecial Revenue

FundCapital Projects

FundDebt Service

FundsSpecial

Assessment Funds

Enterprise FundsInternal Service

Funds

Expendable Trust Funds

Nonexpendable Trust Funds

Agency FundsProvides for

ongoing activities of a

self-sustaining operation

Assets held in Trust by the Organization

Revolving Funds

• An authority, in the case of government usually a statutory one, to use the revenues generated from an activity to finance it.

•  This authority generally continues on a permanent basis from one year to the next without further authority being needed.

• Always created through budgetary expenditure means, but then those funds move off-budget.

• Although surpluses or deficits may occur from year to year, they are generally expected to balance out over time.

• Many arrangements exist for the use of retained earnings, with the principle being that the fund retains its earnings unless some form of gain sharing is put in place.

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Zero Base Budgeting •  Objective to “reset the clock” each year. •  Traditional incremental budgeting assumes that there is a

guaranteed budgetary base-the previous year’ level of appropriations -and the only question is how much of an increment will be given.

•  Zero Based Budgeting implies that managers need to build a budget from the ground up, building a case for their spending as if no baseline existed- to start at zero.

•  Resources are not necessarily allocated in accordance with previous patterns and consequently each existing item of expenditure has to be annually re-justified.

The purpose of ZBB is to reevaluate and reexamine all programs and expenditures

for each budgeting cycle by analyzing workload and efficiency measures to

determine priorities or alternative levels of funding for each program or expenditure.

Through this system, each program is justified in its entirety each time a new

budget is developed.

Strengths of ZBB

•  ZBB does not assume that last year’s allocation of resources is necessarily appropriate for the current year.

•  The systematic nature of such a fundamental review imposes a discipline on the organization which has produced in practice secondary advantages.

•  It produces in a readily accessible form more and better management information.

•  If implemented well, ZBB can eliminate a sense of “entitlement” to cost increases.

•  Improved discipline in developing budgets. • More meaningful budget discussions during plan

review sessions.

Weaknesses of ZBB

•  ZBB vastly overestimates people’s ability to calculate. • Multiple impacts often ignored •  The ranking process is difficult •  The implementation of a ZBB system requires a great

deal of time. • Attempts by agencies to manipulate priority listings by

ranking popular items lower than items that would have little chance of funding – the Musical Ride.

• Established programs have political support and they will continue to receive their share of the budget regardless of any analysis produced.

THE BUDGET PROCESS

The Budget Process ■  A process of planning and control. ■  A look ahead at what an organization can and can't do ■  A process of allocating scarce resources to unlimited

demands

■  The Budget Cycle - Preparation

–  based on guidelines –  normally done by responsibility center managers

- Review and Adoption - Implementation and Control - Evaluation of Results and Feedback

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Budget Process: Know it and Use it

• Every organization has a budgetary process of some kind • Increasingly they attempt to be strategic for the organization • Managers are not simply recipients of budgets: they are players in the budget process • Sustaining programs, getting program changes, resisting change or helping it all mean knowing how the budget process works and using it to your advantage

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The Budget Cycle

Length of time required to prepare, administer & close

out a single year budget.

47 Expenditure Management Cycle – Broader than Just the Budget Cycle

Planning system

Medium term plans, e.g. three

year rolling plans Annual budgets Development, recurrent and

revenue

Fund release procedure, e.g...

warranting

Accounting for revenue and expenditure

Public expenditure review Institutions

Reports and financial statements

Audit system

Project appraisal Resource

allocation

Monitoring & controlling

Accountability

Expenditure review

Financial management system boundaries

Source: Adapted from Integrated Financial Management. Michael Parry, International Management Consultants Limited. Training Workshop on Government Budgeting in Developing Countries. THE UNITED NATIONS. December 1997.

Budget Calendar

Fiscal Year 1999 Fiscal Year 2000 Fiscal Year 2001

Budget Close-out - 3 months

Budget Preparation - 3 to 9 months

Elements of an Effective Budget Cycle

• Basic framework exists and is used • Desired outcomes known •  Linkage to strategic plans • Common format, readily understood •  Timetable for preparation clear and reasonable • Set of directions – rules of the game • Budgetary and program limits known • Established methodologies for costing and forecasting

where needed • Directions on availability of new funds, use of current

funds and reallocation rules

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Simple Budget Cycle

Start/Restart

Strategic Planning Phase

Budget Preparation Phase

Budget Review Internal Executive

Results Feedback Auditing for Compliance and for

Results

Budget Review and Approval – Legislative

Budget Execution

What to look for in a strategic budget linkage

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Strategic Plan

Does this organization know its Mission?

Does this organization have an end state or vision?

What are the ground rules or basic operating assumptions and principles?

Does it have a grip on reality – what is its situation analysis including risks.

Does it have goals and objectives that make sense?

Are there targets with measures that we can understand.

Does what it is going to do this year mesh with its goals and mission?

What’s it going to cost?

Is it sustainable?

Budget Processes as a Planning Tool

• Budgets are where the rubber hits the policy road

• Budgets clear permissions to move ahead on plans

• Delivery capacity on plans directly linked to resources available

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Budgets as a Control Tool

• When a budget is approved, the expenditure estimates become appropriations • An appropriation both authorizes expenditures and limits expenditures • Both defines and limits managerial discretion • Can be used to limit uses to specific allotments or funds

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How Priorities are Set

•  Bottom up and top down: what are the elements of this process?

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Ways Governments Set Budget Priorities

• Political direction, platform, commitments • Effective business planning • Pressure responses: emergencies, external threats • Public participation, consultation

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Governance: Defining a process, involving all key players with a clear understanding that senior management will

have to make decisions in the end.

Key Drivers for Budget Increases

•  External forces: •  Legal requirements •  Political imperatives: more cops on the street •  Collective bargaining – salary costs •  New standards •  Population growth – do you have an established formula? •  Technology and equipment turnover

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Various approaches to the budget process……

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Top Down

Bottom Up Iterative

Key Drivers for Budget Increases

•  Internal forces: •  Standardized growth formulae – good or bad? •  Commitments •  Entitlement programs, e.g. some pension plans •  Previous history •  Politics and power

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Key Drivers for Budget Decreases • Running out of money •  Program redundancy •  Philosophical shifts • New delivery instruments • New funding instruments

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Building the Budget

•  This is the process of micro-budgeting • Building the budget logic but also the budget story • Within organizations, tends to be a two-way process:

direction from above and input from below • Often costs are driven by variables outside the

control of line managers, e.g. collective bargaining • No guarantee that funds will be allocated to cover

costs

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Pluses and minuses of top-down and bottom-up approaches to budgeting.

Building the budget: understanding costs, need and demand

• Role of past experience, especially in incremental situations • Types of measures:

•  Need •  Demand •  Workload

• Productivity assumptions and targets • Revenue assumptions

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Budget Gaming

Some Gaming Types: S.G. Ginsburg The Gardner

The Duck Hunter

The Entrepreneur

The Gambler

The Surgeon The Good Soldier

The Drowning Manager

The Savior

The Honest Manager

Projections and Forecasts

• Budgets often build on previous year’s base plus or minus • Differing set of assumptions: optimistic and pessimistic • Controllable and uncontrollable costs •  Fixed and variable costs • Direct and indirect costs and the full cost principle •  Treatment of overhead • Mandated standards

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Tensions Inherent in Public Sector Budgeting

• Revenue versus expectations • Central agency versus program organizations • New versus old • Complexity versus clarity

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The Authorizing Process

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Key Actors in Budget Process: Westminster

•  Finance Ministry or Treasury: Coordinate & drive budget process, set limits, establishes discipline (or not)

•  Spending departments: Responsible for expenditures within their jurisdiction.

•  Head of State & Cabinet: Make political decisions about tradeoffs. •  Legislature: Scrutinize & authorize revenues and expenditures. •  Supreme audit institutions: Audit government accounts for

compliance and performance. •  Others: Media, civil society organizations, donors & international

financial institutions.

Who are the key actors in a municipal budget process? How is it different from the Westminster model?

§ Budget tabled in thelegislature

§ Consideration byparliamentarycommittee(s)

§ Parliament accepts,amends or rejects thebudget

§ Finance ministry ortreasury issuesguidelines to spendingdepartments or agencies

§ Spending departmentssubmit draft budgets

§ Negotiation and finaldecisions by executive

Drafting Legislative Implementation Audit

§ Funds apportioned tospending departments toimplement activities

§ Finance ministrymonitors spending

§ Request for legislativeapproval of adjustmentbudget if necessary

§ Supreme audit institutionassesses departmentalaccounts andperformance

§ Audit reports publishedand reviewed byparliament

Before beginning of relevant fiscal year Fiscal year starts and ends Following end of fiscal year

Stages of the annual budget process

Drafting Stage

•  A draft budget that can be submitted to legislature. •  Mostly internal to the executive, secretive. •  Sets fiscal policy & estimates revenues on projections to

establish total resources. •  Finance ministry or central office issues guidelines to spending

departments. •  Budget requests from spending departments. •  Negotiations at bureaucratic and political levels. •  In municipal governments, council will often get involved in

preliminary discussions or others will have staff draft the first draft

Legislative stage

• Budget tabled in the legislature/council/board. • Considered by parliamentary committee(s). • Parliament votes on Supply. Council approves budget. • Municipal governments will often engage the public in

consultations at this stage

Execution/implementation Stage

•  Funds apportioned to departments to implement activities.

•  Central financial controller monitors spending – more or less.

•  Request for legislative approval of adjustment budget if necessary – Supplementary Bugets.

•  Fiscal risks are inherent in a changing economic environment – purpose of contingency reserves.

•  In-year adjustment decisions should be transparent and thoroughly scrutinized.

Reporting and Audit Stage

• Governments report on how they performed: •  Annual Reports •  Results-Based Reporting

• Supreme audit institution assesses departmental accounts and performance.

• Audit reports should be published promptly and submitted to parliament.

• We will look at this stage in more detail in a later session.

Defining Budget Success •  Is it just getting more money? • Other factors come into play as competition for scarce

resources never ends • One time win can create downstream costs. How? •  There is always a tomorrow.

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Elements of Success: Internal • Good planning •  Building strategic linkage • Knowing how the systems works – formal and informal •  Building a constituency and coalitions – getting the

corporate/ financial and senior management on side

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Elements of Success: Internal • Doing your homework • Understanding alternative delivery options • Good understanding of cost and cost drivers •  Building a good business case as a tool not an end in itself • Creating a distinctive product •  Take a mature time perspective

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