Framework For Effective Local
Government Finance
World Bank – Public Sector
Management Thematic Group
Michael Schaeffer
March 2005
The ‘Quick Start’ Framework
• Components of Effective Local Government
•
•
•
•
•
Finance
A Shift in the Nature of Local Government
Budgeting
The Capital Budget
The Role of Financial Reporting and Accounting
The Treasury System
Sequencing of Management Reforms
2
Essential Components:
• Control Structure Derived From Legislative
•
•
•
•
Framework
A Standardized Chart of Accounts / Accounting
System
An Effective Treasury and Cash Management
System
Internal / External Reporting
Effective [Timely] Budget and Reporting System
3
An Effective Financial Management
System
Components of an
Effective Financial Management System
Community Driven
Performance Measurements
Community Ownership
Budget Policies
Formulation and Execution
Community (Participation) Driven
Effective Treasury and Cash
Management Systems
Standardized
Chart of Accounts
Accounting Systems
Transparent/ Accountable
(External / Internal Audits)
4
Shift in the Nature of Local
Government Budgeting
“Conventional
Budgeting:”
Budget Process
Rules
Inputs
Compliance
Hierarchal/Centralized
Control
“New Public
Expenditure
Management:”
Budget Policies/Institutions
Incentives
Outputs/Outcomes
Performance Orientation
Decentralized
Responsibilities
Transparency and
Accountability
5
Framing Local Government Policy
Budgets are Fundamental for Meeting Three
Important Policy Objectives:
1. Aggregate Fiscal Discipline;
2. Allocation of Resources [Consistent with
Strategic Policy and Priorities]; And,
3. Efficiency and Effectiveness
6
Local Government Budgets:
In Theory and Practice
Good Budget Practices
Comprehensive
Disciplined
Legitimate
Flexible
Predictable
Contestable: Subject to review and
evaluation
Honest
Information must be accurate and timely.
Transparent: Information about budget
practices must be accessible and
communicated to a wider audience.
Accountable: Decision makers must be
held responsible for the exercise of
authority provided to them.
Source: Public Expenditure Management Handbook (1998) World
Bank
Poor Budget Practices
Unrealistic Planning and budgeting
Short-term budgeting with no medium or long-term
implications
Numerous budget revisions throughout the year
Government spends as cash becomes available not
according to preset priorities
Deferred budgeting: Arrears build-up as expenditures
are pushed into subsequent years.
Distorted priorities.
Informal management: Extralegal behavior dictates
how government operates with respect to hiring and
procurement etc.,
Corruption: Lack of enforcement of formal rules
breeds illegal behavior (corruption).
Source: A. Shick (1998) A Contemporary Approach to Public Expenditure
Management. World Bank Institute.
7
Effective Financial Management
and Budgeting
• Set of Activities Where Intentions of Local Government
•
•
•
Managers and Politicians Becomes Operational
One Mechanism to Determine Local Government
Performance is Audit
Performance Based Local Government Unit [LGU]
Financial Management Necessitates a Change in Local
Government Financial Management and Organization
Must Produce Information in an Integrated Manner –
Budgeting, Accounting, Cash (Treasury) and Debt
Management Must be Linked
8
Working Within Proper Legal
Environment
• Detailed Rules with Respect to Local
•
•
•
Government Budgeting, Accounting, Cash And
Debt Management
Internal / External Audit Responsibilities Should
be Designated
Role of Any Oversight Agency Should be Defined
Jurisdictions, Level of Autonomy, and the
Components of Local Government Financial
Management Systems Should be Spelled Out
9
Perspective on Budgeting
• Establish Clear Operating Procedures Between
•
•
•
•
•
Management Sections of Each Implementing
Department
Limit Programmatic Classifications to Only What
is Necessary for Effective Decision-making
Simplify and Limit Account Classifications
Match Budget Authority with Operating Level
Codify Budget Procedures in a Manual
Develop Performance Measurements that Can Be
Used to Measure Efficiency / Effectiveness
10
Budget Formulation and Adoption
• Local Government Budget Should include
the Following:
– Program Elements Should Be Limited /
Meaningful
– Present Multi-Year Data to Include Prior,
Current and Forecast
– Include all Units that Require Government
Resources in the Budget Formulation Process
11
Revenue Mobilization and
Forecasting:
•
Two Principles:
1.
2.
•
•
•
Own-source Revenues Should Be Sufficient to Enable LGUs to
Finance all Locally Provided Services From Own Resources
To Extent Possible, LGU Revenues Should Be Collected at the
Local Government Level
Most Basic Forecast – Use Revenues From Current
Year Increased By a Growth Factor
Better to Use Information on Forecasted Tax Bases and
Planned Rates to Explicitly Calculate What is Legally
Collectible
Should Use Information on Tax Compliance Levels to
Determine Likely LGU Revenues
12
Expenditure Forecast and Control
• LGU Budgets Should Be Examined For
•
•
•
Conservative Characteristics
Appropriations Should Be Fixed at Levels
Determined By Best Estimates of Available Work,
Services, and Price Levels For the Year
Local Population [and, Legislature] Have Right to
Know LGU Policy Objectives and Targets
Informing General Public Increases
Transparency, Accountability, and Allows For a
General Consensus to Be Reached
13
Budget Execution and Expenditure
Control
• Key Elements For Consideration in The Financial
Management of Budget Implementation:
– Provide Guidelines For Re-programming Budget Line
Items
– Re-programming Requiring Higher Level Approval
Should Only Be For Shifts Between Major Line Items
– Establish Clear Procedures for Committing Funds
– Establish Clear Procedures for Distributing Allotted
Budget Authority on a Quarterly [Monthly] Basis
– Quarterly Budget Allocations Must Be Made in
Conjunction With Aggressive Cash Management
14
Factors Influencing Escalating
Expenditures
• Soft Budget Constraints
• Fragmented Approaches to Budgeting
• Creating Future Expenditure Commitments
By Under provisioning
• Lack of Transparency
• Systematic Errors in Budget Forecasting
15
The Capital Budget
• Concerned With Creation of Long-Term Assets
• Organized Along Multi-Year (5-Year) Capital
•
•
Investment Plan
Financing of Investments Often Requires a
Different [More Complex] Set of Capacities
Officials Also Need Skills to Procure Construction
Services in a Cost-Effective, Open Manner
16
Structure of Capital Budget
• Inventory of Capital Assets
• Multi-Year Capital Investment Plan (CIP)
• Financing Plan
17
Structure of a Capital Budget
Revenue (Receipts)
Expenditures
I. Taxes and Property Earmarked
for Capital Projects
I. Acquisition of Existing Assets
Plant, Property, Equipment
Financial
II. Surpluses from the Current
Account
II. Acquisition of New Assets
Plant, Property, Equipment
Financial (Other than capital
transfers)
III. Proceeds from Borrowing
Domestic
Accounts Maintained by the
Government
External
Repayment of Loans
III. Capital Transfers
Transfers to Other Levels of
Government
Transfers to Public Sector
Enterprises
IV. Depreciation Allowances
IV. Repayment of Loans
V. Sale of Property
VI. Capital Grants
Source: A. Premchand (2000) “Capital Budgets: Theory and Practice.”
18
Determining Capital Expenditure
Resource Allocation
• Used in the Production [Supply] of Goods
and Services [Productivity Criteria]
• Life Extends Beyond a Fiscal Year
• Not Intended For Resale in the Ordinary
Course of Operations
19
Number of Capital Projects that
LGU Can Finance, Depends On:
• Level of Recurring Future Operating
Expenditures
• Cost Recovery Elements
• Availability of Cost Sharing By Different
Tiers of Government [or PPP]
• Debt Structures and Instruments
20
Capital Budget Issues
Functional Area
Issues
I. Project and Investment Appraisal
1.Need to apply uniform and consistent
guidelines
•Analysis techniques in many countries are qualitatively deficient.
•Analysis studies may lend themselves to manipulation and often
become studies designed to support decisions already undertaken.
II. Funding Arrangements
1.Centralized Borrowing
Centralized borrowing may lead to resource fungibility and the loss of
project identity. In the case of India (State and Local Governments) it
may be difficult to measure loan performance effectiveness
III. Budget Formulation
1.Medium Term Rolling Plans
2.Contingent Liability and Associated Risk
Management Should be Part of the Budget
Decision Making Process
3.Risk Assessment
IV. Budget Implementation
1.Release of Funds
2.Underfunding
3.Payment
1.Possibility of Contributing to Budgetary Rigidity
2.Most Local (State) Budget Systems Have no Mechanism For this
Purpose. Some Countries Have Initiated Efforts to Pass Legislation
and Associated Regulations.
3.Changes in Interest, Inflation (and, Exchange Rates) Pose Serious
Implications for the Financing of Self-Financing and Self-Liquidating
Projects. In Many Cases, These Costs Are Borne by the General
Budget. In Order to Understand the Risks, These Transactions need to
be More Transparent.
1.Capital Projects Have Their Own Seasonality of Expenditure Flows.
Each Project May Have Its Own Distinctive Requirements. Funding,
Budgetary Authority, and Cash Management Must be Synchronized in
Conformity with Project Requirements and Implementation Schedule.
2.Projects are in Many Cases Underfunded. Even the Amounts
Estimated in the Budget May not be Released in a Timely Manner.
3.Project Payments are Generally Decentralized. There may be delays
in payments. Arrears in Payments are Common and Reveal A Failure
of Cash (Expenditure) Management System.
Source: A. Premchand (2000) Capital Budgets: Theory and Practice, and Schaeffer et al Croatia: Investment Packaging Manual (2004)
21
Role of Accounting and Financial
Reporting
• Accounting is Systematic Gathering of
Financial Transactions
• Compiling and Reporting of Transactions in
a Meaningful and Systematic Manner
22
Unified Chart of Accounts
• Represents Basic Structure of Municipal
Financial Accounting
• Must Include all Categories of Assets,
Liabilities, Revenue and Expenditures, And
Equity Accounts
• Provides a Logical Structure For Classifying
Transactions
23
Accounting Treatments:
• Cash:
– Simplest of All Accounting Procedures
– Records How Much is Received
– Records How Much is Paid Out
– Records How Much is in the Bank
– Simplest to Implement
– However, May not Provide for Adequate
Controls on LGU Transactions
24
Cash Accounting: Not
Recommended By GAAP
• Cash Received as Loan Illustrated as Revenue on Operating Statement not
•
•
•
•
•
•
•
as Liability on Balance Sheet
To Correct: Most Cash Accounting Systems Recognize not only Cash, But
Other Assets and Liabilities Arising Through Prior Cash Transactions.
Does Not Alter Fact that Outstanding Obligations In the Form of Contract or
Purchase Orders are Not Immediately Reflected In Accounting Records
records.
Available Balance May Be Overstated
Can Lead to Unwise LGU Expenditures and Potential Overspending
LGUs Operating on A Cash Basis May Ignore Obligations to Vendors For
Services Received [But Not Yet Paid]
This Type of Action Creates A Floating Debt Outside the Normal Financial
Management System
Cash Basis Accounting Does Not Adequately Record Liabilities Either to
Provide Future Services or In Recognition of Services or Goods Received For
Which the Bill Has Not Been Paid.
25
Accrual Accounting
• Relates Revenues and Expenditures Not to the Time in
•
Which the Cash is Received or Disbursement Made, But
To the Period For Whose Benefit The Transaction Occurs
Involves Shifting Existing Financial Features of Current
LGU Financial Operations
– Shifting the Recording Basis From Cash To Commitment
– Separation of Financial Activities into Current and Capital
– Include Full Depreciation Allowances that Permit Allocation of
Costs over the Life of The Asset Rather Than Recording
Expenses When they are Incurred
– Preparation of Financial Statements in Conformity with
International Accounting Standards (IAS) or Generally Accepted
Accounting Principles (GAAP)
26
Modified Accrual
• Most Transactions are Accrued in the Period in Which
•
•
Benefit Received
Other Transactions – Especially Revenue are Accrued on
a Cash Basis
General Rule:
– Expenses are Accrued
– Income From Taxes, Fees, and Other Sources are Recorded only
When Collected (Cash Basis)
• Net Effect:
1. Bring Income in Line With Actual Cash Available to Pay Bills
2. Ensuring the Recording of Expenses cannot be Manipulated by
Delaying Until the Bill is Paid
27
Deciding On An Accounting System
• Moving From Cash to Modified, Accrual
Systems Requires Changes in the
Organization Flow of Local Government
Institutions and Increase in LGU Capacity
• Primary Importance of LGU Accounting
System is that Financial Information
Should be Timely, Transparent and
Complete
28
Universal Features of Accounting
Systems
• Common Denominator:
– All Systems Should Track Appropriations
– Supplementary Estimates
– Use of Appropriations
• Release of Funds
• Commitments
• Expenditures at Verification Stage
• Payments
• May be More Effective to Assist LGUs in
Improving Cash Basis Accounting First – Rather
than Shifting to Other Accounting Systems
29
Financial Reporting
• Process of Compiling and Organizing Financial
•
Information Into Meaningful Reports
Financial Reports Should [In General] Include:
– Balance Sheet [Not with Cash] – {However Can Use
Simple Balance Sheet Recording Assets / Liabilities}
– Income Statement
– Cash Flow Statement
30
Auditing
• Audit Report Should:
– Analyze the Financial Position of the Local
Government
• Include Trends
• Quality of Receipts [Revenues]
• Expenditure Analysis
– Evaluate Performance of Government on Various
Financial Management and Accounting Issues
– Include Audit Observations
31
Auditing and Local Government
• Audit Function of Local Government Found
at Three Levels
– The Local Government Itself (Internal)
– Central [Supreme] Audit Office
– External Private Auditing Companies
32
Shortcomings In LGU Audits
• Audit Oriented Toward Reviewing
Transactions Rather than Performance
• Do Not Focus on Systematic Review of the
Effectiveness of Internal Control Systems
• In Some Cases, Appropriate Certification
of Financial Reports [Annual Accounts] Not
Provided
33
Treasury System
• Treasury Function Covers the Following:
– Cash Management
– Management of Bank Accounts
– Financial Planning and Cash Flow Forecasting
– Public Debt Management
– Administration of Grants and Transfers
– Financial Asset Management
34
What is Cash Management?
• Controls Aggregate Local Government
Spending
• Implements the Budget Efficiently
• Minimizes the Cost of Borrowing
• Maximizes Opportunities for Using
Government Resources
35
Controlling Cash Flows
• Minimizing the Interval Time When Cash is Received and
•
•
the Time Available For Financing Expenditure Programs
Excess Cash Resources Should Not Be Idle
LGU Treasurer Should
– Establish Written Procedures for Certifying Payments and
Transferring Payment Requests to Cash Management
– Continuously Update Cash Flow Projections
– Develop Payment Schedules that Allow Individual Departments
to Track Payment Requests
– Establish Standards and Procedures to Assure that Expenditures
are Paid Within a Stipulated Time Frame
36
Framework For LGU Financial Management
Feeders: Local
Government
Information
Systems
HR & Payroll
Benefits
Travel
Acquisition
Property
Management
Inventory
Revenue
Grants
Loans
Insurance
Others
Core Financial Functions
Funds Management
General Ledger Management
Cost Management
Payment Management
Receivable Management
Reporting
Data Mining and Mapping
Service
Delivery
Chart of
Account /
Accounting
Management
Information and
Decision Support
Financial
Information:
Financial
Statements
Financial Reports
Budgeting
Budget and
Performance
Integration
Human Capital
Management
Program
Management
Performance
Measurement
Resource Cost
Accounting
Life Cycle
Management
Planning and
Decisions Support
Strategic Planning
Annual
Performance
Report
Fee Setting
Competitive
Sourcing
37
Sequencing
• Chart of Accounts
• Accounting
• Local Government Fiscal Discipline
• Treasury and Budget Systems
38