Using costing of services to improve performance-oriented budgeting

Using costing of services to improve performance-oriented budgeting By Jim Mc. Crindell and Vijay Jog 1 © Corporate Renaissance Group

Copyright Corporate Renaissance Group www. crgroup. com 613 -232 -4295 All rights reserved. This document may not, in whole or in part, be copied, photocopied, reproduced, translated, or reduced to any electronic medium or machinereadable form without prior consent in writing from Corporate Renaissance Group. We are grateful for the use of some copyrighted material from our strategic partner - Cost Technology Inc. 2 © Corporate Renaissance Group

Let us start with an example • We have secured funding for a project to improve overall health of children in a designated area by providing health services • We are interested in ensuring that the funding is making an impact and with right financial controls 3 © Corporate Renaissance Group

Management Information Health services $500, 000 4 • Goal/objective: Improve the health of the local population by reducing incidents of disease • Budget/spending authority: • $500, 000 for wages and material • Measurement/control: money went to health related service for wages and material • Report card: money was correctly spent Corporate Renaissance Disease levels hard to quantify Group ©

We have management information • It can be audited and reported • Financial control system needs are met But not sufficient for some important management questions? What did we get from the $500, 000 budget? 5 © Corporate Renaissance Group

Resources, activities and outputs Health services $500, 000 Resource Drivers time and material Immunization $100, 000 20 percent of wages and material relates to the immunization activity Activity Drivers # of immunizations (5000) Average Unit Cost $20 6 © Corporate Renaissance Group

Now we have better information • how much efforts went in immunization? (Activity) • what was the cost of the activity “immunization”? (Activity cost) • How many immunizations were done? (output) • what was the cost per immunization? (efficiency) • How to use this information for work load management, linking to objectives, bench marking, decision making? Qu: can we know more? 7 © Corporate Renaissance Group

Resources activities and outputs Health services $500, 000 Resource Drivers time and material Immunization $100, 000 Activity Drivers # of immunizations (5000) Average Unit Cost $20 TB $30, 000 (#3, 000) $10 /Unit Cholera $20, 000 (1, 500) 13. 33/unit Hepatitis $55, 000 (#500) ($110/unit) 8 © Corporate Renaissance Group

Now we have even better information • Know costs at more detailed level which may allow us to redirect efforts • know that immunization costs depend on the type • may be able to breakdown vaccine costs separate from process (labor) costs • May better link to specific objectives Note: still do not know outcome/impact because: A) it could only be known after a while and B) impacted by other outputs (better sanitary systems, better water, better education, etc. ) 9 © Corporate Renaissance Group

What more we would like to know? Percentage of children immunized how much time it takes to get immunized (waiting list and time) Quality of immunization service (? ? ? ) 10 © Corporate Renaissance Group

“Costs” is only one (but very important) dimension of service performance Value/cost Resources Service/quality Cycle/turnaround time Activities and Operational Environment 11 © Corporate Renaissance Group

From example to concepts 12 © Corporate Renaissance Group

Service costing is a critical element of performance-oriented budgeting because it allows us to answer key questions …. . • What does it cost to deliver these services? • Are we delivering our services costeffectively? • How do our service costs compare? • How much should we charge for these services? • Is there is an alternative, less costly, way to deliver these services? 13 © Corporate Renaissance Group

Hence: Activity-Based Costing (ABC) The basic assumption of ABC is very simple. ABC assumes that services create need for outputs which create the demand for activities which, in turn, consume resources. By tracing costs to services/outputs according to the activities required to provide them, ABC provides a more accurate picture of costs and performance. 14 © Corporate Renaissance Group

The ABC Cross Financial system RESOURCES The Cost Assignment View or ABC $ used to do work Resource Drivers Cost Drivers Activities Why work is done Work The Process View or ABM 15 Objects of Work (or outcomes) Performance Measures How well the work is done? Cost Time Quality Activity Drivers To what, or for whom, work is done © Corporate Renaissance Group

Knowledge of Costs enhances accountability Costing of Services 16 © Corporate Renaissance Group

ABC provides a multi-dimensional cost view of the organization Organization • Departments • Branches • Divisions • Regions Activities 17 • Processing claims • Paying pensions • Teaching • Nursing • Maintaining buildings • etc Resources • Salaries • Supplies • Travel • Depr. • etc. © Corporate Activity Costs and Activity Based costs of services Renaissance Group

Activities may be part of a “process” transcending departmental boundaries Health Department Financial Support to Hepatitis Victims process xxxxx 18 activity xxxxx xxxxx Determining Medical Eligibility Tax Department xxxxx xxxxx Determining Financial Eligibility Treasury xxxxx xxxxx Payments to Eligible Clients Reviewing and Paying © Corporate Renaissance Group

Multiple usage of service cost information Alternative Service Delivery Cost Reduction Performance Measures Benchmarking Business Planning Service User Fees Costs Service Accountability Standards 19 © Corporate Renaissance Group

Dealing with Direct Payments and Transfers • Some government service costs consist mainly of direct payments to persons and organizations, e. g. , – pensions – grants and contributions • Activity costs relate to the cost of administering such services. • Thus, the total cost of the services provided can be identified along with the efficiency of providing the services (e. g. , cost of processing pension payments per dollar of pension payment or per cheque) 20 © Corporate Renaissance Group

From concepts to implementation …. • Implementing of ABC and ABM requires a different approach to resource allocation, management reporting, financial system design/usage and incentive/promotion systems. 21 © Corporate Renaissance Group

Note …. • Traditional financial systems are mainly tracking systems - they only tell us how much was spent by line item (salaries, benefits, travel, etc. ) and organization but not: what was done with these resources? • In these systems, variance from budget drives performance evaluation rather than what was done with the resources given • Performance measures on quality, delivery time as well as on satisfaction and effectiveness are typically not available or not an integral part of the budgeting process 22 © Corporate Renaissance Group

The Big Picture 23 © Corporate Renaissance Group

Implementing an ABC System. . . Identify objectives, and organizational structure, resources, products and services Identify activities within each cost/ Responsibility centre Integrate with existing financial and operational systems Postimplementation challenges Build ABC model Process for Continuous Improvement and Refocus Senior management buy in 24 Story boarding Systems experience ABC software © Corporate Process experience Renaissance Group

ABC implementations do not require sophisticated systems architecture and networks • If the organization has a G/L (line item reporting), then implementing of ABC and PM systems is not very costly or time consuming after the initial activity and service maps • Activity (process) and non-financial performance data be developed through consultation with relevant managers and employees (often exists informally). • In initial development minimize numbers of activities/indicators (significant ones) 25 © Corporate Renaissance Group

Premises/solutions (continued) • ABC systems are periodic - they are not transactional. Thus, Off-line ABC systems are better. ABC systems also require operational data on outputs • In the absence of these systems, organizations do not have the basic information on their performance 26 © Corporate Renaissance Group

Incorporating ABC/PM into a Performance-oriented budgeting system • Link financial system to ABC and Performance Measurement Systems and then allocate/manage budgets PM Financial System (Resource Info. ) 27 ABC Resources to Activities to outputs Organizationwide Performance Measures Budget Planning and Resource Management © Corporate Renaissance Group

Financial System Cost centre Costs Operational systems • ABC modelling • Activity mapping Activity Costs Unit costs Performance measures The PM System 28 ABC System ABC Costs to cost object © Corporate Renaissance Group

Success criteria for Implementing Costing and Performance Measurement Systems • Political and Senior Bureaucrat Support • Reflected in organizational vision and “values” • Embedded in planning, decision-making, reporting and incentive systems • Seen as strategic and tactical “management” tools • Driven by need for improved performance measurement and accountability • Ready to accept approximately right rather than precisely wrong information 29 © Corporate Renaissance Group