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
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 add 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 income comes
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 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.
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.
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
Company A’s Utilities
Wages
15,000,000
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.
This plan is known as
the operational plan. This type of budgeting
will result to an
operational budget
commonly known as
the financial version
of the plan.
Accounting
The monitoring of
financial
transactions during
the implementation of
the operational
budget is called
accounting.
The monitoring
involves recording
and reconciliation of
financial flows.
Au
Auditing
The verification and
authentication of
financial records is
known as auditing.
The auditor would
indicate if financial
transactions were
recorded following
commonly accepted
accounting rules or
whether financial
transactions are within
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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