BUDGET MODULE GETTING IT MANAGING IT AND SHEDDING

BUDGET MODULE: GETTING IT, MANAGING IT AND SHEDDING IT ANDREW GRAHAM SCHOOL OF POLICY STUDIES QUEENS UNIVERSITY MPA 827 2014

Define Today: Budgets and Budget Process Budget Architecture Budget Success Business Cases Tomorrow: Planning and Budgeting Tools Capital Development Cost Benefit Tools Reallocation Friday: Budget Reduction and Reallocation Reduction Processes Strategic Reviews 2 Budgets Module Budget Process

3 “ Every agency wants more money; the urge to survive and expand is built in. ” Aron Wildavsky

An Allocation A Limit A Plan What is a Budget? A Schedule A Reality Check

ANOTHER DEFINITION A budget process is a system of rules governing the decisionmaking that leads to a budget, from its formulation, through its legislative approval, to its execution. Karl-Martin, Ehrhart, Roy Gardner, Jürgen von Hagen, and Claudia Keser Processes: Theory and Experimental Evidence, November 2000 Budget

THE BUDGET AS AN INSTRUMENT OF PUBLIC POLICY AND MANAGEMENT • Planning Instrument • Political Instrument • Social Instrument • Economic Instrument • Legal Instrument 6 Source: Jerome B. Mc. Kinney and Lawrence C. Howard, Public Administration: Balancing Power and Accountability (Oak park, IL: Moore Publishing, 1979)

Need Want Can Budget

A budget is a financial plan for achieving the financial and operational goals of an organization. It expresses what is to be undertaken in the defined period and authorizes the financial authorities needed. Developing objectives for acquisition and use of resources. Control Steps taken by management to ensure that objectives are attained. 8 Planning

WHAT IS A PUBLIC SECTOR BUDGET? • Result of intense planning process, short-term decisions, roles of the dice and political nuance Budgets from Ministers of Finance, i. e. high level political documents not the sole source of program funding: • • Statutory funding Self-funded programs Management budget sets limits, targets and authorities to get on with the work Legal instrument to allow spending = Appropriations 9 •

BUDGET PERSPECTIVES • Budget applies differently at different levels • Government-level: broad, policy-driven, focus on change and announcements, combines revenue with expenditure • Department: will focus on overall results, generalized allocation to program pockets, more detail • Unit: budget is tightly defined, focus on inputs, highly specific, focus on defining resources available 10 Our focus is departmental and unit-based.

BUDGETING IN TIME CONTEXT Historic Information Plus Effects of Outside Environment Forecasting & Planning n io re at tu m Fu for In C In urr fo en rm t at io n Evaluating Performance Controlling operations Current Operating Data

12 Budget Architecture

Types of Budgets • Operating Budget: – also called recurrent budget – funds designated to continuing operations “Plan for the day-in and day-out operations of the organization. It is generally prepared for one year. ” Capital Budget: – budget for permanent works: defining permanent – tends to combine current year and future year plans – current year often transferred into Operating Budget “Plan for the acquisition of buildings and equipment that will be used by the organization in one or more years beyond the year of acquisition. ” 13 •

Types of Operating Budgets Budget Type Characteristics General Use Line Item Expenditures and revenues are related to commodities Control Performance Expenditures and revenues are related to workload Management efficiency Program/Result s Based Expenditures and revenues are related to public goals Planning and Impact 14 Not mutually exclusive.

TYPES OF OPERATING BUDGETS Line • Input Oriented: Expenditures related to inputs. • Control Responsibility Centre/Program • Goals/Unit Oriented • Activity Based: Expenditures related to workload. • Mix of Financial and Program Control Performance/Re sults-Based • Linked to Planning • Outputs/Outcome Orientation: Expenditures related to outputs. • Less Control-Oriented • Adaptive • Market Oriented Not mutually exclusive. 15 Flexible

LINE ITEM OPERATING BUDGET • • Simplest form of budgeting • • Often detailed in object codes – little detail. • • Relatively easy to prepare Budget information organized according to types of expenses, expenditure or cost categories Primary orientation is expenditure control and accountability: permits inter-budget cost comparisons, creates common reference points 16 Does not provide any information regarding activities and functions of a program

LINE ITEM OPERATING BUDGET EXAMPLE Budget of the Killaloe General Hospital for Fiscal Year 200 X Budget 8, 000, 000 250, 000 750, 000 Total 11, 000 17 Object Code 100. Salaries 200. Supplies 300. Rentals 400. Professional Fees

LINE ITEM BUDGETING Limitations: • Rigid, unable to cope with • rapidly changing priorities and circumstances • creation of new government services • Budget evaluation mechanism difficult without mechanism to link things to be bought with things to be done. • New budgets based on previous budget with increments for price increases • No evaluation of whether objectives are still met or costeffective

LINE ITEM BUDGETING Advantages: • Easy to make • Micro-level expense control • Where the rubber hits the road: this is the details that bedevil 19 • Reliance on past data

RESPONSIBILITY CENTRE/ PROGRAM BUDGET • Distributes budget to internal units: Responsibility Centre • Program could involve several responsibility centres • Important means of assigning resources to program objectives, specific offices and specific locations • Seldom see this on its own for operational purposes • Usually in combination with a line item approach • Designed to follow the money. 20 A responsibility centre is part of the organization, such as a department or unit, for which a manager is assigned responsibility, usually with spending authority for the assigned budget as well as responsibility for its proper use.

Responsibility Center Budget - Example Budget of the Killaloe General Hospital for Fiscal Year 200 X Responsibility Centre Budget 4, 000, 000 1, 000 2, 500, 000 05. Outpatient Care 06. Administration Total 1, 500, 000 1, 000 11, 000 21 01. Operating Room 02. Laboratory 03. Radiology 04. Patient Care

PROGRAM BUDGET - EXAMPLE Bureau of Public Safety and Leisure Services FY 200 x-0 y 05 -Public Safety Program Element Amount 0501 -Fire Protection 3, 500, 000 0502 - Police 5, 000 Subtotal 06 – Leisure Service 8, 500, 000 0601 – Parks 2, 000 0602 – Library 1, 000 Subtotal 3, 000 Total 11, 500, 000 22 Program

PROGRAM AND LINE ITEM BUDGET - EXAMPLE Bureau of Public Safety and Leisure Services Detailed Budget Information FY 200 x-200 y 05 - Public Safety Program Element 0501 – Fire Protection Responsibility Centre 050101 Central Office Line Expenditure Amount 250, 000 Supplies 050102 – Upper Level Station Staffing 500, 000 Staffing Supplies 050103 – River Street Station Staffing Supplies Total 1, 250, 000 1, 200, 000 150, 000 3, 500, 000 23 Program

FUNCTIONAL BUDGETS Result of combining a line item (input) and program approach • Functional Budgets focus on the major functions performed by an organization. • Combine elements of Line-Item and Responsibility Centered budgets • This format is often used for external reporting • Note the line item detail 24 •

FUNCTIONAL BUDGETS - EXAMPLE Budget of the Killaloe General Hospital for Fiscal Year 2011 100. Salaries 200. Supplies 300. Rentals 400. Professional Fees Total 01. Operating Room 3, 250, 000 4, 000 02. Laboratory 550, 000 350, 000 25, 000 75, 000 1, 000 03. Radiology 450, 000 0 100, 000 1, 000 04. Patient Care 2, 000 400, 000 0 100, 000 2, 500, 000 05. Outpatient Care 1, 050, 000 125, 000 50, 000 1, 250, 000 06. Admin 700, 000 425, 000 50, 000 100, 000 1, 250, 000 Total 8, 000, 00 2, 000 150, 000 850, 000 11, 000, 00 25 RC

PROGRAM BUDGETS/ RESULTS-BASED BUDGETS • Budgets meant to link funding to expected results • Program formulation and resources justification involve a set of predefined objectives, expected results, outputs, inputs and performance indicators which constitute a logic framework 26 • Performance in achieving results is measured by predefined performance indicators.

PERFORMANCE BUDGET – SMALL AND UNPRETENTIOUS EXAMPLE Road Maintenance Budget FY 2006 -2007 Activity Cost Formula Amount Paving Roads Miles to be paved: 10 Cost per mile: $400 K 4, 000 Resurfacing Roads Miles: 5 Cost per mile: $150 K 750, 00 4, 750, 000 27 Total Road Maintenance Costs

PERFORMANCE BUDGETS/RESULTS BASED BUDGETS Strengths: • • • 28 Budget based on outputs Emphasis on performance and results Greater autonomy and flexibility meant to follow Greater accountability and reporting Departments more aware of outputs and cost of producing outputs • Puts decisions on deployment of resources in the hands of people at operations

PERFORMANCE BUDGETS/RESULTS BASED BUDGETS Shortcomings: 29 • No clear link to desired outcomes – the attribution issue • Lack of focus on key internal processes • Generally poor costing of inputs to results – the path is not clear • With tighter fiscal position, need for greater emphasis on interministry allocations • Diminishes need for cost control and basic probity.

FLEXIBLE BUDGET n Organizations often experience more or less volume than budgeted. n n Flexible budgets look at expected revenues, expenses, and net income under different volume assumptions. The key to flexible budgeting is the identification of: è Fixed Costs - which do not change with volume. è Variable Costs - which do change with volume. n Flexible budget results are normally shown in a side-by-side columnar format. A flexible budget is a form of "What if? " analysis. 30 n

Hot Meals for School Flexible Operating Budget for 200 X 300 Volume of Breakfast Provided[1] 450 600 Expenses Salaries 50, 000 Supplies[2] 180, 000 270, 000 360, 000 Rent 14, 400 Other 5, 000 249, 400 339, 400 429, 400 Municipality 200, 000 Fund raising 75, 000 125, 000 Total Revenue 275, 000 325, 000 Surplus/(Deficit) 75, 000 (14, 400) (104, 400) Total Expense Revenues 31 [1] Assuming that the service is provided 200 days a year [2] Assume the cost per meal is $3. 00 with little flexibility for economies of scale.

OFF-BUDGET EXPENDITURES • Off-budget expenditures refer to financial transaction that are not accounted for in the budget • Most public budgets exclude certain governmental activities • Generally (but not always) refers to activities of public enterprises, credit provided or guaranteed by government or subsidies channelled through the tax system • Increasing trend to include them in the financial statements of government 32 • Weaker control of these, but there is control nonetheless

OFF-BUDGET EXPENDITURES Introduction of accrual also highlights financial obligations of a non-cash nature that create potential liabilities for the government, e. g. loan guarantees The main forms of off-budget expenditures are: off-budget funds; direct loans; guarantees; Public Private Partnerships (PPPs) Public sector entities that are commercial and legally excluded from the budget, e. g. Post Office. 33 • • •

Funds in Budget Architecture 34 A fund is defined as a fiscal accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equity or balances, and charges, which are segregated of the purpose of carrying on specific activities or attain certain objectives for which special regulations, restriction or limitations apply.

FUNDS IN BUDGET ARCHITECTURE Often funds are managed and reported separately – leading to a separate set of financial statements. • The use of funds restricts budgetary flexibility but displays allocation for specialized purposes in a transparent way – funds are often mandated in accounting standards or law, e. g. for municipal governments. • Often, special funds are created to segregate monies for programs for special purposes or as a result of unique designated revenue sources 35 •

FUNDS IN BUDGET ARCHITECTURE • Use of funds varies with governments • Municipal governments tend to be built almost entirely around funds. 36 • The federal government and provinces will create special funds for a variety of purposes, some that are linked to unique sources of funds through fees or special taxes, some of which are administered at arms length from normal practice.

FUND TYPES Government Funds Proprietary Funds Fiduciary Funds General Fund Enterprise Funds Special Revenue Fund Internal Service Funds Expendable Trust Funds Capital Projects Fund Debt Service Funds Special Assessment Funds Provides for ongoing activities of a selfsustaining operation Nonexpendable Trust Funds Agency Funds Assets held in Trust by the Organization

REVOLVING FUNDS 38 • An authority, in the case of government usually a statutory one, to use the revenues generated from an activity to finance it. • This authority generally continues on a permanent basis from one year to the next without further authority being needed. • Always created through budgetary expenditure means, but then those funds move off-budget. • Although surpluses or deficits may occur from year to year, they are generally expected to balance out over time. • Many arrangements exist for the use of retained earnings, with the principle being that the fund retains its earnings unless some form of gain sharing is put in place.

ZERO BASE BUDGETING • Objective to “reset the clock” each year. • Traditional incremental budgeting assumes that there is a guaranteed budgetary base-the previous year’ level of appropriations -and the only question is how much of an increment will be given. • Zero Based Budgeting implies that managers need to build a budget from the ground up, building a case for their spending as if no baseline existed- to start at zero. • Resources are not necessarily allocated in accordance with previous patterns and consequently each existing item of expenditure has to be annually re-justified.

The purpose of ZBB is to reevaluate and reexamine all programs and expenditures for each budgeting cycle by analyzing workload and efficiency measures to determine priorities or alternative levels of funding for each program or expenditure. Through this system, each program is justified in its entirety each time a new budget is developed.

STRENGTHS OF ZBB • ZBB does not assume that last year’s allocation of resources is necessarily appropriate for the current year. • The systematic nature of such a fundamental review imposes a discipline on the organization which has produced in practice secondary advantages. • It produces in a readily accessible form more and better management information. • If implemented well, ZBB can eliminate a sense of “entitlement” to cost increases. • Improved discipline in developing budgets. • More meaningful budget discussions during plan review sessions.

WEAKNESSES OF ZBB • ZBB vastly overestimates people’s ability to calculate. • Multiple impacts often ignored • The ranking process is difficult • The implementation of a ZBB system requires a great deal of time. • Attempts by agencies to manipulate priority listings by ranking popular items lower than items that would have little chance of funding – the Musical Ride. • Established programs have political support and they will continue to receive their share of the budget regardless of any analysis produced.

THE BUDGET PROCESS

THE BUDGET PROCESS n A process of planning and control. n A look ahead at what an organization can and can't do n A process of allocating scarce resources to unlimited demands The Budget Cycle - Preparation – based on guidelines – normally done by responsibility center managers - Review and Adoption - Implementation and Control - Evaluation of Results and Feedback 44 n

BUDGET PROCESS: KNOW IT AND USE IT Every organization has a budgetary process of some kind Increasingly they attempt to be strategic for the organization Managers are not simply recipients of budgets: they are players in the budget process 45 Sustaining programs, getting program changes, resisting change or helping it all mean knowing how the budget process works and using it to your advantage

THE BUDGET CYCLE Length of time required to prepare, administer & close out a single year budget.

EXPENDITURE MANAGEMENT CYCLE – BROADER THAN JUST THE BUDGET CYCLE Financial management system boundaries Project appraisal Planning system Resource allocation Medium term plans, e. g. three year rolling plans Annual budgets Development, recurrent and revenue idity Liqu ent agem man Expenditure review Public expenditure review Institutions Pro Accountability Fund release procedure, e. g. . . warranting t jec re tu di l o en xp ontr E c t ev revi ent ew g Pos n ori nit mo Audit system Reports and financial statements g itorin Mon g ollin contr & Accounting for revenue and expenditure 47 Source: Adapted from Integrated Financial Management. Michael Parry, International Management Consultants Limited. Training Workshop on Government Budgeting in Developing Countries. THE UNITED NATIONS. December 1997.

BUDGET CALENDAR

ELEMENTS OF AN EFFECTIVE BUDGET CYCLE • • 49 Basic framework exists and is used Desired outcomes known Linkage to strategic plans Common format, readily understood Timetable for preparation clear and reasonable Set of directions – rules of the game Budgetary and program limits known Established methodologies for costing and forecasting where needed • Directions on availability of new funds, use of current funds and reallocation rules

Start/Restart Budget Execution Budget Review and Approval – Legislative Simple Budget Cycle Strategic Planning Phase Budget Preparation Phase Budget Review Internal Executive 50 Results Feedback Auditing for Compliance and for Results

WHAT TO LOOK FOR IN A STRATEGIC BUDGET LINKAGE Does this organization know its Mission? Does this organization have an end state or vision? What are the ground rules or basic operating assumptions and principles? Strategic Plan Does it have a grip on reality – what is its situation analysis including risks. Does it have goals and objectives that make sense? What’s it going to cost? Does what it is going to do this year mesh with its goals and mission? 51 Is it sustainable? Are there targets with measures that we can understand.

BUDGET PROCESSES AS A PLANNING TOOL 52 • Budgets are where the rubber hits the policy road • Budgets clear permissions to move ahead on plans • Delivery capacity on plans directly linked to resources available

BUDGETS AS A CONTROL TOOL When a budget is approved, the expenditure estimates become appropriations An appropriation both authorizes expenditures and limits expenditures Both defines and limits managerial discretion 53 Can be used to limit uses to specific allotments or funds

BUILDING THE BUDGET • This is the process of micro-budgeting • Building the budget logic but also the budget story • Within organizations, tends to be a two-way process: direction from above and input from below • Often costs are driven by variables outside the control of line managers, e. g. collective bargaining • No guarantee that funds will be allocated to cover costs 54 Pluses and minuses of top-down and bottom-up approaches to budgeting.

BUILDING THE BUDGET: UNDERSTANDING COSTS, NEED AND DEMAND Role of past experience, especially in incremental situations Types of measures: • Need • Demand • Workload Productivity assumptions and targets Revenue assumptions 55 Budget Gaming

PROJECTIONS (FORE AND AFT) AND FORECASTS • Budgets often build on previous year’s base plus or minus • Differing set of assumptions: optimistic and pessimistic • Controllable and uncontrollable costs • Fixed and variable costs • Direct and indirect costs and the full cost principle • Treatment of overhead 56 • Mandated standards

TENSIONS INHERENT IN PUBLIC SECTOR BUDGETING • Revenue versus expectations • Central agency versus program organizations • New versus old 57 • Complexity versus clarity

58 THE AUTHORIZING PROCESS: FROM THE PERSPECTIVE OF THE LEGISLATURE

KEY ACTORS IN BUDGET PROCESS Finance ministry or treasury: Coordinate & drive budget process Spending departments: Responsible for expenditures within their jurisdiction. Head of State & Cabinet: Make political decisions about tradeoffs. Legislature: Scrutinize & authorize revenues and expenditures. Supreme audit institutions: Audit government accounts for compliance and performance. Others: Media, civil society organizations, donors & international financial institutions.

DRAFTING STAGE • A draft budget that can be submitted to legislature. • Mostly internal to the executive, secretive. • Sets fiscal policy & estimates revenues on projections to establish total resources. • Finance ministry or central office issues guidelines to spending departments. • Budget requests from spending departments. • Negotiations at bureaucratic and political levels.

LEGISLATIVE STAGE • Budget tabled in the legislature/council/board. • Considered by parliamentary committee(s). • Parliament votes on Supply. Council approves budget.

EXECUTION/IMPLEMENT ATION STAGE • Funds apportioned to departments to implement activities. • Central financial controller monitors spending – more or less. • Request for legislative approval of adjustment budget if necessary – Supplementaries. • Fiscal risks are inherent in a changing economic environment – purpose of contingency reserves. • In-year adjustment decisions should be transparent and thoroughly scrutinized.

AUDIT STAGE • Supreme audit institution assesses departmental accounts and performance. • Audit reports should be published promptly and submitted to parliament. • We will look at this stage in more detail in a later session.

Factors That Undermine Fiscal Discipline Unrealistic Constraints When totals are selected for political reasons, without regard to their achievability, they may weaken fiscal discipline. Unrealistic Budgets Some governments (especially in poor countries) adopt budgets that purport to show fiscal discipline but have little to no possibility of being implemented. Entitlements When citizens have a legal right to payments from the government regardless of budget conditions, it may be difficult to stay within fiscal targets. Contingent Liabilities The cost of contingent liabilities often is underestimated when the government accepts the risk (such as guaranteeing loans or the performance of enterprises). When the cost comes due (because of default or other contingency) it is not controllable through ordinary budget means.

Factors that Degrade Operational Efficiency Perverse incentives Spenders have incentive to use all the resources provided them; if they don’t, they risk cuts in the next budget Information asymmetry Service providers know more about outputs and costs than do those who allocate resources: To get more money, providers manipulate or withhold information from superiors Rigidity Managers have no opportunity to use their skills and information to improve efficiency Compliance costs Detailed, ex ante controls are costly and drive out initiative and variation Budget maximizing behavior Inasmuch as government must pay whatever it costs to operate its programs, inefficient producers are rewarded with bigger budgets Capture Government is captured by service providers: it lacks independent information on performance and must purchase services from them

Practices that Strengthen Fiscal Discipline • Targets should reflect political commitments made by government leaders. • Targets must be realistic and achievable. • Targets should be set and enforced within a medium-term fiscal framework. • Limits on aggregates should be supported by sub-targets on sector/portfolios. • Fiscal constraints should cover mandatory spending.