POSDCORB-BUDGETING
By: Alberto D. Pena, PH.D
Associate Professor, Ret., University of Connecticut (USA)
Member of the Faculty, MDI, Illinois State University (USA)
POSDCORB-BUDGETING
• Budgeting is the process of allocating resources to various activities
indicated in the plan.
• It is the financial version of the plan.
• In POSDCORB, budgeting refers to the allocations of money to the
various activities and projects in the operation plan.
• Changes in the operational plan will change the budget.
• If the changes in the operational plan hits snags due to budget
constraints the executives has to find new sources of funds or scale
down the ambitions in the plan.
POSDCORB-BUDGETING…..
• A government budget is both planning and legal document.
• It is a law and that law cannot be change easily and the executives are
enjoined to spend within the budget and in accordance with
expenditures items allowed in the budget.
• Changes in the budget has to go through the legal and political
procedures. New expenditures has to be deliberated again in
Congress or Parliament and submit the approved changes to the
President or Prime Minister for signature.
• This does not preclude the fact that budget changes does happen but
it takes time.
POSDCORB-BUDGETING…..
• Budgeting in the private sector including NGOs are planning
document.
• Technically it can be change without too much hassle compared to
the government budget.
• However, 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.
• You do not just change the rules in the middle of the game as the
saying goes.
POSDCORB-BUDGETING…..
• The Concept and Process of Budgeting:
• Budgeting is the process of allocating financial resources to different objects and subjects
of expenditures.
• It articulates the objectives of the organization and provides the vehicle for
implementing its policies.
• For the private sector organizations it is a means for achieving operational efficiencies
and profitability.
• Budgeting in the public sector incorporates the administrative and political mandates and
objectives of the organization.
• For both sectors, budgeting 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.
POSDCORB-BUDGETING…..
• 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 budget and
subsequently the plan.
• Changes in the plan will change the budget and changes in the budget
will change the plan.
POSDCORB-BUDGETING…..
• The budgeting process is under the shadow of constraints.
• Scarcity of resources puts meaning to being efficient, effective, and
economical. Organizations like to achieve their objectives at a lesser cost
and gain more benefits per unit of cost.
• It is against this backdrop that 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 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.
POSDCORB-BUDGETING…..
• The budget structure consists of two main parts: Sources of Funds and
Allocation of Funds.
• For a corporation, the funds could come from various sources including
operating revenues, investment income, sales of assets, and loans.
• For a public entity, 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.
• The largest source of funds for government agencies, such as a ministry or
department, 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.
POSDCORB-BUDGETING…..
• The usual allocation for these funds would include salaries and fringe
benefits, supplies, utilities, payment of liabilities, payment to outside
vendors and service providers, repairs and maintenance, purchase of
equipment, human resource development, etc.
• In addition to these recurrent allocations, the organization would add
additional allocations for non-recurrent activities in a particular budgeting
year such as estimated expenses for the new branding strategy (for
corporations), expenses for additional fund raising (public agencies), and
other allocations not included in the recurrent expenditures.
• The non-recurrent portion of the budget would also include allocations for
capital investments such as acquisition of equipment, construction of new
facilities, etc. which are called investment projects.
POSDCORB-BUDGETING…..
• The total amount to be raised from various sources should be equal the
total amount for the allocation of funds.
• 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 to covering unforeseen expenditures, the
purpose of putting reserves is to avoid the bureaucracy of supplemental
budgeting.
• It may not be too important for corporations but supplemental budgeting
or request for additional fund is a very tedious process for government
agencies. The budget of government entities is a legal document that
cannot be changed easily. For a private corporation and NGOs, a budget is
only a planning document.
POSDCORB-BUDGETING…..
• 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.
• Since the budget is only the financial picture of a plan, the budget will
change as the plan changes.
• 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.
POSDCORB-BUDGETING…..
• 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 because 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.
POSDCORB-BUDGETING…..
• 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.
POSDCORB-BUDGETING…..
• There are important implications in the statements of budgeting
objectives.
• One is the objective of maintaining fiscal discipline enjoining managers to
abide by the budget as much as possible.
• Budgeting is a serious process and should not be taken lightly. 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 inability to forecast financial needs and economic events.
• Fiscal discipline also means that proper administrative procedures and
fiscal policies have been followed.
POSDCORB-BUDGETING…..
• The second objective refers to 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.
• The synchronization of the plan with the budget appears to be automatic
following the flow of financial management system.
• In practice however, it is conceivable that actors and decision makers in making
the plan and in making the final budget might be different. There are also cases
where financial constraints may force the organization to change course.
• If for some reasons 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.
POSDCORB-BUDGETING…..
• The third objective refers to achieving efficiencies in delivering
services, mostly referring 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.
POSDCORB-BUDGETING…..
• The Operation Budget:
• The budget mentioned above is an 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. The array of these expenditure items is envisioned to
carry out the operation of the organization for the calendar or fiscal year.
• It implies 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.
POSDCORB-BUDGETING…..
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Procedural Sequence in the Budgeting Process:
Operational budgeting follows two procedural sequences.
One is to first estimate revenues and then makes the allocations within the estimated income.
The other is to make the estimates of different allocations and develop strategies to raise
revenues to cover the planned allocations.
• The first procedure is a common practice for business corporations, whose income comes mainly
from the sale of their products.
• The second procedure is common to public organizations that depend on public fundraising (in
case of NGOs), taxation (in case of national and local governments) and government support (in
case of government ministries and other agencies).
• 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.
POSDCORB-BUDGETING…..
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Budget Formats:
The operational budget can be represented by using two formats.
One format is called Line-Item Budget and the other Performance Budget.
Referring to line item budget and performance budget as mere formats
could be over simplified since both budget presentations have their own
unique concepts and applications.
• For our immediate purpose, the line item budget format will be used as the
basis for discussing significant issues in budget preparation and analysis
such as cost centers, budget codes, and historical analysis.
• Line-item budgeting is the most common presentation for operation
budget. Performance budget is most useful in programs, projects, and
budgets of specific departments and units.
POSDCORB-BUDGETING…..
• Line Item Budgeting:
• Line items normally refer to the objects of expenditures in the
allocation portion of the operation budget.
• 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.
POSDCORB-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 are also instances where a source of fund is “lined” with specific allocation.
This concept of line item budgeting is identified with public sector budgeting.
Examples include specific tax revenues that could only be used for certain
expenditures as in road user tax or property taxes. Another example is revenue
from the issuance of bonds. Revenue from some bond issues could only be used
for specific projects.
• This practice is most common to government agencies and non-government,
non-profit organizations known as NGOs. It is the main reason why these
organizations normally use fund accounting in recording financial transactions.
POSDCORB-BUDGETING…..
• The need for aggregation in the allocations for satellite units of a large
organization may occupy specific “lines” in the budget.
• For example, the Ministry of Health may occupy just one “line” in the
national budget. It simply means that such allocations can only be used by
the Ministry.
• 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.
POSDCORB-BUDGETING…..
• Line Items in Aggregate Amounts:
• We already illustrated the need for aggregation according to organizational levels
as in the case of national budget to ministry budget and further to a particular
unit of the ministry. 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. This is especially true with
large organizations. 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.
POSDCORB-BUDGETING…..
• On the “Sources of Funds” side, the item on Sales Revenue is an aggregate
amount representing sales of different products of the corporation. If the
corporation has 6 products for sale, the Sales Revenue figure in the
corporate operation budget represents the sales of these individual
products.
• This is also true in other “Sources of Funds” items such as the Income from
Short-Term Investments, Income from Long-Term Investments, and Income
from Royalty Payments, and Other Income. This is done in order to present
the operation budget in a simple and very readable document.
• Presenting the details of each “Sources of Funds” item would clutter the
presentation of the operation budget. These details are presented as
attachments to the operational budget for the purpose of reference and
auditing.
POSDCORB-BUDGETING…..
• In the “Allocation of Funds” portion of the corporate operation budget, the
amounts are also in aggregates.
• For example, the Salaries and Wages item might consist of different
categories of personnel including allocations for consultants.
• The budget attachment for this item can be shown by categories of
personnel such as permanent employees, contractual employees, and
consultants.
• The attachment can also be presented by location of employees, i.e. by
departments such as general administration employees (Office of the
General Manager), administrative department, finance department,
marketing department, maintenance department, etc.
• These attachments are important for referencing, auditing, and managerial
and cost control analysis.
POSDCORB-BUDGETING…..
• Budget Analysis:
• After familiarizing with the format of the line item budget, managers could
now focus on analyzing the budget.
• The understanding of the operational budget will put every manager in a
very effective position to participate in the management of the
organization.
• Budget analysis should focus on the following: 1) identification and analysis
of revenue and cost centers; and 2) historical analysis.
• 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.
POSDCORB-BUDGETING…..
• 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.
• 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. In other words, management should pay more attention to these
sources of funds. This is one important uses of operational budget as a planning document.
POSDCORB-BUDGETING…..
• Expenditure centers embrace many forms with one unifying concept: It is a place for
controlling and containing costs.
• In other words, it is the place where efficiency battles are being fought. Cost
containment can be done through major cost items or through departmental units or
both.
• Major cost items: These items can be identified in the operational budget. This is done
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
(say 50% of the total), then it is clearly a major item to watch. Similar analysis will apply
to other items like cost of energy and utilities, travel, supplies, maintenance and repairs,
etc. In some cases however salaries and wages for permanent employees are difficult to
control compared to salaries and wages for temporary employees such as casual
employees and consultants. This is mostly true in government budgeting. In
corporation, salaries and wages are subject to continuous scrutiny and control.
POSDCORB-BUDGETING…..
• Departmental Units:
• Organizational units can also be cost centers.
• By following the established organizational chart, the organization can
identify cost centers and their hierarchical relationships.
• For corporations, the departments that have the highest percentage of
total budget allocation will be the cost centers. These could be the
production department and the marketing department.
• This is also true for public agencies such as NGOs and government entities.
In public agencies, the units that have the major portions of the total
budget are cost centers. Management should pay more attention to these
units for controlling cost.
POSDCORB-BUDGETING…..
• 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. This is usually done in case of fund management by
NGOs and government agencies.
• 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.
POSDCORB-BUDGETING…..
• Historical Analysis of Budgets:
• Ratio analysis is a standard operating procedure for budget analysis. It
is used in the identification of revenue and expenditure centers.
• The same ratios are used in the historical analysis of budgets. The
main difference is time perspective. The former (analysis of revenue
and expenditure centers) is based on the current budget while the
later (historical analysis) is based on previous budgets in relation to
the current budget.
• The former would establish a condition for the present while the later
would establish a trend.
POSDCORB-BUDGETING…..
• Historical analysis of the operational budget will establish a trend of where
the organization has been or where it is going.
• In addition to the ups and downs in the recurrent line items, the historical
analysis would indicate major innovations or improvements that the
organization has introduced through the years.
• Historical analysis would also trace the growth or reduction in different line
items. These changes will show past realignment of the budget due to
changes in priorities or whether cost- reduction measures are in place.
• It also serves as an input in the projection of the budget in the future.
• Historical analysis involves ratio analysis of line items in the context of time
series, normally for the previous five years.
POSDCORB-BUDGETING…..
• The Financial Management System
• The financial management system consists of the following elements:
• Planning, Budgeting, Accounting, and Auditing. It starts with planning
or the identification of activities to be done, normally within one
fiscal or calendar year.
• This plan is known as the operational plan.
• The process of allocating financial resources to implement the
activities in the operational plan is called budgeting.
• This type of budgeting will result to an operational budget commonly
known as the financial version of the plan.
POSDCORB-BUDGETING…..
• The monitoring of financial transactions during the implementation of
the operational budget is called accounting.
• The monitoring involves recording and reconciliation of financial
flows.
• The verification and authentication of financial records is known as
auditing.
• The auditor’s opinion would point to whether the financial
transactions were recorded following commonly accepted accounting
rules or whether financial transactions are within the legal
requirements of government, internal policies of the organization, or
specific contractual requirements.
POSDCORB-BUDGETING…..
POSDCORB-BUDGETING…..
• The financial system is both structural and procedural.
• It is a structural system because it consists of elements that are
dependent or structurally connected with each other and requires
certain recording and reporting formats. Because of these standard
formats, financial documents can be read and analyzed more easily.
• The financial system is also a procedural system 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.
POSDCORB-BUDGETING…..
• Embedded within the elements of financial system (budgeting,
accounting, and auditing) 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.