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Public SectorFinancialManagement forManagers
Andrew GrahamSchool of Policy Studies,Queenss UniversityKingston, Canada
November 2011
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Public Sector Financial Management for Managers
Acknowledgement
PublicSectorFinancialManagementforManagershasbeenproducedfortheCanadianGovernanceSupportOfficewith
fundingfrom
the
Canadian
International
Development
Agency,
GovernmentofCanada,asageneralguideforfinancial
managementforlinemanagersintheAfghanistanpublicservice.
ItcanbefreelyreproducedbyanyAfghanMinistry,Government
DepartmentorAgency.
PleaseacknowledgetheGovernmentofCanadainany
reproductions.
Usebyinternationalorganizationsrequirestheexpress
permissionofCANADEM.
CANADEM 2011
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Table of Contents
Section1:TheNatureofPublicSectorFinancialManagement...................................................... 1
KeyPoints.................................................................................................................................... 1
Question1:WhatisthePublicsector?....................................................................................... 2
5KeyFeatures:................................................................................................................................ 2
Question2:WhatisFinancialManagement?............................................................................. 3
8KeyFeatures:................................................................................................................................ 3
Section2:CornerstoneOne:AllocatingResourcesBudgets....................................................... 5
KeyPoints.................................................................................................................................... 5
TheBudgetCycle......................................................................................................................... 5
BudgetMethodologies................................................................................................................ 6
OrganizingBudget
Information
.......................................................................................................
6
ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005........................................... 8
TraditionalBudgetingversusPerformanceBudgeting.................................................................. 10
Section3:UnderstandingtheBudgetaryProcess......................................................................... 11
KeyPoints.................................................................................................................................. 11
BudgetsandPlanningCycles..................................................................................................... 11
ElementsofanEffectiveBudgetCycle.................................................................................. 12
StrategicPlanningPhase....................................................................................................... 12
CostAnalysis
Phase
...................................................................................................................
13
TheRoleofRevenueinCostAnalysis................................................................................... 13
HowtoDetermineCosts....................................................................................................... 13
FixedandVariableCosts........................................................................................................ 14
GettingApprovaltoSpend:TheAppropriationProcess........................................................... 14
CentralAgencyversusProgramOrganizations..................................................................... 15
TheNewVersustheOld........................................................................................................ 15
ComplexityversusClarity...................................................................................................... 15
OnBudgetVersusOffBudget................................................................................................ 15
Conclusion................................................................................................................................. 16
Section4:Budgeting:CapitalPlanning.......................................................................................... 17
KeyPoints.................................................................................................................................. 17
CapitalBudgets.......................................................................................................................... 17
CharacteristicsofCapitalAssets............................................................................................ 17
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ToolsofCapitalPlanningandBudgeting................................................................................... 18
CapitalImprovementPlans................................................................................................... 18
TimeValueofMoney................................................................................................................ 20
PresentValueandFutureValue............................................................................................ 20
NetPresentValue.................................................................................................................. 22
RiskAssessment........................................................................................................................ 22
ExamplesofRiskCategoriesinAssessingCapitalAssetRisks....................................................... 22
Conclusion................................................................................................................................. 23
Section5:CornerstoneTwo:MonitoringMoneyManagerialControl...................................... 25
KeyPoints.................................................................................................................................. 25
WhatisManagementControl?................................................................................................. 25
ManagementControlFramework......................................................................................... 25
RiskandRiskManagement................................................................................................... 26
UnderstandingandDefiningtheRisks............................................................................. 27
ControlProceduresandPolicies............................................................................................ 28
WhoandWhentoControl............................................................................................... 28
WhoistheController?..................................................................................................... 29
TrustandEthicsinControl.................................................................................................... 29
Trust.................................................................................................................................. 29
Ethics................................................................................................................................
29
ValuesandEthicsApproaches.......................................................................................... 30
ControllershipCapacityChecklist.............................................................................................. 31
StrategicLeadership......................................................................................................... 31
ClearAccountability......................................................................................................... 32
SharedValues&Ethics..................................................................................................... 32
MatureRiskManagement................................................................................................ 32
IntegratedPerformanceInformation............................................................................... 32
MotivatedPeople............................................................................................................. 32
RigorousStewardship....................................................................................................... 33
Section6:CashManagement:InYearControl............................................................................. 35
KeyPoints.................................................................................................................................. 35
ObjectivesofEffectiveCashManagement,MonitoringandControl....................................... 35
EstablishingaCashManagementSystem............................................................................. 36
InyearBudgetDesignFactors.......................................................................................... 37
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EstimatingWorkFlows..................................................................................................... 37
UseofHistoricalData....................................................................................................... 38
MonitoringFinancialPerformanceandVarianceAnalysis.................................................... 38
SettingupaMonitoringTimetable.................................................................................. 39
Governance......................................................................................................................
39
PerformanceReports....................................................................................................... 39
EastbrookCorrectionalFacility,Eastbrook,NovaScotia.............................................................. 39
Staffing:PlanversusActual........................................................................................................... 40
VarianceReports.............................................................................................................. 40
ForecastedversusActualReport...................................................................................... 40
AnalysisofKeyVariancesReport..................................................................................... 40
HistoricalInformation...................................................................................................... 41
Historical
Staffing
Patterns:
Custodial
Only:
Year
Average
...........................................................
41
ReallocationandReadjustment............................................................................................ 42
TheAuthoritytoReallocate............................................................................................. 42
FreeingUptheFunds....................................................................................................... 42
Conclusion................................................................................................................................. 43
Section7:CornerstoneThree:ReportingOnHowMoneyIsSpentAccounting....................... 44
KeyPoints.................................................................................................................................. 44
AccountingPrinciples................................................................................................................ 44
1.The
Entity
Principle
.......................................................................................................
44
2.MoneyasaMeasure/theCostPrinciple..................................................................... 45
3.TheGoingConcernPrinciple........................................................................................ 45
4.TheConservatismandCostConcept............................................................................ 45
5.TheMatchingPrinciple................................................................................................. 46
6.TheConsistencyPrinciple............................................................................................. 46
7.TheMaterialityPrinciple.............................................................................................. 46
8.TheDualityPrinciple..................................................................................................... 46
9.TheAccrualPrinciple.................................................................................................... 47
TheQualityofInformation.................................................................................................... 47
TheOutputsofAccounting.................................................................................................... 48
TheAccountingCycle....................................................................................................... 48
DoubleEntryBookkeepingandtheFundamentalAccountingEquation...................................... 48
DebitsandCredits......................................................................................................................... 49
ExamplesofDebitsandCreditsTransactions............................................................................... 49
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Wherearetheseactivitiesactuallyrecorded?.............................................................................. 50
KeyDefinitionsofTermsUsedInFinancialStatements................................................................ 50
AnExampleofDepreciation.......................................................................................................... 52
Equity/NetAssets/FundBalance................................................................................................... 53
TheBalance
Sheet
.........................................................................................................................
53
TheIncomeStatement.................................................................................................................. 54
ByObject:salaries,benefits,rentals,costofservices................................................................... 54
IncomeStatementOrganizedbyObject(PlusYeartoYearComparison).................................... 54
TheStatementofCashFlows........................................................................................... 54
Conclusion................................................................................................................................. 55
Section8:AccrualAccounting:ProvidingaFullerStory................................................................ 56
KeyPoints.................................................................................................................................. 56
Whydo
we
need
Accrual
Accounting?
......................................................................................
56
CashBasisAccounting:AnOverview..................................................................................... 57
AnotherExampleofCashAccounting........................................................................................... 57
ExampleofCashAccounting......................................................................................................... 57
AccrualBasisAccounting:AnOverview................................................................................ 57
ExampleofAccrualAccounting............................................................................................. 58
TheDifferencebetweenCashandAccrualAccounting........................................................ 58
CashVersusAccrualTreatmentofAssetAcquisitionandUse...................................................... 59
Implicationsof
the
Accrual
Accounting
.................................................................................
59
AnExampleofaWeekintheLifeofOneGovernment................................................................ 60
FinancialReportsoftheGovernment........................................................................................... 61
TheProsandConsofCashandAccrualAccountingandBudgeting..................................... 62
ConclusionsandOverview........................................................................................................ 64
Section9:AccountabilityandReporting....................................................................................... 65
KeyPoints.................................................................................................................................. 65
WhatisAccountability?............................................................................................................. 65
TheRelationshipofAccountabilityandFinancialManagement........................................... 66
TheUsersofFinancialandPerformanceReports..................................................................... 67
TheObjectivesofFinancialandPerformanceReporting.......................................................... 68
TheRoleofAuditintheAccountabilityProcess....................................................................... 69
InternalAuditFunctions................................................................................................... 69
LegislativeAuditors.......................................................................................................... 70
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Independence................................................................................................................... 70
ReportingtotheLegislature............................................................................................. 70
ThirdPartyAccountabilityandtheBurdenofOversight................................................. 71
Conclusion................................................................................................................................. 73
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Public Sector Financial Management for Managers 2
identifysomeofthecomponentsofthesethreebroadstagesbyaskingthequestions:
WhatisthePublicsector,andwhatisFinancialManagement?
Question 1: What is the Public sector?
Summary:ThePublicsectorneedstoworkwithinspecificfinancialboundarieswhile
tryingtosolveproblemsaffectingthecitizensitrepresentsandserves.
5KeyFeatures1:
i)ThePublicsectorisbroad.Itencompassesallorganizationsthatreceivetheirfunding
frompublicsourcessuchastaxes,feesorlicences.Therefore,itwillembracenotjust
governmentdepartments,butalsogovernmententerprises.
ii)ThePublicsectorhasmultiplegoals.Ratherthanhavingasinglebottomline,the
publicsector
has
several,
which
are
being
pursued
at
once.
iii)ThePublicsectorusesvarioustoolstoreachitgoals.Thereareaseriesof
instrumentsusedtoachievethegoalsofgovernment2.
iv)ThePublicsectoroftenusesthePrivateSectortodeliverPublicGoods.Modern
governmentsfrequentlyusecontractswithprivatecorporationsasameansofacquiring
neededexpertise,outsourcingwork,orextendingtheirworkforceswhileseemingto
containthegrowthofthepublicservice.
Thiscontractedworkdoesnotmeanthattheregularpublicserviceisrelievedofits
accountabilityforpublicfunds.Governmentsdevoteconsiderableenergyto
administeringcontracts,especiallyduringaperiodofincreasedscrutinybythepublic
andbythecontractingcommunityinparticular.
v)ThePublicsectorisademocraticinstitution.Governmentsownnoneofthe
resourcestheyspend.Taxpayersdo.Inademocraticsociety,thewaysinwhich
governmentsspendresourcesmustbetransparentandreadilyopentoquestioning.
AccountingforPublicsectorfundsandtheirproperexpenditureisnotonlypartofgood
management,itisessentialtogoodgovernmentandgoodgovernanceofthepublic
enterprise.Itisalsowheregovernmentsaremostheavilyscrutinizedandwherethey
cangetintoagreatdealoftrouble.Suchscrutinyisoneofthebasisofagovernments
legitimacy.
1CICAPublicsectorAccountingHandbook,RevisedUpdateNo.18,SectionPS1100,AppendixA
2Salamon,LesterA,RethinkingPublicManagement:ThirdPartyGovernmentandtheToolsof
GovernmentAction,PublicPolicy29,no.1(Summer,1981)andSalamon,LesterAandMichaelS.Lund,TheToolsApproach:BasicAnalysitcsin BeyondPrivatization;TheToolsofGovernmentActioneditedbyLesterASalamon,..2350,Washington,UrbanInstitutePress,1989
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Public Sector Financial Management for Managers 3
Question 2: What is Financial Management?
Summary:FinancialManagementhelpstoprovidekeyinformationtodecisionmakers
anditintroducescontrolsthateitherpreventabuseorcreateincentivesforgood
servicetothepublic.FinancialManagementhelpsthePublicsectorcollectmoney,
allocate
money,
spend
money,
weigh
the
costs
and
benefits
of
certain
programs,
accountformoney,reportonhowmoneywasspent,andplanforthelongterm.
8KeyFeatures:
i)FinancialManagementinvolvesthecollectionofmoney.ThePublicsectormakes
mostofitsmoneythroughtaxation,transfers,fees,thesaleofgoods.
ii)FinancialManagementinvolvesallocatingresources.TheincomeofthePublicsector
isnottiedtoanyonespecificgoal.Rather,Publicsectorfundsareconsolidatedintoa
ConsolidatedRevenueFund(CRF)andsubjectedtoademocraticdecisionmaking
processthat
distributes
them
across
arange
of
activities.
This
is
known
as
the
budgetary
process.Thereareexceptionstothisruleinwhichspecifictaxesorfeesaredirectedto
specificprograms.
ABudgettellsthepublichowthegovernmentintendstospenditsmoney.The
budgetaryprocessisaplanningtoolandatoolofregulationandcontrol.Agovernment
budgetsetsalegallimitforexpenditures.Italsocreatesthelegalauthorizationfor
delegatedofficialstospendfund.
ABudgetisalsothetoolbywhichthegovernmentsfinancialperformanceisjudged.
Managersareheldtoaccountfortheirperformancerelativetothebudget.
iii)FinancialManagementinvolvesspendingmoney.Delegatedofficialsareexpected
tospendpublicfundsforthepurposesforwhichtheywereallocated.Therefore,
financialmanagementinvolveshavingcontrolsinplacetomonitorexpenditures.
iv)FinancialManagementinvolvesoversightwatchingthemoney.Thegovernment
mustfrequentlyandsystematicallymonitorandreportontheflowofmoney.This
ensuresactualfinancialactivitymatchesplannedfinancialactivity.Financialrolesand
responsibilitiesaswellasfinancialreportingtimelines,areoutlinedinlawtoensure
specificindividualsarelinkedtothesuccessorfailureofaparticularstageinthe
financialprocess.
Information
systems
support
these
roles
by
making
public
servants
awareoftheirlevelofprogress.
Legislationcreatingpublicorganizationscanbeverybroadwithrespecttotheamount
oflegislativecontrolthatisexertedastheorganizationgoesaboutitsdaytoday
business.Legislaturesseldomengageintheactualmanagementofpublicorganizations.
Rather,theyserveotherkeyroles:creatingtheorganization,settingoutthepolicies
thattheywillcarryout,providingthefundingtocarryoutthepolicies,holdingthe
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organizationtoaccounteitherdirectlyorthroughexternalauditorsappointedbyand
responsibletothelegislatures.
v)FinancialManagementinvolvesaccountingformoneycollectedandmoneyspent.
The
Public
sector
must
assure
the
public
that
its
money
is
being
spent
well.
This
means
theyneedtoask:
Ismoneybeingspentforanappropriateuseforthepublicgood?
Arefundsbeingallocatedforthestatedpurpose?
Arefundsbeingspentaccordingtotherulesthatapply?
Didthefundsachievetheintendedresults?
Canthefundsbetracedandidentified?
Canothersassessthefinancialinformationoftheorganizationexternalreview
oraudit?
Essentially,pastfinancialbehaviormustbereconciled,audited,andreviewedinrelation
tothebudgettogivethelegislatureandpublictheassurancesthatfundswerespentfor
theirintendedpurpose.Thepublicaccountsandtheassociatedfinancialstatementsare
themaindocumentsusedbygovernmenttoshowfinancialactivity.
vi)FinancialManagementinvolvestakingcareofassets.Publicsectororganizations
buildoracquirecapitalassets.Theyowncapitalassets,whichcanbeconsiderable,in
ordertodeliverservicesandthepublicgoodobjectivesthattheywanttoachieve.
Consequently,thePublicsectorhasconsiderablemaintenancerequirementsand
operationalcosts.Financialmanagersmustensurethatassetsareproperlypurchased
andsustainable.
vii)FinancialManagementdoesrequiredueregardforprocess,recordkeepingand
reporting.Therecanbeatensionbetweentheobjectivesofthepublicservicetoquickly
servetheneedsofcitizensandeffectivefinancialmanagement,seeingitasinhibiting
effectiveclientservicethroughexcessivecontrols,inadequatefundingora
preoccupationwithpaperwork.Nonetheless,theserequirementsremainessentialfor
propercontrolandaccountabilityaswellaspublicconfidenceinthegovernments
financialprudenceandhonesty.
viii)FinancialManagementisEverybodysBusiness:Oftenpublicservantsdonotsee
themselvesasmanagersofresources,butratheraspolicymanagersofhighly
specializedfunctions.
Because
of
the
complexity
of
the
Public
sector,
the
finance
functionwillhaveitsownseniormanagerswhoareoftenseparatefromlineor
operatingmanagers.Tensionsoftenensuebetweenthesetwocultures.Theseare
normaland,whenwellmanaged,healthyandnecessary.
Inreality,allmanagersarefinancialmanagers.Theabilitiestoobtainresourcesto
achieveprogramobjectives(budgeting),maximizeprogrambenefitswithinthebudget
(allocation),effectivelymanagethebudgettoachievefullbenefit(cashmanagement),
anddemonstrateresultsandprocessadherence(accountability),areimportant
managementskillsforallgovernmentemployees.
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Public Sector Financial Management for Managers 5
Section2:CornerstoneOne:AllocatingResourcesBudgets
Key Points
A budget is a time limited plan that puts resources in place to implement the
goalsofanorganization.
Forthepublicsector,abudgetisalegallyauthorizedannualmonetizedplanthat
establishesspendinglimitsforthevariousprogramsthatcomeoutoflegislation,
policy,andorganizationalintent.Abudget,therefore,doestwothings:
1)Ittranslatespolicyintentionintospecificactivitiesthroughresource
allocation.
2)Itisalsothebasisforfinancialcontrolwithinthepublicsectororganizationin
thatitarticulatesexpectationsofrevenueandexpenditures.Assuch,itisa
usefulbenchmarktocontroltheoperationsofgovernmentdepartmentsandagencies.
Typically,aGovernmentwillhaveanorganizationwidebudget.
Thisdocumentwillthengetdividedintopartsinordertoformdepartmentbudgets.
And then those department budgets will be further divided in order to produce
branchbudgetsofvarioussorts.
Inthissection,wewillexplorethevarioustypesofbudgetsusedinthepublicsector.
The Budget Cycle
There are three budgets in playat all times for public sector managers: past, present
andfuture.
The manager has an immediate concern for the management of funds within the
currentfiscalyear.Thisistherealmoftheuseandcontroloffunds,cashmanagement,
andprogrammanagement.
However, the manger also has to continuously participate as part of the planning
processtosecurefundsforcomingyears.Thisistheexpenditureplanningprocess,the
policy planning cycle or the strategic exercises of the organization. This is for
developmentofthefuturebudget.
Finally, the manager must account for past use of funds. This is based on the past
budgetandthewayitwasspent.
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Importantly,thisthirdbudgetlife thepast iscriticalsincesomuchofthebudgeting
process is incremental in nature, as changes are made in small increments based onprior years levels of resources, e.g. an increase of 2% per annum with no change in
program fund distribution. Many organizations make the majority of their budget
decisionsbased
on
past
performance
and
allotments.
How
much
was
actually
used
in
thepastisanimportantfactor.
Budget Methodologies
Core Elements: There are three core elements to a budget: revenue, operations and
capital.Thesearedescribedbriefly.
RevenueBudgets:Forthemostpart,governmentsmanagetheirrevenuestrategiesat
thewholeofgovernmentlevel,imposingtaxesandfees.Theythendistributemoneyto
departments
through
the
budgetary
and
appropriations
process.
Individual
managers
havelittletodowiththispartofthebudgetprocess,unlesstheyworkontherevenue
sideofgovernment.
Operating Budgets: Operating budgets describe the programs and resources used to
carrythemoutwithinaspecifiedperiodoftime.Theoperatingbudgetcontainstheplan
forrevenuesandexpendituresfortheperiod,usuallyreferredtoasafiscalyear.
In governmental terms, the expenditure plan represents the authorized limit of
expenditures for the operating unit.Most operating budget provide funds for such
elements
as
staff,
benefits,
supplies
and
operating
expenses
as
well
as
grants
anddisbursements.
CapitalBudgets:Capitalbudgetscontaintheplansandresourceallocationsforcapital
acquisitions..Theyreceivedifferenttreatmentthanoperatingfundsbecausetheiruseis
oftenamorecomplexandlongertermpropositionthantheoneyearoperatingfunds.
Theyofteninvolvecomplexplanningprocesseswithconsiderablefinancialriskandcash
outlay.
Landandbuildingsarewellknowncapitalgoods. Increasingly, informationtechnology
infrastructure is a part of the capital budgets. Determining what is and what is not
treatedas
acapital
item
is
amatter
of
policy
within
public
sector
organizations.
OrganizingBudgetInformation
Budgetsvaryconsiderably incomplexity.Thiswilldependuponthepurpose forwhich
theywerecreatedandhowtheywillbeused.Inseekingthebestwaytodisplaybudget
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information, there are three main approaches, each with useful intent as well as
limitations:
Lineitembudgets,
Programbudgets,
Functionalbudgets
which
combine
the
former
two,
and
Performancebudgeting.
Mostgovernmentpracticeallthreeforms,usingthemtomeetthevariousgoalsofa
budget.Forinstance,asimplelineitembudget,describedbelow,willmeettheneedsof
amanagertounderstandwhatresourcesshehasandforwhatkindofpurpose,e.g.,
staff,supplies,etc.Aprogrambudgetwilllinksuchinformationtotheprogramswithina
particularunit.Afunctionalbudget,averycommontool,combinesthelineand
programbudget.Aperformancebudgetwilllinkthemoneyallocatedtospecific
anticitipatedperformanceoutcomes,e.g.,pavingsomanykilometersofroadsforso
muchmoney.
Each
is
useful
in
its
own
turn.
LineItemBudgets:Thelineitembudgetisoneoftheeasiesttoprepareandoneofthe
mostusefulintermsofcontrolofbudgetswithinaspendingperiod.
The financial information is organized according to the types of expenses or cost
categories.Thesegenerallyfocusonstaff,supplies,rentals,andcontracts,allofwhich
canbecharacterizedascostsofoperations.
AsimplelineitembudgetfortheOttawaGeneralHospital,focusingonexpensesonly,is
shownhere.
Themainorientationofalineitembudgetisexpenditurecontrolandaccountability.
Thisbudgetwillinformthemanagerorstakeholderswhatisbeingspentonwhatitem
ofexpenditure.Theseareknownasinputsinthattheyidentifythecategoriesof
resources,e.g.stafforsupplies,neededtodothework.Sinceitusescommonobjectsor
objectscodes,italsopermitsinterbudgetcostcomparisonsbetweenprogramsor
Line-Item Budget of the Ottawa General Hospital for Fiscal Year 2005
Object Budget100. Salaries $8,000,000200. Supplies 2,000,000300. Rentals 250,000400 .Profess ional Fees 750,000
Total $11,000,000
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Public Sector Financial Management for Managers 8
organizationswithsimilarfunctions.Agoodexample,ifallhospitalsusedthesame
objectcodesorlineitems,isthatitwouldenableaninterestedobservertodetermineif
theOttawaHospitalhadahigherstaffcosttooverallbudgetratiothananothersimilar
hospital.
ProgramBudgets:Programbudgetsarebudgetswhichareorganizedfordisplay
purposesaccordingtoprogramtypes.Itshowshowresourcesareallocatedtoeach
particularprogram.Thistypeofbudgetassignsresourcestotheoperatingunit,zone,
areaorspecializedprogramwithinwhichitisbeingspent.
ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005
Unit Budget
1.OperatingRoom $4,000,000
2.Laboratory 1,000,000
3.Radiology 1,000,000
4.PatientCare 2,500,000
5.OutpatientCare 1,500,000
6.Administration 1,000,000
Total $11,000,000
FunctionalBudgets:Afunctionalbudgetisabudgetthatcombinesthelineitembudget
withtheunitbudgettoprovideamorecompletepictureoftheresourcedistribution
withinan
organization.
Thisisoftentheformatthatisusedforexternalreportinginformation.Ithasthebenefit
ofallowingabetterbasisforcomparisonamongunits.Forinstance,oneareamayhave
highsalarycosts,e.g.operatingroomwhileanother,e.g.,administration,maybelower.
Thatmayreflectthelabourintensityoftheworkorthesizeoftheunitaswellasthe
costoftheprofessionalandsupportstaffineachunit.
Thefunctionalbudgetdeliversabetterunderstandingofwhatfundsaretobespentfor.
Itcombinesinformationaboutinputsandunitsorprogramsthatarebeingfunded.
Below
is
a
display
of
the
functional
budget
of
Ottawa
General
Hospital.
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Public Sector Financial Management for Managers 9
FunctionalBudgetoftheOttawaGeneralHospitalforFiscalYear2005
Unit 100.Salaries 200.Supplies 300.Rentals 400.Professional
Fees
Total
1.Operating
Room
3,250,000 250,000 50,000 450,000 4,000,000
2.Laboratory 550,000 350,000 25,000 75,000 1,000,000
3.Radiology 450,000 450,000 0 100,000 1,000,000
4.PatientCare 2,000,000 400,000 0 100,000 2,500,000
5.Outpatient
Care
1,200,000 175,000 25,000 100,000 1,500,000
6.
Administration
475,000 325,000 50,000 100,000 1,000,000
Total 7,925,00 2,000,000 150,000 925,000 11,000,00
PerformanceBudgets:Performancebudgetsareintendedtolinkresourcestothe
resultsdesiredfromaprogram.Whilealineitembudgetisfocusedentirelyoninputs
andazerobasedbudgetgoesbacktobasicsandreinventsitselfeachyear,the
performancebudgethascertainfeaturesthatmoveitmoreintotherealmofpublic
sectoraccountabilitywithagreateremphasisonoutcomesandresults:
1. thereismeasurementofthegoodsandservicetobedelivered,
2. unitcostsaredeveloped,
3. budgetfiguresaredevelopedbasedonthelevelofserviceasdeterminedby
multiplying
the
unit
cost
and
level
of
service,
4. expectedoutputsarereportedwithinthebudget.
Theperformancebudgetisdesignedtoprovideaclearerpictureofwhatlevelofservice
istobeprovidedforhowmuchmoneyandwithwhatresults.Anexampleofthiswould
betoaddadditionalinformationtotheOttawaHospitalbudgetdocumentsthatoutline
someofthefollowingoutcomes:
a. numberandtypesofoperations,
b. waitingtimesforoperations
c. costperoperations
d. overheadcostsasapercentageofoverallbudget
e. changesin
service
levels.
Theperformancebudgetisagoodsteptowardscostingofservices,identifyingclearly
servicelevelsofcurrentresourcesandhelpingdecisionmakersmakeabetterlink
betweenthosetwowhendeterminingfutureresourcing.
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Public Sector Financial Management for Managers 10
TraditionalBudgetingversusPerformanceBudgeting
TraditionalBudgeting PerformanceBudgeting
BudgetOrientation MoneyControl Linkingmoneytoprogram
andactivities
AppropriationControl
LevelDepartment
Program
BasicBudgetingUnit Object,objectcodeorline
item
Activity
EfficiencyMeasurement None Unitcost,volumes
ResultMeasurement
(Effectiveness/Quality)
None Programlevels,activity
levels
BudgetPeriod Oneyear Ongoingyearoveryear
Someofthekeyelementsofperformancebasedbudgetsare:
1. servicesaredefinedandmeasurescreatedforthem,
2. disaggregatingofservicespermitsindividualcostingandthedevelopmentof
workloadmeasurements
3. servicestandardsaredeveloped,4. thereisastandardizedcostingmethodology,5. unlikeotherbudgetformats,therewillbeaconsiderableamountofnarrativeto
explainservicelevels,how
6. theyarecostedandhowcostsaredistributed,
7. someformofbenchmarkingisinvolved:thisprovidescomparativedataofcosts
andworkload
levels
in
similar
circumstance,
e.g.
comparing
the
cost
of
garbage
collectionfromonetowntoanother.
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Public Sector Financial Management for Managers 11
Section3:UnderstandingtheBudgetaryProcess
Key Points
Agoodbudgetprocessisfarmorethanthepreparationofalegaldocumentthat
appropriatesfunds.
Goodbudgetingisabroadlydefinedprocessthathaspolitical,managerial,
planning,communication,andfinancialdimensions.
Agoodbudgetprocessischaracterizedbyseveralessentialfeatures.Agood
budgetprocess:
Incorporatesamedium
term
perspective
Establisheslinkagestobroadorganizationalgoals
Focusesbudgetdecisionsonresultsandoutcomes
Involvesandpromoteseffectivecommunicationwithstakeholders
Provideincentivestogovernmentmanagementandemployees
Thesekeycharacteristicsofgoodbudgetingmakeclearthatthebudgetprocessisnot
simplyanexerciseinbalancingrevenuesandexpendituresoneyearatatime,butis
strategicinnature,encompassingamulti yearfinancialandoperatingplanthat
allocatesresourcesonthebasisofidentifiedgoals.
Budgets and Planning Cycles
Arrivingatthefinalbudgetwillentailsomemeasureofforecasting,analysisofoptions,
settinginplaceplansoverthelongtermandfinallyassigningresourcelevels.Thisisthe
budgetcycle.Understandinghowitworksisessentialforapublicsectormanager.
Budget cycles tend to be portrayed in calendar form. Below is a typical public sector
budgetcycles.
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Elem
The
Strat
Strat
purp
Public Sect
entsofanE It T
T
d
T
a T
b
G
i
T
salementscaStrategicCostAnalApproval
egicPlanniegic plansseoftheo
R
r Financial M
ffectiveBucreatesacoecycleense budgetpartment.ere isacod
compara
ere isanadgetswithivernmentsportantinfereisacolaries,equiberolledPlanningPhysisPhase,Phase
gPhasesually conrganization
PerformanceMonitoring
eview, Audit andEvaluation
Learninto N
anagement f
getCyclemmonframresthatpocycle is limonappr
ivecosting.
reeduponntheorganiprovide grmationabmoncostiment,etc.pintothrease,nd
ain a fundanditsinte
PlE
OperationalImplementati
and Control
g and Inputxt Year
or Managers
eworkforaliticalpriorinked to toachacrostimetablefzation.uidance toouttolerablgmethodol
essentialp
amental sededdirecti
anning to Plan:tablish System
ApprGov
Body/n
lltheplayeiesareset.e overallgovernme
orpreparat managersecostlevelogyforco
hases:
of componoverapr
Vision, MissionValues, Legal
Mandate
LiCosts
val byrning
inister
sintheproplanningt topermiionandconon budge.moninputs
nents thatescribedpe
,
Goals andOjbectives:Measures
k toBudget
1
esstouse.ycle of thcomparisosiderationt limits ansuchassta
describe thiod.
2
enfdff
e
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Public Sector Financial Management for Managers 13
Mission comprehensivestatementexpressingthepurposeoftheorganization.
Vision statementoftheendresultspursuedbytheorganization.
GuidingPrinciples philosophythatsteerstheorganizationindeliveringservices
andaccomplishing
its
mission.
SituationAnalysis descriptionofkeyinternalandexternaltrendsthatarelikely
tohaveanimpactontheagencyoverthetimeperiodoftheplan.
Goals statementsthatdescribetheagencysdestination,direction,and intent
fortheperiodoftheplan.
Objectives initiativesthatimplementthegoals.
PerformanceMeasuresandTargetsprecisemilestonesforeachobjectivethat
willhelp theorganizationwillevaluateprogresstowardtheobjectivesand the
goalsthatitsupports.
Linkage
of
General
Goals
to
Annual
Performance
Plan
description
of
the
relationship between annual goals in the performance plan andthe general
multiyeargoalsandobjectivesinthestrategicplan.
Resources Needed description of the human, capital, information, and other
resources and the operational processes, skills, and technology needed to
achieve the agency goals; highlighting where significant change from currently
availableresourceswillbeneeded.Note:this isnotthebudgetforthecoming
year, but a resource discussion that will certainly affect budget decisions in
futureyears.
ProgramEvaluations
description
of
how
the
results
of
programs
or
policy
will
beevaluated.
Cost-Analysis Phase
TheRoleofRevenueinCostAnalysis
Managers have to make predictions about anticipated revenues because without
understanding what resources will be available to government, it becomes extremely
difficulttodecidewhatprojectsshouldbeallocatedresources.Usinghistoricaltrenddata
isaneasilyavailableand useful tool forpredicting revenue.Onceaprediction ismade,
attentioncould
then
be
made
about
costs
and
the
spending
priorities
of
government.
HowtoDetermineCosts
One way of examining costs is to divide them into two basic categories: Direct and
Indirect.
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Public Sector Financial Management for Managers 14
Directcostsarecosts incurredwithintheorganizationalunit forwhichthemanagerhasresponsibility, and costs of resources used for direct provision of goods or services or
activitiesthatrelatetothecoremissionoftheorganization.3
IndirectcostsorOverheadare:costsassignedtoanorganizationalunitfromelsewhereintheorganizatione.g. informationtechnologysupport,andcostswithinaunitthatare
notincurred
for
direct
provision
of
goods
or
services,
i.e.
core
business
or
mission
central,
butarenonethelessneededtoprovidethoseservices,e.g.logisticalsupport,information
technology,physicalplant,financialservices.4
Often organizations fail to fully take into account all the costs of service delivery. The
objectiveofsoundbudgetingpractice,however,istoarriveatafullunderstandingofthe
totalcostofproviding themissioncriticalservicesof theorganizations.Therefore,both
indirectanddirectcostsneedtobeincludedinanybudget.
Fixedand
Variable
Costs
Another essential tool of costing is the use of fixed and variable costs. This analysis is
important for it enables the manager to determine how costs will react when certain
variables are changed. It can establish cost sensitivity, i.e. the point at which costs can
eitherbereducedorincreasedwithchangesinactivity.Establishinganunderstandingof
cost sensitivities will enable the manager to better understand the impact of program
changes.
Fixed costs are those costs that do not change in total as the volume of service units
changesoverarelevantrangeofactivity.5Variablecostsarecoststhatvarydirectlywith
changesin
the
volume
of
service
units
over
arelevant
range
of
activity.6
Getting Approval to Spend: The Appropriation Process
Asthebudgetprocesssuchasdescribedabovebecomesmoreinstitutionalizeditengages
more players and eventually produces a formal budget submitted to the authorizing
authority. In general, this will mean that the final stage of the budgetary process will
providelegislativeapprovaloftheplannedexpenditures.Thepurposeofthisauthorityis
toobtainspecificapprovaltospendmoney.Suchauthorizationiscalledanappropriation.
Appropriations create the authorization for spending the amount in the budget. In this
way
the
budget
moves
from
being
a
submission
for
funds,
then
a
plan,
then
a
budget
to
becomingthelegalinstrumentofthegovernment,whichbothpermitstheexpenditureof
fundsandrestrictsthatflowtothelevelssubmittedforapproval.
3Finkler, p. 97
4 Finkler, op.cit.5Finkler, p. 99
6Finkler, op.cit. p. 99
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Public Sector Financial Management for Managers 15
CentralAgencyversusProgramOrganizations
Typically, during the budgetary cycle, the overall planning and legislative process is
supportedbycentralagenciessuchastheMinistryofFinance.Centralagenciesprovidea
wholeof
government
assessment
of
the
supply
of
revenue
as
well
as
the
tolerable
scope
forprogramexpansion.Theyensurethatdebtisavoidedby lookingatthebigpictureof
programspending.Centralagenciesusetheanalyticaltoolsmentionedabovetoprovidea
detailed assessment of the costs of government programs and then provide
recommendationstothelegislature.
Thereisaninherenttensionbetweenthedesiresofprogramdepartmentsofgovernment
to spend to meet all their program needs and aspirations and the desire of central
agencies to control the demands to what is both realistic within government revenue
projectionsanddesirablewithinthegovernmentsoverallpriorities.Suchtensionmeans
thatprogram
managers
will
have
to
work
effectively
with
central
agencies
ifthey
are
to
besuccessfuldefendersoftheirprogramfundsorproponentsofnewfunding.
TheNewVersustheOld
Perhaps one of the greatest sources of tension within budgetary systems and the
budgetary approval process is the desire by governments to extract funds from one
spendingcentreandmove ittoanother.Whilethisgoesbymanynames, it isgenerally
knownasreallocationofexisting funds.This isoftenamatterof fundingnewprograms
withexistingfunds.
Governments will be continually looking for ways to improve efficiency of current
operationstoreducecosts.Theywillalsobelookingforprogramsthatnolongerservean
importantpublicpurpose.
ComplexityversusClarity
Budgetsaremadeupofastreamofdecisions,somewhatinvolvespendingandsomethat
involvelimitingspending.Veryfewdecisionsarealikeandavarietyofpolitical,socialand
economicfactors
come
into
play
in
their
creation.
For
many
public
sector
organizations,
in
order to achieve the objective of public involvement and transparency, the budget
processcanbea longone, involvingmanydifferent forums, inordertoarriveata final
product.
OnBudgetVersusOffBudget
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Public Sector Financial Management for Managers 16
A challenge for many countries is getting a true picture of government expenditures.
Oftengovernmentswillseektominimizethescopeofpublicexpendituresbytakingsome
expenditure items offbudget. This can be done for legitimate policy and accounting
reasons.Forinstance,ifapublicsectorprogram isselffunding,suchasonethatobtains
allof its revenues fromservice fees, itcanbesaid tooperateoffbudgetas itdoesnot
take upany appropriated funds from thebudget. Often suchentitiesestablish financial
reporting
statements
seperate
from
the
overall
government
financial
statements.
This
servesonegoodofclarity.However,itisalsocontendedthatremovingitfromthegeneral
governmentbooksdistortsthedegreeofpublicsectorspending.Thisdebateisuniversal.
Oneelementofconcern,however,iswhenoffbudgetentitiesarecreatedtodeliberately
mask or distort either government revenues, e.g. development grants from external
sourcesorremoveeffectivelegislativeoversightofthispartofthepublicsector.
Conclusion
The
process
of
formulating
and
getting
approval
for
a
budget,
at
any
level
and
in
any
kind
ofpublicsectororganization, isan integralpartofhow thatorganizationcarriesout its
mission. It can be complex or simple, depending on the nature of the organization.
However,somecommonelementsforpublicsectororganizationsemerge:
Budgetsbringtogetherneedsandcapacity,oftenfromdifferentpartsof
theorganizations,whetheritistaxcapacityandprogramdemandsorclient
needsandfundraisingcapacityoftheorganization.
Budgetsdemandatechnicalcommandofthekeyelementsofneeds
measurement,effectivecostingofprogram,revenueprojections.
Budgetsin
the
public
sector
are
legal
documents
that
define
expenditures
authoritiesandlimitittothoselevelsonceapprovedbytheauthorizing
legislature.
Budgetmakingtakesplaceinanorganizationalculture,richinnuance,with
powerplayingasmucharoleofgoodpolicymaking.
Budgetsareinherentlytransparentinthepublicsector,bothintermsofhowtheyareformedandinhowtheyareexecuted.
Budgetsareboththeresultofplanningbasedonpastexperienceandthe
existingpolicyormissionframeworkoftheorganizationandfuture
orientations.
Budgetsinthepublicsectoraresubjecttointensescrutinynotonlyby
thosewhowillmanagethem,butalsothosewhowillbenefitfromorbe
subjecttothem.
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Public Sector Financial Management for Managers 17
Section4:Budgeting:CapitalPlanning
Key Points
Capitalassetsareexpensive,havealonglife,canlockinanorganizationinterms
ofalternativeoremergingtechnology.
Thetotalcostofacapitalassetovertimemayincludesizeableoperatingexpenses.
Itsacquisitioncandistortoperationalplanningifthisisnotadequatelyconsidered
attheplanningphase.
Capitalrequiressomespecialtreatmentbothfromthebudgetingandaccounting
perspective.
Capital Budgets
Acapitalbudgetisaplanfortheacquisitionofbuildingsandequipmentthatwillbeused
bytheorganizationinoneormoreyearsbeyondtheyearofacquisition. Adistinction
thathasalreadybeendrawnbetweenoperatingandcapitalbudgetsisthatoftime.
Operatingbudgetsareappropriatedandreporteduponforasinglefiscalyear.Generally,
theoperatingassetsareapprovedandusedupwiththeyear.Thecapitalbudget,whileit
involvesactualcashdisbursementswithinthecourseofafiscalyear,moreofteninvolves
aflowofcashoveranumberofyearstocreateanasset,whichhasalifelongerthanone
yearataminimum.
Therefore,boththeinvestmentflowandtheassetreturnextendoveraconsiderable
periodoftime.Havingcapitalprojectsdependentonyeartoyearapprovalsrestrictsthe
capacityoftheorganizationtocommittothefullcostoftheproject.Approvingthefirst
phaseofamajorconstructioninvestmentandthenreviewingitentirelywhilenot
approvingthenextphasecanleadtoaseriesofcomplicationsfromwasteofpublicfunds
toareluctancetoengageinthehighriskventureinthefirstplace.
Finally,itisoftenthecasethatcapitalprojectsinvolvelongtermdebtforthe
organization.Thechallengeoflongtermfinancinginvolvesagoodunderstandingofthe
truecosts
of
the
investment.
CharacteristicsofCapitalAssets
Fromanaccountingpointofview,somethingisacapitalassetwhenitmeetsfourcriteria:
thattheyareusedintheproductionorsupplyofgoodsand
services(productivitycriterion),
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Public Sector Financial Management for Managers 18
thattheirlifeextendsbeyondafiscalyear(longevitycriterion)
thattheyarenotintendedforresaleintheordinarycourseofoperations
that the monetized value of the asset is sufficiently high (materiality
principle)
Tools of Capital Planning and BudgetingEffectivecapitalbudgetingbeginswithanunderstandingoftwoelements:
o CapitalImprovementsthecapitalrequirementsoftheorganization,bothnow
andinthefuture
o Maintenanceunderstandingoftherequirementstomaintainpresentcapital
assetsinausefulstate.
Governmentsstruggleonbothcounts,becauseoftheconcernforthecostsinvolvedand
becausetheyhavenotalwayssufficientlyseencapitalassetsasbeingsubjectto
deteriorationand
in
need
of
renewal.
As
well,
in
the
absence
of
life
cycle
analysis
and
the
applicationoftruecostingtoolssuchasTimeValueofMoneyandReturnonInvestment
Analysis,capitalexpendituresareusuallyseenasanannualexpenditureandnotan
investmentflow.
HerearesometoolsofgoodCapitalPlanning
CapitalImprovementPlans
ACapitalImprovementPlanhasamultiyearperspective.Itcanberenewedandupdated
ratherthanrecreatedeachyear.Inthisway,majorcapitalinvestmentdepreciationisnot
forgottenand
maintenance
issues
remain
on
the
table.
It
is
very
easy,
especially
in
a
politicalenvironment,toforgetpipesunderthegroundortheexistingbuildingsinan
efforttofocusonmoreimmediatecrisesorthedesiretocreatenewcapitalprojects.An
exampleofacriticalareainthisregardistheneedtoupgraderoadsonaregularbasis.It
maynotbethemostpoliticallyexcitingthing,butitisnecessary.Anditcostsmoney.
SomeofthestepstobefollowinginthecreationofaCapitalImprovementPlanare:
o StrategicRelevance:Astatementthatlinkstheorganizationsgoalsandobjectives
toitspresentandfuturecapitalneeds
o Analysisof
Factors
Affecting
the
Organizations
Capital
Asset
Base:
Some
factors
totakeintoaccountinthatregardare:
o Demographics:Bothcurrentandfutureindicators,suchaspopulation
changesbyagecohort;impactsofbirths,deaths,immigrationand
emigration;andissuesspecifictoprogramareas.
o Programchanges:Theseincludenewinitiatives,programterminationsor
changesinprogramparameters.
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Public Sector Financial Management for Managers 19
o Technologicalchanges:Technologicalimperativesareessential
considerationstoday,especiallyasbusinessprocessesbecomemoreweb
based.
o Economicorbusinesschanges:Theseincludecurrentandprojected
financialormarkettrendsandopportunitiesandemergingtrendsinthe
waybusinessisconducted.Anexampleistheemergenceofservice
providersas
alternative
service
deliverers
of
public
services.
o Legislation:Factorstoconsiderhereincludeanynewstatutory
requirementsaffectingtheorganizationoritsserviceplan.
o Environmentalfactors:Theseincludetheimpactofanypotentialchangestoenvironmentalstandards.
o InventoryandConditionAnalysis:Acomprehensiveassetinventory,includingan
assessmentofthephysicalcondition,functionality(i.e.abilitytosupportcurrent
programdelivery)andutilization(capacity)ofitscapitalstock.Thisshouldbe
updatedonanannualbasis.Thefollowinginformationshouldbepartofthis
analysis:
o Baselineinformation:Informationonassetssuchas land,buildings,buildingsystemsandequipment,trackingsuchfactorsas:
i. ownershipstatusii. locationandzoning
iii. structuraltypes
iv. size(landareaifapplicable,squarefootage,vehiclecapacity,etc.)v. ageandhistory(e.g.rehabilitation,repairs,maintenanceactivity,
additions,renovations)
vi. value
vii. currentuse,
viii. estimatedservicelife;and
ix. anyothersignificantissuessuchasenvironmentalliabilities.
o Physicalconditionandriskfactors:Anassessmentorratingofthephysicalconditionoftheinventory,includingmaintenancerequirements,seismic
vulnerability,asbestos,etc.
o Functionality:Anassessmentofhoweffectivelyeachassetmeetsexistingprogramorserviceneeds;functionalityissometimesmeasuredasthe
differencebetweencurrentoperatingcostsandtheprojectedcostof
operatinga"state
of
the
art"
facility.
o PurposeorUseoftheAsset:Anassessmentofhoweachassetisbeingused;thisissometimesmeasuredbycomparingforecastservicedemand
againstanassetscurrentcapacity
o Maintenance Needs: Maintenance requirements must be identified in capitalplans. Plans should also explain the methodologies used to develop the
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Public Sector Financial Management for Managers 20
maintenanceforecasts(e.g.measurementtools,standardsandformulasbasedon
assetvalueorsquarefootage).
o EstimatesofRequiredResources:Estimatesofcapitalassetrelatedneedsshould
beaggregatedintoidentifiablecategories.Theoverallcapitalcosts,whenoutlined
thoroughly, can be staggering for public sector organizations. Very seldom do
revenueexpectations
match
the
straight
line
anticipated
capital
costs.
Usually
at
thispoint,variousprioritysettingprocessescomeintoplay.
o DevelopmentofStrategiesandAlternatives:TheCapitalImprovementPlan(CIP)
itself does not provide decisions about capital expenditures. Rather, it is the
background against which the public sector organization will set priorities. One
importantservice itcanprovide istoofferalternativestrategiesfordealingwith
capital pressures. For instance, the CIP could also identify alternative delivery
forms such as publicprivate partnerships that would, in essence, transfer the
capital costs of a new building to the private sector builder while imposing a
downstreamoperatingcostforgovernmentintheformofguaranteedrentaland
paymentof
debt
costs
back
to
the
supplier.
Time Value of Money
Becausecapitalprojectsarecostlyandofteninvolvemajorgovernmentinvestments,the
costoftheprojecthastobesetintothetimeframewithinwhichgovernmentswillincur
thecosts.Atthispoint,someformoftimevalueofmoneyanalysiswillhavetobeapplied
beforefinalspendingdecisionscanbemade.
Thesimplestexplanationoftimevalueofmoneyisthatadollartodayisworthmorethan
a
dollar
tomorrow
or
at
any
time
in
the
future.
Partially,
this
difference
in
value
is
attributabletotheearningandcompoundingofinterestforadollarinvestedtoday. This
is also attributable to opportunity cost, meaning that money spent now addresses
presentneedswhilemoneydeferredmissestheopportunitytodoso.
Anotherfactorthatrelatestothetimevalueofmoneyisrisk. Riskinthisinstancerefers
topossible lossofvalueof the fundsavailable throughanunsuccessful investment ina
capitalproject.Thedollar inhandtodayhasnorisk. It isfirmlywithinthecontrolofthe
organizationand it candisposeof it,save itor invest itas itsees fit. Thepromiseofa
dollartomorrowcarriessomeriskthatyouwon'tgetitoryouwon'tgetitwhenyouhave
been
promised
you
will
get
it.
Taking all these elements into account, time value of money considerations encourage
mangers to calculate the monetized benefits of a capital investment and then discount
thosebenefitsinawaythatreflectsthedecliningvalueofadollarofbenefitoccurringin
thefutureratherthantoday.
PresentValueandFutureValue
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Public Sector Financial Management for Managers 21
Applyingtechniquesofinterestcompoundinganddiscounting,itispossibletodetermine
eitherthepresentvalue(PV)orfuturevalue(FV)ofacapital investment,usingasimple
formulathatapplies interestandtimetotheamountsthatareeitheravailablenow for
investmentincapitalorthepresentvalueofafuturepayment.Thevariablesusedinboth
calculationsare:
PV=Present
Value
FV=FutureValue
i=InterestRatePerPeriod
n=NumberofCompoundingPeriods
Present Value is an amount today that is equivalent to a future payment, or series of
payments, that has been discounted by an appropriate interest rate. Since money has
timevalue,thepresentvalueofapromised futureamountisworth less the longeryou
haveto
wait
to
receive
it.
The
difference
between
the
two
depends
on
the
number
of
compoundingperiodsinvolvedandtheinterest(discount)rate.
Therelationshipbetweenthepresentvalueandfuturevaluecanbeexpressedasshown:
Relationship between Future Value and Present Value
PV = FV [ 1 / (1 + i)n ]
Example: You want to buy an emergency generator for the Fire Departmentthat will only become useful 5 years from now for $150,000. Assuming a 6%interest rate compounded annually, how much should you invest today toyield $150,000 in 5 years?
FV = 150,000i =.06n = 5
PV = 150,000 1 / 1 + .065
= 150,000 1 / 1.3382255776 = 112,088.73
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Public Sector Financial Management for Managers 22
NetPresentValue
NetPresentValue (NPV) isameanstocalculatewhetherthepublicsectororganization
willbebetterorworseoff if itmakeacapital investment. Itdoesso bycalculating the
presentvalueofinflowsminusthepresentvalueofoutflows.
NPV=PV
Inflows
PV
Outflows
Risk Assessment
It iscriticaltounderstandandassesstherisk involved ineach initiative.Risksshouldbe
identifiedattheearlieststageofplanningastheymayimpactfinancingandprocurement
options. Once risks have been identified, they must be analyzed and evaluated to
determine the likelihood, consequences and level of risk. Finally, a risk management
and/ormitigationstrategymustbeputinplace.
Risksshould
also
be
reviewed
and
updated
as
the
initiative
moves
forward.
Thetablebelowprovidesexamplesoftheriskcategoriesthatshouldbeconsideredwhen
planning and managing infrastructure expenditures. It also provides examples of how
thesetypesofrisksmaybetreatedtoreducethelikelihoodorconsequencesofpotential
losses.
ExamplesofRiskCategoriesinAssessingCapitalAssetRisks7
RiskCategory DescriptionandTreatment
GeneralRisks
Examples
include
high
level
concerns
related
to
the
decision
to
undertake
an
initiative. Risk treatmentmay includedocumenting howan initiative fitswith
established strategic objectives; assessing the requirements for a new
corporate structure; enhancing the initiatives profile with the public, media
andgovernments;andworkingcollaborativelytoenhancelabourandindustrial
relations.
PolicyRisks Examples include the likelihood that an initiative represents, or may be
affected by, a major shift in government or agency policy, or change in
legislation.
PublicInterestRisks Examplesincludetheinitiativesenvironmentalimpactanditsrelationtopublic
health, safety and security issues. Risk treatment may include working with
neighbours and the community to address public concerns in the initiative
planningphase.
ManagementorOrganizationalRisks
Examples include the complexities associated with partnerships, investmentsand management. Risk treatment may include managing dependencies on
linkedfundingandcontingentinvestments;ensuringtheavailabilityofqualified
initiativemanagers;andensuringtheinitiativedevelopmentteamhasaccessto
appropriateexpertisewhenundertakinganewtypeofinitiative.
7BC Capital Asset Management Framework
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Public Sector Financial Management for Managers 23
Design/Construction,
Commissioning,
PartnershiporSupplier
Risks
Examplesincludesponsorrisk(e.g.,thelikelihoodthataprivatepartnermaybe
unable to deliver) and general supplier/market capacity. Risk treatment may
includeensuringtheavailabilityofmaterialandequipmentsupplies;ensuring
thatexperienceddesigners,contractorsandtradespeopleareavailable inthe
required time frame; anticipating the need for community permits and
approvals;anddesigningconstructionwindowstoavoiddelaysduetoadverse
weather.
PoliticalRisks
Often
unspoken,
but
certainly
real
are
many
political
risks
associated
with
capitalprojects.Examplesofsomeare:
short tenure of a government that may mean the project is re
evaluatedorchangedbyanewgovernment,
local opposition to a project that leads to considerable political
controversyandreversalongroundsofcommunityconcerns
failuretoadequatelyconsultortakeintoaccountvariousstakeholder
interests
SiteRisks Examplesincludetherisksassociatedwithsiteselectionandacquisition.
Risktreatmentmayincludeensuringthatthesiteisavailableatanaffordableprice;
evaluatingsitechallengessuchassoilcontaminationorpotentialflooding;andensuring
thedesired
site
is
free
of
potential
land
claim
issues.
FinancingRisk Examplesincludeanentitysabilitytodrawtherequiredfinancialresourcesandthe
overallfinancialviabilityoftheinitiative.Risktreatmentmayincludeensuringthat
financingisavailableattheappropriatetime;anticipatingtheimpactofinterestrate
increases;andevaluatingthecreditworthinessofpotentialpartners.
Cost,
Economicor
MarketRisks
Examplesincludeallpossibleeventsthatcouldaffectcashflowduringinitiative
development.Risktreatmentmayincludeplanningforcontingenciesinthemarketsuch
asadropindemandforservices;anticipatingthepotentialforlabourormaterialcost
escalations;ensuringfundingisavailabletocoveroperations,maintenanceand
administration;andassessingthepotentialforcompetingfacilities.
Ownership
and
Operations
Risk
Examplesincludelabour relations,maintenance,andtechnicalandassetobsolescence
risks.Risktreatmentmayincludetakingstepstokeepmaintenanceinlinewithforecast
levelsand
taking
appropriate
measures
to
address
the
likelihood
of
abandonment.
OtherRisks Risksthatcouldbesubstantiveandrequireresolutionand/or
managementpriortocommitmenttotheexpenditure,orduringdelivery,including
uncontrollableforcemajeureriskssuchasweatherandglobaluncertainty.Risktreatmentmayincludedevelopingcontingencyplanstoavoidorreduceconstruction
delaysduetoemergenciesordisaster;andensuringthatbusinesscontinuityplans
addressawiderangeofpotentialevents.
Conclusion
Theconceptualtoolsandplanningprocessessuggestedhereisanimportantpartof
organizationalfinancialmanagementwherevercapitalplaysanimportantroleincarrying
outthatorganizationsmission.Thinkingaboutcapitaloftenchallengesthelinemanager
toescapetheyeartoyearoperatingbudgetorientationandlookattheimplicationsof
suchelementsastheactualcostofaninvestmentincapitalforbothoperatingcostsdown
theroadandfurthercapitalinvestments.
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Public Sector Financial Management for Managers 24
Oneoftheothervery importantreasonstohaveaspecialawarenessofcapitalbudgets
andhowcapitalbehavesovertimeisthatofteningovernment,theissueofmaintenance
andreplacementofcapitalgoodsiseasilydeferredwhendifficultbudgetcutshavetobe
made. What this has led to in some countries is a serious underinvestment in
infrastructurethatwillnowcostmuchmore,inpresentvalueterms,toreplace.Thishas
beenthevictoryoftheshorttermoverthelongterm.Unseensewersveryseldomattract
politicalattention
until
they
break
down.
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Public Sector Financial Management for Managers 25
Section 5: Cornerstone Two: Monitoring MoneyManagerial Control
Key Points
Thebudgetisaplan.Onceapproved,ithastobecarriedout.Thedesiredoutcomeof
implementingthebudgetistoachievetheobjectivesoftheprogram,projectorlineof
activityinthemostefficientandeffectivemeansthatarereasonabletothesituationbut
withanequalconcernfortheproperuseofpublicfunds.Inanyenterprise,thisrequiresa
seriesofcontrols.Takentogether,theseformafullcontrolframework.Controlbegins
andendswithafocusontheendstobeachievedandhowtomonitorperformance.
Forthelinemanager,controlsestablishtheextentoftheirdiscretionandoutlinetherules
bywhichtomakedecisions.Effectivecontrolswillensurethatthereisatimely
understandingoftheperformancewithintheorganizationthatwouldpermitadjustments
inbudgets,behavior,orprogramexpectationstoaccommodateunforeseensituations
andmonitortheimpactofmanagersdecisions.
What is Management Control?
Managementcontrolsystemsconsistofallorganizationalstructures,processesand
subsystemsdesigned
to
elicit
behavior
that
achieves
the
strategic
objectives
of
an
organizationatthehighestlevelofperformancewiththeleastamountofunintended
consequencesandrisktotheorganization.8
Management Control Framework
Acontrolframeworkisawayofdescribingthearchitectureofcontrolforthe
organization.Acontrolframeworkwithinanorganizationwillinvolvecertainkeyfeatures:
Establishingtheorganizationsgoalsandobjectives
Assigningroles
and
responsibilities.
Performancestandardswheretheycanbeestablished.
8Systems Theory and Management ControlBy:Dr. Shahid Ansari:http://faculty.darden.virginia.edu/ansaris/Systems%20Theory%20and%20MCS-TN.pdf
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Public Sector Financial Management for Managers 26
Anunderstandingoftherisksinherentintheprogramandthe
environmentalinwhichitistakingplace
Positivemitigationandmonitoringtoolstocontinuallyreassesstherisks
Aseriesofcontrolproceduresandpoliciestobothaddresstherisks
identifiedandtosatisfycertainlegislativeorpolicycreatedrequirements
foradequatecontrol
Asystemofmonitoringatboththeoperationalandfinanciallevelto
ensurethattheorganizationfullyunderstandswhatishappeningrelative
toitsgoalsandtheriskenvironment
Asystemofauditingandevaluation,bothinternalandexternal,that
providesassurance,fromanindependentperspective,thatthereisan
adequatecontrolframework,thatitisworking(andnotjustpaper)and
thattheoutcomes,bothoperationalandfinancial,areastheorganization
claims.
Risk and Risk Management
Inmanyways,actuallyexercisingcontrolmeansanticipatingandmitigatingriskswithin
theorganizationorprogram.ControlisaboutRiskManagement.Riskandrisk
managementhavebothanarrowdefinitionassociatedwithfinanciallossandalarger,
morecomprehensiveoneassociatedwithorganizationalgoalsandthethreatstoattaining
them.Inthecontextoffinancialmanagement,riskmanagementencompassesboth.
Nonetheless,riskcanbroadlybedefinedasfollows:anythreat,event,patternofpastor
anticipatedbehaviourorpredictedeventthatcoulddetertheorganizationfromachieving
itsgoals.
Inapplyingthisdefinitiontopublicsectorfinancialmanagement,thereareclearlysome
conditionsthathavetotakenintoaccount.First,thegoalsofallpublicsector
organizationsaretoperformapublicgoodinthemannerprescribedbylaworpolicyina
costeffectivemanner.Second,itispossibletoreadilyinterpretthisdefinitioninfinancial
termsinanumberofways:
Thedangerofnotmanagingentrustedfundseffectivelyorlegally,
Thedangerofinadequatefundingcombinedwithexaggeratedobjectives,
Thedangerofspendingoverbudgetwithouttakingmitigatingmeasures,
Thedangeroffraudormisuseoffunds,
Thedanger
of
unforeseen
circumstances
that
strain
or
threaten
the
financialcapacityoftheorganization,
Thedangeroflossofconfidencefromthepublic,thelegislature,donorsor
stakeholdersinthecapacityoftheorganizationtodeliveritsservicesas
promised.
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Public Sector Financial Management for Managers 27
Riskmanagement,therefore,istheestablishmentofproceduresandmanagement
systemstoidentify,assess,validate,mitigateandmonitorriskstotheorganizationinsuch
awaytoeliminatethem,effectivelyreducetheirimpactorbepreparedtorespondto
them.
UnderstandingandDefiningtheRisks
Akeypartofriskmanagementinvolvestheneedformanagerstomakedecisionsabout
whatriskstoactonandwhichonesdonotrequireanyactionatthetimeofreview.
.
Notallrisksarethesame.Itisnecessaryfortheorganizationtodecidewhichonesare
importantanddemandingofacertainlevelofmitigationandwhichonesareeithernota
significantthreat,nottimelyoreasilymitigatediftheydooccur.
Anumberofsystemshavebeenestablishedtohelporganizationsdeterminethelevelof
riskthattheycanaccept.Suchsystemsarevaluableastheyestablishacommonlanguage
andframeworkfororganizationstoeffectivelycometoanunderstandingoftherisksthey
faceand
the
meaning
of
their
identification
of
them.
Ensuring
that
all
levels
of
the
organizationsusesuchcommontoolsensuresthatmisunderstandingsaboutrisksandthe
controlneedsthatmayflowfromthemarereduced.
Belowisastandardgridtoenableorganizationtorankriskontwokeyaxes:impactand
likelihood.Withoutdeterminingwhatthelikelihoodandpotentialimpactofanyidentified
risk,thereisnoreasonablewaytodeterminewhattodoabouttherisk.Further,thisis
thekeywaytodifferentiaterisksanddeterminewheretoapplyscarcemanagerial
resourcesinthemitigationprocess.
IMPACT POTENTIAL RISKMANAGEMENTACTIONS
Significant
Considerablemanagement
required
Must manage andmonitor risks
Extensivemanagement
essential
ModerateRisks may be worth
accepting withmonitoring
Management effortworthwhile
Management effortrequired
Minor Accept risks Accept, but monitorrisks
Manage andmonitor risks
LOW MEDIUM HIGH
LIKELIHOOD
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Public Sector Financial Management for Managers 28
Control Procedures and Policies
WhoandWhentoControl
Nowthatwehaveanideaaboutwhereourobjectivesmaybecompromisedthrougha
risk
identification
process,
we
need
decide
how
to
achieve
the
kinds
of
controls
that
are
needed.Theactofcontrollingfinancialresourcesisanactiveonethatboththemanager
oftheprogramandthefinancialexpertshavebeengagedin.Itcannotbelefttofinance
toprovideallthecontroloversight.Itistoocloselytiedtothemanagersresponsibilities
todeliverthepublicgoodforwhichheorsheisresponsible.
Thefirstcontrolquestiontoaskwhencontemplatingthemeansofcontrolis:whoto
controlandwhentodoit.
Intermsofwhotocontrol,therearetwochoices:theorganizationasawholeoran
individual.Theindividualmaybeapersonwithintheorganizationwhoismakinga
decisionto
spend
funds
on
behalf
of
the
organization.
Alternatively,
the
individual
may
be
therecipientofapublicgoodorentitlement.Inmanycases,whentheorganizationisto
bethesubjectofcontrol,thecontrolswillentailinformationatanaggregatedlevelof
performance,e.g.quarterlyreportsoncontractsauthorizedandlevels.Ifitisan
individual,itmaybeattheindividualtransactionlevel.
Intermsoftimeorwhentocontrol,thealternativesaretoexercisecontroleitherbefore
oraftertheindividualororganizationhasacted.Beforethefact,orexante,controlsinvolvesubjectingadecisionthattheorganizationorindividualisabouttomaketosome
levelofapprovalorreviewinadvance. Asanexample,anorganizationmayrequire
approvalfrom
its
central
office
before
purchasing
equipment
over
the
value
of
$50,000.
Thisapprovalisaformofcontrolandrequiredbecauseofthematerialityofthepurchase.
Thisisinspiteofthefactthatpurchaseofthisitemmayhavebeenapprovedaspartofa
largerbudgetplan.
Afterthefact,orexpost,controlinvolvesareviewprocessfordecisionsandexpendituresthathavealreadybeenmade.Insuchcircumstances,theactor,beittheindividualorthe
organization,isfullyresponsiblefortheactionthatwastaken,astheyhadtheauthority
toapproveitandactionwastakenasaresultoftheirauthorization.Forexample,a
chequemaybeissuedontheauthorityofanindividual,notsubjecttoanyotherreview,
excepttoverifythatitistheapprovedofficialwhohasthatauthority. However,some
formof
control,
through
monitoring,
sampling,
summarized
reporting
or
variance
analysis,
isputinplacetooverseethequalityofdecisionsalreadymadeeitheratanindividual,or
aggregatelevel.Thisisthemorecommonformofcontrolexercisedoverfinancial
transactionswithinorganizations.Itismoreefficientintermsofprocessingpayments,
etc.italsofocusespriorapprovalsontheriskiertransactions,therebyeffectively
budgetingseniormanagementandgovernancentime.
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Public Sector Financial Management for Managers 29
WhoistheController?
Thenextquestiontoaskiswhothecontrolleris.Thesimplefactisthat
controller/controlleerelationshipsexistatmanylevelsandoperateinmanyways.
Therefore,whileonemanagermayexercisecontroloveragroupofstaffandsetup
processesofcontrolsuchasregularperformancereviews,delegationtolimitstodefine
discretion,etc.,
that
very
manager
will
almost
certainly
be
subject
to
controls
both
from
asuperiorandalsofromoversightbodiessuchasexternalauditors.Anotherpointisthat
theyareimperfectandoftencloudedbyothermatters,betheyoperational,financialor
political.
Trust and Ethics in Control
Ifriskmanagementisthefaceofcontrolthewayinwhichcontrolisexpressedthan
trustandethicsaretheheartofcontroltheculturalrealitythateithersupportor
destroyeven
the
most
perfect
control
plan.
Fundamentally,allcontrolsarebuiltaroundtwonotions:
thedegreeoftrustthecontrollerplacesintheorganizationorpersonswith
authorityandresponsibility,and
theassumptionsaboutethicalbehaviorinthecultureandlegalframework
oftheorganization.
Trust
Trustisacalculationthatismadebytheorganizationaboutitsownpeople,aboutother
organizationsandotherpeopleaswellasitsleadership.Trustisalsoanimportant
elementin
balancing
the
desire
for
full
assurance
through
control
(no
surprises,
no
errors)
withthecostorimprobabilityinachievingit.Intheend,morecontrolsystems,nomatter
howtechnologicallysoundordetailed,dependonthepeoplerunningthemandoperating
withinthem.Therefore,adegreeoftrustisnecessarilyextendedtooperatorsofthe
systemswiththeassumptionthattheirintentionsaresoundandthat,basedontheir
trackrecord,suchtrustisdeserved.
Ethics
Notallcontrolisaboutsystems,procedures,documentationandprocess.Infact,allof
thiscontrolcouldbehappeningand,withthewrongvaluesinplay,seriousintrusionsinto
pubictrust
could
be
accruing.
This
could
be
either
through
misappropriation
of
public
funds,usingthemforpurposesnotintendedortheirdiversiontootherpurposesofa
personalnature.Itisaxiomaticthatthepublicsectororganizationsandthepeoplewithin
themhavetoactinanethicalmanner.
Therefore,ensuringthattheethicalframeworkoftheorganizationsanditspersonnelis
soundisyetanotherformofcontrol,onethatisessentialtothesuccessofallother
efforts.
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Public Sector Financial Management for Managers 30
Values and Ethics Approaches
Political and senior management leadership that promotes ethicalconduct
Clear statements of values and ethics or codes of conduct Approaches to decision making that
o require consideration of values and ethicso align management policies to support ethical conducto offer recourses to report ethical concerns
Clear guidance for interaction between the public and private sectors Assessment of and reporting on effectiveness of values and ethics
initiatives
Source: Organization for Economic Co-operation and Development (OECD),Principles for Managing Ethics in the PublicService
Oneofthemostimportantelementsofestablishingstrongvaluesandethicsisthrough
ethicalleadershipwithintheorganization.Notethatthisisthefirstitemidentifiedbythe
OECDinitsframeworkforethicalpublicsectororganizations,aslistedbelow:
TheattributesofethicalleadershipweredocumentedbytheCanadianfederal
governmentsTaskforonPublicServiceEthics9:
Createasupportiveworkenvironmentthat
o valuespeople,treatingthemwithdignity,civilityandfairness;o emphasizesopennessandthesharingofinformation;
o promoteshonestandcollegialleadership;
o encouragesandsupportsspeakingtruthtopower;and
o supportsabalancedfamilyandworklife.
Makedecisionsthat
o servethepublicinterest;
o respectdemocraticprinciplesandtheruleoflaw;
o ensuredueprocess,impartialityandobjectivity;
o provideeffectiveservicestocitizens;and
o promotetransparency,
probity
and
accountability.
9AStrongFoundation:ReportoftheTaskForceonPublicServiceServiceValuesandEthics,JohnC.Tait,
Q.C.,Chair,availableathttp://www.myschool monecole.gc.ca/Research/publications/html/p91/1_e.html
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Public Sector Financial Management for Managers 31
Someofthetoolsthatpublicorganizationscananddousetoensurethattheyhave
promotedethicalbehaviourare:
establishingcodesofconductorethicstosignaltheimportantvaluesofthe
organization
supportingsanctionsforethicalmisconduct
usingmeritprinciplesinhiringandpromotion awidevarietyoftraininginitiativesonethicsforbothnewemployeesand
thosealreadyinposition
identificationofhighriskpositions(notpersons)whereeitherspecial
trainingonethicalchallengesorspecialsurveillanceiscalledfor
disclosureofanyconflictsofinterestandpoliciestosupportthis,noting
thatthisbecomesmoreimportantthehighertheleveloftheposition,
toolstorep
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