Financial Planning and Management in Public Organizations by Alan Walter Steiss and Chukwuemeka O'C Nwagwu


Budgeting is a cyclical decision-making process for allocating limited fiscal resources to achieve organizational priorities and objectives. A budget can be defined as "the financial articulation of the activities of a government unit. . . which recognizes anticipated revenues, authorizes activities, and appropriates expenditures" for a specific time period. [1] Budgeting involves the systematic evaluation of prior commitments and their con-sequence in terms of anticipated outcomes or accomplishments. Properly applied, budgeting can contribute significantly to greater efficiency, effectiveness, and accountability in the overall management of an organization's financial resources.

Budgeting: Keystone of Government Activities

The budget is the most important policy document at all levels of government. Always voluminous and complex, "budgets simultaneously record policy decision outcomes, cite policy priorities and program goals and objectives, delineate a government's total service efforts and measure its performance, impact and overall effectiveness." [2] A number of issues, such as the size, scope, and composition of budgets at all levels of government currently dominate public discourse and are likely to do so in the future.

The preoccupation with the budget process stems from the increasing inability of government to deal with the rise of public expenditures, taxes, deficits, and debt. The ever pervasive federal budget deficit is now viewed as the nation's number one political and economic problem, As Allen Schick has augured, budgeting is central to all government activities. "The capacity to govern is the capacity to budget." [3] As the United States remains marred in deficit, the President and Congress are deadlocked in political grandstanding over budget and program priorities, new spending cuts and/or taxes, and other fundamental philosophical differences. The budget is the link between political and economic choices.

Principal and Practices of Budgeting

A budget is more than a fixed document, presented annually for review and approval by a governing body. Budgeting represents a complex decision process whereby (1) policy is formulated, (2) action programs are put into effect, and (3) both strategic and management controls are established. As Gladstone once remarked, "budgets are not merely affairs of arithmetic, but in a thousand ways go to the root of prosperity for individuals, the relations of the classes, and the strength of the kingdom." [5] The annual cyclical nature of the budget process should not be misinterpreted as an inflexible routine. The needs of the public, citizen interests, organizational technology and service delivery systems tend to change over time. Budgets must have the capacity to adapt to these environmental dynamics.

Budgeting has always been viewed as a process for systematically relating the expenditure of funds to the accomplishment of planned objectives. [6] Against this backdrop, the budget process must cope with the unprecedented problems of priorities, expenditures, revenue, and debt financing. A budget represents the culmination of a complex decision process whereby public policy is translated into action programs, and both legislative expectations and management controls are established. In so doing, the budget will encompass many interrelated functions, including: (a) allocating resources (b) raising revenue, (c) stabilizing the economy, (d) holding operating agencies accountable, (e) controlling expenditures, (f) facilitating the intergovernmental transfer of funds, (g) achieving planned objectives, and (h) managing programs and projects. [7]

Thus, it is possible to define more clearly what the basic objectives of budgeting can and should be. A budget can be defined as a comprehensive plan, expressed in financial terms, by which an operating program is effective for a given period of time. It includes estimates of: (a) the services, activities, and projects to be carried out, (b) the resulting expenditure requirements, and (c) the resources usable for their support. [8] A budget provides the legal basis for spending and accountability, especially in not-for-profit organizations. Through the budgeting/ accounting process, revenue and expenditure information is structured to facilitate the continuous monitoring, evaluation, and control of financial resources. Financial authority and responsibility can be delegated, while appropriate central control is maintained.

The process itself provides a framework for making decisions about the size, allocation, and financing options appropriate to achieve program and policy objectives. Goal determination and the proportion of resources to be allocated for the accomplishment of these goals "are the very real stuff of politics." Consequently, the attempt to allocate scarce resources among competing objectives generate intense conflict among the participants in the budgetary process. Budgeting is conflict-ridden every step of the way, and the smaller the available resources, the more intense will likely be the conflict.

As the debate over the national budget bears out, the budget process is extremely political and seriously contentious. The figures tell who won, who lost, or who stay even in the conflicts over available resources. The budget also summarizes the total work program of the government for the fiscal year. "Agency by agency, program by program, and project by project, the budget incorporates thousands of decisions on what will be done and at what cost." [9]

Budgeting also involves decision-making under conditions of uncertainty, where such decisions may have significant long-term consequences. The purpose of budgeting should include both policy formulation and program management. Before a budget is proposed, goals and objectives should be formulated, policies analyzed, and plans and programs delineated. The financial commitment to organizational programs is (or should be) a clear declaration of policy. The fiscal stewardship that builds on the budget is a primary responsibility of management. Public budgeting also serves as a substitute for mechanisms of the economic market system. It is the process by which decisions are made regarding "who gets what."

Operating and Capital Budgets

A distinction often is made between an annual operating budget and a capital budget. The annual operating budget includes as estimate of expenditures in such areas as salaries, wages, contractual services, materials and supplies, and other "consumables" which, in turn, must be balanced against the recommended revenue program. for the coming fiscal year. The operating budget provides information to each successive level of management as a basis for evaluating competing requirements for limited financial resources. Although the budget sets limits on spending, adoption of the annual operating budget should be viewed as a positive act. Emphasis on the control aspects of budgeting often results in a negative perception of the process, which can adversely affect the execution of the budget.

An operating budget:

(1) provides the basis for the adoption of 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 a fiscal audit and performance evaluation both during and after the close of the fiscal year.

(4) provides the basis upon which the governing body may adopt an ordinance or resolution which authorizes agencies to incur obligations and to make payments with respect to these commitments.

A capital budget identifies the capital expenditures to be incurred to meet long-term needs for public improvements (capital facilities) and the means of financing these commitments for the current fiscal period. A capital budget often is supported by a capital improvements program, which documents improvement priorities over a longer time period (usually five to six years). A capital facilities plan, encompassing an even longer time horizon (15 to 20 years), may also be developed to provide an analysis of the fiscal resources available to support long-term debt commitments.

Capital budgeting has been a vehicle of financial planning and man-agement for local and state governments since the early 1900s. The first Comprehensive Capital Investment Plan was introduced in Kalamazoo, Michigan in 1921, but elements of capital budgeting date back to 1681, when the first capital program was developed for the City of Philadelphia under the direction of William Penn.

The budget for a specific project or program may include capital commitments. These anticipated capital expenditures, in turn, should be reflected in the overall capital budget of the jurisdiction. The principal resource allocations to support the activities of public agencies, however, are reflected in an operating budget, that is, a budget subject to periodic (e.g., annual) review and authorization.

Different budgeting and accounting principles and procedures are associated with each of these basic budgets. The balance of this chapter will focus on the annual operating budget. The next chapter is devoted to the planning and budgeting of capital facilities.

The Budget Cycle

Budgeting requires careful scheduling to ensure adequate time and information for sound decisions. The budget process involves four major steps: (1) executive preparation; (2) legislative review, modification, and enactment; (3) budget execution; and (4) post audit and evaluation. These steps must be undertaken in an orderly sequence with responsibility for the performance of each step clearly assigned if important deadlines are to be met and the mass of detail required in the budget process is to be coordinated.

The budget cycle begins with the issuance of a budget memorandum or budget call, outlining: (1) established goals and objectives; (2) anticipated fiscal policies; and (3) specific performance expectations. A budget manual details the policies and special instructions to guide the preparation of the budget. A budget calendar sets forth key dates and assigns responsibility for carrying out the preparation of the budget. Controlling dates of the budget calendar for local governments often are set by state law, city charter, or local ordinance. The budget calendar should identify important deadlines, such as the date for submitting the budget to the governing body, for legislative adoption, and for setting the annual property tax levy and millage rate.

Budget targets may be established as part of the budget call, reflecting preliminary estimates of revenue potentials. Budget justifi-cations may be required to place agency programs into overall perspective and may include measures of efficiency and effectiveness.

The total time for the annual budget preparation cycle may vary from four to six months in larger cities and from two to three months in smaller municipalities and other public jurisdiction. The time required for each step will also vary with the size of the jurisdiction, established legal requirements, and the type of budget format applied.

The Executive Budget

The chief executive has primary responsibility for the preparation of budget estimates and for the development of a preliminary budget document. The executive budget is then presented to the governing body for review and adoption. In larger jurisdictions, the chief executive may rely on a budget office, a finance department, and financial planning analysts to develop the background information and financial details necessary to support the budget document.

A budget guidance memorandum should be issues to all organizational units, along with a set of instructions for competing the required forms and supporting justifications. The guidance memorandum should outline: (1) anticipated fiscal policies, (2) agreed-upon goals and objectives, and (3) performance expectations of the current administration. Statements outlining the overall programs of the organization should establish appropriate levels of program activity or service for the various component units. These service levels should be further specified in the budget submission of each unit.

The required budget forms should be completed by each unit, reflecting the most appropriate assignment of resources--personnel, equipment, materials and supplies, and so forth--to carry out its program responsibilities. Board goals and objectives identified in the guidance memorandum may have to be further refined in order to place specific agency programs within this broader perspective. Various performance measures and measures of effectiveness may be required in the budget justifications. These justifications may also include a priority listing of all programs. Major policy issues or administrative problems, if any, should be identified, and requirements for new organizational policy or legislation should also be outlined, as appropriate.

The central budget agency checks agency submissions for completeness and accuracy. Agency requests are then compiled into a preliminary document to provide an overall summary of total dollar needs. State laws usually prohibit local jurisdictions from making expenditure commitments that exceed revenue expectations. Preliminary estimates may also be prepared by the budget staff to reflect changes in employee compensation and benefits, estimates of debt service requirements and interfund trans-fers, and any policy changes inherent in agency budget requests.

The Budget Document

Balancing expenditure requests against total anticipated revenues is a major budgeting task for the chief executive and his or her staff. Since department heads are concerned primarily with the operations of their own units, the budget requests they submit, in the aggregate, usually exceed estimate revenues. Thus, the process at this stage is often one of budgeting cutting to bring the total budget into line with overall fiscal constraints. It may be necessary and appropriate, however, to identify new or modified fiscal policies to provide the resources necessary to meet justified program needs.

Department head should be given an opportunity to meet with the chief executive to explain or defend all, or selected portions, of their budget submissions, Such meetings may be wide-ranging in scope, or they may be restricted to a few points requiring further clarification prior to a final executive decision.

The executive budget document should provide a clear picture of the programs to be carried out and the fiscal resources to support these activities. This document must be designed so that it can be readily understood by members of the governing body and program managers, as well as by financial experts. Important factors in an effective budget presentation include a well-constructed budget message, carefully chosen summaries, and the use of tables and charts to explain service programs and the interrelationship among various elements of proposed financial commitments.

Budget Adoption

Every effort should be made to provide a full explanation of the budget in terms of the range and scope of services it represents. The governing body should receive more than a thick document, with page after page of exhibits, offering little or not explanation of the services to be provided or the intent of the administration. Handed such a document, members of the governing body tend to focus on details of expenditures, such as the amount requested for office supplies, publications, and so forth. Such nit-picking over details arises from the absence of any broad explanation of the programs to be undertaken. As a consequence, important policy decisions--for example, determining appropriate levels of service--may never be directly addressed. The governing body may wish to consult with the chief executive and budget staff for detailed explanations of the proposed programs and the means of financing them.

In local government, public hearings generally are required by law so that citizens may express their sentiments on the budget. These hearing should be widely publicized. Although relatively few citizens attend unless they are irate over some aspect of the budget, public officials should be prepared for surprises. The turnout may be much larger than anticipated, and officials must be prepared to answer any and all questions.

A summary of the tentative budget may be published, together with a notice of the time and place of the hearing. On the basis of these hearing and subsequent executive sessions, the governing body may make amendments to the expenditure portion of the budget and to the proposed revenue measures.

The governing body may approve the budget by resolution, or it may adopt a separate appropriation ordinance which lists specific amounts for specific agencies by specific categories of expense. An appropriation ordinance provides a more effective bench mark for budget administration and post-auditing. Care must be taken, however, not to limit the ability of agencies/programs to adjust to changing conditions in order to implement activities during the fiscal year.

Budget Execution

The preceding steps in the formulation and review of the budget are of relatively little consequence if the budget is not properly administered. Budget execution is both a financial process and a substantive operational process. Authorized projects and programs must be initiated within an established time schedule, within monetary limits, and ideally, within standard cost limits. Budget execution is the longest stage in the budget cycle, covering the full fiscal year and overlapping the formulation and review stages of the budget for the succeeding and prior years, respectively.

Budget execution procedures vary considerably from one public organization to the next. In some cases, these procedures consist of little more than "cash flow bookkeeping," whereby actual expenditures are recorded in accordance with predetermined system of accounts. In more advanced systems, however, the steps in budget administration include: (1) appropriation, (2) allocation and allotment, (3) expenditure control, and (4) adjustment. Under these procedures, the budget is viewed as both a mandate for and a limit on expenditures. The budget contains estimates of revenues to be collected, and the operating and accounting cycles of government are based on the budget.

In government, an appropriation represents the legal authority to spend. As a rule, such authority is very specific about how much each agency can spend, and for what. The budget contains estimates of the revenues to be collected, and the operating and accounting cycles are based on the budget. The fiscal period begins with the effective date of the budget. The budget is formally recorded by the initial accounting entries for the fiscal period, at the level of detail specified in the appropriations.

The budget is further subdivided through an allocation process. Allocations may be identified in the budget document or may be made administratively in executing the budget. Allocations can be made according to objects and/or character of expenditure, activity, organiza-tional units, programs, and/or functions. The budget of the Public Health Department, for example, might be subdivided through the allocation process to stipulate amounts for outpatient clinics, public health nurses, a community mental health program, and so forth. Allocations are often made for personal services (salaries, wages, and fringe benefits) and for operations, with further subdivisions by major line-items (such as travel, materials and supplies, and fixed assets or equipment).

Provision may also be made for an allotment system, whereby budget allocations are further subdivided into time elements--for example, monthly or quarterly allotments for personal services or for some items in the nonpersonal service categories. A system of allotments is particularly appropriate when expenditures are contingent upon some future event, such as the availability of a federal or state grant or the projected opening of a new public facility. For example, assume that the Fire Department's budget makes provision for utility services in a new fire station. These funds should not be made available before the new station is completed and opened. Under this an approach, the portion of the budget in question remains unallocated until it is required for actual commitment. Thus, if the facility is not completed on schedule, moneys initially earmarked for these purposes are restricted until required for the originally approved use. The basic function of the allocation and allotment processes is to assign elements of the overall budget to specific categories of expenditure to ensure that the funds are reserved for those categories.

Expenditure Controls

Budgetary accounting provides the principal control mechanisms for enforcing allocation, allotment, and appropriation limits. The techniques of budgetary accounting will be discussed in further detail in a subsequent chapter. An encumbrance system is perhaps the important feature of budgetary accounting in terms of controls on expenditures.

Specific allocations may be encumbered--reserved from the appropriation at the outset of the fiscal year. These commitments are then liquidated on an "as billed" basis--for example, payments for employee benefits, legal services, or consulting fees. The purpose of an encumbrance is to ensure that these funds will be available at the time needed--that they will not be spent for other purposes. In addition to all actual expenditures, commitments for goods and services that have been ordered but not yet received must be recorded in an encumbrance system. In this context, an encumbrance simply records the placing of a purchase order or the letting of a contract against the appropriation or allocation.

The basic function of an encumbrance system is to protect against a "floating debt"--incurring fiscal obligations in excess of appropriated or allocated funds. Suppose, for example, that sizable maintenance agreements, payable in four quarterly installments, are required on computer hardware leased from vendors. These payments may be scheduled so that the final quarter can be deferred until the next fiscal year, thereby freeing up additional operating funds to meet the day-to-day expenses of the computing center. Such deferred bills, however, become a burden on the next fiscal period. The appropriation/allocation for that subsequent period may become exhausted prematurely, thus encouraging further deferrals. Although the computing center may appear to stay within its budget for any given fiscal period, eventually the accumulated debt must be funded. An encumbrance system is designed to prevent this type of problem.

Other mechanisms through which the local governing body is can control specific expenditure are: (1) line-item appropriations, (2) detailed controls on specific funds, (3) periodic budgetary reports, and (4) audits at the close of the fiscal year. Line-item appropriations--funding for specific, detailed spending purposes--became so commonplace in the era of fiscal control that the budget format has come to be known as a line-item budget. The governing body may retain some control in the budget execution stage by requiring that any proposed transfers between major appropriation items (usually above some arbitrary percentage level) receive its approval. Mandatory expenditures may also be imposed on local governments by the state legislature (for example, for education), and a state supervisory authority may need to be satisfied that the legal aspects of budgeting have been met. Monthly or quarterly budget reports offer an opportunity to assess the overall progress toward the attainment of program objectives within the authorized levels of funding. A comprehensive review may be scheduled during the time that the budget for the succeeding year is being prepared.

Budget Adjustments

These periodic assessments, along with changing conditions, often necessitate significant adjustments in the budget during the fiscal year. Sufficient information should be maintained--through the accounting process and other sources--to anticipate requirements for formal budget amendments during the fiscal year. Some amendments require immediate attention; others can be handled more efficiently through a single omnibus amendment, ordinarily made during the final three or four months of the fiscal year. Budget amendments may require legislative action by the governing body, especially if a supplementary appropriation is involved. Revised estimates must be made during the final quarter of the fiscal year to determine the closing status of any unallocated fund balances. Specific allocations are often limited as to their fiscal year carry-over; that is, unspent budget allocations may revert to the general treasury at the end of the fiscal year. Year-end reversion of funds is often cited as a major shortcoming of traditional budgeting procedures. This practice offers no incentive for conserving resources and, in fact, promotes year-end spending.

Some allocations may lapse at the end of the fiscal year only if they are not encumbered. Even if the funds have been encumbered, the National Council on Governmental Accounting recommends that government units either honor the contracts in progress at the end of the fiscal year or cancel them. If the government unit intends to honor outstanding contracts: (a) encumbrances outstanding at year end should be disclosed in the notes to the financial statements or by reservations of fund balance and (b) the subsequent year's appropriation should provide authority to complete these transactions. [10] A comparable amount of funds must be reserved in the subsequent appropriation to cover the estimate expenditures for the unperformed portions of existing contracts.

In attempting to "zero out" budget allocations as the end of the fiscal year approaches, agencies must exercise caution to ensure that the items of expenditure or encumbrances will withstand the test of a post-audit--that is, are eligible items of expenditure for the agency to incur. If allocations do not revert at the end of the fiscal year, or if only the unencumbered portions lapse, "encumbrances outstanding at year end should be reported as reservations of fund balance for subsequent year expenditures based on the encumbered appropriation authority carried over." [11]

Internal and External Audits

There are two basic types of audits: internal and external. Internal audits are conducted periodically by in-house staff and result in reports for internal control purposes. The external audit, normally required by state law, is conducted by independent accountants after the fiscal year has been completed. An external audit may be submitted to the regulating state agency (such as, the Auditor of Public Accounts), as well as to the local governing body. The governing body, in turn, should review the audit to ensure that revenue and expenditure activities have been conducted in accordance with the intentions of the budget and appropriation ordinance.

The traditional emphasis of the post audit has been on financial compliance--on an assessment of financial transactions for accuracy, legality, and fidelity. More recently, emphasis has been placed on management audits, which seek to assess efficiency and economy of resource utilization and to examine the adequacy of management information, administrative procedures, and organizational structure. This emphasis has been further expanded to include an assessment of program results. Such audits seek to 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.

These three components--financial and compliance, economy and efficiency, and program results--when taken together, have been desig-nate by the U.S. General Accounting Office as a performance audit. [12] Such an audit is generally undertaken when a program or project has been completed or has reached a major milestone in its funding. In some instances, auditors must review the performance of agencies or programs because standards of performance accountability are spelled out in legislation, regulations, or other governmental guidelines. Thus, the scope of auditing is expanding because the notion of accountability has been expanding.

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