Performance Based Budgeting
Encyclopedia
Adopting public sector’s performance-based budgeting to the private sector using the CPM framework. In performance-based budgeting first the goals and objectives of organization or department are identified, then measurement tools are developed and the last step is reporting.
- but it needs to be divided into two different classes: budgeting for public entities and private entities.
This differentiation is important because public bodies need to go through many processes before moving into the budget execution phase and post-execution analyses; furthermore, the entire process involves the collaboration of different bodies throughout the government
. This collaboration is not only for budget preparation, negotiation and approval processes, but also for the spending approval after the whole budget allocation is finalized. Compared to private sector, it is cumbersome.
Another factor is the increasing awareness of the policies of the World Bank
in pursuit of restructuring the budgeting and spending processes of developing nations via the World Bank Treasury Reference Model. This new model has led the public sector to understand, digest and adopt a new style.
According to this new budgeting methodology, traditional methods of analyzing and utilizing budget figures are insufficient. In traditional terms, organizations start building up their long-term plans and break those plans into annual budgets that are formed as forecasts. At the end of the year, budget figures are compared with actual results and a simple actual-budget variance comparison is calculated. Since the analysis is simple, this analysis lacks any sophistication in terms of adjusting similar budget items for forthcoming periods by increasing or decreasing the expenditure estimates. Basically, variance results are generally used for revising monetary amounts for the next planning and budgeting cycle, and also for very simple departmental performance tracking.
This new approach to budget analysis and utilization is many steps ahead of traditional methods. As an example, a governmental project to enhance the social welfare of children in a remote area can help explain the performance-oriented approach. For such projects, which are generally composed of long-term plans, governments decide on objectives and the activities that are required to be accomplished to achieve them. Practical ways of enhancing social welfare of children in a rural area might include increasing the job skills of parents in the area.
In order to achieve such an objective, the government may plan to establish schooling infrastructures in various locations, complete with the necessary equipment, and further plan to assign trainers to those schools for implementing the educational programs. All these activities have a cost aspect and, at this point, long-term plans are broken down into annual budgets that incorporate the monetary figures. Once the long-term plans are accomplished, the traditional way to gauge the effectiveness of this whole project would be to assess the gap between the budget and the actual money spent. However, with the new budgeting approach, the questions to answer are tougher:
Peter van der Knaap from the Ministry of Finance in the Netherlands suggests: “The general purpose of the proposals is to make budget documents and, hence, the budgetary process more policy-oriented by presenting information on (intended and achieved) policy objectives, policy measures or instruments, and their costs.” Furthermore, van der Knaap explains that this type of budgeting has the following major performance indicators:
Within this kind of a planning and budgeting setup, the lack of reliable information on the effects of policies emerges as a serious issue. Therefore, it is important to approach the planning and budgeting cycle in a holistic and integrated way, with collaboration across the areas of policy design, performance measures definition and policy evaluation.
As explained by Carter (as quoted in ) “Performance budgets use statements of missions, goals and objectives to explain why the money is being spent. It is a way to allocate resources to achieve specific objectives based on program goals and measured results.” The key to understanding performance-based budgeting lies beneath the word “result”. In this method, the entire planning and budgeting framework is result oriented. There are objectives and activities to achieve these objectives and these form the foundation of the overall evaluation.
According to the more comprehensive definition of Segal and Summers , performance budgeting comprises three elements:
Segal and Summers point out that within this framework, a connection exists between the rationales for specific activities and the end results and the result is not excluded, while individual activities or outputs are. With this information, it is possible to understand which activities are cost-effective in terms of achieving the desired result.
As can be seen from some of the definitions used here, Performance-Based Budgeting is a way to allocate resources for achieving certain objectives ,
Harrison elaborates: “PBB sets a goal, or a set of goals, to which monies are “connected” (i.e. allocated). From these goals, specific objectives are delineated and funds are then subdivided among them.”
This is a sort of a Balanced Scorecard approach in which KPIs are defined and linkages are built between causes and effects in a tree-model on top of a budgeting system which should be integrated with the transactional system, in which financial, procurement, sales and similar types of transactions are tracked. Moreover, linking resources with results provides information on how much it costs to provide a given level of outcome. Many public bodies fail to figure out how much it costs to deliver an output, primarily due to problems with indirect cost allocation. This puts the Activity-Based Costing framework into the picture..
Both the concepts of scorecards, as first introduced by Kaplan and Norton, and activity-based costing are today well-known concepts in the private sector, but much less so for the public-sector bodies…until the advent of Performance-Based Budgeting! Another conceptual framework that has gained ground is the relatively recently introduced CPM, again more popular in the private sector. The point is that the CPM framework has not much touched on the topic of Performance-Based Budgeting, although the similarities in policies offered by these frameworks are worth a deeper look. The technical foundation that the CPM framework puts on the table may well be a perfect means to rationalize the somewhat tougher budgeting approach, not only for the public sector but also for commercial companies..
These metrics and targets feed the next step in the process, Planning and Budgeting, and are eventually communicated to the front-line employees that will carry out the day-to-day activities. Targets and thresholds are loaded from the planning systems into a Business Activity Monitoring engine that will automatically notify responsible persons of potential problems in real time. The status of the business is reviewed regularly and re-forecast and, if necessary, budget changes are made. If the business performance is significantly off plan, executives may need to re-evaluate the strategy as some of the original assumptions may have changed. Optionally, activity-based costing efforts can enhance the strategic planning process – deciding to outsource key activities, for example. ABC can also facilitate improved budgeting and controls through Activity-Based Budgeting which helps coordinate operational and financial planning.
The ability to establish CPM to enhance control on budget depends first upon achieving a better understanding of the business through unified, consistent data to provide the basis for a 360-degree view of the organization. The unified data model allows you to establish a single repository of information where users can quickly access consistent information related to both financial and management reporting, easily move between reporting the past and projecting the future, and drill to detailed information.
By then, you are ready to plug in - on the unified data - the applications that support consolidations, reporting, analysis, budgeting, planning, forecasting, activity-based costing, and profitability measurement. The applications are then integrated with the single repository of information and are delivered with a set of tools that allow users to follow the assessment path from strategy, to plans and budgets and to the supporting transactional data.
CPM and the adoption of more public-sector oriented PBB are not easy to tackle, but in the ever-changing business and political climate they are definitely worth a closer look.
Introduction
Today, when the management of money is more important than ever for public and private entities, budgeting plays an enormous role in controlling operations efficiently and effectively. Budgeting in itself is a familiar process to even the smallest economic unit – the householdHousehold
The household is "the basic residential unit in which economic production, consumption, inheritance, child rearing, and shelter are organized and carried out"; [the household] "may or may not be synonymous with family"....
- but it needs to be divided into two different classes: budgeting for public entities and private entities.
This differentiation is important because public bodies need to go through many processes before moving into the budget execution phase and post-execution analyses; furthermore, the entire process involves the collaboration of different bodies throughout the government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
. This collaboration is not only for budget preparation, negotiation and approval processes, but also for the spending approval after the whole budget allocation is finalized. Compared to private sector, it is cumbersome.
Another factor is the increasing awareness of the policies of the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
in pursuit of restructuring the budgeting and spending processes of developing nations via the World Bank Treasury Reference Model. This new model has led the public sector to understand, digest and adopt a new style.
According to this new budgeting methodology, traditional methods of analyzing and utilizing budget figures are insufficient. In traditional terms, organizations start building up their long-term plans and break those plans into annual budgets that are formed as forecasts. At the end of the year, budget figures are compared with actual results and a simple actual-budget variance comparison is calculated. Since the analysis is simple, this analysis lacks any sophistication in terms of adjusting similar budget items for forthcoming periods by increasing or decreasing the expenditure estimates. Basically, variance results are generally used for revising monetary amounts for the next planning and budgeting cycle, and also for very simple departmental performance tracking.
This new approach to budget analysis and utilization is many steps ahead of traditional methods. As an example, a governmental project to enhance the social welfare of children in a remote area can help explain the performance-oriented approach. For such projects, which are generally composed of long-term plans, governments decide on objectives and the activities that are required to be accomplished to achieve them. Practical ways of enhancing social welfare of children in a rural area might include increasing the job skills of parents in the area.
In order to achieve such an objective, the government may plan to establish schooling infrastructures in various locations, complete with the necessary equipment, and further plan to assign trainers to those schools for implementing the educational programs. All these activities have a cost aspect and, at this point, long-term plans are broken down into annual budgets that incorporate the monetary figures. Once the long-term plans are accomplished, the traditional way to gauge the effectiveness of this whole project would be to assess the gap between the budget and the actual money spent. However, with the new budgeting approach, the questions to answer are tougher:
- Did we really succeed in enhancing the social welfare of children?
- Did this project cost what we expected?
- Have we done what we should have done in enhancing the social welfare of children?
Peter van der Knaap from the Ministry of Finance in the Netherlands suggests: “The general purpose of the proposals is to make budget documents and, hence, the budgetary process more policy-oriented by presenting information on (intended and achieved) policy objectives, policy measures or instruments, and their costs.” Furthermore, van der Knaap explains that this type of budgeting has the following major performance indicators:
- (the quantity, quality, and costs of) products and services (output) produced by government or government services in order to achieve certain effects, and;
- the intended effects of those measures (outcome).
Within this kind of a planning and budgeting setup, the lack of reliable information on the effects of policies emerges as a serious issue. Therefore, it is important to approach the planning and budgeting cycle in a holistic and integrated way, with collaboration across the areas of policy design, performance measures definition and policy evaluation.
Performance-based budgeting (PBB)
This whole framework points us to a newer way of budgeting, the so-called Performance-Based Budgeting.As explained by Carter (as quoted in ) “Performance budgets use statements of missions, goals and objectives to explain why the money is being spent. It is a way to allocate resources to achieve specific objectives based on program goals and measured results.” The key to understanding performance-based budgeting lies beneath the word “result”. In this method, the entire planning and budgeting framework is result oriented. There are objectives and activities to achieve these objectives and these form the foundation of the overall evaluation.
According to the more comprehensive definition of Segal and Summers , performance budgeting comprises three elements:
- the result (final outcome)
- the strategy (different ways to achieve the final outcome)
- activity/outputs (what is actually done to achieve the final outcome)
Segal and Summers point out that within this framework, a connection exists between the rationales for specific activities and the end results and the result is not excluded, while individual activities or outputs are. With this information, it is possible to understand which activities are cost-effective in terms of achieving the desired result.
As can be seen from some of the definitions used here, Performance-Based Budgeting is a way to allocate resources for achieving certain objectives ,
Harrison elaborates: “PBB sets a goal, or a set of goals, to which monies are “connected” (i.e. allocated). From these goals, specific objectives are delineated and funds are then subdivided among them.”
Achieving PBB
For this type of advanced budgeting, which requires the definition of Key Performance Indicators (KPIs) at the outset, linking these performance indicators to resources becomes the vital part of the entire setup. This is similar to the Corporate Performance Management (CPM) framework, which is “where strategy and planning meet execution and measurement”, according to John Hagerty from AMR Research.This is a sort of a Balanced Scorecard approach in which KPIs are defined and linkages are built between causes and effects in a tree-model on top of a budgeting system which should be integrated with the transactional system, in which financial, procurement, sales and similar types of transactions are tracked. Moreover, linking resources with results provides information on how much it costs to provide a given level of outcome. Many public bodies fail to figure out how much it costs to deliver an output, primarily due to problems with indirect cost allocation. This puts the Activity-Based Costing framework into the picture..
Both the concepts of scorecards, as first introduced by Kaplan and Norton, and activity-based costing are today well-known concepts in the private sector, but much less so for the public-sector bodies…until the advent of Performance-Based Budgeting! Another conceptual framework that has gained ground is the relatively recently introduced CPM, again more popular in the private sector. The point is that the CPM framework has not much touched on the topic of Performance-Based Budgeting, although the similarities in policies offered by these frameworks are worth a deeper look. The technical foundation that the CPM framework puts on the table may well be a perfect means to rationalize the somewhat tougher budgeting approach, not only for the public sector but also for commercial companies..
The way to CPM and PBB
Leading companies are integrating various business intelligence applications and processes in order to achieve corporate performance management. The first step is for senior management to formulate the organization’s strategy and to articulate specific strategic objectives supported by key financial and non-financial metrics.These metrics and targets feed the next step in the process, Planning and Budgeting, and are eventually communicated to the front-line employees that will carry out the day-to-day activities. Targets and thresholds are loaded from the planning systems into a Business Activity Monitoring engine that will automatically notify responsible persons of potential problems in real time. The status of the business is reviewed regularly and re-forecast and, if necessary, budget changes are made. If the business performance is significantly off plan, executives may need to re-evaluate the strategy as some of the original assumptions may have changed. Optionally, activity-based costing efforts can enhance the strategic planning process – deciding to outsource key activities, for example. ABC can also facilitate improved budgeting and controls through Activity-Based Budgeting which helps coordinate operational and financial planning.
The ability to establish CPM to enhance control on budget depends first upon achieving a better understanding of the business through unified, consistent data to provide the basis for a 360-degree view of the organization. The unified data model allows you to establish a single repository of information where users can quickly access consistent information related to both financial and management reporting, easily move between reporting the past and projecting the future, and drill to detailed information.
By then, you are ready to plug in - on the unified data - the applications that support consolidations, reporting, analysis, budgeting, planning, forecasting, activity-based costing, and profitability measurement. The applications are then integrated with the single repository of information and are delivered with a set of tools that allow users to follow the assessment path from strategy, to plans and budgets and to the supporting transactional data.
CPM and the adoption of more public-sector oriented PBB are not easy to tackle, but in the ever-changing business and political climate they are definitely worth a closer look.
External links
- Indonesia – The Challenges of Implementing a Performance-based Budget System, Ian Lienert, IMF, 2007
- Performance Budgeting: Linking Funding and Results, Marc Robinson (ed.), IMF, 2007
- More on IMF Annual Meetings Performance Budgeting, Seminar, Marc Robinson, IMF, 2007
- Program and Performance Budgeting Enthusiasm in India -- IMF Training Course, Holger van Eden, IMF, 2007
- From Line-item to Program Budgeting, John Kim, Seoul, 2007