It's all in the budget

‘Cash is king’ might be a hoary old axiom, but it’s also realistic. And this isn’t a reference to the cash accounting versus accrual accounting debate, but the vital need to recognise that without sufficient liquidity such as cash in the bank or a line of credit (bank overdraft, commercial bills, etc) your business will haemorrhage – perhaps fatally.

In years past, public sector agencies have had a primary financial focus of expenditure; hence the cash method of accounting sufficed. Government appropriations or warrants were also cash based. Recently, however,
the growth of government-owned corporations, better governance and accountability practices, community demands for better services without increases taxes or charges, and the introduction of AAS 27 and AAS 29 (specialist standards for the public sector agencies), have led to a platform where financial reporting is now more meaningful for stakeholders. 

Revenue, expense and balance sheet items are now all considered equally in public finance debates. Accordingly, the need to develop accurate revenue and expense forecasts is just as important for the public sector as it is for the
private sector. Management of both sectors need performance reports (actual verse budget) at least monthly to assist their decision making. 

Public sector agencies receive their appropriation, grants or revenue in different ways. Departments receive funding as appropriations under statute. Statutory authorities receive grants from departments, and commercial arms of government (insurance, electricity, water providers and the like) generate their own source revenue from providing services to the public. Local governments, however, are different because they receive a combination of specific and general grants from governments, as well as generating their own income from rates and charges. Suffice to say, revenue prediction needs just as much attention as expenses.

An accurate budget

The loading of an accurate budget for both expenses and revenues is critical if your senior management team is to make any sense of the monthly or quarterly financial reports they receive. To achieve this, it is necessary to involve those managers who will be held accountable for any over-runs or under-utilisation of their expense budgets in actually providing the projected expense cashflows that will be loaded into the financial system. This also applies to those managers responsible for revenue prediction/collection. In this way you stand a fighting chance of having meaningful performance data; those managers will be able to provide meaningful reasons on deviations away from your budget, thus prepare revised plans.

In any organisation there will be some expenses that are historically predictable, such as rent and utilities. But the real challenges occur for those organisations that are project driven, and where there is no prior history on which to predict future expenses. In these circumstances I see time and time again the easy option of divide by 12 and spread evenly over 12 months, when with a bit of thought and a look at the project plan, useful insights would have provided insight on when expenses will be incurred and when (if any) revenues will start arriving.

However, don’t become obsessed with your cashflows being 100 per cent correct, as they only represent your best estimate at a point in time. That said, if your total budget is $4bn, represented by 100 expense categories across 10 divisions, with $3.8bn caught by just 14 expense categories, you would be wise to invest the time to get these 14 cashflow predictions as accurate as possible.

Rounding needs to be managed. When developing your cash forecasts to load into your finance system, it is wise to have your management team agree to a minimum dollar value to cashflow to and ultimately report variances at. For most agencies, to the nearest thousand dollars is fine. If, however, your managers decide that they have both the time and the inclination to prepare estimates to a lower level, then let them.

On the rare occasion that you find such a person, nurture them, and hopefully their interest in finance matters will rub off on other managers.

Budget reviews are one of many tools of management used to prioritise resources to areas of higher need.

As a minimum, a quarterly review of your financial position is warranted to identify trends, and allow for a formal mid-year review that reallocates resources where necessary. They are not designed to massage the budget and actual figures in order to remove the period variations. Yet there will be pressure on you many times in your career to do just that – to avoid explaining variances.

What is a reportable variance depends on the individual agency. This tolerance of budget variences seem to vary from plus or minusfive to 10 per cent, with a major deciding factor being the expense category, its political sensitivity and initial budget size.

Budgets should be based on the best information available at the time of their development. Therefore, the explanations on the variances provides useful data to senior management on what environmental changes have occurred since these estimates were developed. It is the dollar variance, together with the explanations, that allow management to assess the current situation and react accordingly. Actions here could be to reassess project start dates. For instance, surplus expense variations could permit a project to commence earlier, or be deferred if unexpected cost pressures have suddenly appeared.

Labour forecasts

Again, this is one item where simply dividing the annual budget by 12 and evenly spreading across the year will not provide the best performance monitoring. Labour budgets should take into account the seasonal nature of the workforce and be based on the number of working days in each month. On-costs such as superannuation, leave accruals, state and commonwealth taxes, allowances and penalty rates should also be calculated into the cashflow with care.

A tip here is that variables such as fortnights in the year or month, payroll tax, superannuation rates and leave accrual percentages should all be kept in a data division / table in your spreadsheets – not hard coded into formulas. This will be a great help if any variable changes during the year and a re-forecast is required. Also, if your workforce is reasonably static, last year’s labour forecast could be the starting point for next year’s plan, with only minor adjustments to a few key variables, such as working days in each month.

Asset purchasing

This area does not get as much attention from public sector agencies as it should, and is reflective of a paranoia with the profit and loss at the expense of both the balance sheet and statement of cashflows. All agencies need a plan or budget that clearly predicts when both inflows and outflows of cash from asset sales and purchases will occur to maximise cash investment potential. What is required, therefore, is the same level of energy used to produce a balanced P&L being channelled into asset management.

Do we really need to own this asset as opposed to leasing it; was its purchase part of our five to 10-year asset plans? Have the additional depreciation and maintenance charges been allowed for in the current budget? Is there adequate cash in the bank to pay for it? Too often the answer to these questions is no, but the get out of jail card is generally that the asset is simply replacing an existing asset that has exceeded its useful life, so some provisions for these expenses were made based on the former asset. Clearly, new asset purchases that do not replace existing assets are more problematic, unless the asset forms part of a complete asset plan that includes allocations for the purchase, maintenance and depreciation of the asset.

Depreciation forecasting in a government agency requires special care and a minimum time horizon that matches the asset plan. This is a non-cash expense and as such directly provides a funding source for your asset/capital replacement programs. Depreciation in the public sector should be based on the useful economic life of the asset and not on the Tax Office schedules that are more commercially based.

On the cash versus accrual side of the ledger, though, have you noticed that even though accrual accounting has been mandatory in most government and semi-government bodies for more than a decade, there is still panic within these agencies to spend up in April, May and June (or else they may not receive the same funds next year)? These agencies report their financial positions to government statisticians, Treasury, parliament and internal clients in accrual format but senior management are still caught in a time warp of cash accounting internally. This could be partially attributed to these agencies’ obsession with the P&L’s bottom line, rather than first focusing on the agencies’ achievements.

Which headline would you prefer to read in the newspaper: ‘Government delivers on all promised projects and services within budget’; or ‘Government surpluses a wasted opportunity’? You can make a difference to this debate by focusing management attention on performance and efficient resource usage data, together with the P&L’s bottom line, rather than solely focusing on either surplus or deficit. I live in hope that one day all political parties and interest groups will be focused on performance and efficient resource utilisation in the first instance.

Reference: September 2006, volume 76:08, p. 62-65

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