Budgeting Budgeting Practice Budget Monitoring Purpose Legislative/Professional Framework Management Control System Information Systems Analysing Variances with a Control Report - Example Conclusion Examples of Financial Regulations – Unitary Authority Contents of a Scheme of Delegation – Education Service June 2004 Purpose Control of financial resources has always been important in public services and arguably pressures have intensified in recent years given pressures on public services to respond to higher customer demands alongside downward pressures on budgets. Budgetary control is the process of preparing plans and budgets budgets and then monitoring actual activity and expenditure/income. Where actual differs from plan, then the appropriate corrective action needs to be taken. Budget monitoring is therefore a significant part of the budgetary control process. The main purpose of budget monitoring in public services is to ensure that total income and expenditure planned at the budget stage is adhered to as far as possible during the budget period. The emphasis is on staying within planned expenditure because most public service organisations are working with a fixed level of resource provided by government. However for the more commercially orientated public service organisations the emphasis may be more on the ‘bottom line’ i.e. the difference between income and expenditure. There are two key elements to any monitoring system – the management control system that allocates responsibilities to budget holders and sets out the framework of rules under which they operate, and the information system that supplies relevant information to these budgetholders. These are discussed in detail below. Legislative/Professional Framework Legislation Legislation specifically requiring budget monitoring to take place is difficult to find for most public service organisations. Legislation often establishes a statutory duty for Directors of Finance to ensure that adequate policies and procedures are in place to ensure an effective system of financial control but does not specifically state that this includes budget monitoring. It is therefore down to executive action to specify the need for budget monitoring and the way in which budget monitoring takes place. For instance the NHS Executive requires Trusts to submit monitoring information to it on behalf of the Secretary of State. Standards CIPFA's A Statement on the Role of the Finance Director in Local Government (2003) places a responsibility upon the Finance Director to ensure that financial management arrangements are sound and effective. Best Value Reviews During Best Value reviews of finance departments it is common practice to assess the quality of financial and management information systems provided by such departments. This will include the budget monitoring system. Where this is found to be poor this will be identified as an area for action. Corporate Governance Financial Regulations should state the frequency with which budget monitoring reports are made to the organisations board/elected members. Other contents of financial regulations will include arrangements for virement and financial underspends/overspends These regulations should be disseminated by a number of routes, e.g. local intranets, awareness sessions etc . An example of the content of financial regulations that affect budgetary control are included under Examples of Financial Regulations – Unitary Authority. Where there is a scheme of delegated budgets in place, this should lay down the responsibility of respective parties for monitoring. All budget managers should ensure that they have familiarised themselves with the precise regulations for the organisations where they work. Management Control System Responsibility Accounting A key principle of budgetary control is to align budget holder financial responsibilities and management responsibilities. This is important if managers are to ‘own’their budgets. The budget holder structure depends upon who is responsible for making which decision. An aligned structure of financial management needs to extend througout the organisation, simply delegating responsibility to chief officers is insufficient. Four principles should lie at its heart: every budget should have a budget holder – ideally only one; front line managers should, as far as possible, be budget holders for items under their control, but not for items that they cannot influence in practice; items excluded from front line managers’ control should be managed elsewhere; senior managers should supervise the financial management of those reporting to them. Section 32, pg. 6, Better Financial Management, Management Paper No. 3, Audit Commission, May 1989. The following stages are involved in the operation of a responsibility accounting system: 1. Define the organisational structure. 2. Locate responsibilities to budget holders within the organisational structure. 3. Prepare budgets with involvement of budget holders. 4. Implement information systems which will provide relevant information to the budget holders. 5. Train budget holders on their roles. Budget holders will not normally be trained accountants and therefore it is important that the finance department provides advice and training to these Budget holders. Timetable For Monitoring Timetable To support budget holders a timetable of financial reports can be established. Financial reports need to be issued within a timeframe that allows the cost centre managers to be able to prepare their individual and departmental monitoring reports. Meetings There will be different levels of meeting involved in the budget monitoring cycle: meetings between the budget holders and their line manager, feeding up to the relevant director (or departmental management team); between finance or financial officers and cost centre managers or the departmental management team; senior management team; and member meetings such as committee or cabinet. Under the new political structures in Local Government there may be mayoral or scrutiny meeting requirements as well. Virement Virement is the movement of budget from one budget head to another budget head. It is normally required when a budget head is identified as overspending. Clear guidance is needed for the use of virement powers. Virement between budgets is an integral and important feature of budgetary control. It provides the Head of Service and Business Manager with the flexibility to adapt expenditure patterns to meet changing locally determined service needs and objectives, or a response to unforeseen cost increases. Virement regulations are normally controlled via Financial Regulations, and these vary greatly between organisations. Some organisations still require Chief Officers to obtain elected member approval for relatively small amounts of transfers within their departmental budgets. However restrictive virement procedures can lead to lack of flexibility in responding to changing circumstances. Virement can also be used as a tool to incentivise budget holders if they can identify economies and efficiencies. Windfall savings are often treated differently from planned savings, with windfall savings being taken by the centre of the organisation since they have not arisen due to managers actions. Underspends/Overspends An extension of virement is the ability to carry forward over or under spending's into the next financial year. This is not common in public service organisations in England and Wales, but there is a legal requirement for underspending/overspendings on delegated school budgets to be carried forward under the Education Reform Act 1988, where experience shows that it leads to better use of resources at operational level. It prevents the rush to spend up to budget at the end of the financial year in March, which can lead to poor spending decisions. In Scotland most Local Authorities now have year end flexibility schemes, as does the Scottish Executive. These developments should be considered by other organisations. Delegation/Aggregation The Education Reform Act 1988 introduced Local Management of Schools which transferred responsibility for most of school management, including budgets to governors at school level. In addition to this some public service organisations have implemented discretionary schemes with a view to giving management more freedom at an operational level. The argument for delegation is that it brings with it flexibility, responsiveness to local circumstances and ultimately better decision making and performance. However to succeed such initiatives need to have a scheme of delegation explaining which budgets are being devolved and who is responsible for their management. They need to be supported by an information system providing adequate budgetary control information. The level of delegation needs to ensure that those making decisions are made responsible for the financial consequences. Budgets should be delegated to whatever layer of management is able to most influence spending/income patterns. It is important, where delegation operates, that budget holders are fully aware of the budgets for which they are responsible, and those for which they are not responsible. A list of typical contents of a scheme of delegation is shown below under Contents of a Scheme of Delegation – Education Service. Information Systems Information needs to be: Timely; Accurate; Frequent, and; Relevant. The system needs to have flexibility in format definition in order that a range of reports can be produced to meet the needs of different users. These reports should be clearly structured and capable of being understood by non accountants. In recent years on line access to information has become increasingly common. Timeliness Information must be up to date if effective action is to be undertaken. If the information is late, corrective action will be delayed. Users should be encouraged to access information on line, rather than wait for month end reports. e.g. if payroll is run on the 8th of the month, three weeks are effectively lost if the information on payroll costs are not accessed until the month end. Accuracy Managers need to be confident that the information is accurate enough for their purposes, but absolute accuracy may not be necessary. Frequent Control information needs to be frequent enough. In most organisations this normally means on a monthly basis, but more frequent information may be needed in important areas. Relevance The level of detail of information will depend upon the needs of the recipient . A budget holder at operational level will require detailed figures whereas a Director will only require an overall summary. It may be appropriate to include only headings for which the budget manager is responsible, though conversely the manager may wish to see the full service cost including those outside of his/her span of financial control. Contents of Report Profiling Meaningful budgetary information requires comparison of actual versus budget on a year to date basis and overall impact. Profiling budgets means that they are broken down each month into the likely pattern of expenditure. The biggest area of expenditure in most public service organisations is normally on wages and salaries and it is important that these areas receive the greatest attention in the profiling exercise. Commitments Commitments are where orders have been placed but the service or goods have not been received. They may also include firm intentions to spend where no transactions have yet taken place. The inclusion of commitments in the expenditure incurred to date minimises the risk of managers committing the same resources on other things. Without a computerised commitment accounting system there is a significant amount of time required to administer and maintain a commitment system. It is also assumed that reports for budget holders will include accruals, where the goods or services have been received but not paid for. Inflation The existence of inflation at even the low levels experienced in recent years complicates the comparison between actual and budgeted expenditure. Fixed price budgeting (i.e. at a November price base with a subsequent allocation to cover actual inflation) tends to create confusion among budget holders since it requires several amendments to budget during the course of the year. Thus in recent years it has become more common to budget at outturn prices including the level of pay and price inflation anticipated. However this can cause problems where actual pay/price increases are significantly different from the anticipated level allowed for in the budget. Contingencies During the year unpredictable events can occur. In order to encourage self-reliance and prudence departments can be encouraged to set aside an element of their budget as a contingency. Open rules about the setting and requirement of contingencies can overcome the ‘hidden’ contingencies that many budget managers keep. A control on the level of contingency needs to be in place to ensure that the level is sufficient to meet most occurrences – it is common to set the level of contingency at around 2% of total budget. Non Financial Information The financial information in budget monitoring systems measures resource inputs. This however is of limited use unless it is compared with output measures in order that judgements can be made on whether the money been spent efficiently and effectively. It may be beneficial from a management information viewpoint to also use unit information where price bases fluctuate, e.g. units of energy, telephone units. In local authorities with Continuous Performance Assessment there is a greater drive to link financial and non-financial data, such as staff numbers, staff turnover, housing occupancy rates, bed occupancy rates, or other performance criteria. Coding Systems All monitoring systems are based upon the coding of transactions. The Audit Commission have identified the specific features of a good coding structure. A good coding structure is: matched to the management hierarchy and reporting framework to enable clear identification of cost centres by budget-holders; standardised so that sub and detail codes stand for the same thing across the range of services and cost centres, and; incorporates sufficient capability and flexibility to accommodate new information requirements or different report formats. Section 38, pg 8, Audit Commission, Management Paper No. 11, December 1993, Regular as Clockwork: Raising the Standards of Local Government Financial Accounting. Analysing Variances with a Control Report - Example Cost centre managers will normally receive financial reports, at cost centre and subjective level, and if required at detailed level. In recent years online reporting tools have been used to provide similar information. An example of a budget report is shown below. Table Title:Planning Section - January (Month 10) Each area of expenditure will probably have a different planned expenditure pattern. It is common for salaries to be profiled over twelve monthly instalments since there is likely to be a large core of permanent employees. However part year effects of pay awards and seasonal working may also need to be reflected in the profiling. Some budgets are demand led, for both expenditure and income. In the above illustration the external income for planning is profiled so that most of the income is normally expected before December. However planning income is dependent upon the level of demand for planning applications, which cannot be predicted with any degree of precision. In the illustration there has been planning application income received in the current month, and the budget profiling is incorrect. Likewise, the annual budget will probably have been estimated from the historical demand levels, and predicted major developments, but is at risk if the planned developments or normal levels of demand do not materialise, hence the cumulative variance is an under recovery of planned income. Conclusion It is important to remember that the primary purpose of the budgetary monitoring system is to control as closely as possible the income and expenditure of the organisation. There are invariably variances between the actual and the budgeted plans regardless of how carefully the budget is prepared. The important objective is to find out why the variances have occurred and take corrective action before it is too late to do anything about it. Examples of Financial Regulations – Unitary Authority General The executive will determine the overall spending plans of the Council and approve budgets for all service areas at the beginning of the year. Heads of Service agree the allocation of budgets to Business Unit level in conjunction will all Business Managers and Finance Managers. Business Managers have responsibility for managing their unit’s budget. Budgetary Control Heads of Service and Business Managers are required to monitor their budgets regularly during the year and take immediate action as necessary. Where the chosen action indicates that the budget would overspend, authority to vire must be sought. Under no circumstances should expenditure be incurred without appropriate provision being put in place first. Council budgets are prepared on a cash limited basis. No supplementary estimates will be provided for inflation increases once budgets have been approved. Unavoidable cost increases for which insufficient allowance has been made in the budget will need to be met by equivalent reductions elsewhere. Virement Virement is defined as the Head of Service or Business Manager’s ability to transfer sum from one budget to another or to establish a new budget, in order to meet planned expenditure needs in accordance with policies and priorities of the service. The ability to exercise virement does not apply to Central Recharges nor Capital Accounting Charges. Where virement would mean that the underlying policies agreed by Boards and Policy and Resources Committee require change, the approval of the Board and Resources Committee is required (eg making virement between pay and non-pay budgets). Whilst the exercising of virements by Heads of Service and Business Managers is as flexible as possible, limits and guidelines are set to ensure the overall control of the council’s finance. Virement Limits Approval must be sought from the appropriate officers, in accordance with the following limits: Up to £5,000 - Business Manager and Finance Manager; Up to £10,000 - Head of Service and Finance Manager; Up to £25,000 - Head of Service and Head of Finance; The resources and Assets Board/Policy and Resources Committee must approve virements over £25,000. No virement should be made between different Service Area Boards Budgets except with their approval and that of the Resources & Assets Board/Policy and Resources Committee. Overspending No Head of Service of Business Manager should plan to overspend his/her budget. All expenditure plans should be consistent with Business Plans and the unit’s Service Plan. Potential overspends will have been addressed during the year and, in some cases, virement will have been exercised. In exceptional circumstances up to £5,000 or 5% of the Business Units net expenditure whichever is greater may be overspent in one year to a maximum of £100,000. All deficits will be carried forward to the next financial year as a first call on the budget for the year. Underspending Underspending of £10,000 or 10% whichever is the greater of the Business Unit net expenditure may be carried forward from one year to the next. Contents of a Scheme of Delegation – Education Service Scope of delegated budget i,e.what items of school spending it is intended to cover. Resource Allocation Formula for allocating the total budget down to school level. Timing of notification from LEA to School of its budget. Arrangements for delegation of responsibilities within the school between governors and senior management in respect of budget planning and monitoring. Ability of school to carry forward underspends/overspends. Provision of financial information systems to schools to assist budget planning and monitoring. Duty of governing body to report to LEA any significant predicted overspend. The CFO’s statutory responsibility to produce year end financial accounts and the requirement of schools to provide such information as is needed to fulfil this role. LEA policy on operation of allowing schools bank accounts. The rights of governing body to purchase services from where they feel is the most appropriate subject to the terms of financial regulations setting out god practice in respect of tendering and value for money from all expenditure. Conditions under which delegation may be withdrawn.