Public Sector Financial Management for Managers 2

8/22/2019 Public Sector Financial Management for Managers 2

1/82

Public SectorFinancialManagement forManagers

Andrew GrahamSchool of Policy Studies,Queenss UniversityKingston, Canada

November 2011


2/82

Public Sector Financial Management for Managers

Acknowledgement

PublicSectorFinancialManagementforManagershasbeenproducedfortheCanadianGovernanceSupportOfficewith

fundingfrom

the

Canadian

International

Development

Agency,

GovernmentofCanada,asageneralguideforfinancial

managementforlinemanagersintheAfghanistanpublicservice.

ItcanbefreelyreproducedbyanyAfghanMinistry,Government

DepartmentorAgency.

PleaseacknowledgetheGovernmentofCanadainany

reproductions.

Usebyinternationalorganizationsrequirestheexpress

permissionofCANADEM.

CANADEM 2011


3/82


Table of Contents

Section1:TheNatureofPublicSectorFinancialManagement...................................................... 1

KeyPoints.................................................................................................................................... 1

Question1:WhatisthePublicsector?....................................................................................... 2

5KeyFeatures:................................................................................................................................ 2

Question2:WhatisFinancialManagement?............................................................................. 3

8KeyFeatures:................................................................................................................................ 3

Section2:CornerstoneOne:AllocatingResourcesBudgets....................................................... 5

KeyPoints.................................................................................................................................... 5

TheBudgetCycle......................................................................................................................... 5

BudgetMethodologies................................................................................................................ 6

OrganizingBudget

Information

.......................................................................................................

6

ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005........................................... 8

TraditionalBudgetingversusPerformanceBudgeting.................................................................. 10

Section3:UnderstandingtheBudgetaryProcess......................................................................... 11

KeyPoints.................................................................................................................................. 11

BudgetsandPlanningCycles..................................................................................................... 11

ElementsofanEffectiveBudgetCycle.................................................................................. 12

StrategicPlanningPhase....................................................................................................... 12

CostAnalysis

Phase

...................................................................................................................

13

TheRoleofRevenueinCostAnalysis................................................................................... 13

HowtoDetermineCosts....................................................................................................... 13

FixedandVariableCosts........................................................................................................ 14

GettingApprovaltoSpend:TheAppropriationProcess........................................................... 14

CentralAgencyversusProgramOrganizations..................................................................... 15

TheNewVersustheOld........................................................................................................ 15

ComplexityversusClarity...................................................................................................... 15

OnBudgetVersusOffBudget................................................................................................ 15

Conclusion................................................................................................................................. 16

Section4:Budgeting:CapitalPlanning.......................................................................................... 17

KeyPoints.................................................................................................................................. 17

CapitalBudgets.......................................................................................................................... 17

CharacteristicsofCapitalAssets............................................................................................ 17


4/82


ToolsofCapitalPlanningandBudgeting................................................................................... 18

CapitalImprovementPlans................................................................................................... 18

TimeValueofMoney................................................................................................................ 20

PresentValueandFutureValue............................................................................................ 20

NetPresentValue.................................................................................................................. 22

RiskAssessment........................................................................................................................ 22

ExamplesofRiskCategoriesinAssessingCapitalAssetRisks....................................................... 22

Conclusion................................................................................................................................. 23

Section5:CornerstoneTwo:MonitoringMoneyManagerialControl...................................... 25

KeyPoints.................................................................................................................................. 25

WhatisManagementControl?................................................................................................. 25

ManagementControlFramework......................................................................................... 25

RiskandRiskManagement................................................................................................... 26

UnderstandingandDefiningtheRisks............................................................................. 27

ControlProceduresandPolicies............................................................................................ 28

WhoandWhentoControl............................................................................................... 28

WhoistheController?..................................................................................................... 29

TrustandEthicsinControl.................................................................................................... 29

Trust.................................................................................................................................. 29

Ethics................................................................................................................................

29

ValuesandEthicsApproaches.......................................................................................... 30

ControllershipCapacityChecklist.............................................................................................. 31

StrategicLeadership......................................................................................................... 31

ClearAccountability......................................................................................................... 32

SharedValues&Ethics..................................................................................................... 32

MatureRiskManagement................................................................................................ 32

IntegratedPerformanceInformation............................................................................... 32

MotivatedPeople............................................................................................................. 32

RigorousStewardship....................................................................................................... 33

Section6:CashManagement:InYearControl............................................................................. 35

KeyPoints.................................................................................................................................. 35

ObjectivesofEffectiveCashManagement,MonitoringandControl....................................... 35

EstablishingaCashManagementSystem............................................................................. 36

InyearBudgetDesignFactors.......................................................................................... 37


5/82


EstimatingWorkFlows..................................................................................................... 37

UseofHistoricalData....................................................................................................... 38

MonitoringFinancialPerformanceandVarianceAnalysis.................................................... 38

SettingupaMonitoringTimetable.................................................................................. 39

Governance......................................................................................................................

39

PerformanceReports....................................................................................................... 39

EastbrookCorrectionalFacility,Eastbrook,NovaScotia.............................................................. 39

Staffing:PlanversusActual........................................................................................................... 40

VarianceReports.............................................................................................................. 40

ForecastedversusActualReport...................................................................................... 40

AnalysisofKeyVariancesReport..................................................................................... 40

HistoricalInformation...................................................................................................... 41

Historical

Staffing

Patterns:

Custodial

Only:

Year

Average

...........................................................

41

ReallocationandReadjustment............................................................................................ 42

TheAuthoritytoReallocate............................................................................................. 42

FreeingUptheFunds....................................................................................................... 42

Conclusion................................................................................................................................. 43

Section7:CornerstoneThree:ReportingOnHowMoneyIsSpentAccounting....................... 44

KeyPoints.................................................................................................................................. 44

AccountingPrinciples................................................................................................................ 44

1.The

Entity

Principle

.......................................................................................................

44

2.MoneyasaMeasure/theCostPrinciple..................................................................... 45

3.TheGoingConcernPrinciple........................................................................................ 45

4.TheConservatismandCostConcept............................................................................ 45

5.TheMatchingPrinciple................................................................................................. 46

6.TheConsistencyPrinciple............................................................................................. 46

7.TheMaterialityPrinciple.............................................................................................. 46

8.TheDualityPrinciple..................................................................................................... 46

9.TheAccrualPrinciple.................................................................................................... 47

TheQualityofInformation.................................................................................................... 47

TheOutputsofAccounting.................................................................................................... 48

TheAccountingCycle....................................................................................................... 48

DoubleEntryBookkeepingandtheFundamentalAccountingEquation...................................... 48

DebitsandCredits......................................................................................................................... 49

ExamplesofDebitsandCreditsTransactions............................................................................... 49


6/82


Wherearetheseactivitiesactuallyrecorded?.............................................................................. 50

KeyDefinitionsofTermsUsedInFinancialStatements................................................................ 50

AnExampleofDepreciation.......................................................................................................... 52

Equity/NetAssets/FundBalance................................................................................................... 53

TheBalance

Sheet

.........................................................................................................................

53

TheIncomeStatement.................................................................................................................. 54

ByObject:salaries,benefits,rentals,costofservices................................................................... 54

IncomeStatementOrganizedbyObject(PlusYeartoYearComparison).................................... 54

TheStatementofCashFlows........................................................................................... 54

Conclusion................................................................................................................................. 55

Section8:AccrualAccounting:ProvidingaFullerStory................................................................ 56

KeyPoints.................................................................................................................................. 56

Whydo

we

need

Accrual

Accounting?

......................................................................................

56

CashBasisAccounting:AnOverview..................................................................................... 57

AnotherExampleofCashAccounting........................................................................................... 57

ExampleofCashAccounting......................................................................................................... 57

AccrualBasisAccounting:AnOverview................................................................................ 57

ExampleofAccrualAccounting............................................................................................. 58

TheDifferencebetweenCashandAccrualAccounting........................................................ 58

CashVersusAccrualTreatmentofAssetAcquisitionandUse...................................................... 59

Implicationsof

the

Accrual

Accounting

.................................................................................

59

AnExampleofaWeekintheLifeofOneGovernment................................................................ 60

FinancialReportsoftheGovernment........................................................................................... 61

TheProsandConsofCashandAccrualAccountingandBudgeting..................................... 62

ConclusionsandOverview........................................................................................................ 64

Section9:AccountabilityandReporting....................................................................................... 65

KeyPoints.................................................................................................................................. 65

WhatisAccountability?............................................................................................................. 65

TheRelationshipofAccountabilityandFinancialManagement........................................... 66

TheUsersofFinancialandPerformanceReports..................................................................... 67

TheObjectivesofFinancialandPerformanceReporting.......................................................... 68

TheRoleofAuditintheAccountabilityProcess....................................................................... 69

InternalAuditFunctions................................................................................................... 69

LegislativeAuditors.......................................................................................................... 70


7/82


Independence................................................................................................................... 70

ReportingtotheLegislature............................................................................................. 70

ThirdPartyAccountabilityandtheBurdenofOversight................................................. 71

Conclusion................................................................................................................................. 73


8/82

Key

Theachi

andWhil

capaFina

mon

Man

Thes

vario

Public Sec

Sectio

Points

ublicsectovearangexpectation.

thetermrity,intheecialManagyinasystegementha ResourceControlle

Accounta

3Cornersusparts,w

or Financial

n 1: Th

isresponsifpublicgoesourcesend,eachofmentisanmatic,efficis3CornerstAllocation(dDelivery(bility(Repo

onesofPubichwillbe

anagement

NaturMa

leforbringds.Thisres

bracesmatheseinvolimportanttent,transpaones:GettingMopendingMtingonMo

licsectorFixploredin

CDelMa

ccountinReportinand Audi

for Manager

of Pubageme

ingtogetheponsibilityc

yelementsemoney.olthathelrent,andleey),ney),andey).

ancialManetailedthr

ReAllBu

ntrolledivery: Risnagemen

:

lic Sectt

rlargeamoomeswith

people,ti

sthePubligitimatewa

agementcaughoutthi

ourcecation:geting

r Fina

ntsofresoonsiderabl

e,attentio

sectortaky.Publicse

nbebrokenguide.We

cial

rcestocomplexit

,focus,and

careoftorFinanci

downintoanbegint

1

l


9/82

Public Sector Financial Management for Managers 2

identifysomeofthecomponentsofthesethreebroadstagesbyaskingthequestions:

WhatisthePublicsector,andwhatisFinancialManagement?

Question 1: What is the Public sector?

Summary:ThePublicsectorneedstoworkwithinspecificfinancialboundarieswhile

tryingtosolveproblemsaffectingthecitizensitrepresentsandserves.

5KeyFeatures1:

i)ThePublicsectorisbroad.Itencompassesallorganizationsthatreceivetheirfunding

frompublicsourcessuchastaxes,feesorlicences.Therefore,itwillembracenotjust

governmentdepartments,butalsogovernmententerprises.

ii)ThePublicsectorhasmultiplegoals.Ratherthanhavingasinglebottomline,the

publicsector

has

several,

which

are

being

pursued

at

once.

iii)ThePublicsectorusesvarioustoolstoreachitgoals.Thereareaseriesof

instrumentsusedtoachievethegoalsofgovernment2.

iv)ThePublicsectoroftenusesthePrivateSectortodeliverPublicGoods.Modern

governmentsfrequentlyusecontractswithprivatecorporationsasameansofacquiring

neededexpertise,outsourcingwork,orextendingtheirworkforceswhileseemingto

containthegrowthofthepublicservice.

Thiscontractedworkdoesnotmeanthattheregularpublicserviceisrelievedofits

accountabilityforpublicfunds.Governmentsdevoteconsiderableenergyto

administeringcontracts,especiallyduringaperiodofincreasedscrutinybythepublic

andbythecontractingcommunityinparticular.

v)ThePublicsectorisademocraticinstitution.Governmentsownnoneofthe

resourcestheyspend.Taxpayersdo.Inademocraticsociety,thewaysinwhich

governmentsspendresourcesmustbetransparentandreadilyopentoquestioning.

AccountingforPublicsectorfundsandtheirproperexpenditureisnotonlypartofgood

management,itisessentialtogoodgovernmentandgoodgovernanceofthepublic

enterprise.Itisalsowheregovernmentsaremostheavilyscrutinizedandwherethey

cangetintoagreatdealoftrouble.Suchscrutinyisoneofthebasisofagovernments

legitimacy.

1CICAPublicsectorAccountingHandbook,RevisedUpdateNo.18,SectionPS1100,AppendixA

2Salamon,LesterA,RethinkingPublicManagement:ThirdPartyGovernmentandtheToolsof

GovernmentAction,PublicPolicy29,no.1(Summer,1981)andSalamon,LesterAandMichaelS.Lund,TheToolsApproach:BasicAnalysitcsin BeyondPrivatization;TheToolsofGovernmentActioneditedbyLesterASalamon,..2350,Washington,UrbanInstitutePress,1989


10/82


Question 2: What is Financial Management?

Summary:FinancialManagementhelpstoprovidekeyinformationtodecisionmakers

anditintroducescontrolsthateitherpreventabuseorcreateincentivesforgood

servicetothepublic.FinancialManagementhelpsthePublicsectorcollectmoney,

allocate

money,

spend

money,

weigh

the

costs

and

benefits

of

certain

programs,

accountformoney,reportonhowmoneywasspent,andplanforthelongterm.

8KeyFeatures:

i)FinancialManagementinvolvesthecollectionofmoney.ThePublicsectormakes

mostofitsmoneythroughtaxation,transfers,fees,thesaleofgoods.

ii)FinancialManagementinvolvesallocatingresources.TheincomeofthePublicsector

isnottiedtoanyonespecificgoal.Rather,Publicsectorfundsareconsolidatedintoa

ConsolidatedRevenueFund(CRF)andsubjectedtoademocraticdecisionmaking

processthat

distributes

them

across

arange

of

activities.

This

is

known

as

the

budgetary

process.Thereareexceptionstothisruleinwhichspecifictaxesorfeesaredirectedto

specificprograms.

ABudgettellsthepublichowthegovernmentintendstospenditsmoney.The

budgetaryprocessisaplanningtoolandatoolofregulationandcontrol.Agovernment

budgetsetsalegallimitforexpenditures.Italsocreatesthelegalauthorizationfor

delegatedofficialstospendfund.

ABudgetisalsothetoolbywhichthegovernmentsfinancialperformanceisjudged.

Managersareheldtoaccountfortheirperformancerelativetothebudget.

iii)FinancialManagementinvolvesspendingmoney.Delegatedofficialsareexpected

tospendpublicfundsforthepurposesforwhichtheywereallocated.Therefore,

financialmanagementinvolveshavingcontrolsinplacetomonitorexpenditures.

iv)FinancialManagementinvolvesoversightwatchingthemoney.Thegovernment

mustfrequentlyandsystematicallymonitorandreportontheflowofmoney.This

ensuresactualfinancialactivitymatchesplannedfinancialactivity.Financialrolesand

responsibilitiesaswellasfinancialreportingtimelines,areoutlinedinlawtoensure

specificindividualsarelinkedtothesuccessorfailureofaparticularstageinthe

financialprocess.

Information

systems

support

these

roles

by

making

public

servants

awareoftheirlevelofprogress.

Legislationcreatingpublicorganizationscanbeverybroadwithrespecttotheamount

oflegislativecontrolthatisexertedastheorganizationgoesaboutitsdaytoday

business.Legislaturesseldomengageintheactualmanagementofpublicorganizations.

Rather,theyserveotherkeyroles:creatingtheorganization,settingoutthepolicies

thattheywillcarryout,providingthefundingtocarryoutthepolicies,holdingthe


11/82


organizationtoaccounteitherdirectlyorthroughexternalauditorsappointedbyand

responsibletothelegislatures.

v)FinancialManagementinvolvesaccountingformoneycollectedandmoneyspent.

The

Public

sector

must

assure

the

public

that

its

money

is

being

spent

well.

This

means

theyneedtoask:

Ismoneybeingspentforanappropriateuseforthepublicgood?

Arefundsbeingallocatedforthestatedpurpose?

Arefundsbeingspentaccordingtotherulesthatapply?

Didthefundsachievetheintendedresults?

Canthefundsbetracedandidentified?

Canothersassessthefinancialinformationoftheorganizationexternalreview

oraudit?

Essentially,pastfinancialbehaviormustbereconciled,audited,andreviewedinrelation

tothebudgettogivethelegislatureandpublictheassurancesthatfundswerespentfor

theirintendedpurpose.Thepublicaccountsandtheassociatedfinancialstatementsare

themaindocumentsusedbygovernmenttoshowfinancialactivity.

vi)FinancialManagementinvolvestakingcareofassets.Publicsectororganizations

buildoracquirecapitalassets.Theyowncapitalassets,whichcanbeconsiderable,in

ordertodeliverservicesandthepublicgoodobjectivesthattheywanttoachieve.

Consequently,thePublicsectorhasconsiderablemaintenancerequirementsand

operationalcosts.Financialmanagersmustensurethatassetsareproperlypurchased

andsustainable.

vii)FinancialManagementdoesrequiredueregardforprocess,recordkeepingand

reporting.Therecanbeatensionbetweentheobjectivesofthepublicservicetoquickly

servetheneedsofcitizensandeffectivefinancialmanagement,seeingitasinhibiting

effectiveclientservicethroughexcessivecontrols,inadequatefundingora

preoccupationwithpaperwork.Nonetheless,theserequirementsremainessentialfor

propercontrolandaccountabilityaswellaspublicconfidenceinthegovernments

financialprudenceandhonesty.

viii)FinancialManagementisEverybodysBusiness:Oftenpublicservantsdonotsee

themselvesasmanagersofresources,butratheraspolicymanagersofhighly

specializedfunctions.

Because

of

the

complexity

of

the

Public

sector,

the

finance

functionwillhaveitsownseniormanagerswhoareoftenseparatefromlineor

operatingmanagers.Tensionsoftenensuebetweenthesetwocultures.Theseare

normaland,whenwellmanaged,healthyandnecessary.

Inreality,allmanagersarefinancialmanagers.Theabilitiestoobtainresourcesto

achieveprogramobjectives(budgeting),maximizeprogrambenefitswithinthebudget

(allocation),effectivelymanagethebudgettoachievefullbenefit(cashmanagement),

anddemonstrateresultsandprocessadherence(accountability),areimportant

managementskillsforallgovernmentemployees.


12/82


Section2:CornerstoneOne:AllocatingResourcesBudgets

Key Points

A budget is a time limited plan that puts resources in place to implement the

goalsofanorganization.

Forthepublicsector,abudgetisalegallyauthorizedannualmonetizedplanthat

establishesspendinglimitsforthevariousprogramsthatcomeoutoflegislation,

policy,andorganizationalintent.Abudget,therefore,doestwothings:

1)Ittranslatespolicyintentionintospecificactivitiesthroughresource

allocation.

2)Itisalsothebasisforfinancialcontrolwithinthepublicsectororganizationin

thatitarticulatesexpectationsofrevenueandexpenditures.Assuch,itisa

usefulbenchmarktocontroltheoperationsofgovernmentdepartmentsandagencies.

Typically,aGovernmentwillhaveanorganizationwidebudget.

Thisdocumentwillthengetdividedintopartsinordertoformdepartmentbudgets.

And then those department budgets will be further divided in order to produce

branchbudgetsofvarioussorts.

Inthissection,wewillexplorethevarioustypesofbudgetsusedinthepublicsector.

The Budget Cycle

There are three budgets in playat all times for public sector managers: past, present

andfuture.

The manager has an immediate concern for the management of funds within the

currentfiscalyear.Thisistherealmoftheuseandcontroloffunds,cashmanagement,

andprogrammanagement.

However, the manger also has to continuously participate as part of the planning

processtosecurefundsforcomingyears.Thisistheexpenditureplanningprocess,the

policy planning cycle or the strategic exercises of the organization. This is for

developmentofthefuturebudget.

Finally, the manager must account for past use of funds. This is based on the past

budgetandthewayitwasspent.


13/82


Importantly,thisthirdbudgetlife thepast iscriticalsincesomuchofthebudgeting

process is incremental in nature, as changes are made in small increments based onprior years levels of resources, e.g. an increase of 2% per annum with no change in

program fund distribution. Many organizations make the majority of their budget

decisionsbased

on

past

performance

and

allotments.

How

much

was

actually

used

in

thepastisanimportantfactor.

Budget Methodologies

Core Elements: There are three core elements to a budget: revenue, operations and

capital.Thesearedescribedbriefly.

RevenueBudgets:Forthemostpart,governmentsmanagetheirrevenuestrategiesat

thewholeofgovernmentlevel,imposingtaxesandfees.Theythendistributemoneyto

departments

through

the

budgetary

and

appropriations

process.

Individual

managers

havelittletodowiththispartofthebudgetprocess,unlesstheyworkontherevenue

sideofgovernment.

Operating Budgets: Operating budgets describe the programs and resources used to

carrythemoutwithinaspecifiedperiodoftime.Theoperatingbudgetcontainstheplan

forrevenuesandexpendituresfortheperiod,usuallyreferredtoasafiscalyear.

In governmental terms, the expenditure plan represents the authorized limit of

expenditures for the operating unit.Most operating budget provide funds for such

elements

as

staff,

benefits,

supplies

and

operating

expenses

as

well

as

grants

anddisbursements.

CapitalBudgets:Capitalbudgetscontaintheplansandresourceallocationsforcapital

acquisitions..Theyreceivedifferenttreatmentthanoperatingfundsbecausetheiruseis

oftenamorecomplexandlongertermpropositionthantheoneyearoperatingfunds.

Theyofteninvolvecomplexplanningprocesseswithconsiderablefinancialriskandcash

outlay.

Landandbuildingsarewellknowncapitalgoods. Increasingly, informationtechnology

infrastructure is a part of the capital budgets. Determining what is and what is not

treatedas

acapital

item

is

amatter

of

policy

within

public

sector

organizations.

OrganizingBudgetInformation

Budgetsvaryconsiderably incomplexity.Thiswilldependuponthepurpose forwhich

theywerecreatedandhowtheywillbeused.Inseekingthebestwaytodisplaybudget


14/82


information, there are three main approaches, each with useful intent as well as

limitations:

Lineitembudgets,

Programbudgets,

Functionalbudgets

which

combine

the

former

two,

and

Performancebudgeting.

Mostgovernmentpracticeallthreeforms,usingthemtomeetthevariousgoalsofa

budget.Forinstance,asimplelineitembudget,describedbelow,willmeettheneedsof

amanagertounderstandwhatresourcesshehasandforwhatkindofpurpose,e.g.,

staff,supplies,etc.Aprogrambudgetwilllinksuchinformationtotheprogramswithina

particularunit.Afunctionalbudget,averycommontool,combinesthelineand

programbudget.Aperformancebudgetwilllinkthemoneyallocatedtospecific

anticitipatedperformanceoutcomes,e.g.,pavingsomanykilometersofroadsforso

muchmoney.

Each

is

useful

in

its

own

turn.

LineItemBudgets:Thelineitembudgetisoneoftheeasiesttoprepareandoneofthe

mostusefulintermsofcontrolofbudgetswithinaspendingperiod.

The financial information is organized according to the types of expenses or cost

categories.Thesegenerallyfocusonstaff,supplies,rentals,andcontracts,allofwhich

canbecharacterizedascostsofoperations.

AsimplelineitembudgetfortheOttawaGeneralHospital,focusingonexpensesonly,is

shownhere.

Themainorientationofalineitembudgetisexpenditurecontrolandaccountability.

Thisbudgetwillinformthemanagerorstakeholderswhatisbeingspentonwhatitem

ofexpenditure.Theseareknownasinputsinthattheyidentifythecategoriesof

resources,e.g.stafforsupplies,neededtodothework.Sinceitusescommonobjectsor

objectscodes,italsopermitsinterbudgetcostcomparisonsbetweenprogramsor

Line-Item Budget of the Ottawa General Hospital for Fiscal Year 2005

Object Budget100. Salaries $8,000,000200. Supplies 2,000,000300. Rentals 250,000400 .Profess ional Fees 750,000

Total $11,000,000


15/82


organizationswithsimilarfunctions.Agoodexample,ifallhospitalsusedthesame

objectcodesorlineitems,isthatitwouldenableaninterestedobservertodetermineif

theOttawaHospitalhadahigherstaffcosttooverallbudgetratiothananothersimilar

hospital.

ProgramBudgets:Programbudgetsarebudgetswhichareorganizedfordisplay

purposesaccordingtoprogramtypes.Itshowshowresourcesareallocatedtoeach

particularprogram.Thistypeofbudgetassignsresourcestotheoperatingunit,zone,

areaorspecializedprogramwithinwhichitisbeingspent.

ProgramBudgetoftheOttawaGeneralHospitalforFiscalYear2005

Unit Budget

1.OperatingRoom $4,000,000

2.Laboratory 1,000,000

3.Radiology 1,000,000

4.PatientCare 2,500,000

5.OutpatientCare 1,500,000

6.Administration 1,000,000

Total $11,000,000

FunctionalBudgets:Afunctionalbudgetisabudgetthatcombinesthelineitembudget

withtheunitbudgettoprovideamorecompletepictureoftheresourcedistribution

withinan

organization.

Thisisoftentheformatthatisusedforexternalreportinginformation.Ithasthebenefit

ofallowingabetterbasisforcomparisonamongunits.Forinstance,oneareamayhave

highsalarycosts,e.g.operatingroomwhileanother,e.g.,administration,maybelower.

Thatmayreflectthelabourintensityoftheworkorthesizeoftheunitaswellasthe

costoftheprofessionalandsupportstaffineachunit.

Thefunctionalbudgetdeliversabetterunderstandingofwhatfundsaretobespentfor.

Itcombinesinformationaboutinputsandunitsorprogramsthatarebeingfunded.

Below

is

a

display

of

the

functional

budget

of

Ottawa

General

Hospital.


16/82


FunctionalBudgetoftheOttawaGeneralHospitalforFiscalYear2005

Unit 100.Salaries 200.Supplies 300.Rentals 400.Professional

Fees

Total

1.Operating

Room

3,250,000 250,000 50,000 450,000 4,000,000

2.Laboratory 550,000 350,000 25,000 75,000 1,000,000

3.Radiology 450,000 450,000 0 100,000 1,000,000

4.PatientCare 2,000,000 400,000 0 100,000 2,500,000

5.Outpatient

Care

1,200,000 175,000 25,000 100,000 1,500,000

6.

Administration

475,000 325,000 50,000 100,000 1,000,000

Total 7,925,00 2,000,000 150,000 925,000 11,000,00

PerformanceBudgets:Performancebudgetsareintendedtolinkresourcestothe

resultsdesiredfromaprogram.Whilealineitembudgetisfocusedentirelyoninputs

andazerobasedbudgetgoesbacktobasicsandreinventsitselfeachyear,the

performancebudgethascertainfeaturesthatmoveitmoreintotherealmofpublic

sectoraccountabilitywithagreateremphasisonoutcomesandresults:

1. thereismeasurementofthegoodsandservicetobedelivered,

2. unitcostsaredeveloped,

3. budgetfiguresaredevelopedbasedonthelevelofserviceasdeterminedby

multiplying

the

unit

cost

and

level

of

service,

4. expectedoutputsarereportedwithinthebudget.

Theperformancebudgetisdesignedtoprovideaclearerpictureofwhatlevelofservice

istobeprovidedforhowmuchmoneyandwithwhatresults.Anexampleofthiswould

betoaddadditionalinformationtotheOttawaHospitalbudgetdocumentsthatoutline

someofthefollowingoutcomes:

a. numberandtypesofoperations,

b. waitingtimesforoperations

c. costperoperations

d. overheadcostsasapercentageofoverallbudget

e. changesin

service

levels.

Theperformancebudgetisagoodsteptowardscostingofservices,identifyingclearly

servicelevelsofcurrentresourcesandhelpingdecisionmakersmakeabetterlink

betweenthosetwowhendeterminingfutureresourcing.


17/82


TraditionalBudgetingversusPerformanceBudgeting

TraditionalBudgeting PerformanceBudgeting

BudgetOrientation MoneyControl Linkingmoneytoprogram

andactivities

AppropriationControl

LevelDepartment

Program

BasicBudgetingUnit Object,objectcodeorline

item

Activity

EfficiencyMeasurement None Unitcost,volumes

ResultMeasurement

(Effectiveness/Quality)

None Programlevels,activity

levels

BudgetPeriod Oneyear Ongoingyearoveryear

Someofthekeyelementsofperformancebasedbudgetsare:

1. servicesaredefinedandmeasurescreatedforthem,

2. disaggregatingofservicespermitsindividualcostingandthedevelopmentof

workloadmeasurements

3. servicestandardsaredeveloped,4. thereisastandardizedcostingmethodology,5. unlikeotherbudgetformats,therewillbeaconsiderableamountofnarrativeto

explainservicelevels,how

6. theyarecostedandhowcostsaredistributed,

7. someformofbenchmarkingisinvolved:thisprovidescomparativedataofcosts

andworkload

levels

in

similar

circumstance,

e.g.

comparing

the

cost

of

garbage

collectionfromonetowntoanother.


18/82


Section3:UnderstandingtheBudgetaryProcess

Key Points

Agoodbudgetprocessisfarmorethanthepreparationofalegaldocumentthat

appropriatesfunds.

Goodbudgetingisabroadlydefinedprocessthathaspolitical,managerial,

planning,communication,andfinancialdimensions.

Agoodbudgetprocessischaracterizedbyseveralessentialfeatures.Agood

budgetprocess:

Incorporatesamedium

term

perspective

Establisheslinkagestobroadorganizationalgoals

Focusesbudgetdecisionsonresultsandoutcomes

Involvesandpromoteseffectivecommunicationwithstakeholders

Provideincentivestogovernmentmanagementandemployees

Thesekeycharacteristicsofgoodbudgetingmakeclearthatthebudgetprocessisnot

simplyanexerciseinbalancingrevenuesandexpendituresoneyearatatime,butis

strategicinnature,encompassingamulti yearfinancialandoperatingplanthat

allocatesresourcesonthebasisofidentifiedgoals.

Budgets and Planning Cycles

Arrivingatthefinalbudgetwillentailsomemeasureofforecasting,analysisofoptions,

settinginplaceplansoverthelongtermandfinallyassigningresourcelevels.Thisisthe

budgetcycle.Understandinghowitworksisessentialforapublicsectormanager.

Budget cycles tend to be portrayed in calendar form. Below is a typical public sector

budgetcycles.


19/82

Elem

The

Strat

Strat

purp

Public Sect

entsofanE It T

T

d

T

a T

b

G

i

T

salementscaStrategicCostAnalApproval

egicPlanniegic plansseoftheo

R

r Financial M

ffectiveBucreatesacoecycleense budgetpartment.ere isacod

compara

ere isanadgetswithivernmentsportantinfereisacolaries,equiberolledPlanningPhysisPhase,Phase

gPhasesually conrganization

PerformanceMonitoring

eview, Audit andEvaluation

Learninto N

anagement f

getCyclemmonframresthatpocycle is limonappr

ivecosting.

reeduponntheorganiprovide grmationabmoncostiment,etc.pintothrease,nd

ain a fundanditsinte

PlE

OperationalImplementati

and Control

g and Inputxt Year

or Managers

eworkforaliticalpriorinked to toachacrostimetablefzation.uidance toouttolerablgmethodol

essentialp

amental sededdirecti

anning to Plan:tablish System

ApprGov

Body/n

lltheplayeiesareset.e overallgovernme

orpreparat managersecostlevelogyforco

hases:

of componoverapr

Vision, MissionValues, Legal

Mandate

LiCosts

val byrning

inister

sintheproplanningt topermiionandconon budge.moninputs

nents thatescribedpe

,

Goals andOjbectives:Measures

k toBudget

1

esstouse.ycle of thcomparisosiderationt limits ansuchassta

describe thiod.

2

enfdff

e


20/82


Mission comprehensivestatementexpressingthepurposeoftheorganization.

Vision statementoftheendresultspursuedbytheorganization.

GuidingPrinciples philosophythatsteerstheorganizationindeliveringservices

andaccomplishing

its

mission.

SituationAnalysis descriptionofkeyinternalandexternaltrendsthatarelikely

tohaveanimpactontheagencyoverthetimeperiodoftheplan.

Goals statementsthatdescribetheagencysdestination,direction,and intent

fortheperiodoftheplan.

Objectives initiativesthatimplementthegoals.

PerformanceMeasuresandTargetsprecisemilestonesforeachobjectivethat

willhelp theorganizationwillevaluateprogresstowardtheobjectivesand the

goalsthatitsupports.

Linkage

of

General

Goals

to

Annual

Performance

Plan

description

of

the

relationship between annual goals in the performance plan andthe general

multiyeargoalsandobjectivesinthestrategicplan.

Resources Needed description of the human, capital, information, and other

resources and the operational processes, skills, and technology needed to

achieve the agency goals; highlighting where significant change from currently

availableresourceswillbeneeded.Note:this isnotthebudgetforthecoming

year, but a resource discussion that will certainly affect budget decisions in

futureyears.

ProgramEvaluations

description

of

how

the

results

of

programs

or

policy

will

beevaluated.

Cost-Analysis Phase

TheRoleofRevenueinCostAnalysis

Managers have to make predictions about anticipated revenues because without

understanding what resources will be available to government, it becomes extremely

difficulttodecidewhatprojectsshouldbeallocatedresources.Usinghistoricaltrenddata

isaneasilyavailableand useful tool forpredicting revenue.Onceaprediction ismade,

attentioncould

then

be

made

about

costs

and

the

spending

priorities

of

government.

HowtoDetermineCosts

One way of examining costs is to divide them into two basic categories: Direct and

Indirect.


21/82


Directcostsarecosts incurredwithintheorganizationalunit forwhichthemanagerhasresponsibility, and costs of resources used for direct provision of goods or services or

activitiesthatrelatetothecoremissionoftheorganization.3

IndirectcostsorOverheadare:costsassignedtoanorganizationalunitfromelsewhereintheorganizatione.g. informationtechnologysupport,andcostswithinaunitthatare

notincurred

for

direct

provision

of

goods

or

services,

i.e.

core

business

or

mission

central,

butarenonethelessneededtoprovidethoseservices,e.g.logisticalsupport,information

technology,physicalplant,financialservices.4

Often organizations fail to fully take into account all the costs of service delivery. The

objectiveofsoundbudgetingpractice,however,istoarriveatafullunderstandingofthe

totalcostofproviding themissioncriticalservicesof theorganizations.Therefore,both

indirectanddirectcostsneedtobeincludedinanybudget.

Fixedand

Variable

Costs

Another essential tool of costing is the use of fixed and variable costs. This analysis is

important for it enables the manager to determine how costs will react when certain

variables are changed. It can establish cost sensitivity, i.e. the point at which costs can

eitherbereducedorincreasedwithchangesinactivity.Establishinganunderstandingof

cost sensitivities will enable the manager to better understand the impact of program

changes.

Fixed costs are those costs that do not change in total as the volume of service units

changesoverarelevantrangeofactivity.5Variablecostsarecoststhatvarydirectlywith

changesin

the

volume

of

service

units

over

arelevant

range

of

activity.6

Getting Approval to Spend: The Appropriation Process

Asthebudgetprocesssuchasdescribedabovebecomesmoreinstitutionalizeditengages

more players and eventually produces a formal budget submitted to the authorizing

authority. In general, this will mean that the final stage of the budgetary process will

providelegislativeapprovaloftheplannedexpenditures.Thepurposeofthisauthorityis

toobtainspecificapprovaltospendmoney.Suchauthorizationiscalledanappropriation.

Appropriations create the authorization for spending the amount in the budget. In this

way

the

budget

moves

from

being

a

submission

for

funds,

then

a

plan,

then

a

budget

to

becomingthelegalinstrumentofthegovernment,whichbothpermitstheexpenditureof

fundsandrestrictsthatflowtothelevelssubmittedforapproval.

3Finkler, p. 97

4 Finkler, op.cit.5Finkler, p. 99

6Finkler, op.cit. p. 99


22/82


CentralAgencyversusProgramOrganizations

Typically, during the budgetary cycle, the overall planning and legislative process is

supportedbycentralagenciessuchastheMinistryofFinance.Centralagenciesprovidea

wholeof

government

assessment

of

the

supply

of

revenue

as

well

as

the

tolerable

scope

forprogramexpansion.Theyensurethatdebtisavoidedby lookingatthebigpictureof

programspending.Centralagenciesusetheanalyticaltoolsmentionedabovetoprovidea

detailed assessment of the costs of government programs and then provide

recommendationstothelegislature.

Thereisaninherenttensionbetweenthedesiresofprogramdepartmentsofgovernment

to spend to meet all their program needs and aspirations and the desire of central

agencies to control the demands to what is both realistic within government revenue

projectionsanddesirablewithinthegovernmentsoverallpriorities.Suchtensionmeans

thatprogram

managers

will

have

to

work

effectively

with

central

agencies

ifthey

are

to

besuccessfuldefendersoftheirprogramfundsorproponentsofnewfunding.

TheNewVersustheOld

Perhaps one of the greatest sources of tension within budgetary systems and the

budgetary approval process is the desire by governments to extract funds from one

spendingcentreandmove ittoanother.Whilethisgoesbymanynames, it isgenerally

knownasreallocationofexisting funds.This isoftenamatterof fundingnewprograms

withexistingfunds.

Governments will be continually looking for ways to improve efficiency of current

operationstoreducecosts.Theywillalsobelookingforprogramsthatnolongerservean

importantpublicpurpose.

ComplexityversusClarity

Budgetsaremadeupofastreamofdecisions,somewhatinvolvespendingandsomethat

involvelimitingspending.Veryfewdecisionsarealikeandavarietyofpolitical,socialand

economicfactors

come

into

play

in

their

creation.

For

many

public

sector

organizations,

in

order to achieve the objective of public involvement and transparency, the budget

processcanbea longone, involvingmanydifferent forums, inordertoarriveata final

product.

OnBudgetVersusOffBudget


23/82


A challenge for many countries is getting a true picture of government expenditures.

Oftengovernmentswillseektominimizethescopeofpublicexpendituresbytakingsome

expenditure items offbudget. This can be done for legitimate policy and accounting

reasons.Forinstance,ifapublicsectorprogram isselffunding,suchasonethatobtains

allof its revenues fromservice fees, itcanbesaid tooperateoffbudgetas itdoesnot

take upany appropriated funds from thebudget. Often suchentitiesestablish financial

reporting

statements

seperate

from

the

overall

government

financial

statements.

This

servesonegoodofclarity.However,itisalsocontendedthatremovingitfromthegeneral

governmentbooksdistortsthedegreeofpublicsectorspending.Thisdebateisuniversal.

Oneelementofconcern,however,iswhenoffbudgetentitiesarecreatedtodeliberately

mask or distort either government revenues, e.g. development grants from external

sourcesorremoveeffectivelegislativeoversightofthispartofthepublicsector.

Conclusion

The

process

of

formulating

and

getting

approval

for

a

budget,

at

any

level

and

in

any

kind

ofpublicsectororganization, isan integralpartofhow thatorganizationcarriesout its

mission. It can be complex or simple, depending on the nature of the organization.

However,somecommonelementsforpublicsectororganizationsemerge:

Budgetsbringtogetherneedsandcapacity,oftenfromdifferentpartsof

theorganizations,whetheritistaxcapacityandprogramdemandsorclient

needsandfundraisingcapacityoftheorganization.

Budgetsdemandatechnicalcommandofthekeyelementsofneeds

measurement,effectivecostingofprogram,revenueprojections.

Budgetsin

the

public

sector

are

legal

documents

that

define

expenditures

authoritiesandlimitittothoselevelsonceapprovedbytheauthorizing

legislature.

Budgetmakingtakesplaceinanorganizationalculture,richinnuance,with

powerplayingasmucharoleofgoodpolicymaking.

Budgetsareinherentlytransparentinthepublicsector,bothintermsofhowtheyareformedandinhowtheyareexecuted.

Budgetsareboththeresultofplanningbasedonpastexperienceandthe

existingpolicyormissionframeworkoftheorganizationandfuture

orientations.

Budgetsinthepublicsectoraresubjecttointensescrutinynotonlyby

thosewhowillmanagethem,butalsothosewhowillbenefitfromorbe

subjecttothem.


24/82


Section4:Budgeting:CapitalPlanning

Key Points

Capitalassetsareexpensive,havealonglife,canlockinanorganizationinterms

ofalternativeoremergingtechnology.

Thetotalcostofacapitalassetovertimemayincludesizeableoperatingexpenses.

Itsacquisitioncandistortoperationalplanningifthisisnotadequatelyconsidered

attheplanningphase.

Capitalrequiressomespecialtreatmentbothfromthebudgetingandaccounting

perspective.

Capital Budgets

Acapitalbudgetisaplanfortheacquisitionofbuildingsandequipmentthatwillbeused

bytheorganizationinoneormoreyearsbeyondtheyearofacquisition. Adistinction

thathasalreadybeendrawnbetweenoperatingandcapitalbudgetsisthatoftime.

Operatingbudgetsareappropriatedandreporteduponforasinglefiscalyear.Generally,

theoperatingassetsareapprovedandusedupwiththeyear.Thecapitalbudget,whileit

involvesactualcashdisbursementswithinthecourseofafiscalyear,moreofteninvolves

aflowofcashoveranumberofyearstocreateanasset,whichhasalifelongerthanone

yearataminimum.

Therefore,boththeinvestmentflowandtheassetreturnextendoveraconsiderable

periodoftime.Havingcapitalprojectsdependentonyeartoyearapprovalsrestrictsthe

capacityoftheorganizationtocommittothefullcostoftheproject.Approvingthefirst

phaseofamajorconstructioninvestmentandthenreviewingitentirelywhilenot

approvingthenextphasecanleadtoaseriesofcomplicationsfromwasteofpublicfunds

toareluctancetoengageinthehighriskventureinthefirstplace.

Finally,itisoftenthecasethatcapitalprojectsinvolvelongtermdebtforthe

organization.Thechallengeoflongtermfinancinginvolvesagoodunderstandingofthe

truecosts

of

the

investment.

CharacteristicsofCapitalAssets

Fromanaccountingpointofview,somethingisacapitalassetwhenitmeetsfourcriteria:

thattheyareusedintheproductionorsupplyofgoodsand

services(productivitycriterion),


25/82


thattheirlifeextendsbeyondafiscalyear(longevitycriterion)

thattheyarenotintendedforresaleintheordinarycourseofoperations

that the monetized value of the asset is sufficiently high (materiality

principle)

Tools of Capital Planning and BudgetingEffectivecapitalbudgetingbeginswithanunderstandingoftwoelements:

o CapitalImprovementsthecapitalrequirementsoftheorganization,bothnow

andinthefuture

o Maintenanceunderstandingoftherequirementstomaintainpresentcapital

assetsinausefulstate.

Governmentsstruggleonbothcounts,becauseoftheconcernforthecostsinvolvedand

becausetheyhavenotalwayssufficientlyseencapitalassetsasbeingsubjectto

deteriorationand

in

need

of

renewal.

As

well,

in

the

absence

of

life

cycle

analysis

and

the

applicationoftruecostingtoolssuchasTimeValueofMoneyandReturnonInvestment

Analysis,capitalexpendituresareusuallyseenasanannualexpenditureandnotan

investmentflow.

HerearesometoolsofgoodCapitalPlanning

CapitalImprovementPlans

ACapitalImprovementPlanhasamultiyearperspective.Itcanberenewedandupdated

ratherthanrecreatedeachyear.Inthisway,majorcapitalinvestmentdepreciationisnot

forgottenand

maintenance

issues

remain

on

the

table.

It

is

very

easy,

especially

in

a

politicalenvironment,toforgetpipesunderthegroundortheexistingbuildingsinan

efforttofocusonmoreimmediatecrisesorthedesiretocreatenewcapitalprojects.An

exampleofacriticalareainthisregardistheneedtoupgraderoadsonaregularbasis.It

maynotbethemostpoliticallyexcitingthing,butitisnecessary.Anditcostsmoney.

SomeofthestepstobefollowinginthecreationofaCapitalImprovementPlanare:

o StrategicRelevance:Astatementthatlinkstheorganizationsgoalsandobjectives

toitspresentandfuturecapitalneeds

o Analysisof

Factors

Affecting

the

Organizations

Capital

Asset

Base:

Some

factors

totakeintoaccountinthatregardare:

o Demographics:Bothcurrentandfutureindicators,suchaspopulation

changesbyagecohort;impactsofbirths,deaths,immigrationand

emigration;andissuesspecifictoprogramareas.

o Programchanges:Theseincludenewinitiatives,programterminationsor

changesinprogramparameters.


26/82


o Technologicalchanges:Technologicalimperativesareessential

considerationstoday,especiallyasbusinessprocessesbecomemoreweb

based.

o Economicorbusinesschanges:Theseincludecurrentandprojected

financialormarkettrendsandopportunitiesandemergingtrendsinthe

waybusinessisconducted.Anexampleistheemergenceofservice

providersas

alternative

service

deliverers

of

public

services.

o Legislation:Factorstoconsiderhereincludeanynewstatutory

requirementsaffectingtheorganizationoritsserviceplan.

o Environmentalfactors:Theseincludetheimpactofanypotentialchangestoenvironmentalstandards.

o InventoryandConditionAnalysis:Acomprehensiveassetinventory,includingan

assessmentofthephysicalcondition,functionality(i.e.abilitytosupportcurrent

programdelivery)andutilization(capacity)ofitscapitalstock.Thisshouldbe

updatedonanannualbasis.Thefollowinginformationshouldbepartofthis

analysis:

o Baselineinformation:Informationonassetssuchas land,buildings,buildingsystemsandequipment,trackingsuchfactorsas:

i. ownershipstatusii. locationandzoning

iii. structuraltypes

iv. size(landareaifapplicable,squarefootage,vehiclecapacity,etc.)v. ageandhistory(e.g.rehabilitation,repairs,maintenanceactivity,

additions,renovations)

vi. value

vii. currentuse,

viii. estimatedservicelife;and

ix. anyothersignificantissuessuchasenvironmentalliabilities.

o Physicalconditionandriskfactors:Anassessmentorratingofthephysicalconditionoftheinventory,includingmaintenancerequirements,seismic

vulnerability,asbestos,etc.

o Functionality:Anassessmentofhoweffectivelyeachassetmeetsexistingprogramorserviceneeds;functionalityissometimesmeasuredasthe

differencebetweencurrentoperatingcostsandtheprojectedcostof

operatinga"state

of

the

art"

facility.

o PurposeorUseoftheAsset:Anassessmentofhoweachassetisbeingused;thisissometimesmeasuredbycomparingforecastservicedemand

againstanassetscurrentcapacity

o Maintenance Needs: Maintenance requirements must be identified in capitalplans. Plans should also explain the methodologies used to develop the


27/82


maintenanceforecasts(e.g.measurementtools,standardsandformulasbasedon

assetvalueorsquarefootage).

o EstimatesofRequiredResources:Estimatesofcapitalassetrelatedneedsshould

beaggregatedintoidentifiablecategories.Theoverallcapitalcosts,whenoutlined

thoroughly, can be staggering for public sector organizations. Very seldom do

revenueexpectations

match

the

straight

line

anticipated

capital

costs.

Usually

at

thispoint,variousprioritysettingprocessescomeintoplay.

o DevelopmentofStrategiesandAlternatives:TheCapitalImprovementPlan(CIP)

itself does not provide decisions about capital expenditures. Rather, it is the

background against which the public sector organization will set priorities. One

importantservice itcanprovide istoofferalternativestrategiesfordealingwith

capital pressures. For instance, the CIP could also identify alternative delivery

forms such as publicprivate partnerships that would, in essence, transfer the

capital costs of a new building to the private sector builder while imposing a

downstreamoperatingcostforgovernmentintheformofguaranteedrentaland

paymentof

debt

costs

back

to

the

supplier.

Time Value of Money

Becausecapitalprojectsarecostlyandofteninvolvemajorgovernmentinvestments,the

costoftheprojecthastobesetintothetimeframewithinwhichgovernmentswillincur

thecosts.Atthispoint,someformoftimevalueofmoneyanalysiswillhavetobeapplied

beforefinalspendingdecisionscanbemade.

Thesimplestexplanationoftimevalueofmoneyisthatadollartodayisworthmorethan

a

dollar

tomorrow

or

at

any

time

in

the

future.

Partially,

this

difference

in

value

is

attributabletotheearningandcompoundingofinterestforadollarinvestedtoday. This

is also attributable to opportunity cost, meaning that money spent now addresses

presentneedswhilemoneydeferredmissestheopportunitytodoso.

Anotherfactorthatrelatestothetimevalueofmoneyisrisk. Riskinthisinstancerefers

topossible lossofvalueof the fundsavailable throughanunsuccessful investment ina

capitalproject.Thedollar inhandtodayhasnorisk. It isfirmlywithinthecontrolofthe

organizationand it candisposeof it,save itor invest itas itsees fit. Thepromiseofa

dollartomorrowcarriessomeriskthatyouwon'tgetitoryouwon'tgetitwhenyouhave

been

promised

you

will

get

it.

Taking all these elements into account, time value of money considerations encourage

mangers to calculate the monetized benefits of a capital investment and then discount

thosebenefitsinawaythatreflectsthedecliningvalueofadollarofbenefitoccurringin

thefutureratherthantoday.

PresentValueandFutureValue


28/82


Applyingtechniquesofinterestcompoundinganddiscounting,itispossibletodetermine

eitherthepresentvalue(PV)orfuturevalue(FV)ofacapital investment,usingasimple

formulathatapplies interestandtimetotheamountsthatareeitheravailablenow for

investmentincapitalorthepresentvalueofafuturepayment.Thevariablesusedinboth

calculationsare:

PV=Present

Value

FV=FutureValue

i=InterestRatePerPeriod

n=NumberofCompoundingPeriods

Present Value is an amount today that is equivalent to a future payment, or series of

payments, that has been discounted by an appropriate interest rate. Since money has

timevalue,thepresentvalueofapromised futureamountisworth less the longeryou

haveto

wait

to

receive

it.

The

difference

between

the

two

depends

on

the

number

of

compoundingperiodsinvolvedandtheinterest(discount)rate.

Therelationshipbetweenthepresentvalueandfuturevaluecanbeexpressedasshown:

Relationship between Future Value and Present Value

PV = FV [ 1 / (1 + i)n ]

Example: You want to buy an emergency generator for the Fire Departmentthat will only become useful 5 years from now for $150,000. Assuming a 6%interest rate compounded annually, how much should you invest today toyield $150,000 in 5 years?

FV = 150,000i =.06n = 5

PV = 150,000 1 / 1 + .065

= 150,000 1 / 1.3382255776 = 112,088.73


29/82


NetPresentValue

NetPresentValue (NPV) isameanstocalculatewhetherthepublicsectororganization

willbebetterorworseoff if itmakeacapital investment. Itdoesso bycalculating the

presentvalueofinflowsminusthepresentvalueofoutflows.

NPV=PV

Inflows

PV

Outflows

Risk Assessment

It iscriticaltounderstandandassesstherisk involved ineach initiative.Risksshouldbe

identifiedattheearlieststageofplanningastheymayimpactfinancingandprocurement

options. Once risks have been identified, they must be analyzed and evaluated to

determine the likelihood, consequences and level of risk. Finally, a risk management

and/ormitigationstrategymustbeputinplace.

Risksshould

also

be

reviewed

and

updated

as

the

initiative

moves

forward.

Thetablebelowprovidesexamplesoftheriskcategoriesthatshouldbeconsideredwhen

planning and managing infrastructure expenditures. It also provides examples of how

thesetypesofrisksmaybetreatedtoreducethelikelihoodorconsequencesofpotential

losses.

ExamplesofRiskCategoriesinAssessingCapitalAssetRisks7

RiskCategory DescriptionandTreatment

GeneralRisks

Examples

include

high

level

concerns

related

to

the

decision

to

undertake

an

initiative. Risk treatmentmay includedocumenting howan initiative fitswith

established strategic objectives; assessing the requirements for a new

corporate structure; enhancing the initiatives profile with the public, media

andgovernments;andworkingcollaborativelytoenhancelabourandindustrial

relations.

PolicyRisks Examples include the likelihood that an initiative represents, or may be

affected by, a major shift in government or agency policy, or change in

legislation.

PublicInterestRisks Examplesincludetheinitiativesenvironmentalimpactanditsrelationtopublic

health, safety and security issues. Risk treatment may include working with

neighbours and the community to address public concerns in the initiative

planningphase.

ManagementorOrganizationalRisks

Examples include the complexities associated with partnerships, investmentsand management. Risk treatment may include managing dependencies on

linkedfundingandcontingentinvestments;ensuringtheavailabilityofqualified

initiativemanagers;andensuringtheinitiativedevelopmentteamhasaccessto

appropriateexpertisewhenundertakinganewtypeofinitiative.

7BC Capital Asset Management Framework


30/82


Design/Construction,

Commissioning,

PartnershiporSupplier

Risks

Examplesincludesponsorrisk(e.g.,thelikelihoodthataprivatepartnermaybe

unable to deliver) and general supplier/market capacity. Risk treatment may

includeensuringtheavailabilityofmaterialandequipmentsupplies;ensuring

thatexperienceddesigners,contractorsandtradespeopleareavailable inthe

required time frame; anticipating the need for community permits and

approvals;anddesigningconstructionwindowstoavoiddelaysduetoadverse

weather.

PoliticalRisks

Often

unspoken,

but

certainly

real

are

many

political

risks

associated

with

capitalprojects.Examplesofsomeare:

short tenure of a government that may mean the project is re

evaluatedorchangedbyanewgovernment,

local opposition to a project that leads to considerable political

controversyandreversalongroundsofcommunityconcerns

failuretoadequatelyconsultortakeintoaccountvariousstakeholder

interests

SiteRisks Examplesincludetherisksassociatedwithsiteselectionandacquisition.

Risktreatmentmayincludeensuringthatthesiteisavailableatanaffordableprice;

evaluatingsitechallengessuchassoilcontaminationorpotentialflooding;andensuring

thedesired

site

is

free

of

potential

land

claim

issues.

FinancingRisk Examplesincludeanentitysabilitytodrawtherequiredfinancialresourcesandthe

overallfinancialviabilityoftheinitiative.Risktreatmentmayincludeensuringthat

financingisavailableattheappropriatetime;anticipatingtheimpactofinterestrate

increases;andevaluatingthecreditworthinessofpotentialpartners.

Cost,

Economicor

MarketRisks

Examplesincludeallpossibleeventsthatcouldaffectcashflowduringinitiative

development.Risktreatmentmayincludeplanningforcontingenciesinthemarketsuch

asadropindemandforservices;anticipatingthepotentialforlabourormaterialcost

escalations;ensuringfundingisavailabletocoveroperations,maintenanceand

administration;andassessingthepotentialforcompetingfacilities.

Ownership

and

Operations

Risk

Examplesincludelabour relations,maintenance,andtechnicalandassetobsolescence

risks.Risktreatmentmayincludetakingstepstokeepmaintenanceinlinewithforecast

levelsand

taking

appropriate

measures

to

address

the

likelihood

of

abandonment.

OtherRisks Risksthatcouldbesubstantiveandrequireresolutionand/or

managementpriortocommitmenttotheexpenditure,orduringdelivery,including

uncontrollableforcemajeureriskssuchasweatherandglobaluncertainty.Risktreatmentmayincludedevelopingcontingencyplanstoavoidorreduceconstruction

delaysduetoemergenciesordisaster;andensuringthatbusinesscontinuityplans

addressawiderangeofpotentialevents.

Conclusion

Theconceptualtoolsandplanningprocessessuggestedhereisanimportantpartof

organizationalfinancialmanagementwherevercapitalplaysanimportantroleincarrying

outthatorganizationsmission.Thinkingaboutcapitaloftenchallengesthelinemanager

toescapetheyeartoyearoperatingbudgetorientationandlookattheimplicationsof

suchelementsastheactualcostofaninvestmentincapitalforbothoperatingcostsdown

theroadandfurthercapitalinvestments.


31/82


Oneoftheothervery importantreasonstohaveaspecialawarenessofcapitalbudgets

andhowcapitalbehavesovertimeisthatofteningovernment,theissueofmaintenance

andreplacementofcapitalgoodsiseasilydeferredwhendifficultbudgetcutshavetobe

made. What this has led to in some countries is a serious underinvestment in

infrastructurethatwillnowcostmuchmore,inpresentvalueterms,toreplace.Thishas

beenthevictoryoftheshorttermoverthelongterm.Unseensewersveryseldomattract

politicalattention

until

they

break

down.


32/82


Section 5: Cornerstone Two: Monitoring MoneyManagerial Control

Key Points

Thebudgetisaplan.Onceapproved,ithastobecarriedout.Thedesiredoutcomeof

implementingthebudgetistoachievetheobjectivesoftheprogram,projectorlineof

activityinthemostefficientandeffectivemeansthatarereasonabletothesituationbut

withanequalconcernfortheproperuseofpublicfunds.Inanyenterprise,thisrequiresa

seriesofcontrols.Takentogether,theseformafullcontrolframework.Controlbegins

andendswithafocusontheendstobeachievedandhowtomonitorperformance.

Forthelinemanager,controlsestablishtheextentoftheirdiscretionandoutlinetherules

bywhichtomakedecisions.Effectivecontrolswillensurethatthereisatimely

understandingoftheperformancewithintheorganizationthatwouldpermitadjustments

inbudgets,behavior,orprogramexpectationstoaccommodateunforeseensituations

andmonitortheimpactofmanagersdecisions.

What is Management Control?

Managementcontrolsystemsconsistofallorganizationalstructures,processesand

subsystemsdesigned

to

elicit

behavior

that

achieves

the

strategic

objectives

of

an

organizationatthehighestlevelofperformancewiththeleastamountofunintended

consequencesandrisktotheorganization.8

Management Control Framework

Acontrolframeworkisawayofdescribingthearchitectureofcontrolforthe

organization.Acontrolframeworkwithinanorganizationwillinvolvecertainkeyfeatures:

Establishingtheorganizationsgoalsandobjectives

Assigningroles

and

responsibilities.

Performancestandardswheretheycanbeestablished.

8Systems Theory and Management ControlBy:Dr. Shahid Ansari:http://faculty.darden.virginia.edu/ansaris/Systems%20Theory%20and%20MCS-TN.pdf


33/82


Anunderstandingoftherisksinherentintheprogramandthe

environmentalinwhichitistakingplace

Positivemitigationandmonitoringtoolstocontinuallyreassesstherisks

Aseriesofcontrolproceduresandpoliciestobothaddresstherisks

identifiedandtosatisfycertainlegislativeorpolicycreatedrequirements

foradequatecontrol

Asystemofmonitoringatboththeoperationalandfinanciallevelto

ensurethattheorganizationfullyunderstandswhatishappeningrelative

toitsgoalsandtheriskenvironment

Asystemofauditingandevaluation,bothinternalandexternal,that

providesassurance,fromanindependentperspective,thatthereisan

adequatecontrolframework,thatitisworking(andnotjustpaper)and

thattheoutcomes,bothoperationalandfinancial,areastheorganization

claims.

Risk and Risk Management

Inmanyways,actuallyexercisingcontrolmeansanticipatingandmitigatingriskswithin

theorganizationorprogram.ControlisaboutRiskManagement.Riskandrisk

managementhavebothanarrowdefinitionassociatedwithfinanciallossandalarger,

morecomprehensiveoneassociatedwithorganizationalgoalsandthethreatstoattaining

them.Inthecontextoffinancialmanagement,riskmanagementencompassesboth.

Nonetheless,riskcanbroadlybedefinedasfollows:anythreat,event,patternofpastor

anticipatedbehaviourorpredictedeventthatcoulddetertheorganizationfromachieving

itsgoals.

Inapplyingthisdefinitiontopublicsectorfinancialmanagement,thereareclearlysome

conditionsthathavetotakenintoaccount.First,thegoalsofallpublicsector

organizationsaretoperformapublicgoodinthemannerprescribedbylaworpolicyina

costeffectivemanner.Second,itispossibletoreadilyinterpretthisdefinitioninfinancial

termsinanumberofways:

Thedangerofnotmanagingentrustedfundseffectivelyorlegally,

Thedangerofinadequatefundingcombinedwithexaggeratedobjectives,

Thedangerofspendingoverbudgetwithouttakingmitigatingmeasures,

Thedangeroffraudormisuseoffunds,

Thedanger

of

unforeseen

circumstances

that

strain

or

threaten

the

financialcapacityoftheorganization,

Thedangeroflossofconfidencefromthepublic,thelegislature,donorsor

stakeholdersinthecapacityoftheorganizationtodeliveritsservicesas

promised.


34/82


Riskmanagement,therefore,istheestablishmentofproceduresandmanagement

systemstoidentify,assess,validate,mitigateandmonitorriskstotheorganizationinsuch

awaytoeliminatethem,effectivelyreducetheirimpactorbepreparedtorespondto

them.

UnderstandingandDefiningtheRisks

Akeypartofriskmanagementinvolvestheneedformanagerstomakedecisionsabout

whatriskstoactonandwhichonesdonotrequireanyactionatthetimeofreview.

.

Notallrisksarethesame.Itisnecessaryfortheorganizationtodecidewhichonesare

importantanddemandingofacertainlevelofmitigationandwhichonesareeithernota

significantthreat,nottimelyoreasilymitigatediftheydooccur.

Anumberofsystemshavebeenestablishedtohelporganizationsdeterminethelevelof

riskthattheycanaccept.Suchsystemsarevaluableastheyestablishacommonlanguage

andframeworkfororganizationstoeffectivelycometoanunderstandingoftherisksthey

faceand

the

meaning

of

their

identification

of

them.

Ensuring

that

all

levels

of

the

organizationsusesuchcommontoolsensuresthatmisunderstandingsaboutrisksandthe

controlneedsthatmayflowfromthemarereduced.

Belowisastandardgridtoenableorganizationtorankriskontwokeyaxes:impactand

likelihood.Withoutdeterminingwhatthelikelihoodandpotentialimpactofanyidentified

risk,thereisnoreasonablewaytodeterminewhattodoabouttherisk.Further,thisis

thekeywaytodifferentiaterisksanddeterminewheretoapplyscarcemanagerial

resourcesinthemitigationprocess.

IMPACT POTENTIAL RISKMANAGEMENTACTIONS

Significant

Considerablemanagement

required

Must manage andmonitor risks

Extensivemanagement

essential

ModerateRisks may be worth

accepting withmonitoring

Management effortworthwhile

Management effortrequired

Minor Accept risks Accept, but monitorrisks

Manage andmonitor risks

LOW MEDIUM HIGH

LIKELIHOOD


35/82


Control Procedures and Policies

WhoandWhentoControl

Nowthatwehaveanideaaboutwhereourobjectivesmaybecompromisedthrougha

risk

identification

process,

we

need

decide

how

to

achieve

the

kinds

of

controls

that

are

needed.Theactofcontrollingfinancialresourcesisanactiveonethatboththemanager

oftheprogramandthefinancialexpertshavebeengagedin.Itcannotbelefttofinance

toprovideallthecontroloversight.Itistoocloselytiedtothemanagersresponsibilities

todeliverthepublicgoodforwhichheorsheisresponsible.

Thefirstcontrolquestiontoaskwhencontemplatingthemeansofcontrolis:whoto

controlandwhentodoit.

Intermsofwhotocontrol,therearetwochoices:theorganizationasawholeoran

individual.Theindividualmaybeapersonwithintheorganizationwhoismakinga

decisionto

spend

funds

on

behalf

of

the

organization.

Alternatively,

the

individual

may

be

therecipientofapublicgoodorentitlement.Inmanycases,whentheorganizationisto

bethesubjectofcontrol,thecontrolswillentailinformationatanaggregatedlevelof

performance,e.g.quarterlyreportsoncontractsauthorizedandlevels.Ifitisan

individual,itmaybeattheindividualtransactionlevel.

Intermsoftimeorwhentocontrol,thealternativesaretoexercisecontroleitherbefore

oraftertheindividualororganizationhasacted.Beforethefact,orexante,controlsinvolvesubjectingadecisionthattheorganizationorindividualisabouttomaketosome

levelofapprovalorreviewinadvance. Asanexample,anorganizationmayrequire

approvalfrom

its

central

office

before

purchasing

equipment

over

the

value

of

$50,000.

Thisapprovalisaformofcontrolandrequiredbecauseofthematerialityofthepurchase.

Thisisinspiteofthefactthatpurchaseofthisitemmayhavebeenapprovedaspartofa

largerbudgetplan.

Afterthefact,orexpost,controlinvolvesareviewprocessfordecisionsandexpendituresthathavealreadybeenmade.Insuchcircumstances,theactor,beittheindividualorthe

organization,isfullyresponsiblefortheactionthatwastaken,astheyhadtheauthority

toapproveitandactionwastakenasaresultoftheirauthorization.Forexample,a

chequemaybeissuedontheauthorityofanindividual,notsubjecttoanyotherreview,

excepttoverifythatitistheapprovedofficialwhohasthatauthority. However,some

formof

control,

through

monitoring,

sampling,

summarized

reporting

or

variance

analysis,

isputinplacetooverseethequalityofdecisionsalreadymadeeitheratanindividual,or

aggregatelevel.Thisisthemorecommonformofcontrolexercisedoverfinancial

transactionswithinorganizations.Itismoreefficientintermsofprocessingpayments,

etc.italsofocusespriorapprovalsontheriskiertransactions,therebyeffectively

budgetingseniormanagementandgovernancentime.


36/82


WhoistheController?

Thenextquestiontoaskiswhothecontrolleris.Thesimplefactisthat

controller/controlleerelationshipsexistatmanylevelsandoperateinmanyways.

Therefore,whileonemanagermayexercisecontroloveragroupofstaffandsetup

processesofcontrolsuchasregularperformancereviews,delegationtolimitstodefine

discretion,etc.,

that

very

manager

will

almost

certainly

be

subject

to

controls

both

from

asuperiorandalsofromoversightbodiessuchasexternalauditors.Anotherpointisthat

theyareimperfectandoftencloudedbyothermatters,betheyoperational,financialor

political.

Trust and Ethics in Control

Ifriskmanagementisthefaceofcontrolthewayinwhichcontrolisexpressedthan

trustandethicsaretheheartofcontroltheculturalrealitythateithersupportor

destroyeven

the

most

perfect

control

plan.

Fundamentally,allcontrolsarebuiltaroundtwonotions:

thedegreeoftrustthecontrollerplacesintheorganizationorpersonswith

authorityandresponsibility,and

theassumptionsaboutethicalbehaviorinthecultureandlegalframework

oftheorganization.

Trust

Trustisacalculationthatismadebytheorganizationaboutitsownpeople,aboutother

organizationsandotherpeopleaswellasitsleadership.Trustisalsoanimportant

elementin

balancing

the

desire

for

full

assurance

through

control

(no

surprises,

no

errors)

withthecostorimprobabilityinachievingit.Intheend,morecontrolsystems,nomatter

howtechnologicallysoundordetailed,dependonthepeoplerunningthemandoperating

withinthem.Therefore,adegreeoftrustisnecessarilyextendedtooperatorsofthe

systemswiththeassumptionthattheirintentionsaresoundandthat,basedontheir

trackrecord,suchtrustisdeserved.

Ethics

Notallcontrolisaboutsystems,procedures,documentationandprocess.Infact,allof

thiscontrolcouldbehappeningand,withthewrongvaluesinplay,seriousintrusionsinto

pubictrust

could

be

accruing.

This

could

be

either

through

misappropriation

of

public

funds,usingthemforpurposesnotintendedortheirdiversiontootherpurposesofa

personalnature.Itisaxiomaticthatthepublicsectororganizationsandthepeoplewithin

themhavetoactinanethicalmanner.

Therefore,ensuringthattheethicalframeworkoftheorganizationsanditspersonnelis

soundisyetanotherformofcontrol,onethatisessentialtothesuccessofallother

efforts.


37/82


Values and Ethics Approaches

Political and senior management leadership that promotes ethicalconduct

Clear statements of values and ethics or codes of conduct Approaches to decision making that

o require consideration of values and ethicso align management policies to support ethical conducto offer recourses to report ethical concerns

Clear guidance for interaction between the public and private sectors Assessment of and reporting on effectiveness of values and ethics

initiatives

Source: Organization for Economic Co-operation and Development (OECD),Principles for Managing Ethics in the PublicService

Oneofthemostimportantelementsofestablishingstrongvaluesandethicsisthrough

ethicalleadershipwithintheorganization.Notethatthisisthefirstitemidentifiedbythe

OECDinitsframeworkforethicalpublicsectororganizations,aslistedbelow:

TheattributesofethicalleadershipweredocumentedbytheCanadianfederal

governmentsTaskforonPublicServiceEthics9:

Createasupportiveworkenvironmentthat

o valuespeople,treatingthemwithdignity,civilityandfairness;o emphasizesopennessandthesharingofinformation;

o promoteshonestandcollegialleadership;

o encouragesandsupportsspeakingtruthtopower;and

o supportsabalancedfamilyandworklife.

Makedecisionsthat

o servethepublicinterest;

o respectdemocraticprinciplesandtheruleoflaw;

o ensuredueprocess,impartialityandobjectivity;

o provideeffectiveservicestocitizens;and

o promotetransparency,

probity

and

accountability.

9AStrongFoundation:ReportoftheTaskForceonPublicServiceServiceValuesandEthics,JohnC.Tait,

Q.C.,Chair,availableathttp://www.myschool monecole.gc.ca/Research/publications/html/p91/1_e.html


38/82


Someofthetoolsthatpublicorganizationscananddousetoensurethattheyhave

promotedethicalbehaviourare:

establishingcodesofconductorethicstosignaltheimportantvaluesofthe

organization

supportingsanctionsforethicalmisconduct

usingmeritprinciplesinhiringandpromotion awidevarietyoftraininginitiativesonethicsforbothnewemployeesand

thosealreadyinposition

identificationofhighriskpositions(notpersons)whereeitherspecial

trainingonethicalchallengesorspecialsurveillanceiscalledfor

disclosureofanyconflictsofinterestandpoliciestosupportthis,noting

thatthisbecomesmoreimportantthehighertheleveloftheposition,

toolstorep

Documents

Public Sector Financial Management for Managers 2