Click here for Full Text
V. BUDGETING AS A MECHANISM FOR FINANCIAL PLANNING AND MANAGEMENT
Budgeting is a cyclical decision-making process for allocating limited fiscal resources to achieve organizational priorities and objectives over a specific time period.
BUDGETING: KEYSTONE OF GOVERNMENT ACTIVITIES
In the public sector, a budget is:
o A control mechanism --a budget seeks to assure fiscal integrity, accountability, and legal compliance--the traditional role of the budget.
o A management tool--a budget can be used to achieve operating economies and performance efficiencies.
o A component of planning--a budget must reflect public goals and objectives and the overall effectiveness of government programs in meeting public service needs.
Principal and Practices of Public Budgeting
A budget represents the culmination of a complex decision process whereby policy is translated into operating programs and both legislative expectations and management controls are established.
A budget provides the legal basis for spending and accountability.
o Revenue and expenditure information is structured to facilitate the continuous monitoring, evaluation, and control of financial resources.
o Financial authority and responsibility can be delegated, while appropriate central control is maintained.
Operating and Capital Budgets
An operating budget:
(1) Provide the basis for revenue measures and adjustments to fiscal policy.
(2) Facilitates the scheduling of work and the coordination of personnel and nonpersonnel service requirements
(3) Establishes the parameters for fiscal audits and performance evaluations both during and after the close of the fiscal year.
(4) Provides the basis for an ordinance or resolution to authorize agencies to incur obligations and to make payments with respect to these commitments.
A capital budget identifies the capital expenditures required to meet public improvement needs and the means of financing these commitments for the current fiscal year.
o A capital improvements program documents improvement priorities over a longer time period (usually five to six years).
o A capital facilities plan encompasses an even longer time horizon (15 to 20 years)to provide an analysis of financial resources available to support long-term debt
The Budget Cycle
The budget process involves four steps: (1) executive preparation; (2) legislative review, modification, and enactment; (3) budget execution; and (4) post audit and evaluation.
The budget cycle begins with the issuance of a budget call, outlining: (1) goals and objectives; (2) anticipated fiscal policies; and (3) specific performance expectations.
o A budget manual details policies and special instructions to guide the budget preparation.
o A budget calendar sets forth key dates and assigns responsibility for carrying out the preparation of the budget.
o Budget justifications place agency programs into overall perspective and may include measures of efficiency and effectiveness.
o The budget document should provide a clear picture of the programs to be carried out and the financial basis to support these activities.
The governing body holds public hearings, may make amendments to the proposed budget, and then may approve the budget by resolution or by adopting a separate appropriation ordinance which list specific amounts for specific agencies by specific categories of expense.
Budget execution procedures include: (1) appropriations, (2) allocations and allotments, (3) expenditure controls, and (4) adjustment.
o Appropriations represent the legal authority to spend.
o Initial accounting entries formally record the budget for the fiscal period, at the level of detail specified in the appropriations.
o An allocation process subdivides the budget according to objects and/or character of expenditure, activity, organizational units, programs, and/or functions.
o An allotment system further subdivides budget allocations into time elements--for example, monthly or quarterly allotments for personal services or for some items in the nonpersonal service categories--when expenditures are contingent upon some future event, e.g., the availability of grant funds or the projected opening of a new facility.
o Specific allocations may be encumbered--reserved from the appropriation at the outset of the fiscal year--and then liquidated on an "as billed" basis to ensure that funds will be available at the time needed and will not be spent for other purposes.
o Expenditure control mechanisms include: (1) line-item appropriations that earmark funds for specific purposes; (2) requirements that transfers between major line-items be approved by the governing body; (3) mandatory expenditures imposed by the state legislation (e.g., for education); (4) monthly or quarterly budget reports to assess the overall progress toward the attainment of program objectives within the authorized levels of funding; (5) audits at the close of the fiscal year.
The accounting process should provided sufficient information to anticipate budget amendments during the fiscal year.
Internal and External Audits
Internal audits are conducted by in-house staff and result in reports for internal control purposes.
External audits are conducted by independent accountants after the fiscal year has been completed and are submitted to the regulating state agency (such as the Auditor of Public Accounts), as well as to the local governing body.
o Fiscal compliance has been the traditional emphasis of the post audit--an assessment of financial transactions for accuracy, legality, and fidelity.
o Management audits assess efficiency and economy of resource utilization and examine the adequacy of management information, administrative procedures, and organizational structure.
o Program audits determine whether program objectives have been met and the desired benefits achieved and examine alternative approaches that might yield the desired results at lower costs.
Several alternative budget formats have been developed to meet the broad objectives of fiscal management and control.
These budget formats arose from the fiscal management needs at a particular point in time; each reflects varying decision-making capacities; and each have varying management information needs and output capacities.
Historically, the budget has been viewed as an extension of the accounting and management control system.
Budget requests are supported by detailed objects of expenditures--tabulations of the myriad items required to operate each program, including salaries and wages, rent, office supplies, travel, equipment, and other inputs.
The detail of projected expenditures may be backed up by a personnel schedule which identifies specific authorized positions (i.e., by job titles) and salary commitments of each position.
The object of expenditure budget has two distinct advantages:
(1) Accountability--a pattern of accounts is established that can be controlled and audited; each object of expenditure is documented; and
(2) Management control--deviations above a certain percentage in terms of specific object codes may require approval of the governing body.
Since personnel requirements are closely linked with other budgetary requirements, the control of positions can be used to control the whole budget.
Object classifications show in great detail what is purchased, but not why, i.e., the nature of organizational programs and accomplishments under those programs.
Three components distinguish performance budgeting from other budgetary approaches:
(1) Identification of work programs for management purposes;
(2) Delineation of performance units; and
(3) Efforts to measure performance costs.
The principal focus of the performance budget is at and below the departmental level, where the work-efficiency of operating units can be assessed.
Program budgeting combines a planning framework with the basic functions of management and control.
A program is a distinct organization of resources directed toward a specific objective of either: (a) eliminating, containing, or preventing a problem; (b) creating, improving, or maintaining a condition affecting the organization or its clientele; or (c) supporting or controlling other identifiable programs.
Program objectives must be consistent with the resources available (or anticipated). Specific objectives must describe how and where specific resources (personnel, equipment, materials, capital expenditures, etc.) will be used.
Measures of efficiency and effectiveness provide a "base line" against which to test the notion of program adequacy.
Zero-base budgeting addresses the shortcomings of incremental budgeting, i.e., the continuation of existing programs without periodic re-examination as to their effectiveness and efficiency.
Detailed analyses of programs "to the zero base" have been replaced by the concept of levels of effort.
Responsibility Center Management
Under Responsibility Center Management, all sources of financial support (revenue or income) and all costs--direct and indirect--are attributed to responsibility centers on some equitable and consistent basis.
Costs associated with internal service units (i.e., units which do not receive revenue or income from external sources) are either charged to the responsibility centers on a fee for service basis or are recovered from the responsibility centers through some form of assessment.
Deficits or shortfalls between total costs and revenues/income must be covered through some form of subvention--i.e., a central allocation to ensure the continued operation of programs.
THE NEED TO INTEGRATE PLANNING, MANAGEMENT, AND CONTROL
Contemporary techniques emphasize the planning function but have not been well aligned with appropriate management control and accounting procedures and often fail to produce the desired improvements in terms of more efficient, economical, and effective operations.
Control and Accountability
A budget built on objects of expenditure frequently is called a line-item budget, since proposed expenditures are detailed with great specificity, resulting an array of lines within the budget.
Object codes--three-digit or four-digit numbers--are used to budget and record expenditures in considerable detail.
o Object codes can be further subdivided into subobject classifications--for example, 1200 contractual services can be broken down into: 1210 general repairs; 1220 utility services; 1230 motor vehicle repairs; 1240 travel; and so forth.
o Objects of expenditures can be aggregated under broad expenditure characteristics such as for current operations, capital expenditures, and debt service.
o They also can be recorded as the expenditures of a specific organizational unit, activity classification, program or subprogram, and/or basic function of government.
The object-of-expenditure budget, with its detailed recording of spending requirements and subsequent commitments, provides a most effective basis for fiscal control.
Expenditures can be controlled within relatively narrow, predetermined limits.
The objectives of fiscal control are supported by the financial accounting systems that were developed in parallel with the object-of-expenditure budget.
Work Programs, Activity Classifications, and Performance Measures
The performance budget is envisioned as a series of work programs related to particular processes or functions carried out by governmental agencies.
Activity classifications relate activities to the work responsibilities of distinct operating units and can be applied to: o Processes--the various steps in carrying out the work program of a budget unit.
o Projects that go to make up the total activity areas of an agency.
o Purposes--activities grouped according to broad functions or by clientele.
A performance unit can be described as a team of workers responsible for carrying out a specific task or series of tasks.
Performance costs are those costs directly associated with carrying out these activities.
Unit cost measures aggregate relevant costs associated with the delivery of a particular service and divide these costs by the total units of service provided.
Workload measure relate to the volume of work performed during some time period.
Performance measures--workload or output measures related to unit costs or input measures -- are used as indicators of operating efficiency--e.g., the cost per patient-day of hospital service; the number of cases successfully prosecuted per law enforcement officer; or the response time involved in providing paramedical services.
Program budgeting provides the basis for resource allocation procedures that incorporate the basic objectives of accountability, efficiency, and effectiveness.
A program should facilitate the comparison of alternative methods of pursuing imperfectly determined objectives.
o Programs are concerned with time spans beyond the current fiscal period.
o Program objectives must be consistent with the resources available (or anticipated).
Programs may be subdivided into component parts--subprograms and program elements.
o More specific objectives and activities can be associated with each component.
o Subprograms resources often are interchangeable and an agency must determine how resources are to be distributed among the subprograms to achieve the optimal output.
Program analysis seeks to:
(1) determine whether particular program or proposal is justified,
(2) rank various program alternatives appropriate to a given set of objectives, and
(3) ascertain the optimal course(s) of action to attain such objectives.
Program evaluations may be carried out to:
(1) suggest changes in resource allocations,
(2) improve current operations, or
(3) plan future activities.
Multi-year program plans often are developed to identify the anticipated outputs of services and facilities according to the program and subprogram objectives.
Program and subprogram objectives identify key results to be accomplished within a specific time period; they should be:
o Quantifiable or verifiable.
o Realistic and attainable, but should present a challenge to improve conditions, consistent with existing governmental policies and procedures.
o Consistent with the resources available or anticipated.
o Capable of assigning pecific responsibility and accountability, even when joint efforts among agencies are involved.
Measures of efficiency and effectiveness provide the mechanisms for determining the success (or lack thereof) of a program element in achieving agreed-upon objectives.
The output of many public programs may be difficult to define and secondary measures--called surrogates--must often be used to evaluate costs and to test alternative approaches.
Program budgeting provides a more rational basis for resource allocations by identifying data on costs and benefits and by providing measurements of effectiveness and efficiency.
o Program crosswalk techniques provide a basis for translating traditional budget data into program terms.
o A crosswalk can also be used to provide budgetary information in the more traditional line-item format.
Resources are allocated on the basis of goals, objectives, and strategies.
o Performance expectations are translated into measures of effectiveness and efficiency.
o Program results (actual performance) are evaluated on the basis of planned performance.
o Meaningful cost-effectiveness or cost-benefit analyses can be developed by interrelating key indices from both of these measurement sets.
Service Level Analysis
Limitations of traditional practices of budgeting and accounting are becoming more widely recognized:
(1) Traditional accounting and budgeting practices provide relatively little useful manage-ment information about: (a) the type and level of services provided, (b) the objectives and beneficiaries of the services, or (c) the special resources required in the provision of specific levels of service.
(2) Conventional practices provide few mechanisms to help make choices or to identify the trade-offs among different services on anything approaching a cost-benefit basis.
(3) No meaningful processes exist: (a) to predict how significant changes in funding will affect service delivery, (b) to determine the benefits in services afforded by increases in funding, or (c) to identify the absolute minimum level of service that must be provided.
Service level analysis is applicable to all actionable programs or activities--those in which there is some discretion as to the course of action to be pursued.
o All government activities that compete for general fund revenues (or the equivalent in other public organizations) should be included in the service level analysis.
o Other special funds, such as intergovernmental grants and formula-funded programs, should be identified to determine their importance to other organizational activities.
Service level analysis can assist in the identification of the public costs of constraints imposed by law or statute, intergovernmental commitments, or other legal or fiscal constraints.
Budget units are the basic building blocks responsible for the delivery of services and often correspond to established divisions within the departments or agencies of local or state government or other public organization.
Decision packages are discrete sets of services, activities, and resources required to carry out a given operation or accomplish a program objective.
o Decision packages may involve different methods for delivering a service or alternate approaches that use "more" or "less" of the same basic resource inputs.
o A decision package should be described in such a way that it can be evaluated and ranked against other packages competing for the same limited resources.
Minimum service levels include only the most essential elements or activities within chosen decision packages--the highest priority services or the most critical needs of the government or organization.
o A percentage of the current level may be arbitrarily set as the minimum level--typically, 65 to 80 percent of the current appropriation.
o Each succeeding level should expand the services available until the level of service equals or exceeds current service standards.
Each level of service must be analyzed in terms of the specific quantities and qualities of work to be performed (and services to be provided).
o Appropriate costs should be assigned to each level, and potential service impacts should be described.
o The resources required to deliver each level of service should be summarized for each budget unit, including detailed costs to be met from all funding sources and a listing of personnel, equipment, and other major resource requirements.
Ranking establishes an order or priority among service levels for various activities.
Three approaches can be used to bring proposed expenditures and projected revenue into balance:
(1) Funds can be withheld from the lowest priority service levels.
(2) Efforts can be made to reduce the cost of providing one or more levels of service.
(3) Resources can be increased (for example, by increasing service fees, raising taxes, or liquidating assets).
Funds are allocated to the service levels in order of priority until anticipated resources are exhausted; at this point, a funding "cutoff line" is draw and those services below the line are not funded.
Decision makers are often forced to make across-the-board cuts; service level analysis minimizes this need by creating an explicit priority listing.
A number of organizational and fiscal management improvements can be achieved through the use of service level analysis, including:
(1) Better control of expenditures, reductions in costs, and more effective allocation of fiscal and other resources.
(2) Fuller diagnoses of service needs and greater equity in service delivery.
(3) Improved managerial insights into agency activities and operations.
(4) Increased involvement of operating managers in budget formulation procedures.
(5) Increased credibility of program identification through the establishment of long-range objectives.
Responsibility Center Budgeting
For purposes of budgeting, controllable costs are defined as those costs subject to the influence of a manager of a given program or organizational unit during a given time period.
Noncontrollable costs include all costs that do not meet this test of "significant influence" by a given manager.
Under responsibility center budgeting, all pertinent costs and the revenue to support these costs are assigned to various organizational units designated as responsibility centers.
Costs assigned to responsibility centers should be separated between direct and indirect costs.
o Not all indirect costs are controllable at the responsibility center level, and therefore, a further distinction may be made between controllable and noncontrollable indirect costs.
o A service center may be assigned only the controllable portion of indirect costs, whereas a cost center is fully burdened with controllable and noncontrollable indirect costs.
Once income/revenue and costs have been fully allocated to responsibility centers, in all likelihood, there will be some "deficits" (i.e., where assigned costs exceed income/revenue) which will have to be addressed through some form of subvention.
A project budget represents a portion of the total agency budget for a given fiscal year which may be partially funded by external funding sources.
Project budgets often are prepared for more than one fiscal period and therefore, provision must be made for salary adjustments and inflation.
Extramural funding sources may permit the recovery of indirect costs, i..e, costs that support more than one activity or program within an agency or organization.
Planning, programming, and budgeting are complementary activities in the management process.
o Planning points up needs.
o Programming involves the ordering of proposed activities and projects based on some identification of priorities.
o Budgeting entails the assignment of "price tags" to the implementation of these priorities over a reasonable time period.
The object-of-expenditure budget serves well the purposes of internal fiscal control by offering two distinct advantages over other budget formats:
(1) the close linkage between personnel and other budgetary requirements permits the use of position controls to control the entire budget, and
(2) a detailed set of accounts is established through which expenditures can be recorded, controlled, and audited.
Performance budgeting identifies performance units within work programs and measures performance costs through the use of cost accounting techniques.
The extended time horizon of the program budget shifts the decision focus from the one-year budget cycle to a multi-year time frame, thus providing a more comprehensive basis for annual budget deliberations. The focus of program budgeting is on policy analysis and planning.
Service level analysis seeks to identify budget units and decision packages. By arranging levels of service in descending order of importance and determining a funding cutoff point, alternative approaches can be ranked according to their capacity to meet program objectives.
Each of these budget formats has obvious strengths and weaknesses--by combining the positive points of each format in a hybrid approach, public organizations should be able to develop budget systems that better serve sound fiscal management objectives.