Assignment 2
Budget Assignment
A. Mission and Strategic Plan
The organization’s mission represents its raison d’être. Public, healthcare, and
not-for-profit organizations have missions that relate to providing a public service. Their
mission may be to improve society by providing wide access to culture—through
museums, opera, ballet, or symphony. Or the mission may relate primarily to healing the
ill or feeding and sheltering the poor. For government, the mission may be to provide
essential common services such as police, education, sewers, and fire protection. For
public, health, and not-for-profit organizations, then, profitability is a means to an end
rather than the end itself. To some extent, the healthcare industry is becoming more and
more a part of the for-profit sector. Similarly, the for-profit education sector has grown.
For such proprietary public service organizations, profits do play an important role in the
organization’s mission. However, their profit motive must be balanced with the public
service elements of their mission.
Like all good mission statements, the mission of Meals for the Homeless includes
both breadth and limitations. A mission should be targeted. If the goal is to do everything
for everyone, the mission is unlikely to be achieved and the organization will lack clear
direction. If the mission is too narrow, it may not provide the organization with sufficient
challenge to sustain itself over time. In the mission statement for Meals for the Homeless,
there is breadth in that the goal of the organization is to meet the nutritional needs of
every homeless person who cannot get food from other sources. The limitations are that
the organization is geographically limiting its efforts to Middle City and to supplying
food. It is not providing jobs, shelter, medical care, or other services.
Once the organization has a clearly defined mission, it can develop its strategy for
accomplishing that mission. The strategic plan defines the primary approaches that the
organization will take to achieve its mission. Generally, strategic plans do not have
specific financial targets. However, they set the stage for specific, detailed budgets. The
mission of Meals for the Homeless (Meals) is to ensure an adequate supply of nutritious
food for the homeless. It could attempt to achieve that mission by a large number of
approaches. Meals could be a lobbying organization, raising money and using it to lobby
for legislation requiring the government to provide nutritious food to the homeless.
Another strategy would be to start a “take a homeless person to dinner” campaign. This
approach would consist primarily of advertising, with a goal of encouraging the general
public to buy meals and give them directly to homeless people. The general strategy that
Meals has taken is to solicit donations of food and money, and to use those resources to
prepare and serve meals directly to the homeless. Meals uses two delivery trucks and one
soup kitchen to carry out this strategy. This was pretty much the way things had been for
the past 10 years, despite a growing number of homeless in Middle City.
When Leanna Schwartz became executive director of Meals for the Homeless, she
decided that Meals had a clear mission. It also had an overall strategy or approach for
accomplishing that mission. However, it had no broad goals. As a result, as the needs of
the homeless grew, Meals had not responded. Therefore, as one of her first priorities,
Schwartz decided to form a subcommittee from her Board of Directors to establish a
more formal strategic plan, including a set of goals for the organization. The strategic
plan would serve as a link between the mission and activities that the organization would
undertake to achieve that mission.
B. Long-Range Plan
While the strategic plan establishes goals and broad strategies, the long-range plan
(sometimes referred to as the operating plan) considers how to achieve those goals. Long-
range plans establish the major activities that will have to be carried out in the coming 3
to 5 years. This process provides a link between the strategic plan and the day-to-day
activities of the organization. Organizations that do not prepare a long-range plan are
often condemned to just sustain current activities, at best. Many managers simply try to
replicate the current year’s results when they plan for the coming year. They take
whatever has happened, add a few percentage points for inflation, and assume that they
have an adequate plan for the future. The problem with that approach is that after 5 years
the organization will likely be exactly where it is today. It will be providing the same
quantity and quality of services. It will not be able to look back at where it was 5 years
ago, compare that to where it is today, and find that a satisfying amount of progress has
been made. Most public service managers believe that they are trying to achieve
something. They do not work in the field just to collect a paycheck, but rather to provide
some service to society. Given that, it does not make sense to try to sustain operations
without any significant gains over time.
Management needs vision. Great managers are those individuals under whose
stewardship organizations make great strides forward. In some cases, vision may come
from inspiration that only a few people ever have. In many cases, however, vision is a
result of hard work and careful planning. It is the result of taking the time to think about
the organization’s mission, form a strategic plan with goals, and then establish the tactics
to carry out that plan and achieve the goals. For example, one element of the strategic
plan for Meals for the Homeless is expansion of meals provided from 20 percent to 60
percent of the target population. This cannot be achieved by simply carrying out the
existing daily routine, day after day, year after year. Nor can it happen overnight. A long-
range plan must be developed that will specify how the organization expects to achieve
that goal.
The managers of Meals will have to determine what must happen to attain its
goals. Schwartz would likely start by having conversations with many interested parties
about how best to get meals to the poor of the city. Then, a variety of approaches or
tactics might be considered. Finally, a long-range plan will be formulated. The long-
range plan should focus on both financial and nonfinancial issues. For example, there are
many dimensions to quality in providing a service. How long do the homeless have to
wait in line for the meal? Do the homeless like the way the food tastes? What is the
relationship between each soup kitchen and its community? Organizations, especially
public service organizations, need to be concerned with more than just the number of
units of service provided (output). The number of meals served is important. But Meals’s
longrange plan should more broadly help it to achieve its desired outcomes. Outcomes
are the results that the organization is trying to achieve. These objectives are not all easily
quantified in financial terms.
For example, Meals’s mission calls for providing the homeless with an adequate
amount of nutritious food. Therefore, a desired outcome is providing the homeless with
nutritious meals. To achieve its mission, Meals might adopt a strategy of ensuring its
meals meet all federal government daily recommended levels for a balanced diet. The
long-range plan needs to include specific tactics for that strategy. Meals’s long-range
plan may indicate that every meal must contain some protein, fat, carbohydrates,
vegetables, and fruit. The organization will only deem itself to be effective if it not only
provides meals to enough homeless, but also provides meals that meet its nutritional
targets. Some objectives are more directly tied to financial issues. After gathering input
and considering choices, Schwartz might decide that the most efficient way to expand
from 20 percent to 60 percent coverage (the goal) would be to add three new locations,
strategically located to be readily accessible to the largest number of homeless, and to
add four more vehicles to its current fleet of two (specific tactics to achieve the goal).
These changes will require specific financial resources.
As can be seen from the preceding objectives, unless planning is done in year 1 to
raise money, the organization will never be able to undertake the acquisition and
expansion in years 2 through 5. The organization cannot be satisfied with raising enough
to get through the coming year. For it to thrive, rather than merely survive, it must think
ahead. The long-range plan provides the opportunity to think ahead prior to making
budgets for the coming year. The objectives included in the long-range plan can be
thought of as quantified targets. These targets can relate to both inputs and outputs. For
example, we can think in terms of specific fundraising objectives, specifying the total
dollar amount of donations we plan to receive each year over the coming 5 years. We can
also think in terms of the specific number of delivery trucks to be purchased. These
targets or objectives make it possible to create specific, detailed budgets for the
organization in financial terms.
C. Budgets and Special Purpose Budget
What is a budget? It is simply a plan. The plan indicates management’s objectives
and shows how it expects to obtain and use resources to achieve those objectives. In some
cases the plan may be the result of enacted legislation. The budget indicates the amount
of money that the organization expects to receive from all sources for the time period it
covers, which is usually a year. It also indicates the amount of money that the
organization will have available to spend to provide services. Thus, it provides managers
with a detailed action plan. Based on the information in the budget, managers make
decisions that they believe will help them carry out the plan and therefore accomplish the
organization’s objectives. Budgets must be developed to plan for the accomplishment of
goals and objectives. The process requires that a number of predictions and decisions be
made. How many homeless will there be next year? What percentage of the homeless
will be children? How many workers should the organization assign to fundraising? How
many restaurants should be solicited for food? What vehicles will be purchased, and at
what price? How much will kitchen employees be paid per hour and in total for the
coming year? How much money will Meals receive in donations each month of the year?
All of these questions and many more must be answered in the process of developing the
budgets for the organization.
Virtually all managers become involved in creating and using budgets. Budgeting
is not the sole domain of financial managers. Budgets establish the amount of resources
that are available for specific activities. As we learn from economics, resources are not
unlimited. They must be used wisely. Organizations attempt to do this by planning the
activities they will undertake and how much they will spend on them. However, budgets
do not merely limit the resources that can be spent. They help the organization achieve its
goals and objectives. Budgets help the manager understand whether the organization
expects that receipts will exceed disbursements and a surplus (profit) will occur, or if
spending is expected to exceed receipts, resulting in a deficit (loss). If the latter is the
case, the budget may indicate how the organization plans to cover that deficit without
having to cease operations.
Budgeting for governments as compared with budgeting for other types of public
service organizations is significantly different. It is common for decisions by the Board of
Trustees of a not-for-profit organization to require that the budget for the organization not
show a deficit. In carrying out the plan, however, many times a not-for-profit
organization will actually spend more than the amount in the approved budget,
sometimes resulting in a deficit. For governments, however, by law the amount that is
actually spent generally cannot exceed the budgeted amount. As a result, governments
tend to place more controls on spending, and the options available to government
managers are often more limited than those available to managers of other types of
organizations. Often, balancing the budget results in limiting services provided. This is
true for all kinds of public service organizations. It is frustrating to managers to have to
limit the amount of services provided to the organization’s clients. However, it is worse
to run out of money and to have to stop providing any services at all. Failure to plan
carefully can result in a level of spending that exceeds an organization’s resources and
leads to a financial crisis; in some instances the organization will even be forced to cease
operations.
Although most organizations prepare broad annual budgets that are intended to
include all of their activities for the year, at times a special opportunity may arise. An
organization may wish to consider undertaking an activity, but there is no money set
aside for it in the annual budget. This does not necessarily create an insurmountable
roadblock. At any time during the year, a special purpose budget can be developed for a
specific project, program, or activity. The organization can then decide whether it wishes
to undertake the activity based on the proposed special purpose budget. For example,
suppose that Steve Netzer, the new chief operating officer of the Hospital for Ordinary
Surgery, has an idea for a program that could help the public and might generate
additional patients for the hospital. He would like to send nurses to local supermarkets to
do free blood pressure screenings. The hospital would pay for the nurses and the supplies.
The costs of the nurses and supplies are expenses. Expenses are the resources consumed
in the process of providing goods and services. The hospital expects to earn revenues
from supermarket customers who become patients as a result of medical problems
uncovered by the screening. Revenues are the resources the organization earns in
exchange for providing goods or services.
Will the extra revenues from these new patients be enough to cover the expenses
of care provided to them as well as the expenses related to the screening? A special
budget comparing all of the expenses and revenues can be developed. If the revenues
exceed the expenses as a result of the program, then a profit will be earned. Profit is
simply the excess of revenues over expenses and is sometimes referred to as a surplus or
as net income. If the expenses exceed the revenues, the excess of expenses over revenues
is a loss or deficit. Once the expected profit or loss is known, the organization can decide
if it would like to implement the plan. It is not necessary to wait until the next annual
budget cycle to consider and implement special budgets. Depending on the financial
magnitude of the special activity, the organization’s management may be able to approve
the activity, or it may require approval by the board of directors, governors, or trustees. In
the case of governmental bodies, the additional activity may constitute a change in the
overall budget, and it is essential to ensure that such a change is legal.
This special purpose budget case study raises a number of important points. First,
there is no magic to budgeting. Budgeting requires thought. Does the planned project fit
with the organization’s mission? Does it make sense to undertake this, given what other
organizations are already doing? Can the organization afford to undertake the project?
Budgeting requires estimating all the likely receipts and all the likely payments. The
more facts that are available, the better. Knowing the airline fares, the hotel prices, the
willingness of teens to live four to a room, and the admission rates at various attractions
leads to a more accurate budget. Inevitably, some assumptions must be made, such as the
number of participants. The assumptions should be reasonable. A contingency plan
should exist in case the assumptions do not all come out as anticipated. Moreover, the
process is very likely to require a number of preliminary drafts and revisions before a
feasible plan is developed and accepted by all parties. Even so, things may not occur
according to the budget. Once approved, efforts must be made to try to keep as closely to
the plan as possible.
D. The Master Budget
Although some budgeting is done on an ad hoc basis, as in the case study
discussed previously, most budgeting is done on a regular basis. The master budget
incorporates and summarizes all of the budget elements for the coming year. These
elements provide the specific detail to accomplish both the routine ongoing activities of
the organization and the coming year’s portion of the long-range plan. By incorporating
service volume, prices, costs, cash flow, and capital spending, the master budget becomes
the plan for everything the organization will be doing during the coming year. It is
prepared each year. The main elements of the master budget, sometimes called the
comprehensive budget, are the operating budget and the financial budget. The operating
budget presents a plan for revenues and expenses for the fiscal year. It poses the question:
Do we expect to earn enough during the budget period to pay for the resources we expect
to use during the period? The financial budget includes a cash budget and a capital
budget. The cash budget focuses primarily on the coming year. It asks the question: Do
we expect to have enough money on hand, or do we expect to collect enough during the
budget period to pay for the things that we need during that time? The capital budget
considers outlays for resources that will provide service for a period of time longer than
just the coming year.
Capital budgets focus on the acquisition of long-term resources. Expenses such as
salaries, supplies, and rent would not appear in a capital budget. Instead, one might see a
listing of pieces of equipment and/or buildings. Revenues are often not included in the
capital budget, which focuses on the cost of, and the justification for, the acquisition.
However, revenue flows that result from acquiring the items in the capital budget are
considered in the capital budgeting process. Also, if old equipment or buildings are sold
as they are replaced by new equipment and buildings, the revenues from the proceeds of
those sales may be included in the capital budget.
The operating budget is a plan for expected revenues and expenses. For-profit
organizations generally earn revenues in exchange for providing goods and services. Not-
for-profit organizations may earn revenues in a similar fashion and may also receive
support from contributions or grants. Governments may earn revenues from the sale of
goods and services, but primarily they are entitled by law to collect tax revenues to be
used to provide services. Expenses are the resources that the organization uses in carrying
out its activities. There is often a gap between when an organization provides goods or
services and when it receives cash payments for providing those goods or services.
Similarly, there is often a gap between when an organization consumes resources in the
course of providing goods or services and when it makes cash payments for those
resources.
When patients are treated at HOS, they receive bills for the care provided.
Suppose that a patient is billed $5,000 for the care he or she has received. HOS may
generate $5,000 in revenue by merely providing the care and billing the patient.
Alternatively, HOS may generate the revenue only after it receives payment for the care
that it provided. It depends on HOS’s accounting system, and this is discussed further
below. The basic approach to developing an operating budget is not substantially
different from the approach taken in preparing the special purpose budget. One must
consider all possible sources of revenue or other support. Revenues can be calculated by
predicting the volume of goods or services to be provided and their unit price.
Multiplying the price per unit by the volume of units provides the organization with an
estimate of its revenues.
In addition to having a revenue budget that shows the revenues by each major
source, there should be detailed supporting schedules backing up each line on a budget.
This is true for an expense budget as well. These schedules provide the information that
explains the derivation of each number that appears on the budget. For example, each
piece of property and the assessed value of that property should be listed. These
supporting schedules are not a part of the finished budget. However, they provide
important backup information, especially if questions arise before the budget is adopted.
In preparing the revenue budget, it is extremely important to consider all possible sources
of revenue or support. In addition to taxes or charges for services, these sources might
include ancillary sources such as gift shops or restaurants, endowment income, gifts, or
grants.
Some variables are uncontrollable. However, not everything is outside of the
control of the manager. For example, managers often have to make investment decisions.
If the organization has money that it will not be using right away, it must decide how to
invest that money. Managers can decide to invest in safe investments with low rates of
return or can seek out somewhat riskier investments that have higher possible returns.
Also, things like user fees are subject to some degree of control. Suppose that last year
the town sold 3,000 pool passes at $100 per pass for the season. Since the town’s
population is fairly stable, the forecast is for similar results in the coming year. However,
that represents a forecast of what will happen rather than a budget. Before the budget can
be finalized, it is necessary to consider factors such as the impact of raising or lowering
the price, competition from new county facilities, and the potential impact of making
improvements at the town’s pool. Although it is true that not everything is out of the
manager’s control, neither can managers do whatever they want. In preparing the
previously mentioned revenue budget, Ives made assumptions of modest increases in
taxes and user fees. He knows, however, that if the expense budget is higher than the
revenue budget, he will need larger increases in taxes. Such increases will be politically
difficult to attain. At that point, there will be difficult negotiations with the mayor and
town council over whether to increase taxes or cut services.
Some organizations budget revenues before expenses, and some do the opposite.
The order is not critical, since it is likely to be necessary to make revisions to arrive at an
acceptable budget in any case. In many situations, the revenue and expense budgets will
be prepared simultaneously. For example, government agencies may be preparing their
expenditure budgets individually, while the central government administration is
estimating total revenues that will be available. Dwight Ives’s first attempt at developing
a budget for expenses—here, they are expenditures—considered all of the costs currently
incurred as well as additional expenditures required to incorporate elements of the town’s
long-range plan.
The budgeted expenses or expenditures of the organization are subtracted from
the budgeted revenues to determine whether the plan projects a surplus or deficit for the
coming year. In some instances, a loss may be acceptable. Organizations with large
amounts of accumulated profits from earlier years may be willing to lose money in other
years. In other cases, losses may be inevitable. In general, the town council would not
legally be allowed to adopt a budget containing a deficit. Ives would have to go back to
each element of the operating budget, finding additional revenues and/or reducing
expenditures. This would be similar to the process that Ives required Father Purtell to
undertake to revise the Holy Land trip budget. It would be very helpful if Ives could look
at the budgeted results for each main activity of the town. For example, is the town
swimming pool expected to make money or lose money?
In some organizations, revenues are only acknowledged, or recognized, when
they are received in cash. In those cases, expenses are only recognized when they have
been paid in cash. These are the recognition rules of the cash basis of accounting. For
example, suppose that HOS treats a patient in December 2017 and issues a bill to the
patient upon discharge on December 12, 2017. HOS receives payment for the care from
the patient’s insurance company January 18, 2018. Assuming HOS ends its fiscal, or
accounting, year on December 31 of each year, when should it recognize the revenue
from the patient? Under the cash basis of accounting, the revenue is recognized in 2018.
That is, HOS would project those revenues in its fiscal year (FY) 2018 budget, as
opposed to its FY 2017 budget. Many argue that preparing an operating budget based on
cash inflows and outflows may result in a misleading depiction of an organization’s
results from its financial operations. In the case of HOS, the cost of caring for the patient
(personnel, supplies, etc.) would be recognized as an expense in 2017, if HOS paid or
expected to pay those costs in 2017. However, the related revenues would be recognized
in 2018, if HOS does not expect to receive them in cash until 2018. Across a large
number of patients, it might seem that the organization had a deficit in 2017, even if the
revenues that will ultimately be collected for those patients in 2018 will exceed the
expenses. The operating budget for 2017 would provide an unduly pessimistic view of
the expected financial results from treating patients.
Should the money that HOS is entitled to receive for providing care be considered
revenue in the year care is provided or the year payment is received? If the revenue is
recognized in the year the service is provided, the organization is using the accrual basis
of accounting. As noted earlier, if revenue is recognized in the year the cash is received,
the organization is using the cash basis of accounting. The choice of whether to use a
cash or accrual accounting system is an often debated topic. Cash accounting is easier.
But it does not do a good job of letting managers understand whether the organization’s
activities are profitable. Accrual accounting is more difficult, but it provides a matching
of revenues and expenses. When operating budgets are prepared using the accrual basis
of accounting, the organization accrues, or anticipates, the eventual receipt of money
once the service has been provided. When the organization provides its goods or services,
it has earned its revenue. Thus, in the 2017 operating budget, HOS will include all
amounts it expects to earn in 2017, even if they will not be received in cash by the end of
2017.
The accrual approach applies not only to the sale of goods or services, but to
charitable support as well. Suppose that the director of the Millbridge Ballet Company
convinces the Millbridge Town Council to provide the not-for-profit organization with an
annual subsidy of $10,000 as long as it gives at least 20 performances a year. If it uses the
accrual basis of accounting, Millbridge Ballet would recognize the town support it gives
in 20 performances in the year, even if the town does not make the payment by the end of
the year. By the same token, under an accrual approach to preparing an operating budget,
expenses are recognized in the year in which resources are consumed. If supplies are
bought and used this year, they are considered to be a cost, or expense, in the operating
budget, even if the supplier is not paid until the following year.
The accounting profession strongly endorses accrual accounting. Accrual
accounting allows the organization to compare the money that it is entitled to receive for
this year’s activities to the cost of resources used up carrying out those activities. There is
less room for manipulation than in a system based on cash. Imagine an operating budget
that used cash receipts and disbursements. If one wanted to look especially poor, it is
possible to accelerate payments and postpone collections. If one wanted to look like the
year was especially good, the reverse could be done. By contrast, with accrual accounting
revenues and expenses are associated with a year based on actual activity and are much
less subject to manipulation. To better understand the implications of cash versus accrual,
consider the following example. Tricky Hospital provides $100 million of care each year
and always eventually collects all of that money. Tricky consumes $100 million of
resources each year. In 2015, Tricky’s board of directors wished to look especially needy
so that they could encourage a donor to make a large gift. Tricky paid for all its current
consumption and even prepaid for supplies that would not be received and used until
sometime in 2016. Tricky also made no efforts to encourage rapid payment by its patients
or the patients’ insurers for the care Tricky provided in 2015. As a result, Tricky
collected only $90 million in cash, but it made payments of $110 million.
Note that the accrual system is clearly not as subject to manipulation as the cash
basis approach. When accrual accounting is used, the operating budget gives a good idea
of how profitable the organization can expect to be based on its activities for a particular
period of time. However, it does not give an accurate idea of how much cash it will have.
Tricky Hospital really did use more cash in 2015 than it collects. Since cash may be
received at different times than the revenues and expenses are reported on an accrual
basis, it is necessary to have a cash budget as well as an operating budget to be sure
enough cash is available to meet obligations as they come due.
The financial budget has two primary components: the cash budget and the capital
budget. The cash budget plans for the cash receipts and disbursements of the
organization. The capital budget plans for the acquisition of long-term resources, such as
buildings and equipment. The cash budget is a plan for expected cash receipts and
payments. It is identical to the operating budget for organizations that use the cash basis
of accounting. For organizations using the accrual basis of accounting, the cash budget
provides vital additional information. It helps managers know when there will be cash
available for investment and when a shortage of cash is expected. This information
allows the organization either to arrange for sources of cash (such as a loan from the
bank) to alleviate an expected shortfall or to change the organization’s planned revenues
and expenses to avoid the shortage.
Note that cash budgets are similar to personal checking accounts. The amount of
cash we have at the end of one period of time is still available at the beginning of the next
period. So the beginning cash balance for any cash budget is identical to the ending cash
balance from the previous time period. This budget is generally prepared for the coming
year. However, it is also important to have more frequent cash projections. For example,
within the annual cash budget, there may be monthly cash budgets. Just knowing that
cash receipts are sufficient to cover cash payments for the year may be inadequate. It is
helpful to know if the organization expects to have enough cash to pay its bills each
month. For example, the town of Millbridge has variable cash flows. The town issues
bills for its real estate taxes on a quarterly basis, its user fees mostly during the spring and
early summer, its sewer taxes once a year near the beginning of the year, and its state aid
once a year near the middle of the year. Even if annual cash receipts are enough to cover
payments, Millbridge might need to borrow money to get through certain times of the
year when cash receipts are low. The cash flow is complicated by the fact that not only
are billings not constant throughout the year, but different sources of money arrive with
differing payment lags. Most people pay their taxes promptly, since the town charges a
high interest rate on late payments. By contrast, the state does not make its payments
until near the very end of the year. This allows the state to have the political advantage of
being able to show aid to the municipalities and also keep the money in the state account
earning interest until the very last possible day.
Let’s consider an example of how a cash budget might work. For this example,
assume that Meals for the Homeless has a fiscal year of January through December. It
had $15,000 cash at the end of last year, and had no investments and outstanding loans as
of the end of the year. If an organization finishes a year with $15,000 cash, that cash will
still be available at the beginning of the following year. Meals expects to receive $10,000
a month from the city next year. However, this is a new contract and the city pays each
month with a 1-month delay (also known as a lag), so the payment for January won’t be
received until February, and so on. Meals expects to receive $60,000 in contributions for
the coming year. However, most of them will come in during December. Meals expects
to receive $3,000 every month from January through November, and the remaining
$27,000 in December. It also expects to receive $5,000 every month from other sources.
Despite the fairly wide fluctuations in the receipt of contributions, Meals provides its
services evenly throughout the year. Meals pays $1,000 in rent every month. It expects to
pay its staff $11,000 every month. Its supplies are increasing in cost due to inflation. In
the last month of last year, it used $4,500 of supplies, but it expects that cost to rise $100
each month. Meals pays its suppliers with a 1-month lag, so the $4,500 for December will
be paid in the first month of the coming year. Other expenses that are paid in cash every
month total $3,000. Meals wants to be sure to begin every month after January with
$4,000 cash available. If it has more (or less) than that amount at the end of a month, it
invests (or borrows) money. The organization’s plan is to pay back any outstanding loan
balance in December, when it receives the bulk of its contributions.
Notice that in the January column the budget starts with $15,000. There is no cash
received from the city in January, so the only receipts that month are from donations and
other sources. The starting cash balance plus cash receipts in January provide available
cash of $23,000 for that month. Payments are made for labor, rent, supplies, and other.
Note that the payment for supplies is the $4,500 for the previous month. All four of these
cash payment items total to $19,500 in January. That total of cash payments is subtracted
from the $23,000 of available cash to arrive at a $3,500 subtotal before borrowing or
investing. Since Meals wants to start February with $4,000 of cash on hand, it will have
to borrow $500 at the end of January. The ending cash balance for January becomes the
beginning balance in the February column. During February Meals expects to receive
$10,000 from the city as well as the donation and other cash inflows. Cash payments are
the same as January except for the increasing supply payments. Despite the cash receipt
from the city, payments once again exceed receipts, and Meals expects to have to borrow
$1,600 in order to end February and begin March with $4,000 of cash.
Notice, in the total column for the 3 months, that the first and last rows are not
summed across the columns. That is, the starting cash balance in the total column is the
$15,000 we begin the year with. This represents the starting balance at the beginning of
the year. This makes sense since the first day of the quarter and the year are both January
1. And the ending cash balance in the total column is the $4,000 that we have at the end
of March. Similarly, the last day of the quarter and the last day of the month are both
March 31. But we can add all of the cash receipts, cash payments, and borrowing values
across the page to get the totals for the 3- month period. The starting cash balance of
$15,000 plus all of the cash receipts in total for the 3 months, less all of the cash
payments in total for the 3 months, equals a $200 subtotal for the 3 months (note that this
subtotal is arrived by adding down the total column, not across the subtotal row).
Combined with the $3,800 total amount that has been borrowed over the 3 months, we
get the $4,000 cash value at the end of the quarter. Notice that Meals had to borrow
money every month in the quarter, but it would appear that if things keep going as they
are, the $27,000 of expected cash receipts from donations in December should be enough
to allow for repayment of the total outstanding loan by the end of the year. Being able to
demonstrate in a cash budget that you know when you will be able to repay a loan
increases the likelihood of being able to obtain a loan.
Another type of budget is a capital budget. A capital budget is a plan for
acquisitions of capital assets. Capital assets are resources that have lifetimes that extend
beyond the year in which they are acquired. This typically includes buildings and
equipment. One reason the capital budget is used relates to the issue of accrual
accounting. If Meals for the Homeless buys a delivery truck with a 5-year life, it would
be inappropriate to charge the entire cost of the truck to the coming year. Suppose that a
delivery truck costs $40,000. Even if Meals will pay $40,000 cash for the truck next year,
and therefore it will be a $40,000 reduction in the cash budget, Meals will not fully use
up the truck in the one year. Part of the truck will be used in future periods. It would not
be reasonable to charge the entire $40,000 cost of the truck as an expense in its first year.
Organizations that use accrual accounting would spread the $40,000 cost of the truck out
over the years it is used, charging a portion as an expense each year. Thus, the full cost of
the truck will be included in the capital budget, but only a 1-year portion of the cost of
the truck will be included as an expense, called depreciation expense, in the operating
budget each year.
E. The Budget Process
Although a budget is a plan, budgeting is a process of planning and control. In the
budget process, resources are allocated, efforts are made to keep as close to the plan as
possible, and then the results are evaluated. “Properly applied, budgeting can contribute
significantly to greater efficiency, effectiveness, and accountability in the overall
management of an organization’s financial resources”. The budgeting process is one of
exploring possibilities. Organizations determine what things they can do and what they
cannot. They examine alternatives and choose those that will likely yield the best results.
They become attuned to possible problems and can work to find solutions. Ideally,
budgeting causes managers, policy makers, and legislators to think ahead, have clear
expectations against which to measure performance, and coordinate the activities of the
organization so that everyone is working toward a common purpose. In larger
organizations, coordination is inherently more difficult, and the budget process can
become cumbersome. Such organizations will often have budget departments that devote
substantial efforts to aid managers and policy makers in developing budgets.
Governmental budgeting is often subject to a variety of laws, making the need for
assistance even greater.
The budget preparation process includes developing revenue and spending
projections. In modern government management, approaches for making projections vary
from simple guesses to projections based on the current year plus inflation to use of
sophisticated econometric forecasting. The budget is first prepared. After review by the
body with the authority to adopt the budget (often the board of trustees or the legislature),
it is adopted, with or without changes. It is not uncommon for the decisionmaking body
to request or make changes prior to approval. Once approved, the budget is implemented.
It is the responsibility of the management of the organization or the executive branch of
the government to ensure that the adopted budget is carried out. Finally, the results must
be evaluated. Often, actual results will vary from the adopted budget. This may be
because of inefficiency, or it may be due to non-controllable factors. All significant
variations should be analyzed. This evaluation in turn will provide information to be used
for feedback in preparing the next budget.
Initially, a draft budget must be prepared. Generally, top executives will prepare a
set of assumptions and guidelines that department or agency managers should use as they
develop detailed budgets for their areas. In government, the chief executive will generally
provide a budget guidance memorandum, which provides policies, goals, and
performance expectations. The managers in the organization (unit and department heads
or bureau chiefs and agency directors) then prepare draft budgets, considering their
responsibility center’s needs and the guidelines they have received. A responsibility
center approach divides the budget into units for which individual managers are held
accountable, called responsibility centers.
Organizations quantify their budgets, often assigning measures in dollars or units
or both. For example, during the budget preparation process, Meals for the Homeless will
need estimates of not only the dollar cost of meals, but also the number of pounds of food
needed and the number of meals expected to be served. This requires plans to become
specific, so they can be summarized in a document that can be shared across the
organization. Budget requests are reviewed to ensure that the forms have been completed
fully and without error. The various budget requests from all responsibility units are
aggregated to determine the total resources that have been requested. There is also a
review to ensure that the department budgets all follow the same assumptions about
salary increases, expected workload, and other factors that need to be consistent across
departments. It is common for the total of all spending requests to exceed projected
revenues. In most cases, this requires the organization to go through a process of
negotiation. The first goal of this process should be to eliminate any inefficiency in the
budget. If this still leaves the budget unbalanced, it is necessary to find additional sources
of revenue or to reduce spending. Spending reductions should be selected so as to
minimize the impact on the accomplishment of the organization’s goals and objectives. In
many instances, this requires the organization to establish priorities. Managers should be
given the opportunity in this process to provide their rationale for why their budget
requests are high priorities and should not be among the first items cut.
Once the top management of an organization is comfortable with the budget, it
submits it to the decisionmaking body for review and approval. In the case of the
government, the executive branch submits the budget to the legislative branch for review.
In many cases, the legislative process includes an opportunity for public scrutiny and
comment. In some cases, the public actually votes on the budget, but this is less common
and occurs primarily with respect to school budgets. If the executive is unhappy with
changes made by the legislature, the budget can be vetoed. In many cases the veto can be
for the entire budget; in some cases it may be line item by line item. Generally, there is
some provision for the legislature to override a veto. The body that must approve the
budget should receive not only the budget, but also an executive summary. This summary
should focus on the policy implications of the proposed budget. One should try to avoid
letting the trees get in the way of seeing the forest. Often the extreme detail provided with
budgets causes managers to lose sight of the goals that should be accomplished as the
budget is implemented.
Budgets authorize and limit the amount of spending for each responsibility center
in an organization. Appropriations tend to be specific in terms of the amount that can be
spent and what it can be spent on. Governments next make allocations, subdividing the
appropriation into more detailed categories, such as responsibility centers, programs, or
objects of expenditure. Sometimes, spending is further broken down into allotments.
Allotments refer to a system that allocates budget resources to specific time periods or for
use only after a certain event occurs. This allotment process serves “(1) to avoid
premature exhaustion of appropriations, necessitating supplemental appropriations; (2) to
keep the rate of expenditures in line with the flow of revenue; and (3) to provide the
funds agencies actually need in the course of budget implementation and no more.”
Part of the budget implementation process focuses on expenditure control. A
widely used technique in governments and some not-for-profit organizations is a system
of encumbrances. When the organization places an order for a resource, an encumbrance
is created. The encumbrance identifies the portion of the budget for a specific line item
that has already been “spoken for” by purchase commitments that have been made. For
example, suppose that the Millbridge Town Council has adopted a budget that includes
an appropriation of $20,000 for computer equipment. On the first day of the
government’s fiscal year, October 1, an order is placed for $15,000 worth of equipment.
The equipment arrives 2 months later. The government pays for the equipment a month
after that. In the interim between the placing of the order and the payment for the
computers, Dwight Ives, the town manager, would like to know how much money is
available for computer purchases. He knows that the budget was $20,000, but he suspects
that some purchases may have already been made. As soon as an order is placed, the
government accounting system records an encumbrance in the dollar amount of the order.
If Ives looks at the town budget report on November 1, he will see that the budget is
$20,000, but that there is a $15,000 encumbrance. The available, or unencumbered,
balance is $5,000. Special approvals are generally required to place additional orders that
would exceed the unencumbered balance.
The last element in the budget cycle is the evaluation of results. Budgets not only
create plans, but can be used to help accomplish those plans. One way that this is done is
by comparing actual results to the budget. This is sometimes referred to as performance
evaluation. This is especially helpful if done on an interim basis, during the year. That
allows problems to be corrected midstream, helping the organization accomplish its
budget. Things do not always go as planned. It is important to attempt to assess why. In
some cases, money is being wasted through inefficiency. If so, the inefficiency should be
determined, and corrective action should be taken. In other cases, events have occurred
(e.g., price increases in supplies that are essential) that are beyond the control of the
organization or its managers. However, not all deviations from budgets are negative.
Often, careful review can reveal opportunities an organization can use to their advantage.
In any case, there should be a thorough investigation of why variations occur.
Governments often have a formal midyear review. This serves a critical function.
Since state and local governments must have a balanced budget, it is critical to examine
whether the organization is on track for spending no more than the appropriated amount.
If it turns out that spending is above the budget level, or that revenues are less than
budgeted, then actions must be taken to avoid a deficit. Often this requires cutting
expenditures for the remainder of the year to a lower level than had been expected when
the budget was passed. Many health and not-for-profit organizations undertake similar
reviews for the same purpose. Another purpose of performance evaluation is to enhance
accountability. All organizations want to ensure that their resources are used efficiently
and effectively. This is enhanced if the organization can hold managers and responsibility
centers accountable for their activities and results. Accountability is partly ensured by
frequent comparison of the budget with actual results and analysis of the causes of
variances. Another element critical to accountability is the audit process.
An audit is an examination of records or procedures. Operating or performance
audits seek to identify inefficiencies in the way the organization operates so that they can
be avoided in the future. Financial audits examine whether financial reports are presented
in a fair manner 9 and whether all resource use has complied with relevant laws, rules, or
regulations. Although not all audits are intended to dig deeply enough to discover all
fraud and embezzlements, some audits are conducted specifically to determine if
resources have been used for their intended purposes.
Another element in accountability is the presentation of the budget. Organizations
formalize their budgets by recording them in written form. This allows the budget to be
used to communicate to all of its managers. Human resource managers can do their job
better by knowing the staffing plans of other departments. The managers of the recovery
room in a hospital can manage their department better if they know the number of
surgeries that are expected by the operating room department. The choice of revenue and
expense groupings and the level of detail of information shown in the budget can have a
dramatic impact on the amount of information that is communicated by the budget. In the
case of government, budgets become public documents. An effective presentation can
give the public a tool to keep government accountable for its actions.
The process of developing budgets is highly politicized. This is true in most
public service organizations. To the extent possible, managers should try to establish and
use an objective budget process that best leads to the accomplishment of the
organization’s mission, goals, and objectives. In reality, it is inevitable that politics will
play at least some role in almost all organizations. Politics may take a variety of forms.
The politics may be personal. A department manager may be a relative of a member of
the board and may get, or be perceived as getting, special breaks at budget time. More
broadly, however, politics often revolves around agendas. Proponents of a particular
service or program will lobby for resources for that program. This is true in most
organizations.
Politics is of special concern in the government, which is, after all, a political
arena. It is at least partly through the political process and voting that the public makes its
desires known. Politics serves a major role in resource allocation in governments.
Although budgets should be objective in trying to accomplish the goals and objectives of
the organization, politics has an appropriate role in setting those goals and objectives.
Politics in the public sector takes many different shapes. It takes the form of special
interest groups lobbying for their cause. It takes on the perspective of competing policies
to accomplish similar or different objectives. Sometimes politics in budgeting is
manifested as a power struggle between the branches of government or between political
parties. Managers should be aware of the political nature of budgets within their
organization. This can help them better define their role in the budget process.
F. Behavioral Aspects of the Budget Process
Although it sometimes seems that budgets are all about numbers, this is not the
case. Once a budget has been adopted, it is up to the employees of the organization to
come as close as possible to achieving the budget. People are the key to successful
budgeting. It is critical to understand that the actions of people within an organization
have a tremendous impact on how well the organization does. If people work to
accomplish the goals of the budget, we are likely to have much better outcomes than if
they are indifferent about accomplishing those goals or, even worse, work in opposition
to accomplishment of the organization’s goals. The numbers on paper are just that.
People—their attitudes, needs, and desires—are the key to budgeting. If we don’t
specifically focus on why people would want to accomplish the organization’s goals as
defined by the budget, we are not likely to achieve the best possible actual outcomes.
Therefore, an essential part of the budget process is understanding what motivates the
organization’s employees. We need to understand why employees would make their best
effort to accomplish the organization’s goals and why they wouldn’t. And we need to
understand how incentives can be used to motivate employees to work at their highest
level to accomplish the organization’s goals.
The more input employees have in making plans, the more likely it is that they
will strive to achieve them. People working in a unit or department of an organization
know a great deal about how that unit or department functions. They are in a good
position to be able to propose changes that will improve efficiency. If we solicit input
from managers and staff members in preparing budgets, and develop budgets based on
that input, employees are likely to become vested in showing that the approaches they
have proposed are sound. If budgets are prepared without staff input, staff will likely feel
much less motivated to meet the budgets that have been handed down to them.
Motivation is the critical underlying key to budget success. One of the best
features of budgets is that they present a measurable goal. When there is a clearly stated
goal, managers and staff can work toward that goal. Most people are inherently motivated
to do a good job. They want to gain a sense of accomplishment from their job, and a
budget goal can help them do that. Setting demanding but realistic budget goals,
combined with public praise and rewards when goals are met or exceeded, can enhance
motivation and resulting performance. Compare the likely progress of a dieter with
specific weight-loss goals to one who simply wants to lose a lot of weight, or compare an
athlete with measurable objectives to one who just wants to be strong or run fast. Setting
specific goals and working toward them is a tremendous self-motivator. Most employees
want to have a sense of pride in their organization and want their organization to do well.
Nevertheless, a goal of “spending as little as possible” is no better than the dieter’s hope
to “lose weight.” A more specific goal, such as “Let’s reduce electric consumption by 10
percent as compared to the prior year” is likely to be a better motivator.
Control is complicated by the fact that even when the primary goal is clearly
stated, it is the basic nature of individuals that their own personal goals will often be
different from the goals of their employer. This does not mean that human nature is bad
—just that there is such a thing as human nature and it is foolish to ignore it. For
example, most employees would prefer a salary that is substantially larger than the salary
they are currently receiving. There is nothing wrong with employees wanting more
money. In fact, ambition is probably a desirable trait. On the other hand, employers
generally will not provide employees with more money because they lack the revenues to
pay those higher wages. While the employees are not wrong to desire large raises, the
employer is not wrong to deny such raises. Inherently, a tension or conflict exists as a
result. Nor is it just an issue of salaries. Often employees would like larger offices with
new furniture and remodeled facilities. They would certainly like more staff to enable
them to carry out their department’s mission more effectively. However, organizations
have limited resources and must make choices concerning how to spend those limited
resources.
As a result, even when morale is generally excellent and is not considered to be a
problem, an underlying tension naturally exists. Even though the employees may want to
achieve the mission of the organization, their personal desires will be for things the
organization cannot or will choose not to provide. This is referred to as goal divergence.
For example, employees might prefer to take long breaks frequently throughout the day.
That might well impair their ability to efficiently get their work done. To best achieve its
goals, the organization must bring together the interests of the individual with its own
interests so they can work together. In the budgeting process, the organization wants to
control spending. But it is not the “organization” that controls costs; it is the human
beings involved in the process. There must be some motivation for the human beings to
want to control costs. We need to find a way for the employees to feel that it is in their
interests not to take frequent, long breaks. Bringing the individuals’ desires and the
organization’s needs together is referred to as goal congruence. Since congruent goals are
not inherently the norm, it is necessary to address formally how convergence is to be
obtained. Organizations generally achieve such convergence or congruence by setting up
a system of incentives that makes it serve the best interests of the employees to serve the
best interests of the organization.
G. Incentives
Although employees serving in government, health, and not-for-profit
organizations are motivated by factors other than money, it would be foolish to ignore the
potential of monetary rewards to influence behavior. Public service organizations must
search for the proper mix of incentives that will motivate managers and staff to control
costs. Financial incentives are frequently employed. The most basic financial incentives
are the ability to retain one’s job and to get a good raise. We can use a carrot or a stick to
motivate. The stick: If you constantly take long breaks frequently throughout the year,
you may be fired. Another common motivating tool that incentivizes employees is a
bonus system. This is a carrot approach. For example, one could tell a manager that her
department budget for the year is $3,000,000. However, if her department spends less
than $3,000,000, she and her staff can keep 20 percent of the savings. If the department
spends only $2,900,000, the manager and the staff will get a bonus of $20,000 (i.e.,
$3,000,000 less $2,900,000, multiplied by 20%) to share. The total cost to the
organization is $2,920,000 including the bonus, as opposed to the $3,000,000 budget, so
it has saved $80,000 after paying the bonus. The staff benefits and the organization
benefits. In this case, goal congruence is likely to be achieved. Workers will not take
frequent, long breaks, because they are trying to work more efficiently so they will earn
the available bonus.
Many public service organizations have in fact added bonus systems. The use of
bonus systems has both positive and negative aspects. The positives relate primarily to
the strong motivation employees have to reduce costs. The negatives relate to the fact that
bonuses sometimes create unintended incentives. For example, bonuses give employees a
strong incentive to lower quality of services provided in order to reduce costs and earn a
bonus. Careful metrics must be put in place to ensure that the bonus is not being earned at
the expense of the quality of products and services provided. Managers must try to
anticipate unintended consequences when developing incentive systems. Also, the bonus
must be adequately large to achieve the desired congruence. If you can get away with
taking frequent long breaks, and you are inclined to do so, a bonus that adds up to only
$10 a week for each employee might not provide sufficient motivation to change that
behavior. Would $50 a week per employee be sufficient? $100? Each organization must
give careful thought to developing a motivation system that provides sufficient incentives
to achieve an appropriate level of goal congruence.
Another potential problem with bonuses relates to changes in volume of services
provided. A bonus should not reward employees for lower spending that results simply
from lower volume. Nor should employees fail to get a bonus simply because costs
increased as a result of higher volume. We don’t want to provide an incentive that results
in employees being motivated to reduce the volume of service provided. This can be
avoided by making the bonus system adjust automatically for changes in volume.
Bonuses are not the solution to all motivational problems. Bonus systems have a variety
of other problems. Some bonus systems reward all employees equally if overall spending
is reduced. But if everyone gets a bonus, no one feels that her or his individual actions
have much impact. Individuals may feel that they do not have to work particularly hard to
reap the benefits of the bonus. They will let everyone else do the hard work, and they will
share in the bonus distributed. That can lead to a situation in which no one makes any
effort to control costs. There won’t be a bonus to be shared, and the organization won’t
keep costs under control. In that case, the bonus system will not be providing the
incentives we need. On the other hand, bonuses given only to some employees based on
their individual performance may create jealousy and discontent.
There are incentive alternatives to bonuses. For example, one underused
managerial tool is a letter from supervisor to subordinate. All individuals responsible for
controlling costs should be evaluated explicitly with respect to how well they control
costs. That evaluation should be communicated in writing. This approach costs little to
implement but can have a dramatic impact. Most people respond well to praise and other
forms of positive feedback about their personal performance and their department’s
performance. Framed certificates of achievement along with a moderate monetary reward
for an outstanding achievement can be a strong motivator. Employee of the month and
other similar programs can be strong motivational tools as well. Telling individuals
they’ve done a good job and that their boss and their boss’s boss know that they’ve done
a good job can be an effective way to get people to continue trying to do a good job in the
future. We tend to take a biased approach, complaining to employees when there is a
problem without correspondingly praising them for a job well done when there are no
problems. In the real world, praise is both cheap and, in many cases, effective. On the
other hand, fair criticism, especially in writing, can have a stinging effect that managers
and staff will work hard to avoid in the future. Ultimately, however, people tend to
respond better to praise than to criticism.
There is no question that many people do attempt to satisfice—to do just enough
to get by. One thing incentives are used to accomplish is to motivate those individuals to
work harder. A target that requires hard work and stretching, but that is achievable, can
be a useful motivating tool. If the target is reached, there might be a bonus, or there
should be at least some formal recognition of the achievement, such as a letter. At a
minimum, the worker will have the self-satisfaction of having worked hard and reached
the target. However, it is important to recognize that budget targets should be achievable.
Some organizations have adopted the philosophy that if a high target makes people work
hard, a higher target will make them work harder. This may not be the case. If targets are
placed out of reach, they will probably not result in people reaching to their utmost limits
to come as close to the target as possible. In fact, that approach may lead to cynicism and
hostility toward a management that promises to make bonuses available and then places
them out of reach. It may seem that the organization is short-changing itself whenever
someone achieves a target. One may think, “We set the target too low. Perhaps if the
target were higher, the higher target would have been achieved.” The problem with that
logic is that there are risks associated with it. If an employee fails to meet a target
because of incompetence or because of insufficient hard work, the signal of failure that is
sent is warranted. In fact, repeated failure may be grounds for replacing that individual in
that job. But if an employee is both competent and hardworking, failure is not a message
that should be sent. Even if it is desirable to encourage the individual to achieve even
more, the signal of failure will be discouraging.
When people work extremely hard and fail, they often question why they
bothered to work so hard. If hard work results in failure to achieve the target, then why
not ease off? If they are going to fail anyway, why try very hard? And when people get
discouraged, they may become angry. This situation can lead to turnover and even
sabotage by angry persons who feel their supervisors are against them and that they are
being set up to fail. Thus managers at every level of the organization must be extremely
careful to ensure that all goals assigned are reasonable, or results may be less favorable
than they otherwise would be.
Having a plan is essential for getting the most out of any organization. Planning is
accomplished by establishing the mission for the organization, defining a strategy to
accomplish the mission, developing a long-range plan that defines the organization’s
objectives, and preparing specific detailed budgets that define the resources needed to
accomplish its goals and objectives. A budget is simply a plan. The plan shows how
management expects to obtain and use resources to achieve the organization’s objectives.
It provides a detailed action plan. There is no magic to budgeting. It requires thought.
Budgeting requires estimating all the likely receipts and all the likely payments. The
process usually requires a number of preliminary drafts and revisions before a feasible
plan is developed and accepted by all parties. Once approved, efforts must be made to try
to keep as close to the plan as possible. Although some budgeting is done on an ad hoc
basis (special purpose budgets), most budgeting is done at regular intervals. The master
budget incorporates and summarizes all of the budget elements for the coming year. The
main elements of the master budget, sometimes called the comprehensive budget, are the
operating budget and the financial budget. The operating budget presents a plan for
revenues and expenses for the fiscal year. The financial budget includes a cash budget
and a capital budget. While the cash budget focuses on cash flows for the fiscal year, the
capital budget considers outlays for resources that will provide service for a number of
years into the future.
In some organizations, support and revenues are acknowledged, or recognized, by
the organization only when they are received in cash. In those cases, expenses are
recognized only when they have been paid in cash. They are said to use a cash basis of
accounting. By contrast, if revenue is recognized in the year service is provided, the
organization is said to be using an accrual basis of accounting. Accrual accounting is
more difficult than cash accounting, but it provides a matching of revenues and expenses,
allowing the manager to get a better sense of the profitability of the organization’s
activities. The process of developing budgets is highly politicized. To the extent possible,
managers should try to use an objective budget process that best leads to the
accomplishment of the organization’s mission, goals, and objectives. All organizations
seek to accomplish some end. Hospitals exist to provide healthcare services to their
communities. Museums exist to provide the public with access to fine art. Governments
exist to provide essential services. The budget becomes the tool to facilitate the
accomplishment of these missions.
