Financial
Planning and Management in Public Organizations by Alan Walter Steiss
and Chukwuemeka O'C NwagwuFinancial
Planning and Management in Public Organizations by Alan Walter Steiss
and Chukwuemeka O'C Nwagwu
ANALYTICAL TECHNIQUES FOR FINANCIAL PLANNING
The common denominator among the various resources of any organization is the cost involved in their utilization. Therefore, the focus of management is usually on the most effective deployment of fiscal resources. The consequence of past decisions form the basis for much of the financial and cost analysis in complex organizations. Financial planning and management, however, demand analytical techniques that can accommodate the risk and uncertainty inevitably associated with future decisions.
Trends in Local Government Finance
The impetus for sound financial planning and cost control in public organizations arises from a number of factors, including a significant decline in federal assistance, the growing impact of the fiscal limitations movement, and the difficulties of marketing bonds amidst increasing public demand for fiscal accountability. The financial bankruptcy of New York City (1975) and Cleveland, Ohio (1979) thrust financial management into public discourse. However, more recent events, such as the fiscal debacle of Philadelphia (1991), Bridgeport, Connecticut (1992), and Washington, D.C. (1995), and the bankruptcy of Orange County, California (1995), have shaken public confidence in the ability of local governments to manage their fiscal resources. As a result, the financial functions of public institutions have undergone significant, and perhaps permanent, changes. The new reality is that "those responsible for government fiscal resources--finance directors, cash managers and planners, and analysts--will become increasingly entrepreneurial and make decisions in the context of comprehensive economic and financial strategies as they continue to be increasingly constrained by factors outside their control." [1] To be successful, financial managers must be cognizant of the following emerging trends in local government finance: (1) an entrepreneurial outlook, (2) a strategic approach, and (3) increasing interdependence. [2]
An Entrepreneurial Outlook
Financial managers in local government must become more than strictly administrators of their respective areas of responsibility. They must adopt more of an entrepreneurial outlook in their approaches to these responsibilities. The fiscally conservative bent of the nation means that local financial managers must expand their responsibilities from merely controlling the public purse to accommodating the necessity for long-range planning, risk management, and innovative ideas that stimulate and sustain economic growth--factors critical to securing the local revenue base.
A Strategic Approach
Robert Anthony has noted that the budget in the public sector has three important functions: strategic planning, management, and control. [3] As an instrument of strategic planning, the budget should reflect strategic choices made by society. These choices can be used to enhance or retard economic development and to plan for or ignore the future.
The strategic approach requires financial officers to develop cash budgets that will enable the jurisdiction to determine its revenue and expenditure patterns and to project these patterns into the future. Fore-casting enables financial officers to be more aware of the different possibilities and options that can be employed to achieve fiscal objectives.
Increasing Interdependence
As Chapman has pointed out, increased interdependence will occur in two areas. The first is in the political arena, where financial decisions may be both "constrained or enhanced by priorities of various departments within the jurisdiction, by mandates and economic conditions within the U.S." [4] The other area where interdependence occurs is in the budget itself. On the revenue side, for example, actions to enhance the productivity of a particular revenue source could adversely affect the availability of other sources of revenue. An increase in corporate taxes, for example, may result in corporate relocation with a consequent decline in both sales and corporate tax revenue. On the expenditure side, increases in privatization may result in reduced direct labor costs, but the same aggregate costs may still be incurred. Financial managers and public officials must work together to make sound decisions concerning revenue and expenditure trade-offs, based on compelling empirical analyses concerning issues of tax incidence, marginal costs, and opportunity costs.
Analysis of Financial Data
Various indicators have been used for many years in the private sector to measure the well-being of a business with respect to liquidity, leverage, profitability, and the utilization of assets. The indicators, for the most part are derived from the accounting records of the organization. Accounting data reflect important financial dimensions of an organization. However, analysts need to be aware of several inherent weaknesses of accounting data and to interpret their analyses in light of these weaknesses.
First, accounting data do not reflect non-measurables, such as the quality of the services being delivered or the overall performance of the service delivery agents. Performance is measured in terms of a balance sheet, which in the private sector reflects profits and market share and in the public sector, the fiscal objective of "breaking even." Second, accounting data often goes unchallenged because public officials lack the specialized knowledge germane to the accounting statements or to verify the authenticity of some of the data reported by the accountants. Third, accounting data available to the public are aggregates and, as such, lack the details necessary for making informed decisions. Accounting data may also be biased. For example, the valuation of assets in terms of their acquisition cost or market value may result in biased information if the value of the assets has risen. [5].
Strategic Funds Programming
A fundamental approach to financial analysis considers the sources, flow, and uses of organizational resources in an effort to identify discretionary funds that might be used to implement new programs and strategies. This technique provides a future-oriented perspective on financial requirements and potential sources to meet those needs. As such, it can be applied to organizations in both the private and public sectors.
Introducing a new program or strategy is something like attempting to rebuild a ship while at sea. The current organization must be kept afloat and operating properly at the same time as programs are introduced to move the organization into new areas. Managers may become so enamored with the potential opportunities of a new strategy that they fail to provide sufficient support to current operations. [6] In identifying appropriate sources of funds to implement the new strategy, therefore, management must also weigh the fiscal needs of the current organization.
The first step is to determine how current fiscal resources are allocated from period to period. This cash flow analysis can help identify sources of discretionary funds and show where potential adjustments must be made. Generally speaking, an organization can generate new funds from three sources:
(1) Regular operations and other internal sources (such as, profits after taxes, depreciation, disposition of excess inventory or unused facilities, increased revenue through adjusted tax levies).
(2) Expansion of short-term debt consistent with the fiscal structure of the organization (for example, having banks provide extended lines of credit, leasing rather than buying equipment, factoring accounts receivable).
(3) Changes in the fiscal structure of the organization to permit the addition of new long-term debt or equity funds.
Funds accumulated from these sources generally comprise the total funds available for managing the organization's operations. These funds, in turn, fall into categories: baseline funds and strategic funds.
Baseline funds support the current, ongoing operations of the organization. They are used to pay current operating expenses, provide adequate working capital, and maintain current plant and equipment. Baseline funds are used to maintain (a) the same level of production or services, (b) the organization's "market share," or (c) a specified, ongoing rate of growth.
Strategic funds are invested in the new programs required to meet the organization's goals and objectives. They are used to purchase new assets, such as equipment, facilities, and inventory; to increase working capital; and to support direct expenses for research and development, marketing, advertising, and promotions. Strategic funds are also used in the private sector for mergers, acquisitions, and market development. A market penetration strategy, for example, may call for a more intensive investment of funds in the current business. A market expansion strategy usually requires aggressive use of strategic funds for advertising and promotion. A company must use strategic funds to produce more diverse products or services and to develop new markets for them.
The programming of strategic funds begins with the identification of basic organizational units (program or budget units) and the formulation of goals and objectives for these units. The total amount of strategic funds available to the organization can be determined by subtracting baseline funds from total assets (revenue or appropriations). Strategies must be formulated to carry out the goals and objectives of each unit. Once estimates have been made as to the funds required for each strategy, the strategies can be ranked according to their potential contribution to the achievement of the identified goals and objectives. In undertaking this ranking, the kinds of strategic funds available and the level of risk involved must be taken into account. Procedures for dealing with risk will be described in greater detail in a subsequent section.
The available strategic funds should be allocated to each program according to some set if priorities. Key decision points concerning risk and return are encountered (1) when funds available from internal sources have been fully consumed, and (2) when readily available credit sources have been exhausted. At this point, proposed strategies must be evaluated in terms of changes required in the financial structure of the organization. The final step is to establish a management control system to monitor the generation and application of funds to achieve the desired results.
The programming of strategic funds simply identifies feasible options under different fiscal assumptions. A further assessment of risk and return on investment must be made before the final option is chosen. This approach is discussed in further detail in a subsequent chapter under the heading of Service Level Analysis.
Computer-Assisted Financial Planning
In recent years, computer-based methods of analysis have become a significant tool for financial planning. Interactive financial planning software allows the non programmer to use the computer as an on-line, real-time decision support system (DSS) to test assumptions on which a plan is based, to consider the risk associated with different available alternatives, and to explore a range of possible decision scenarios. Traditional methods of financial analysis often can only explain from hindsight why things went right or wrong under a particular plan of action. Computer-assisted methods of fiscal planning, however, provide a basis for the continuous fine tuning of a plan so as to anticipate things to come and adjust to unanticipated events that may arise as the plan is implemented.
In early approaches to interactive financial planning, a fixed structure was used to provide the capacity to pose "what if" questions about certain input variables. These programs usually display the results as pro forma balance sheets or income statements. Simultaneous equations are used to project the organization's fiscal performance. Sales revenues are often the driving force in these models: alternative income and balance sheet projections can be made by using different sales forecasts. The balance sheets show expected changes in assets and liabilities based on various scenarios with regard to sales.
Obviously the results of such analyses are only as valid as the forecasts made by the planners. However, running through different fiscal scenarios increases management's awareness of potential problems and its preparedness to deal with them when they occur.
Individuals lacking experience in computer programming often were unable to use these early models, however, for two reasons: (1) the need to learn a new, unfamiliar computer language that was often difficult to communicate, and (2) the inflexibility associated with procedural languages, which force the user to make input statements in a sequence difference from the structure of the actual problem. Software packages designed to eliminate these problems are now available. Such software is, in the jargon, "user friendly": menus and submenus are written in English and allow users with very little programming experience to select the analytical steps appropriate to their needs. These packaged programs use a nonprocedural approach in which there is no "correct" or predetermined sequence of statements required to describe the problem. Thus, they offer a great deal of flexibility in terms of both model design and subsequent modifications that may be necessary.
Modern interactive packages for fiscal planning provide a number of important options in addition to generating automatic reports for various "what if" questions. Models applicable to the particular conditions confronting an organization can be developed and used (1) to project financial statements, (2) to analyze cash flow requirements, (3) to optimize financial leverage, (4) to compare lease versus purchase options for different depreciation schedules, and (5) evaluate the impact of proposed mergers or acquisitions. Models can often be consolidated or combined so that managers in different functional areas of the organization can use the same fiscal planning package (and assumptions) to design models to meet their particular needs. By combining these models, it may be possible to attain an overall "meta-model" for the whole organization.
Goal-seeking procedures can also be applied in such models. Certain targets (goals) are set by management, and the computer works back from these targets to determine the conditions that will have to prevail to achieve the specified goals. Goals can be viewed as constraints to problem solving; in some instances, it may be necessary to relax some of the constraints (lower the targets) in order to arrive at a feasible solution.
Available software packages also make it possible to perform sensitivity analyses to determine how an optimal solution might change if some of the key variables in the model should change. Models often respond to key assumptions, while the majority of variables may have little effect on the results. Thus, management has a means of selecting those variables that require a more detailed analysis. This selection is the first step in performing risk analysis.
In the application of deterministic models, it is assumed that a single estimate can be specified for each of the input variables. Behind any precise calculation, however, are often data that may not be precise. Taken together, these combined uncertainties could result in a total uncertainty of major proportions. Many computer-based systems for financial planning, however, have the capacity to introduce and analyze risk and uncertainty, as will be discussed in a later section of this chapter.
Analysis of Cost Data
Accounting data can be useful in assessing the internal strengths and weaknesses of any organization. Numbers connote precision, and precision often is assumed to have its own virtue. It is important to recognize, however, that the numbers provided in balance sheets and income statements are condensed from many detailed accounting records and reports. Therefore, any further analyses based on these data must be undertaken with full awareness of the abstractions that have already been made. While accounting data reflect the financial dimensions of an organ-ization, other important factors that may impinge on the overall performance of the organization, however, and must also be considered.
Factors Influencing Future Costs
No program decision is free of cost, whether or not the decision leads to the actual commitment of organizational resources. Choices among alternative strategies for the accomplishment of the goals and objectives of any organization are likely to involve many costs. Such choices include not only the expenditure of money but also the employment of human resources, the consumption of physical resources, and the use of time--all critical commodities in any organization.
Often the tendency is to consider costs strictly in terms of dollar inputs--the financial resources required to support personnel, equipment, materials, and so forth. Future costs that cannot be easily measured in dollar terms all-too-often are dismissed as noncost consideration. Such costs, however, may have important implications beyond their measurable monetary value.
The program manager must be cognizant of the following factors that influence future costs:
(1) Scope and quality of the services or products to be delivered.
(2) Volume of activity required to deliver these services or products.
(3) Methods, facilities, and organizational structure required to perform these activities.
(4) Qualities and types of labor, materials, equipment, and other cost elements required by these programs.
(5) Price levels of the various cost elements.
These cost factors should be considered: (1) in the development of plans and programs; (2) in the preparation of budget requests; and (3) after commitments have been authorized, as programs or projects enter the implementation phase.
Many activities can be measured in terms of units of production (workload measures). Current records of personnel activities may provide sufficiently accurate and reliable data to determine workloads. In some cases, however, it may be necessary to undertake more extensive analyses of the nature and scope of the activities involved. Further refinements are possible where cost accounting procedures have been adopted.
Having established the volume of work required to perform certain activities, it may be appropriate to examine alternative methods and organizational approaches to determine if greater efficiency and effectiveness can be attained. Work methods should be analyzed to establish the appropriate mix of personnel, equipment, supplies, and other operating requirements to do the job with the least effort and at the least cost. Particular attention should be given to possible increases in productivity through simplified procedures and the use of labor-saving equipment.
Personnel costs are subject to management control in two important areas: salary rates and job classifications. Periodic reviews should be made to see that each employee has the proper work assignment in view of his or her pay rate. All-too-often, skilled employees with higher pay classifications are assigned tasks that lower-rated persons should perform. Eliminating positions at the lower end of the pay scale may result in serious false economies if higher-paid personnel eventually have to do the work previously assigned to these positions.
Changes in salary plans should be made only after a thorough study of such factors as trends in the cost of living, rates paid by comparable organizations, and fringe benefits, including sick leave, vacations, extra holidays, and security of tenure. Often, improved fringe benefits can provide a bigger "payoff" to employees than increases in salaries and wages, which are likely to be subject to a larger "tax bite." Sound personnel and compensation policies will yield economic benefits to the organization in the long run.
Prices for materials and equipment can be controlled to some the extent by scheduling purchases to take advantage of the lowest price consistent with necessary quality. Price trends of frequently used commodities should be continuously analyzed, and appropriate inventories should be maintained for those items subject to price fluctuations. At the same time, the cost of maintaining inventory (space requirements, shelf life, anticipated price changes, and so forth) also must be considered.