POSDCORB BUDGETING By Alberto D Pena PH D

POSDCORB BUDGETING By: Alberto D. Pena, PH. D Associate Professor, Ret. , University of Connecticut (USA) Member of the Faculty, MDI, Illinois State University (USA)

Budgeting is the process of allocating resources to various activities indicated in the plan. It is the financial version of the plan.

Budgeting • Budgeting articulates the objectives of the organization and provides the vehicle for implementing its policies. • It is a tool to implement organizational policies and mission. • It is also a battleground for cost control. • The budgeting process puts into motion the desire of the organization to attain certain levels of efficiency, effectiveness and economy in pursuing its administrative, political, and social objectives.

In the Public and Private Sector IN THE PUBLIC SECTOR • A government budget is both planning and legal document • It is a law and that law cannot be changed easily • Executives are enjoined to spend within the budget • Changes have to go through lengthy and difficult legal and political procedures. • This does not preclude the fact that budget changes happen but it takes time. • Budgeting in the public sector incorporates the administrative and political mandates and objectives of the organization

In the Public and Private Sector IN THE PUBLIC SECTOR • A budget in the private sector including NGOs is a planning document. • Technically it can be changed without too much hassle compared to the government budget. • For private sector organizations, it is a means for achieving operational efficiencies and profitability.

Recap A Budget in the Public Sector Planning Document Legal Document A Budget in the Private Sector Planning Document Lengthy legal and political processes to change Less hassle to change compared to government budget Tool to implement organizational policies and mission Incorporates administrative and political mandates Means for achieving efficiency and profitability

Changing the Budget • Changes in the operational plan will change the budget. • If the changes in the operational plan hits snags due to budget constraints, the executives have to find new sources of funds or scale down the ambitions in the plan. • Meanwhile, frequent changes in the budget reflects poor planning. • Remember that the operational plan is also based on strategic plan and frequent changes in the plan would indicate weak strategies.

Monitoring and Control • The budget is the financial version of the plan. • Allocations to different items of expenditures, activities, and programs give a picture of what the organization plans to do. • It is also a monitoring and control mechanism for the implementation of the plan. • The records of financial transactions through the accounting documents is actually the monitoring and control of the budget and subsequently the plan.

Budgeting • Organizations like to achieve their objectives at a lesser cost and gain more benefits per unit of cost. • It is against this backdrop that concepts and tools such as: – cost effectiveness, – cost accounting, – cost control measures, – benefit cost analysis, – activity based budgeting, – performance auditing, and other financial tools were developed in support of the budgeting process.

Budgeting • Budgeting is the beginning and the end of the financial management system. • By viewing the financial management system as a loop, one can see that the budget is the point of reference for all financial transactions during the accounting year and the budget for the next period is the culmination of all the experiences encountered in the previous year.

The budget structure consists of two main parts: Sources of Funds Allocation of Funds

Sources of Funds For Corporations • Sources of funds include operating revenues, investment income, sales of assets, and loans. For Public Entities • Funds may come from taxes, floatation of bonds, proceeds from endowments, fund raising, income from bank deposits and investments, sales of assets, loans, grants, and other sources.

Sources of Funds • The largest source of funds for government agencies, would be from government budgetary appropriation and special taxation. • Funds from external development assistance may comprise a big portion of financing development projects in developing countries, in addition to government counterparts.

Allocation of Funds • The usual allocation for these funds would include recurrent costs such as salaries, supplies, utilities, liabilities, payment to outside vendors and service providers, repairs and maintenance, etc. • In addition to these recurrent allocations, the organization would additional allocations for non-recurrent activities in a particular budgeting year such as estimated expenses for the new branding strategy (for corporations) and expenses for additional fund raising (public agencies) • The non-recurrent portion of the budget would also include allocations for capital investments such as acquisition of equipment, construction of new facilities, etc.

AMOUNT RAISED AMOUNT ALLOCATED The total amount to be raised from various sources should equal the total amount for the allocation of funds.

Reserves and Contingencies • In practice however, the total amount raised should also cover various reserves such as a reserve for contingency. • The reserve for contingency is meant to cover unforeseen minor expenses and price increases. In addition it also avoids the bureaucracy of supplemental budgeting. • Supplemental budgeting or request for additional funds is a tedious process for government agencies. • For a private corporation and NGOs, a budget is only a planning document.

Estimates • A budget is done at the present to be implemented in the future. Unlike accounting records that contain actual amounts, the amounts in the budget items are estimates. • Because it will be implemented in the future, the estimates could be affected by future events or changes in the plan • Because of its nature, the budgeting process is dotted with cracks and pitfalls. It needs a careful analysis of the assumptions that were used as basis for estimating future revenues and future expenses.

Deficit and Surplus • The reserve for contingency is not a sure way to patch things up. • Significant deviations from the estimates would cause serious deficits or surplus. – For corporate hospitals, it would be a case of misdiagnosis and misuse of funds. – For manufacturing corporations, deficits are costly to patch. It may involve borrowing expensive funds on short notice. On the other hand, significant surplus means tying up valuable funds “on-line” instead of depositing it to higher earning accounts. – For government entities, deficit means putting the budget in the emergency ward. Surplus would mean returning the money to the mother agency or to the government, which may affect future budget requests.

Balancing Act • At the national level, deficit would mean expensive short-term borrowing while surplus would translate to unnecessarily diverting financial resources from private investment to public allocations. • For both private and public organizations, the term “balanced budget” is only an attempt to reconcile the actual funds being raised to actual funds being used. • This balancing act happens towards the later part of the budget year. • In most cases, it is the use of funds that will be subject to more scrutiny.

Implications 1. Maintaining fiscal discipline 2. Setting or following organizational priorities 3. Achieving efficiencies in delivering services

Implications Maintaining Fiscal Discipline • Budgeting is a serious process and should not be taken lightly. • Managers need to abide by the budget as much as possible. It is not just an exercise in arithmetic. • The budget is developed with an intention to follow it. A series of supplemental budgets and revisions, although necessary at times, are reflections of the inability to forecast financial needs and economic events. • Fiscal discipline also means that proper administrative procedures and fiscal policies have been followed.

Implications Setting or Following Organizational Priorities • Priorities have been set in the planning phase of the financial management system and since the budget is the financial picture of the plan, allocations in the budget should be based on these priorities. • In practice however, actors and decision makers might be different. Financial constraints may also force the organization to change course. • If the priorities have to be changed in the operation budget, the priorities expressed in the plan should also be changed. There is a feedback mechanism between planning and budgeting as there is a feedback mechanism between and among the different elements in the financial management system.

Implications Achieving Efficiencies in Delivering Services • Refers to the allocation portion of the operation budget. • It implies that the allocated amounts to different input items are determined based on the most cost effective means of procurement and service delivery. • It is not sufficient to ask the question how much would a budget item needs. • The most important question to ask is how to achieve efficiency in delivering the service.

The Operation Budget • The operation budget contains the estimates of incoming funds from various sources as well as the allocation of these funds to different expenditure items. • It is implied that the allocations in the operation budget are expendable items. In addition to the purely operational expenditure items, it may also contain the programmed expenses for capital projects intended for disbursement within the accounting year. • The whole implementation budget for a large capital project encompassing a multi-year period would be separated.

The Budgeting Process The 2 Procedural Sequences in the Budgeting Process: Estimate revenues and then make the allocations within the estimated income Make the estimates of different allocations and develop strategies to raise revenues to cover the planned allocations.

The Budgeting Process The 2 Procedural Sequences in the Budgeting Process: Estimate revenues and then make the allocations within the estimated income This is common practice for business corporations, whose incomes mainly from the sale of their products.

The Budgeting Process The 2 Procedural Sequences in the Budgeting Process: This is common to public organizations that depend on public fundraising (NGOs), taxation (national and local governments) and government support (government ministries and other agencies). Make the estimates of different allocations and develop strategies to raise revenues to cover the planned allocations.

The Budgeting Process As a matter of fact, the so-called operational budget for government agencies is only a supplement for the general budget appropriation of the national government. The approval of the budget request is a tacit agreement that the government will appropriate and release the amounts requested by the agency.

The Formats The 2 Types of Budget Formats Line-Item Budget ● most common presentation for operation budgets Performance Budget ● most useful in programs, projects, and budgets of specific departments and units.

Line-Item Budgeting Line items normally refer to the objects of expenditures in the allocation portion of the operation budget.

Line-Item Budgeting • It is called line item because the individual objects of proposed expenditures occupy a “line” in the budget presentation. • Common examples of line item include salaries and wages, administrative supplies, purchase from outside vendors, human resource development, utilities, etc.

Line-Item Budgeting • Line item budgeting does not only refer to the objects of expenditures which indicate allocations to specific allocations. This is just the first illustration that an allocation intended for specific “line expenditure” could not be used for other purposes. • In government budgets, the transfer of allocations from one line to another is governed by specific rules since the budget is a legal document. • There also instances where a source of fund is “lined” with specific allocation. • This concept of line item budgeting is identified with public sector budgeting.

Line-Item Budgeting National Budget 2015 • The need for aggregation in the allocations for satellite units of a large organization may occupy specific “lines” in the budget. • For example, the Department of Health may occupy just one “line” in the national budget. It simply means that such allocations can only be used by the Department of Education 367. 1 Billion Department of Public Works and Highways 303. 2 Billion Department of National Defense 144. 5 Billion Department of Interior and Local Government 141. 4 Billion Social Welfare and Development 108. 2 Billion Department of Health 103. 9 Billion Department of Agriculture 89. 1 Billion Department of Transportation and Communications 59. 5 Billion Department of Environment and Natural Resources 21. 5 Billion Department of Science and Technology 17. 8 Billion

Line-Item Budgeting • The budget at the level of the Ministry of Health may present a lump-sum appropriation for a government hospital as a separate “line” indicating the allocation for Hospital A could not be transferred to Hospital B. • A lump-sum allocation to a project could occupy a line in the agency budget also indicating that the money could not be used for other purposes except for the implementation and operation of the project.

Line-Items in Aggregate • The amount of details follows the organizational ladder. More aggregation is needed as we go upward and more details are presented as we go downward. • Aggregation is also evident in specific line items depending on the number of its components. In order not to clutter the presentation, the main budget contains aggregates of similar expenditures in one line item.

Line-Items in Aggregate • An example is a line item on utilities. • This line item could be an aggregate amount for various expenditures such as electricity, water, oil and gasoline, etc. These “sub-items” would be presented in a separate list as an attachment to the budget. Company A’s Utilities Wages 15, 000 Electricity 130, 000 Rent 1, 200, 000 Water 50, 000 Utilities 210, 000 Gas 20, 000 Insurance 75, 000

Line-Items in Aggregate • On the “Sources of Funds” side, Sales Revenue is an aggregate amount. If the corporation has 6 products for sale, the Sales Revenue figure represents the sales of these individual products. • Aggregation is done in order to present the operation budget in a simple and very readable document. • Details are presented as attachments to the operational budget for reference and auditing.

Line-Items in Aggregate • In the “Allocation of Funds” portion amounts are also in aggregates. • For example, the Salaries and Wages item might consist of different categories of personnel. • The budget attachment for this item can be shown by categories of personnel, location, department. . . etc. • These attachments are important for referencing, auditing, and managerial and cost control analysis.

Budget analysis should focus on the following: Identification and Analysis of Revenue and Cost Centers These budget analyses are based on determining the proportionate allocation to one item or to one department in relation to the total budget. This is the reason why they are lumped into the so-called ratio analysis. Historical Analysis

Ratio Analysis of Revenue and Expenditure Centers • Revenue and cost centers refer to the major sources of revenue and major items of expenditures. • Comparing the percentage of each revenue source in relation to the total revenue can identify the revenue centers. • For example, if the revenue from the in-patient department and diagnostic department of a hospital are 50% and 30% respectively, then these are revenue centers.

Revenue Centers • If a business corporation is selling six products and 50% of the total revenue come from the sales of just two products, the production and marketing of these two products becomes revenue centers. • For NGOs, the major revenue centers would be endowments and scheduled fundraising. • • The purpose of identifying revenue centers is to maintain or improve the effectiveness of raising revenues from these sources. This is one of the important uses of the operational budget as a planning document.

Expenditure Centers • Expenditure centers embrace many forms with one unifying concept: It is a place for controlling and containing costs. • Cost containment can be done through major cost items or through departmental units or both. • Major cost items: These items can be identified by computing the proportional percentage of each item from the total budget. • For example, if salaries and wages contribute a significant portion of the total budget, then it is clearly a major item to watch.

Expenditure Centers • Organizational units can also be cost centers. • By following the established organizational chart, the organization can identify cost centers and their hierarchical relationships. • The units or departments that have the highest percentage of total budget allocation will be the cost centers. • For corporations, these could be the production department and the marketing department.

Expenditure Centers • Some financial analysts would even distribute the value of shared human and material resources to different units for the purpose of determining cost centers. • For example, the salary of the General Manager could be proportionately charged to different departments under his/her direct supervision. • The cost of utilities shared by different departments would be distributed in similar fashion.

Expenditure Centers • For ordinary organizations not bound by legal requirements to separate funds, cost centers should be based on direct cost incurred by the department. • The distribution of “overhead” would complicate the determination of cost centers.

Historical Analysis • Ratio analysis is also used in the historical analysis of budgets. • The main difference between Revenue & Expenditure Center Analysis and Historical Analysis is time perspective. The former is based on the current budget while the latter is based on previous budgets in relation to the current budget. • The former would establish a condition for the present while the latter would establish a trend.

Historical Analysis • Historical Analysis would: – indicate major innovations or improvements that the organization has introduced through the years. – trace the growth or reduction in different line items. – serve as an input in the projection of the budget in the future. – involve ratio analysis of line items, usually including the ratios for the previous five years.

Financial Management System The 4 Elements of the Financial Management System Planning It starts with planning or the identification of activities to be done, normally within one fiscal or calendar year. Budgeting The process of allocating financial resources to implement the activities in the operational plan is called budgeting. Accounting The monitoring of financial transactions during the implementation of the operational budget is called accounting. Au Auditing The verification and authentication of financial records is known as auditing. The auditor would indicate if financial This plan is known as The monitoring transactions were the operational plan. This type of budgeting involves recording and recorded following will result to an reconciliation of commonly accepted operational budget financial flows. accounting rules or commonly known as whether financial the financial version of transactions are within the plan. the legal requirements.

Financial Management System

Financial Management System The financial system is both structural and procedural. Structural because • • it consists of elements that are dependent or structurally connected with each other it requires certain recording and reporting formats. Procedural because • it follows specific steps or procedures in allocating financial resources as well as in recording and verifying financial transactions. ★ The key to understanding financial documents is to be familiar with their purpose as well as the forms, formats, and procedures for developing them.

Financial Management System • Embedded within the elements of the financial management system are specialized tools for making financial management more effective and useful. • These include cash flow analysis, cost-effectiveness analysis, risk management, financial projections, financial engineering, cost control measures, capital budgeting, cost accounting, fund accounting, performance budgeting and auditing, project finance, and other improved financial management tools.

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