Developing and Managing Internal Budgets top-down embed hasing variation forecasting allocation bottom-up Better Practice Guide June 2008
ISBN No. 0 642 81021 4 Commonwealth of Australia 2008 COPYRIGHT INFORMATION This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no part may be reproduced by any process without prior written permission from the Commonwealth. Requests and inquiries concerning reproduction and rights should be addressed to the Commonwealth Copyright Administration, Attorney-General s Department, Robert Garran Offices, National Circuit, Barton ACT 2600 http://www.ag.gov.au/cca Questions or comments on the Guide may be referred to the ANAO at the address below. The Publications Manager Australian National Audit Office GPO Box 707 Canberra ACT 2601 Email: webmaster@anao.gov.au Website: http://www.anao.gov.au
Foreword Developing and managing internal budgets is a fundamental element of an organisation s financial management framework. Effective internal budgeting will significantly contribute to the achievement of an organisation s goals and objectives, particularly when embedded into corporate planning and aligned to the external budget. Organisations use internal budgets to establish and communicate funding priorities, support decision making, set financial controls, and monitor and report financial performance. Effective internal budget processes, which underpin the efficient allocation of resources, enable Australian Government organisations to more readily identify and respond to changes in environmental conditions and government priorities. The purpose of this Better Practice Guide is to assist organisations better manage internal budgeting activities. It discusses a range of principles and techniques designed to embed internal budgeting in an organisation s planning, control and accountability systems. It also notes the importance of cultivating an environment that encourages effective internal budget practices an important element of which is to construct internal budgets with direct input from operational managers. Managers are more likely to achieve budget targets that have been agreed with them and are limited to those costs over which they have control. This guide updates the Better Practice Guide on Internal Budgeting issued in February 2003. This guide reiterates many better practices in the former version and takes into account developments in financial management and budgeting affecting Australian Government organisations since the release of the previous guide. While practices described in this guide generally apply to all Australian Government organisations, it is important that each organisation assess the extent that information provided is relevant, appropriate and cost-effective in light of their circumstances. The ANAO consulted with many Australian Government organisations and individuals to improve the usefulness of the guide. I particularly appreciated the assistance of the Department of Finance and Deregulation, Department of the Environment, Water, Heritage and the Arts, Australian Taxation Office, National Library of Australia and the Civil Aviation Safety Authority for commenting on previous versions of the guide and/or providing examples of internal budgeting processes and practices. Ian McPhee Auditor-General June 2008 i
Contents Foreword i 1. Overview of internal budget processes 2 1.1. Introduction 2 1.2. Coverage 2 1.3. Definition of internal budgeting and other common terminology 3 1.4. Acknowledgements 3 1.5. Internal budget processes 4 1.6. Characteristics of effective internal budget processes 6 2. Embedding internal budget processes into organisational planning and management 8 2.1. Integrate the internal budget into organisational planning 9 2.2. Align internal budgeting with organisational roles and responsibilities 11 2.2.1. Ensure clear accountability for all budget allocations 12 2.2.2. Align organisational structures to outcome, output and program responsibilities 13 2.2.3. Present full cost of service delivery 14 2.2.4. Show full financial impacts of budget decisions 16 2.3. Integrate operational and capital budgets 20 2.4. Align internal and external budgets 24 2.5. Harmonise budgeting and reporting 25 2.6. Engage stakeholders in internal budget processes 26 2.6.1. Obtain organisational support for the internal budget 26 2.6.2. Supporting operational managers in internal budget processes 26 2.6.3. Internal budget processes for whole of government initiatives 28 3. Developing and implementing a comprehensive internal budget 30 3.1. Effective planning and coordination 30 3.1.1. Set budget policies 31 3.1.2. Establish budget timetables and milestones 32 3.1.3. Allocate responsibility for budget development 34 3.1.4. Document budget processes and disseminate guidelines 34 3.2. Effective budget construction 35 3.2.1. Budget top-down, bottom-up or both 35 3.2.2. Determining the budget approach 36 3.2.3. Automate internal budget processes 39 3.3. Effective oversight, review and communication 41 ii Developing and Managing Internal Budgets Better Practice Guide
4. Monitoring and evaluating budgeting performance 44 4.1. Monitor and report against internal budgets 44 4.1.1. Report budget performance 44 4.1.2. Assist managers assess budget performance 45 4.1.3. Phase the budget to provide meaningful comparisons 45 4.1.4. Analyse and explain budget variances 47 4.2. Revising the internal budget 50 4.2.1. Frequency of budget updates 50 4.2.2. Revising internal budget allocations 50 4.2.3. Understanding and tracking changes in internal budgets 51 4.3. Forecasting to manage gaps between budget estimates and actual results 52 4.4. Review and improve internal budget processes 54 4.4.1. Measure internal budget accuracy and timeliness 55 4.4.2. Identify opportunities for improvement 56 Appendices and Glossary of terms 57 A Illustrative template guidelines for internal budget processes 58 B Budget summary illustrative structure 60 C Internal budget processes better practice checklist 64 Glossary of terms 70 iii
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Overview of internal budget processes Part 1 Overview of internal budget processes Contents 1. Overview of internal budget processes 2 1.1. Introduction 2 1.2. Coverage 2 1.3. Definition of internal budgeting and other common terminology 3 1.4. Acknowledgements 3 1.5. Internal budget processes 4 1.6. Characteristics of effective internal budget processes 6 1
Overview of internal 1. budget processes 1.1. Introduction Budget processes within Australian Government organisations are guided by the requirements of the Financial Management and Accountability Act 1997 (FMA Act) and the Commonwealth Authorities and Companies Act 1997 (CAC Act). For example, Chief Executives of FMA Act agencies are required to manage the affairs of their agency in a way that promotes the efficient, effective and ethical use of the resources for which they are responsible. Similarly, directors of Australian Government authorities and companies are required to exercise care, diligence and business judgement in carrying out their responsibilities under the CAC Act. Since 1999 2000, Australian Government organisations have budgeted under the accrual based, outcomes and outputs framework. The framework was designed to allow parliamentarians and the public understand the real cost of delivering benefits to the Australian community (outcomes) and goods and services (outputs). Within each organisation, the framework is intended to improve governance and public accountability by driving improvement in the way organisations manage resources and measure results. The adoption of accrual budgeting also aligned financial reporting and budgeting in Australian Government organisations, providing a consistent framework for the measurement and disclosure of budget estimates and actuals and providing enhanced accountability for financial performance. The 2002 Budget Estimates and Framework Review endorsed the accrual accounting framework but made several recommendations to improve the quality of financial information provided to Government. 1 The progressive implementation of these recommendations over the last five years has seen a renewed emphasis on program budgeting and reporting (in addition to, and as part of, the accrual outputs and outcomes framework) as well as a reaffirmation of the continuing importance of cash information, particularly in terms of Government decision-making. In 2006, the Australian Government determined that all organisations in the Australian Government General Government Sector (GGS) must report annually on legislative compliance and financial sustainability to their responsible Minister and the Finance Minister. This included a certification from each Chief Executive (or Board) as to their organisation s ability to meet existing program requirements within agreed resources, including the management of capital and other long term assets and liabilities. The Certificate of Compliance program has reinforced the importance of organisations adopting a longer term focus in their internal planning and budgeting considerations. 1.2. Coverage The principles and considerations outlined in the guide generally apply to all Australian Government organisations, irrespective of size and legislative framework. The guide focuses on internal budget processes undertaken by organisations to manage departmental resources. It does not specifically cover those resources administered on behalf of Government. However, many of the better practices outlined in the guide also apply to administered items. 1 Department of Finance and Administration (2002), Budget Estimates and Framework Review, Canberra. The aim of the review was to assess the accuracy, responsiveness and effectiveness of the budget estimates and advice system in meeting the requirements of government. 2 Developing and Managing Internal Budgets Better Practice Guide
1.3. Definition of internal budgeting and other common terminology The internal budget shows an organisation s expected financial performance, financial position and cash flows disaggregated by area of responsibility. Developing an internal budget involves making decisions on the allocation, use and administration of resources to achieve the organisation s objectives. Overview of internal budget processes The guide uses common budget terms outlined below. A comprehensive glossary is at the end of the guide. Budget allocation Budget phasing Budget transfer Budget variance Cost attribution Direct costs Indirect costs Distribution or disaggregation of an organisation s budget to its various work areas, outputs or programs. Budget phasing represents the pattern of expenditure (or income) over the budget period (for example, over the twelve months of an annual budget). Moving budgeted funds from one group to another group or from one account to another account. Difference between a budget projection and an actual result. Budget variances can be expressed in absolute or percentage terms. Allocation of costs to a particular group, output or program based on pre defined rules and drivers. A cost that can be directly attributed to an activity or the delivery of an output, program or project (for example, costs associated with employees assessing grant applications under a discretionary grant program). A cost that cannot be directly attributed to an activity or the delivery of an output, program or project (for example, costs associated with employees providing administrative services across an organisation). 1.4. Acknowledgements The ANAO appreciates the assistance provided by KPMG in preparing the guide. In addition, a number of Australian Government organisations contributed information and insights that supported the development of the guide, primarily: Australian Maritime Safety Authority; Australian Taxation Office; Civil Aviation Safety Authority; Department of the Environment, Water, Heritage and the Arts; Department of Finance and Deregulation; Department of Health and Ageing; National Library of Australia; National Museum of Australia; and National Water Commission. 3
1.5. Internal budget processes Effective internal budget processes typically involve a series of integrated activities designed to align: organisational planning; financial responsibility, accountability and authority; budgeting and reporting; resource allocation; and the monitoring and evaluation of budgeting performance. Accordingly, the guide examines internal budget better practices across the following broad dimensions: Part Two: Embedding internal budget processes into organisational planning and management; Part Three: Developing and implementing a comprehensive internal budget; and Part Four: Monitoring and evaluating budgeting performance. Figure 1 illustrates the structure and coverage of the guide. Figure 1: Integrated internal budget processes Part Two Embedding internal budget processes into organisational planning Align internal budget with roles and responsibilities Integrate operational and capital budgets Align with external budgeting and reporting Engage stakeholders in internal budgeting Part Three Developing and implementing a comprehensive internal budget Effective planning and coordination Effective budget construction Effective oversight, review and communication Part Four Monitor and report against internal budgets Monitoring and evaluating budgeting performance Revise the internal budget Forecasting to manage gaps between estimates and actual Review and improve internal budget processes 4 Developing and Managing Internal Budgets Better Practice Guide
Part Two of the guide discusses the link between organisational planning and internal budget processes and the role of the internal budget in financial management. Planning, budgeting and reporting processes ideally have a cascading effect within an organisation as strategic goals and priorities flow to operational areas. It is important to allocate internal budgets consistent with the organisation s financial management framework while, at the same time, aligning with managers specific responsibilities. Managers are more likely to take ownership of their allocated budget where they have control, not just accountability, over the implementation of the budget. Close integration between the capital budget and the operational budget further assists organisations assess the long term consequences of budget decisions. Overview of internal budget processes Consistency between internal and external budgets and between reporting of budget estimates and actual results is also important. This helps ensure a close alignment between how an organisation plans and monitors performance internally and how it is held accountable externally. A critical element in gaining broad acceptance of the internal budget is the involvement of senior management and operational management throughout the budget process. Part Two also discusses better practice principles and approaches involved in engaging relevant stakeholders, including supporting operational managers. Finally, Part Two deals with the management of relationships between Australian Government organisations working on whole of government initiatives. Part Three discusses policies, procedures and systems critical to developing an effective internal budget. It is vital that the internal budget function is supported by robust processes and systems for planning and coordination, and that these are clearly articulated and consistently applied across the organisation. This is likely to generate a budget that is timely and accepted by management. Part Three also suggests some better practice principles and approaches to manage and support the development of internal budgets. Part Four discusses the link between preparing the internal budget and reporting and monitoring budgeting performance, including the role of forecasting to manage the gap between budgeted and actual revenues and expenditure. To use resources efficiently and effectively, it is essential organisations build a continuous improvement culture into internal budget processes. Part Four also suggests some better practices to measure, review and refine internal budget processes. 5
1.6. Characteristics of effective internal budget processes Effective internal budget processes incorporate the key characteristics listed in Table 1. Table 1: Key characteristics of effective internal budget processes Characteristic 1 Internal budget processes are embedded in organisational planning and align resources with organisational priorities. 2 Budget allocations and accountabilities align with managerial responsibilities and authority. 3 Operational and capital budgets are seamlessly integrated and multi-year focused. 4 The internal budget is consistent with the external budget and this consistency is retained throughout the budget cycle. 5 The recognition, measurement and disclosure of internal budgets is harmonised with reporting. Reference in guide Part 2.1 Part 2.2 Part 2.3 Part 2.4 Part 2.5 6 Relevant stakeholders are engaged throughout internal budget processes. Part 2.6 7 Internal budget processes are carried out in accordance with clearly defined expectations and assumptions, a coordinated calendar of activity and well documented and communicated policies and procedures. 8 The internal budget is constructed with direct input by operational managers in accordance with strategic targets and priorities established by senior management. 9 Internal budget processes are overseen and formally approved by senior management and subject to rigorous quality assurance processes. 10 Managers are provided with relevant, timely and accurate budget-to-actual information appropriate to their level of responsibility and, in turn, provide clear and consistent feedback in a timely manner about underlying causes and effects of budget variations. 11 Internal budget revisions are limited to approved formal updates to retain clear accountability for budgeting performance. 12 Rolling forecasts are prepared to quickly respond to changes and to manage the gap between budgeted and actual revenues and expenditure in a timely manner. 13 The organisation adopts a continuous improvement culture, and has an ongoing training program, to help ensure the internal budget remains relevant to the organisation s requirements and priorities and is constructed in the most efficient and effective way. Part 3.1 Part 3.2 Part 3.3 Part 4.1 Part 4.2 Part 4.3 Part 4.4 Appendix C includes a checklist of better practices covered in this guide. 6 Developing and Managing Internal Budgets Better Practice Guide
Part 2 Embedding internal budget processes into organisational planning and management Embedding internal budget processes into organisational planning and management Contents 2. Embedding internal budget processes into organisational planning and management 8 2.1. Integrate the internal budget into organisational planning 9 2.2. Align internal budgeting with organisational roles and responsibilities 11 2.2.1. Ensure clear accountability for all budget allocations 12 2.2.2. Align organisational structures to outcome, output and program responsibilities 13 2.2.3. Present full cost of service delivery 14 2.2.4. Show full financial impacts of budget decisions 16 2.3. Integrate operational and capital budgets 20 2.4. Align internal and external budgets 24 2.5. Harmonise budgeting and reporting 25 2.6. Engage stakeholders in internal budget processes 26 2.6.1. Obtain organisational support for the internal budget 26 2.6.2. Supporting operational managers in internal budget processes 26 2.6.3. Internal budget processes for whole of government initiatives 28 7
2. Embedding internal budget processes into organisational planning and management Organisations use internal budgets for financial planning, to establish performance expectations and to set financial controls. In addition, the internal budget can be used for purposes such as identifying costs and determining prices (for example, as part of cost recovery arrangements) and assessing individual managers financial performance. The internal budget is a core element of an organisation s planning and management framework. As shown in Figure 2, an integrated planning and management framework is characterised by close relationships between planning and budgeting and between budgeting and reporting, both within the organisation and externally. Figure 2: Integrated planning and management framework Internal Budgeting External Budgeting Organisational Planning Internal Reporting External Reporting Better practice organisations embed internal budget processes into organisational planning and management. Better practice organisations embed internal budget processes into organisational planning and management by: integrating the internal budget into organisational planning; aligning the internal budget with organisational roles and responsibilities; integrating operational and capital budgets; aligning internal and external budgets; harmonising budgeting and reporting; and engaging stakeholders in the internal budget. 8 Developing and Managing Internal Budgets Better Practice Guide
2.1. Integrate the internal budget into organisational planning The strategic (or corporate) plan sets long term goals and priorities which establish the direction for operational plans within the organisation. Typically, the strategic planning horizon encompasses the next three to five years, although a longer horizon may be appropriate for significant government programs and for capital planning. Ideally, the strategic plan describes and quantifies the direction of the organisation and is endorsed by stakeholders in terms of goals, objectives and timing. Organisations are better positioned to meet their objectives where resources are deployed consistent with organisational priorities. Closely aligning internal budget processes with strategic planning processes will help achieve this. Effective alignment means that organisational plans will be supported by internal budgets which establish funding expectations for the current year and future years consistent with the organisation s goals and priorities. In this light, organisational plans have an appropriate financial basis and will be costed in a manner consistent with the delivery of the plan. The development of the internal budget enables an assessment of the extent to which goals are attainable or whether change is required. By integrating the budget setting process into the planning process, organisations are better positioned to determine budgets and allocate resources based on operational needs and consistent with approved strategies and priorities. Effective integration also promotes better understanding among managers of how their individual activities and budgets fit into organisationwide responsibilities. The strategic plan is typically supported by a range of operational and specific plans, including business plans, group operational plans, workforce plans, capital plans and individual performance agreements. Each plan or agreement translates one or more areas of the strategic plan into detailed operational objectives, activities and accountabilities. The planning process requires clarity about priorities, targets and metrics such that strategic goals can be cascaded down into each plan and agreement. The internal budget should similarly support each level of planning and performance management within the organisation. By integrating the budget setting process into the planning process, organisations are better positioned to determine budgets and allocate resources based on operational needs and consistent with approved strategies and priorities. Embedding internal budget processes into organisational planning and management Better Practice Tip: Link the internal budget to workforce planning The employee budget forms a large proportion of the overall internal budget of many Australian Government organisations. As such, assumptions made in relation to staffing levels and staff movements can have a significant impact on the overall budget. As many organisations face increasingly tight labour markets and higher staff turnover, it is becoming more difficult to prepare a realistic estimate of staff numbers in the internal budget, especially for longer term projections. A key risk in internal budget processes is that budget assumptions are biased towards current market conditions, including around workforce availability. The establishment of a workforce plan is an effective way in which organisations can formally plan for the future workforce and link workforce numbers to organisational needs. The workforce plan sets out the organisation s priorities and strategies for identifying, achieving and maintaining staffing numbers and skills to achieve organisational objectives. The workforce plan can assist the internal budget by providing a reasonable basis for key employee-related assumptions underpinning budget calculations, including a longer term perspective on workforce numbers. 9
One means of establishing top-down direction in the budget setting process is to use the firstyear component of the strategic plan as the basis for the internal budget. Figure 3 illustrates how resources can be directed at achieving organisational goals through the alignment of planning and budgeting at each level within an organisation. Figure 3: Integrating the internal budget into organisational planning Planning Budgeting Strategic Plan Budgeted Financial Statements Workforce Plan Operational Plan Asset Management Plan Employee Budget Operational Budget Capital Budget Group Plans Group Budgets Individual Performance Agreements Budget Allocations Plan Budget Strategic plan (also called Corporate plan): High-level plan that identifies the organisation s role, key goals and targets over the medium to long term (for example, three to five years). Operational plan: Outlines expected operational activities to deliver annual strategies. Workforce plan: Identifies current and future workforce requirements by assessing the workforce required and workforce available to support the organisation s objectives. Asset management plan: A multi-year plan for capital asset acquisition, maintenance and retirement. Group plans: Outline expected activities to be undertaken by each group. Individual performance agreements: Outline expected performance for the year including targets and planned development. Budgeted financial statements: Key statements showing financial performance, financial position and cash flows. Aligns to external budget. Operational budget: Shows the impact of operating decisions on the organisation s sources of income, expenses and cash flows. Employee budget: Shows the cost of employees generally a component of the operational budget although employees involved in capital projects may instead be included in the capital budget. Capital budget: Shows planned asset purchases, construction and disposals. Group budgets: Outline expected resource allocation and revenue sources for each group. Budget allocations: Show allocated budget for particular positions or areas of responsibility. 10 Developing and Managing Internal Budgets Better Practice Guide
Integration is enhanced when planning and budgeting processes source information from the same internal and external data sets. This provides greater visibility in decision-making and consistency in the assumptions made. The finance area is central to the integration of strategic planning and budget setting processes. The finance area can help operational areas translate strategic goals and performance plans into specific budget elements and drivers. The role of the finance area in supporting operational managers is discussed further in Part 2.6: Engaging stakeholders in the internal budget. 2.2. Align internal budgeting with organisational roles and responsibilities The internal budget is allocated to areas within an organisation to facilitate detailed planning and performance management and enforce internal accountability. Budget allocations will be more effective when they reflect the organisation s planning and management framework. Participants in internal budget processes typically include: senior management, responsible for the delivery of outputs and programs and accountable for the performance and financial viability of the organisation as a whole; operational or line managers, responsible for the delivery of specific outputs and programs as well as financial management of their group or team; and business support managers, including the Chief Financial Officer, responsible for the delivery of certain support functions (such as the provision of financial advice) as well as financial management of their own group or team. Budget allocations will be more effective when they reflect the organisation s planning and management framework. Embedding internal budget processes into organisational planning and management It is important that internal budget allocations are consistent hierarchically such that each lower level budget can be aggregated consistent with the organisation s management and accountability structure. However, this does not require the same level of detail to be reported at each level of management. It is preferable for relevant summaries of the internal budget to be prepared for each level of management, such that: budget reporting to senior management is high-level and strategically focused, for example, providing budgets for the organisation as a whole with summarised results for each organisational area, output and program; and budget reporting to operational and financial managers is more detailed than that provided to senior management to enable these managers to identify factors that influence budget results. Ideally, the internal budget is fully allocated across the organisation. Where the internal budget is not fully allocated there is a risk that there may be components of the budget for which no one has taken responsibility. Similarly, where budget allocations do not reflect organisational roles and responsibilities, there is a risk that managers are responsible for multiple allocations of the same budget or for allocations over which they have no control. In allocating the internal budget across an organisation, it is prudent to: clearly assign each budget allocation to an accountable officer with the allocated budget limited to those items where the officer has the responsibility, and the associated authority, to take action; align budget allocations with output and program structures in addition to organisational structures (for example, cost centre structures); allocate the full cost of goods and services across the organisation, distinguishing between those items that the accountable officer has direct control over from those where control is indirect; and allocate all elements of the budget, including balance sheet items, so that officers can view the full financial impact of their decisions. These practices are illustrated in Figure 4 and explained further below. Ideally, the internal budget is fully allocated across the organisation. 11
Figure 4: Better practices in allocating the internal budget Clearly assign accountability. Align with managerial responsibility and authority Align organisational structures to output and program responsibilities Authority Output Accountability Program Group Responsibility Budget Allocation Direct Costs Income and Expenses Indirect Costs Cash Flows Full Costs Assets and Liabilities Show the full cost of service delivery Show the full financial impacts of budget decisions 2.2.1. Ensure clear accountability for all budget allocations Budget allocations will be more effective when they are assigned to an accountable officer or position. General or broad statements of budget management responsibility are likely to create uncertainty about performance expectations and measures of accountability. Conversely, clearly articulated and communicated budget management responsibilities for financial and operational managers and staff helps ensure these responsibilities are widely and consistently understood. An important consideration for organisations is whether the full budget is allocated across the organisation or whether a component is retained centrally by senior management, for example, as unallocated contingency. The retention of a contingency reserve gives an organisation flexibility to cope with uncertainties and to allow adjustments for unanticipated expenditures. However, there is a risk that the reserve is perceived as a slush fund that can be called upon when areas need additional funding. Organisations are also likely to encounter difficulties in allocating contingency reserves to outputs and programs, thereby reducing the accuracy of output and program budgets. As such, it is prudent to keep unallocated contingencies to a minimum and for specific purposes. It is also useful for organisations to have clear protocols in place to specify criteria under which contingency amounts can be accessed. 12 Developing and Managing Internal Budgets Better Practice Guide
Ensure budget accountability aligns with responsibilities and authority Officers should only be held accountable for budgets that they control that is where they have authority to make decisions, allocate resources and commit the organisation to a course of action. Accountability is enhanced when consistency is maintained between budget allocations and the organisation s overall financial management framework, in particular the organisation s delegations framework. It is often desirable to include accountability for budget performance in an officer s individual performance agreement. Officers should only be held accountable for budgets that they control. Managers are more likely to take ownership of their allocated budget where they have input into developing the budget as opposed to having a budget attributed to them. In addition to the allocated budget, responsibility for underlying budget sources and budget assumptions (for example, standard costs) should also be clearly assigned within an organisation to help ensure this data is kept up-to-date. Typically, responsibility for these items would reside in the finance area. 2.2.2. Align organisational structures to outcome, output and program responsibilities Public sector managers have many responsibilities, including to: allocate funds in accordance with the organisation s funding limits and delegations; implement and administer government programs; contribute to the delivery of the organisation s outputs; and ultimately contribute to the achievement of the government s desired outcomes. Embedding internal budget processes into organisational planning and management An effective internal budget structure helps managers plan for, and measure performance against, each area of responsibility. This provides managers with a clear understanding of, and commitment to, the organisation s goals. Aligning organisational structures with output and program responsibilities reduces complexity in linking resources to output and program delivery, as: managers are held accountable for one rather than multiple budgets; the time required to compile the budget is reduced as consolidation points are reduced; organisations can more readily measure the cost of managing administered programs (that is, there is less attribution); and there is a direct link between external appropriation sources and internal resource allocation and between external performance measurements (in the Portfolio Budget Statements) and internal budget activities. Better Practice Tip: Align organisational structures with outcomes, outputs and programs This degree of alignment best defines management accountabilities and responsibilities, and enables organisations to directly translate internal activity reporting to external reporting. 2 If an organisation is unable to align organisational structures to output and program responsibilities, it is important to clearly map linkages between each organisational unit and the outcomes, outputs, and programs to which they are contributing. Some organisations develop a matrix approach to the internal budget where managers are allocated budgets for one or more organisational units 2 Joint Committee of Public Accounts and Audit (JCPAA) Report 388, Review of the Accrual Budget Documentation, 2002, p. 12. 13
as well as contributing to specified outputs and programs. Other organisations identify individual managers with specific responsibility for managing outputs and programs across a range of organisational units. 2.2.3. Present full cost of service delivery Including indirect costs in output and program budgets is necessary to present the full cost of delivering services. Aligning organisational structures to outputs and programs is less straightforward for internal enabling activities (such as corporate support services) and fixed organisational costs (such as rental costs). Ordinarily, these activities contribute to multiple outputs and programs. Nonetheless, including indirect costs in output and program budgets is necessary to present the full cost of delivering services. One approach to allocating indirect costs to outputs and programs is to require each corporate area to identify the program and output they worked on. However, it is often simpler and more cost-effective for an organisation to adopt attribution rules to allocate indirect costs to output and program budgets. As shown in Table 2, a range of approaches are available for attributing direct and indirect costs to outputs and programs. 3 The most appropriate approach to use will depend on the materiality of indirect costs, availability of information and nature of the organisation s activities, outputs and programs the benefits of better information must outweigh the costs of collecting it. Many Australian Government organisations have automated cost-attribution systems to help support transparent and consistent approach to allocating costs to outputs and programs. Table 2: Approaches to attributing costs Attribution basis Description Suggested use Time recording systems Records of usage Activity snapshot Employee costs and associated costs in operational areas are attributed to output and program (or project) based on a time recording method (for example, timesheets). Indirect employee costs (for example, corporate areas) are also allocated based on timesheet activity or are based on another attribution method. Records are kept on the use of infrastructure, plant and equipment, with costs attributed on the basis of this information. Cost attribution is based on an analysis of activities over a representative period, rather than continuously. Examples of activitysnapshot approaches include time and motion studies and collecting timesheets for a representative period. Where staff costs are a significant proportion of overall costs. In project based organisations with a large number of small projects. In organisations recovering costs of activities. Where capital usage costs are a significant proportion of overall costs. In organisations with a small number of large projects or where the pattern of activity is fairly consistent over the course of a year. 3 Management Advisory Board (1997), Beyond bean counting: effective financial management in the APS 1998 & beyond, Part 3, pp. 75 81, contains further discussion on cost attribution approaches. 14 Developing and Managing Internal Budgets Better Practice Guide
Attribution basis Description Suggested use General ledger cost centre structures Activity Based Costing (ABC) Costs directly attributable to an output or program are identified based on the cost centre or profit centre structure in the general ledger. Indirect costs are then attributed using cost drivers or through another of the approaches listed in this table. The organisation is broken down into activities with each activity representing one way in which outputs and programs are delivered. Direct costs are allocated directly to outputs and programs ( cost objects ). The majority of indirect costs are assigned to activities, which are in turn allocated to cost objects. In organisations where there is a close alignment between organisational structures and outputs or programs (that is, a one-to-one mapping). In complex organisations with a range of material indirect costs. In organisations where the data used to capture and measure activities can be generated at little cost and effort. Embedding internal budget processes into organisational planning and management A key advantage of ABC is that it converts indirect costs into direct costs which are directly assigned, rather than allocated, to outputs and programs. Proxy cost drivers Indirect costs are allocated to operational areas (direct cost areas) based on one or only a few key cost drivers which are readily measurable, for example, staff numbers or work space. While there is not a direct relationship between the proxy cost drivers and each indirect cost element, the proxy(s) are representative of the organisation as a whole. In policy or process oriented organisations with a small range of activities and where indirect costs are not a significant proportion of the overall cost base. Internal user charging or Service Level Agreements (SLA) Indirect cost areas (for example, corporate areas) record actual costs incurred for each operational area ( client ), calculate a charge for the service and invoice (either physically or notionally) each client on a regular basis. In organisations where indirect costs are a significant proportion of the organisation s overall cost base. In organisations where internal enabling areas operate as autonomous business operations or are outsourced. In organisations where the data used to measure usage can be generated at little cost and effort. Managerial judgement Indirect costs are allocated to outputs and programs based on management s assessment of where costs are incurred. In organisations where indirect costs are immaterial. 15
In addition to reflecting the full cost of service delivery, it is important that the allocated budget continues to align with managerial responsibilities and authorities. One way to achieve this is to distinguish in budget reporting between those budget items or activities that the output or program manager has direct control over (direct costs) from those items or activities used by the output or program but where control is indirect (indirect costs). Consistent with external budget and reporting standards, there is also a need to distinguish between departmental and administered activities. The involvement of operational managers in establishing attribution rules and identifying key cost drivers increases the likelihood that they will understand and accept the attribution rules. The involvement of operational managers in establishing attribution rules and identifying key cost drivers increases the likelihood that they will understand and accept the attribution rules and take ownership of their allocated budget. The following case study provides an example of the attribution of indirect costs. Case study: Department of Environment, Water, Heritage and the Arts A simple and transparent approach to cost attribution Following a cost-benefit analysis of alternate indirect costing methodologies and taking into account its operational environment, the department concluded that the most appropriate attribution approach for the purpose of overhead allocation was through the use of a single cost-driver based on workpoints (floor space). A workpoint is a point at which a person is able to work, regardless of whether a personal computer is there. It includes storage areas but does not include common areas. In most cases, a workpoint can be attached to an activity. Indirect costs (that is, indirect activity centres) are attributed to direct activity centres through a two-phased attribution process. Firstly, indirect activities that directly support more than one activity within an output or program (for example, divisional executive) are attributed to the relevant output and program direct activity centres. Secondly, indirect activities that support all programs and outputs (for example, the Office of the Secretary) are attributed to direct activity centres based on workpoints. Activity centre budget reports show separately those revenues and expenses that relate to direct activities from those items or activities used by the output or program but where control is indirect (indirect activities). The approach provides a reasonable and cost-effective attribution to support accountability and decision-making by showing the full cost of outputs and programs. 2.2.4. Show full financial impacts of budget decisions Consistent with the external budget, Australian Government organisations generally prepare internal budgets which include income statements, balance sheets and cash flows. However, a key consideration for most organisations is the extent to which all elements of the budget are allocated. For example: whether non cash items such as depreciation are allocated to operational areas; the extent to which budgeted revenues (for example, appropriation and revenues from independent sources, including sales proceeds) are allocated to operational areas; whether assets and liabilities are allocated to operational areas or maintained centrally; and the extent to which operational areas are held accountable for cash estimates, accrual estimates or both. 16 Developing and Managing Internal Budgets Better Practice Guide
It is prudent to devolve all elements of the budget, including balance sheet items, to managers who have control or stewardship over each element. However, the degree of devolution of budget elements is likely to depend on the nature, size and distribution of the organisation s assets and liabilities. Benefits of allocating integrated budgets (that is, inclusive of income statement, balance sheet and cash flow impacts) to operational managers include: the full financial impact of managers decisions are visible to them and they can be held accountable for the full cost of delivering outputs and programs; managers are able to assess budgetary impacts in the same period the underlying activity is planned; operational managers are assigned responsibility to focus on, and manage, the organisation s assets and liabilities; it encourages consideration of alternate asset acquisition options (for example, leasing); there is greater consistency between budget and actual reporting; and there is increased awareness of longer term fiscal challenges. The following example illustrates an effective approach for allocating depreciation to operational areas. The degree of devolution of budget elements is likely to depend on the nature, size and distribution of the organisation s assets and liabilities. Embedding internal budget processes into organisational planning and management Example: Allocating depreciation to operational areas Depreciation is a non cash expense which reflects the allocation of the cost of using existing assets over their useful life. The allocation of depreciation provides operational managers with a more complete understanding of the cost of providing services. Being charged with this cost gives managers greater incentive to identify surplus assets and assess useful lives so that the depreciation charge reflects planned asset usage. There is also greater incentive to consider alternate acquisition options, especially in circumstances where assets are unlikely to be fully utilised. Organisations can support and encourage managers to consider the cost of depreciation when making resource decisions by: separating depreciation on assets managed by each operational area from depreciation on assets used (but not managed) by the operational area, such as head office buildings or fit out. For budget collection and reporting purposes, managers are only required to act on managed assets; deriving depreciation from the capital budget so that managers can observe the operational impact of their investment decisions; distinguishing between capital expenditure on asset replacement (that is, the depreciation component) and asset expansion; integrating the depreciation budget with the asset register so that managers can drill down to the underlying assets; and separating depreciation by class and by nature of funding. For example, some Australian Government organisations are responsible for specialised assets or heritage assets which are long lived or irreplaceable and subject to specific maintenance and funding agreements. The depreciation associated with these assets should be shown separately from the depreciation charged on other assets. The above practices assist in providing managers with the full cost of delivering their services but do not require managers to calculate or estimate depreciation. 17
The key challenge associated with the allocation of full accrual budgets is the ability of non financial managers to understand the inter-relationship between the financial statements and the different measures for which they are accountable. The key challenge associated with the allocation of full accrual budgets is the ability of non financial managers to understand the inter-relationship between the financial statements and, as such, the different measures for which they are accountable. To address this challenge, organisations can: automate relationships between the income statement, balance sheet and cash flow statement such that managers do not have to provide the same information in two or more statements. This may include, for example, the automatic derivation of the cash flow statement from the income statement and balance sheet; and separately disclose budgeted gains and losses which are due to factors outside the manager s control (for example, changes in the market value of assets between budget updates). In circumstances where an organisation determines that central management of a budget element (including cash) is appropriate, it is important to undertake a formal risk assessment and identify appropriate compensating controls to help manage each budget element. This is illustrated in the following two examples. Example 1: Each manager is accountable for an employee expense budget, however the employee provision liability budget is maintained centrally. Senior management have established leave balance targets (including maximum leave days and average leave days) and managers are accountable for monitoring and proactively managing staff leave within these targets. Managers receive regular reports showing employee leave balances and are required to explain exceptional balances. Example 2: Each manager is accountable for supplier expenses, however the creditor liability is not allocated to operational areas as payment is centrally managed under pre determined payment terms (for example, 30 days). Under the organisation s control framework, managers are accountable for the monthly reconciliation of creditor suspense accounts and the review of aged creditors and commitments. All exceptional balances must be explained and actioned. The following case study illustrates use of a fully integrated budgeting and reporting system. Case study: Department of the Environment, Water, Heritage and the Arts A fully integrated budgeting and reporting system The Department of the Environment, Water, Heritage and the Arts (DEWHA) has created an integrated budgeting and reporting system that supports budgeting and reporting by organisation, program and output. Key aspects of the department s integrated internal budget process are discussed below. An established budget framework The DEWHA budget process is guided by a framework of financial management policy documents which articulate the department s principles and approaches to budget management and reporting. These documents include budget policies for the recognition Continued on next page 18 Developing and Managing Internal Budgets Better Practice Guide
and allocation of departmental revenue, including priorities for utilising funding sources to meet required payments, and the department s methodology for allocating and reporting corporate overheads. The policy framework was established before the implementation of DEWHA s current budget and reporting system and, as such, provided the overarching functional requirements to be met in the system implementation. Key stakeholders within and external to DEWHA were consulted and their requirements considered in developing the framework. Most importantly there was significant senior executive involvement in, and support for, the framework and system. Defined roles and responsibilities The DEWHA financial management framework is underpinned by a shared commitment to financial management across the department. To ensure a consistent approach to financial management, the department has a documented policy which clarifies roles and responsibilities in budget management and reporting. This policy is translated into operational budget guidelines for each internal budget update. Within the department, budget processes are overseen by the Budget, Finance and Strategy Committee. The Committee s terms of reference, including roles, responsibilities and accountabilities, are clearly documented in a charter approved by the Secretary. Embedding internal budget processes into organisational planning and management A flexible financial budgeting and reporting structure A key requirement for the department s financial reporting system was the ability to budget and report against multiple accountabilities, including organisational unit, program and output. To achieve these objectives, the department established a budgeting and reporting structure built around activity centres. An activity centre represents a particular activity that is sufficiently specific that it can be mapped to an organisational unit, output and program in a one-to-one relationship. Administered Departmental Special Public Moneys Activity Centre Organisational Unit Program Sub-output Continued on next page 19
Continued from previous page Activity centres are then classified as direct or indirect (for example, corporate activities). Direct activity centres must be able to map to one organisational unit, program and sub-output. Indirect activity centres are allocated to direct activity centres based on the department s corporate overhead allocation methodology. Each activity centre has only one accountable manager, but a manager may have multiple activity centres. This approach provided the department with the flexibility to aggregate activity centre budgets according to different reporting hierarchies, for example, by program, output and division. Benefits All budget and financial reports are from the one system ensuring consistency of information. Readily available information for staff and other stakeholders can be produced. Accountability is understood and recognised for all levels of staff. There is ownership and acceptance of the budget and it is fully automated. 2.3. Integrate operational and capital budgets Integration between the capital budget and the operational budget helps ensure an understanding of the long term consequences of budget decisions. Capital investment decisions have long term implications, potentially affecting an organisation s capital structure and influencing its ability to change operations in the future. Capital investment decisions also commit the organisation to a stream of costs that extend beyond the current year (through depreciation and maintenance costs). As such, having close integration between the capital budget and the operational budget helps ensure an understanding of the long term consequences of budget decisions. The management and associated funding of an organisation s capital requirements involves planning processes that span a number of years. Because of the uneven pattern of capital expenditure, it is important that sufficient funds are created internally (for example, by creating depreciation reserves) to finance replacements. A planned cycle of acquisition and replacement will avoid funding difficulties caused by several major investments taking place in a single financial year and large-scale obsolescence of equipment. Capital budget processes provide a long term assessment of an organisation s capital priorities and associated funding requirements. The capital budget identifies all new asset purchases (that is, expenditure on items that are expected to provide benefits for more than one year), all planned disposals and all costs that are to be capitalised, such as enhancements to existing assets or internally developed assets such as software. The capital budget typically includes: an overview of proposed capital expenditure by year across the capital planning period; The timeframe covered by the capital budget is dependent on the nature of the organisation s asset base but should, at least, encompass the expected useful life of current and planned asset purchases. an overview of sources of funding by year (for example, depreciation reserve, reallocated funds and external funding), and accumulated impacts on existing capital reserves such as quarantined depreciation funding; and a summary listing of proposed capital projects by category, including explanatory detail such as timeframes and milestones. The timeframe covered by the capital budget is dependent on the nature of the organisation s asset base but should, at least, encompass the expected useful life of current and planned asset purchases. Figure 5 illustrates the effective integration of the capital budget into organisational planning and management to develop the overall budgeted financial statements. 20 Developing and Managing Internal Budgets Better Practice Guide
Figure 5: Integrated capital planning and budgeting Strategic Plans Business Case Capital Bid Process Asset Register Key priorities Major Investment decisions Replacement requirements Replacement costs Long-term capital priorities Asset Management Plan Capital requirements Operational priorities Off-balance sheet capital decisions Operational Plans Embedding internal budget processes into organisational planning and management Capital Budget Depreciation Capital maintenance Operational Budget As illustrated in Figure 5, key inputs in developing an effective capital budget include: asset management plan: a multi-year asset management plan provides a framework for decisions to acquire, maintain, replace and retire capital assets. The asset management plan translates the organisation s long term priorities and strategic goals (as determined through the strategic planning process) into capital requirements. It is important that the capital budget directly links to, and flows from, the asset management plan to help ensure capital needs are appropriately costed and funded. asset register: the asset register is more than an accounting record of an organisation s existing asset base it also provides key information required for forward planning such as expected useful lives, replacement values and the purpose for which assets are being used. It is important that the capital budget directly links to, and flows from, the asset management plan. Better Practice Tip: Link the capital budget to the asset register Use the asset register to construct a long term rolling projection of asset replenishment requirements based on estimated replacement costs and useful lives of an organisation s current asset holdings. This provides an overview of projected capital expenditure requirements as well as an indication of annualised funding required to service the replacement cycle. operational budget: the operational budget shows the ongoing impact of holding assets through reporting depreciation. An organisation may also utilise off-balance sheet assets in its day-today operations under leasing agreements or other arrangements that would not show up in the balance sheet. As such, integrating the operating budget and capital budget enables managers to more readily assess whole of life costs of purchasing decisions. Furthermore, the operational budget shows consequential costs to the organisation when capital investment decisions are not made, for example through increased repairs and maintenance expenditure. Integrating the operating budget and capital budget enables managers to more readily assess whole of life costs of purchasing decisions. 21
business cases: given the multi-year significance of capital investment decisions, it would generally be appropriate for organisations to adopt different, and more extensive, submission and approval arrangements for capital decisions than those applied to the operational budget. These arrangements often include requirements to prepare separate capital proposals and establish separate committees to consider and approve the capital budget. It is prudent that all new major capital investment proposals are supported by an appropriate business case for senior management consideration. It is also prudent to apply business case discipline to major replacement projects to help ensure replacement is appropriate to current priorities. At a minimum, the business case for capital investment should: justify the need for the capital investment against the organisation s priorities; concisely, clearly and completely specify what is to be delivered, the overall time and cost limits, and what benefits those deliverables will support; identify sources of funding; describe the implementation in sufficient detail to provide confidence the project is achievable, and set a means for assessing and monitoring progress; identify risks associated with the project (including risks associated with not proceeding) and strategies to address these risks; obtain validation of the project specification and implementation plan to help ensure that the proposed approach is an appropriate way to fulfil the organisation s requirements; and help ensure that decisions for the project are clearly stated, properly documented and taken by the appropriate person. The extent and depth of each key input into the development of an effective capital budget is dependent on the value, nature and size of the organisation s asset base. The following case study illustrates the use of formal governance arrangements over major capital investment decisions. 22 Developing and Managing Internal Budgets Better Practice Guide
Case Study: National Library of Australia Governance over capital budgeting An important aspect of any capital asset replacement process is that effective governance arrangements are in place throughout the organisation. The National Library of Australia (the Library) achieves this through various sub-committees of the Corporate Management Group. There is a Collection Management Committee, a Building Works Coordination Committee and an Asset Management Committee. The Library Council is responsible for endorsing overall acquisition programs and ministerial approval is required for any individual acquisitions or disposals in excess of $1 million. Each of the three committees meet at least quarterly throughout the year to develop, amend and monitor progress against annual asset programs. Meetings are also timed to coincide with overall strategy review and budget timetables. Some staff are members of one or more committees, which helps provide an integrated approach across capital and operational budget requirements. Other than the Collections Management Committee, there is a representative from each division on each committee and that person is responsible for presenting divisional proposals and discussing progress against agreed plans. Embedding internal budget processes into organisational planning and management In October or November each year asset bids for the upcoming year are finalised by the various committees and presented to the Corporate Management Group for consideration as part of the Library s strategy and budget processes. Major capital projects are managed through the Library s Balanced Scorecard system. Planning for capital replacement As most long-lived assets require active management beyond the budget and forward years it is important to take a long term view of their ongoing maintenance and replacement. Within the Library, the Building Works program is based on: a 15 year strategic building asset plan which is revised every three years to identify replacement and maintenance requirements of the various components of the building over that period; a strategic building master plan that focuses on library service issues (for example, collection delivery issues, reading room locations, public program requirements and staffing issues); a collection storage plan that aims to optimise collection storage within the Library buildings and identifies when additional external collection storage is required; and a conservation management plan. The Library also has a separate building management system that identifies building asset replacement and maintenance requirements. This system is also used to help manage associated contracts. Any additional whole of life (for example, maintenance) and depreciation expenses are built into budget proposals as required. Some capital funding is held in reserve each year to take account of major purchases required in future years. These quarantined funds are considered as part of budget processes and are held for major categories of assets and the duration of asset management plans. 23
2.4. Align internal and external budgets Organisations within the Australian Government General Government Sector (GGS) are required to prepare external budgets in accordance with the Australian Government s budget reporting standards. 4 The timing of budget updates is determined by the government s annual budget cycle and includes the main Budget, a mid-year update approximately six months after the release of the Budget, and a revised update before the release of the next year s budget. Additional updates may also be required to support whole of government budget processes and an update is required when an election is called. The external budget is prepared by each GGS organisation to support the Government s fiscal strategy and budget position through a detailed analysis of financial and performance information at the portfolio and organisational level. The external budget also provides the basis on which GGS organisations are appropriated. The external budget is tabled in Parliament and reported publicly. It is critical that each organisation s internal planning and budgeting processes deliver an internal budget that is consistent with the organisation s external budget. It is critical that each organisation s internal planning and budgeting processes deliver an internal budget that is consistent with the organisation s external budget. The benefits of such consistency include: the organisation s internal managers are accountable to the Chief Executive (or Board) on the same basis as the Chief Executive (or Board) is accountable to the Minister; the internal budget is aligned to the Government s priorities; information compiled as part of the external budget process (for example, information on trends, risks and opportunities in the external community as well as whole of government impacts) can be used to guide development of the internal budget; and the external budget is supported by a detailed internal analysis which takes into account available resources and the perspective of operational managers. Alignment of internal and external budgets also provides greater consistency in budget reporting between Australian Government organisations, as the external budget is prepared on a consistent basis across Government. As a consequence, organisations are better able to benchmark budget processes and results against similar Australian Government organisations to identify potential improvements and efficiencies. The use of a coordinated plan and timetable that is consistent with the Australian Government s budget cycle assists organisations to integrate internal and external planning and budgeting processes. The use of a coordinated plan and timetable that is consistent with the Australian Government s budget cycle assists organisations to integrate internal and external planning and budgeting processes. Although it is not always possible due to the timing of government decisions and other changes in the external budget, it is preferable to complete the internal budget as near as possible before the release of the external budget. Part 3.1.2: Establish budget timetables and milestones provides further discussion. In addition to a coordinated plan, it is important that there is consistency in recognition, measurement and disclosure of the internal and external budget, including consistency in accounting policies and the definition of the consolidated budget entity. As illustrated in Figure 6, having consistent internal and external account structures and reporting formats can help avoid the need to remap or recalculate results when moving between the internal and external budget. Part 4.2: Revising the internal budget provides further relevant discussion on maintaining consistency between the internal and external budgets throughout the budget cycle. 4 The legislative framework underpinning the external budgeting process is contained in the Australian Constitution; the Charter of Budget Honesty Act 1998; the annual appropriation Acts, the Financial Management and Accountability Act 1997; and the Commonwealth Authorities and Companies Act 1997. 24 Developing and Managing Internal Budgets Better Practice Guide
Figure 6: Integrating the internal and external budget account structure External Reporting Standards Budgets are reported at a level of detail that is consistent with generally accepted accounting principles as reflected in the Australian Equivalent to International Financial Reporting Standards. Central Agency Budgeting Requirements Organisational Budgeting Requirements Operational Budgeting Requirements Internal and external budgets are reported at a level of detail required by central agencies. Internal budgets are consolidated and reported at a level of detail sufficient to meet senior management planning and reporting requirements. Internal budgets are prepared and reported at a level of detail sufficient to meet operational requirements. Embedding internal budget processes into organisational planning and management 2.5. Harmonise budgeting and reporting Consistency between budgeting and reporting is critical to enable senior management to scrutinise the internal budget fully and accurately. Where consistent policies and formats are adopted for reporting budget estimates and actual results, the organisation has greater certainty in decisionmaking that actual-to-budget variances are due to operational factors rather than accounting treatments. The link between budgeting and reporting is enhanced when organisations prepare a single budget and reporting plan which: sequences budget and actuals reporting activities in a logical fashion; Where consistent policies and formats are adopted for reporting budget estimates and actual results, the organisation has greater certainty in decision making. identifies key deadlines relevant to each process; identifies dependencies and relationships between budgeting and reporting activities; and allocates resources and responsibilities within the finance area and across the organisation to provide for peak periods when budgeting and ex post reporting periods overlap. In addition to an integrated budgeting and reporting cycle, it is important that organisations present budget and actuals reports on the same basis. This includes: harmonising the revenue and expenditure recognition, measurement and disclosure policies for the internal budget with generally accepted accounting principles as reflected in the organisation s audited financial statements; adopting consistent reporting hierarchies for both ex ante (budget) and ex post (actuals) reporting; It is important that organisations present budget and actuals reports on the same basis. applying a standardised chart of accounts and reporting formats for both ex ante and ex post reporting; and using tools and reporting templates which are able to report budget, forecast and actuals data in a single document or file. 5 Where possible, it is desirable to avoid changing reporting structures across financial years and budget cycles so that historical information does not lose its relevance for current budgetary analysis and decision-making. Where changes are required (for example, due to new accounting policies or 5 Part 4.1: Monitor and report against internal budgets provides further discussion on reporting of actual results against budget. 25
structural changes), an effective practice is to provide managers and other key stakeholders with a map showing changes made between the current reporting structures and those that existed at the last update. When functions are transferred between Australian Government organisations as a result of machinery of government changes, accountability and decision-making are enhanced if organisations also map historical information. In this regard, the good practice guide Implementing Machinery of Government Changes 6 makes a number of recommendations to assist organisations implement machinery of government changes, including developing information and communications and records management strategies. It is desirable that these strategies also consider historical budgetary and actual information. 2.6. Engage stakeholders in internal budget processes It is essential that senior and operational management are involved in, and take responsibility for, the budget process. Budgeting is not the preserve of the finance area. Finance officers have a leading role to play in formulating and coordinating the budget process, but it is essential that senior and operational management are involved in, and take responsibility for, the budget process. Key elements to effectively engage stakeholders in the internal budget are: obtaining organisational support for the internal budget; supporting operational managers in internal budget processes; and managing relationships with other Australian Government organisations for whole of government initiatives. 2.6.1. Obtain organisational support for the internal budget Planning and coordinating internal budget processes involves input from across the organisation. In addition to the finance area, this would typically include the participation of senior management and line management but sometimes also representation from other corporate areas and internal audit. For example, the human resources area would generally be a key advisor on workforce planning matters. The Chief Executive (or Board) is ultimately responsible for the efficient and effective management of financial affairs within their organisation. It is critical that the Chief Financial Officer is in a position to provide advice directly to the Chief Executive on the development and management of the organisation s internal budget. 2.6.2. Supporting operational managers in internal budget processes Operational managers are responsible for managing programs and delivering outputs. These managers may not have expertise in financial management, however, it is important that they have sufficient skills and awareness to manage the financial resources under their control. 7 Collectively, operational managers are in the best position to understand day-to-day activities, risks and opportunities that drive the organisation. It is essential to involve operational managers throughout budget processes. Mechanisms to support operational managers develop and manage internal budgets include: Clearly communicating roles and responsibilities: it is important that the organisation s communication strategy helps ensure each operational manager with budget responsibility is informed about their role in budget processes, including timelines for delivery, sign-off 6 Australian Public Service Commission (2007), Implementing Machinery of Government Changes: A good practice guide, viewed 18 February 2008, http://www.apsc.gov.au/publications07/machineryofgovernment.htm. 7 National Audit Office (2008), Managing financial resources to deliver better public services, Report by the Comptroller and Auditor-General, February 2008, p. 14. 26 Developing and Managing Internal Budgets Better Practice Guide
responsibilities and escalation arrangements. It is also important that managers understand and agree to their role in budget processes, for example, through including budget responsibilities in their performance agreement. Educating non financial managers about the budget framework: operational managers with budget responsibility require an understanding of how budget data is generated and reported, as well as how it is used in decision-making. Organisations can support operational managers prepare and manage budgets through a combination of targeted training and guidance provided in non accounting language. Better Practice Tip: Australian Government Budget and Financial Essentials training The Budget and Financial Essentials training program is an Australian Government initiative established by the Department of Finance and Deregulation and conducted in partnership with accredited training providers. It provides introductory training on budget processes and the financial framework for government officials. The training program provides a practical overview of: the Australian Government s financial framework and its practical implications for the day-to-day operations of the Australian Government; It is important that managers understand and agree to their role in budget processes. Embedding internal budget processes into organisational planning and management key elements and timeframes of the Australian Government s budget process; different types of appropriations and how they operate, legislation and conventions that affect them, and associated key technical and process issues; external reporting standards used in Australian Government financial reporting, including the Government Finance Statistics and Australian Accounting Standards; the impact of transactions on key budget balances and how these balances are derived; and Australian Government s charging policies, including cost recovery and competitive neutrality. 8 Enabling managers to input budgets in operational terms: operational managers should not require accounting or costing expertise to prepare an internal budget. An effective practice is to allow operational managers to input budget data on the basis of operational drivers (for example, full-time equivalent employee numbers, beneficiary numbers for transfer payments or stage of completion for capital programs), with the accounting value and classification based on pre determined rules and standard costs. This approach is commonly adopted in the estimation of employee budgets where operational managers are only required to estimate full-time equivalents by staffing classification. The employee budget is then calculated through the application of standard salary costs and pre determined percentages for superannuation on-costs, leave and related entitlements. Providing access to systems and tools: user-friendly systems and tools allow managers to easily submit and retrieve data, and drill-down and analyse drivers and model scenarios to assist in developing internal budgets. Refer to Part 3.2.3: Automate internal budget processes for further information. It is important that staff requiring access to internal budget systems receive training in an organisation s budget policies and procedures and the operation of budget systems, including security principles. In this regard, training will be more effective when it is provided before staff receive access to budget systems and also after any significant changes to budget functionality. It is important that staff requiring access to internal budget systems receive training. 8 Department of Finance and Deregulation website, available from http://www.finance.gov.au/budgetgroup/ Commonwealth_Budget_Overview/budget_and_financial_training.html [accessed 13 February 2008]. 27
Sharing knowledge and ideas on budget practices: in addition to systematic training and guidance, it is important that organisations provide opportunities for managers to interact and share knowledge on a regular basis. Examples of how this may be accomplished include: the establishment of a budget network where finance and operational managers participate in regular forums and information sessions to discuss issues and share ideas for better practice internal budget processes; maintaining an intranet budget site or email forum where managers can access guidance and advice, post queries and share experiences regarding internal budget issues; and hold lessons learned sessions after the completion of the internal budget to identify strengths, weaknesses, and opportunities to improve budget processes. 2.6.3. Internal budget processes for whole of government initiatives Many government initiatives have a whole of government dimension. These initiatives are established and funded in a number of ways, for example, through shared outcomes, special accounts or purchaser provider arrangements. While these considerations are outside the scope of the guide, 9 it is important that each participating organisation structure its internal budget to support strategic objectives and accountability requirements for the initiative as a whole. This requires organisations to work together to develop internal budget and reporting arrangements that meet accountability obligations of each individual organisation and contribute to the collective achievement of, and accountability for, the whole of government outcome. A coordinated approach to internal budgeting requires a shared understanding of different budget roles and responsibilities. An important component of this understanding is clear agreement about where overall responsibility for budget development and monitoring lies, as well as individual responsibilities for different components of the initiative. Arguably, the most critical element in budgeting for a whole of government initiative is senior management commitment to achieving the whole of government outcome, including a collaborative and transparent approach to budget development and monitoring. One approach to whole of government initiatives is to establish a lead organisation. In these instances, there is often merit in formalising such arrangements through memorandums of understanding, agreements or committees. Another approach is to establish a steering committee with responsibility for business issues associated with the initiative, including budget strategies and oversight. Ideally, the steering committee would have senior officer representation from each participating organisation. It is essential to have sufficient transparency of those components of each organisation s internal budget which have been allocated to whole of government initiatives. There is also an expectation that organisations allocate, and if necessary reallocate, resources across organisational boundaries to achieve whole of government outcomes. This requires flexibility and consistency in internal budget processes between participating organisations. Where practicable, compatibility between budget policies, assumptions and data will help align budgets between the participating organisations. In this regard, it is essential to have sufficient transparency of those components of each organisation s internal budget which have been allocated to whole of government initiatives. To achieve a sufficient level of transparency, it is desirable, in certain cases, to establish separate internal budget allocations for whole of government initiatives. Implementing a whole of government program may represent a significant change to the way an organisation operates and is structured. As such, a zero based approach to budget development is often highly desirable to ensure the internal budget is aligned to the Government s objectives in adopting a whole of government approach. Part 3.2: Effective budget construction further discusses zero based budgeting. 9 The Better Practice Guide Implementation of Programme and Policy Initiatives Making Implementation Matter, issued jointly by the Australian National Audit Office and the Department of the Prime Minister and Cabinet in October 2006 discusses whole of government considerations in establishing government programs. 28 Developing and Managing Internal Budgets Better Practice Guide
Part 3 Developing and implementing a comprehensive internal budget Contents 3. Developing and implementing a comprehensive internal budget 30 3.1. Effective planning and coordination 30 3.1.1. Set budget policies 31 3.1.2. Establish budget timetables and milestones 32 3.1.3. Allocate responsibility for budget development 34 3.1.4. Document budget processes and disseminate guidelines 34 3.2. Effective budget construction 35 3.2.1. Budget top-down, bottom-up or both 35 3.2.2. Determining the budget approach 36 3.2.3. Automate internal budget processes 39 3.3. Effective oversight, review and communication 41 Developing and implementing a comprehensive internal budget 29
Developing and implementing a 3. comprehensive internal budget Developing and implementing an internal budget is a major exercise for most organisations. It generally involves a significant amount of an organisation s management and staff time and typically spans many months. As such, the process requires effective: planning and coordination, including clearly defined expectations and assumptions, a coordinated calendar of activity and well-documented and communicated policies and procedures; budget construction through implementing established and agreed budget methodologies and automating budget processes; and oversight, review and communication through active senior management involvement, rigorous quality assurance processes and structured communication. 3.1. Effective planning and coordination Overall responsibility for planning and day-to-day coordination of internal budget processes usually resides in the finance area, principally with the Chief Financial Officer. Ideally, in larger organisations, or organisations with decentralised operations, the Chief Financial Officer is supported in this role by a designated budget unit and a team of budget coordinators located throughout the organisation s operational areas. 10 The responsible area s budget coordination duties typically include: developing budget timetables and identifying responsibilities for budget preparation; designing calculation worksheets and submission templates; developing the key planning assumptions to be applied across the organisation; issuing guidelines and instructions on budget preparation; advising and assisting line areas to develop budgets; undertaking quality assurance checking of estimates and requests submitted by line areas; providing technical advice and guidance to senior management and budget committees, including advice on the robustness of budget bids and opportunities for savings; monitoring progress on budget development throughout the organisation and updating senior management; preparing estimates that are not captured at group level; consolidating group budgets into the organisation-level budget; preparing budget documentation; and reviewing budget processes. Many other managers and staff participate in internal budget processes. To contribute effectively to these processes, it is important that these staff have access to sufficient guidance and support to understand their budgeting roles, including when key budget activities and decisions will occur. This will provide them with an opportunity to plan and participate in the process and help ensure the process is applied consistently. The elements of effective planning and coordination include: setting budget policies; establishing budget timetables and milestones; 10 It would generally not be cost-effective for small organisations, or organisations with largely centralised operations, to have both a designated budget unit and a team of budget coordinators. 30 Developing and Managing Internal Budgets Better Practice Guide
allocating responsibility for budget preparation and review; and documenting budget processes and communicating guidelines. 3.1.1. Set budget policies Effectively integrating planning and budgeting requires the principles, parameters and assumptions underpinning the development of the internal budget to be consistent with the organisation s strategic and operational plans. A documented budget policy is a useful mechanism for senior management to articulate budget priorities and constraints and communicate the organisation s framework for budget development and decision-making. The authority and legitimacy of budget policies are enhanced when they are approved by the Chief Executive or budget committee. Better practice budget policies would generally include the elements listed in Table 3. A documented budget policy is a useful mechanism for senior management to articulate budget priorities and constraints. Table 3: Key elements in an organisation s internal budget policy Internal budget policy would ideally consider the following elements: the organisation s functions, programs, outputs and outcomes and how these relate to organisational and budget structures; the organisation s current and longer term fiscal strategy (including, for example, senior management s position on balancing the budget and drawing on accumulated reserves or surpluses); broad strategic priorities on which the internal budget is based; the organisation s budget objectives and targets for the budget year and forward estimate period with sufficient detail to guide operational areas, individually and across outputs and programs; planned sources of income and how these are to be allocated (including receipts from independent sources); key measures against which budget allocations and submissions will be assessed; key internal and external planning assumptions to be applied across the organisation (for example, salary rates, indexation factors, and productivity gains); Developing and implementing a comprehensive internal budget the reporting basis on which the budget will be prepared; expected impacts and treatments of one-off or temporary conditions in the organisation or in the external market; circumstances under which a departure from the above principles, parameters and assumptions is permitted; and governance arrangements to be followed in developing and approving the internal budget. It is important that these policies provide sufficient information for line areas to develop business plans and budgets that align with the organisation s strategic directions and priorities. Communication of these policies throughout the organisations is discussed in Part 3.1.4: Document budget processes and disseminate guidelines. Collaborative target setting approaches involve line management in establishing organisational objectives, priorities and strategy. This can be accomplished in a number of ways, including representation on a budget committee, establishing a separate advisory committee or through round-table discussions. Interaction with external stakeholders (including ministers and central agencies) is also important to identify their needs, priorities and insights for incorporation into budget planning. 31
It is prudent to prepare longer term internal budget estimates consistent with the organisation s strategic planning process. A critical consideration in budget preparation is the budget horizon, that is, the time period over which the organisation will set its budget. Traditionally, organisations have limited the internal budget to a single year as funding and activity can be estimated with greater reliability. However, it is prudent to also prepare longer term internal budget estimates consistent with the organisation s strategic planning process (three to five years). This will enable an assessment of longer term financial implications of current and proposed policies, services and assumptions. 11 To support integration with external budgets, it is also useful to align the internal budget horizon with the external budget horizon (which includes at least three forward years in addition to the budget year). Capital budgets generally require a longer budget horizon to show the multi-year impact of current and proposed capital investment (depending on the nature and useful lives of the organisation s asset base). 3.1.2. Establish budget timetables and milestones To help ensure deadlines are met and resourcing conflicts are managed, many organisations develop a comprehensive and integrated planning calendar. For many organisations, developing the internal budget takes a number of months. 12 To help ensure deadlines are met and resourcing conflicts are managed, many organisations develop a comprehensive and integrated planning calendar. Ideally, these calendars: identify specific information required for internal budget processes; describe deliverables in detail; incorporate key checkpoints; factor in other relevant deadlines, in particular those relating to the external budget and reporting; and highlight relevant internal and external budget milestones. The following case study illustrates an integrated internal budget development process. 11 It is often more cost-effective for organisations to prepare longer term internal budget estimates at the higher levels as there is less certainty about the accuracy of estimates further into the future, and therefore less benefit in preparing detailed budgets for all operational units. 12 KPMG (2004), 2004 Budgeting and Forecasting Survey Report Process Tweak or Process Overhaul?, reported findings from an international survey of budgeting and forecasting practices in the private and public sectors, that the average cycle time for developing a budget was around 2.6 months, with 84 per cent of respondents requiring more than two months and almost one-third requiring more than three months. 32 Developing and Managing Internal Budgets Better Practice Guide
Case Study: Australian Taxation Office Developing the Internal budget The internal budget development process in the Australian Taxation Office is incorporated into the Tax Office s annual corporate planning timetable. The corporate planning cycle begins in October each year and is primarily risk driven. The process commences with a range of corporate forums that assess the internal and external environments in which the Tax Office operates. Issues arising from those sources are then considered in developing a set of risk and priority statements and, in turn, the corporate plan. Concurrently, the internal budget planning process is undertaken over a period of about nine months beginning with input from Federal budget processes commencing with the annual Senior Minister s review. The corporate planning timetable requires that initial internal budget allocations are released in early December each year for discussion at a key internal governance forum. The Tax Office manages internal budget allocations through a long term finance model that enables the organisation to model both current and future year internal budgets. The model also provides the basis on which scenario planning can be undertaken so as to provide the Executive with a range of resource allocation options. Internal budget planning continues as an iterative process, with the corporate planning timetable providing several other key points during the year at which indicative internal budget allocations for the following year are updated for discussion and review. This means that after the release of initial budget allocations in December, budget allocations are updated as revised resource information is available from decisions made as part of the corporate planning process and the Federal budget. Early development of indicative budget allocations provides the Executive with the opportunity to consider budget allocations well before the commencement of the financial year and consider overall resource allocation to address identified risks and priorities. Developing and implementing a comprehensive internal budget Final internal budget allocations are developed after the Federal budget each year and after the Executive have also considered budget pressure submissions. Budget pressure submissions allow the Executive to consider the impact of priorities on each sub-plans resources and provide the opportunity to adjust internal budget allocations. 33
3.1.3. Allocate responsibility for budget development It is important to clearly assign and communicate responsibilities for budget planning, coordination and development at the beginning of each internal budget process. Internal budget processes involve many areas and individuals within an organisation. As a result, it is important to clearly assign and communicate responsibilities for budget planning, coordination and development at the beginning of each internal budget process. Better Practice Tip: Budget liaison and advisory officers Allocate budget liaison and advisory responsibilities across the budget team with each budget officer (or selected officers) responsible for one or more operational divisions. This provides each division with a single point of contact for budget queries and provides budget officers with the opportunity to obtain a detailed understanding of operational activities. In larger organisations, out-post budget officers to line areas at different stages in the budget process. In smaller organisations, coordinate budget liaison through a nominated budget officer who acts as a point of contact for all budget related queries, ensuring each query is allocated to the appropriate officer and logging progress to ensure feedback is provided in a timely and consistent manner. Given the intensive workload typically associated with preparing internal budgets, it is important that organisations establish arrangements to cater for contingencies such as the unavailability of key personnel during the budget process. This is particularly important in small organisations, which are heavily dependent upon the knowledge and skills of a small number of individuals. To minimise this risk, it is prudent to provide more than one staff member with exposure to each budget responsibility, and include budget responsibilities in succession planning. 3.1.4. Document budget processes and disseminate guidelines Clear and direct communication is essential at the beginning of the budget process and throughout the budget cycle. From preparation through review, it is critical that key budget assumptions are shared and applied consistently. To help ensure a consistent and timely approach to budget development, it is important that budget guidelines are communicated to participating managers and stakeholders at the commencement of each internal budget process. Better practice guidelines and instructions set out: budget policies (see Part 3.1.1: Set budget policies); roles and responsibilities; timeframes and deadlines; and processes and protocols underpinning the budget development process. Guidelines are ideally communicated in written format as well as any other medium which will assist in the efficient and effective dissemination of information (for example, through information sessions). Instructions often include sample forms and checklists to be completed by line areas. It is important that budget guidelines are sufficiently detailed to address an organisation s financial and operating conditions for the given budget period. It is also important that organisations document processes, data sources, calculations, and roles and responsibilities underpinning internal budget processes to provide clarity of roles, responsibilities and tasks at each stage of the process. This may be accomplished through documentation techniques such as process mapping and responsibility maps. 34 Developing and Managing Internal Budgets Better Practice Guide
Documenting budget processes and responsibilities also helps to: identify resourcing gaps, including where budgeting and reporting activities overlap; assign a clear accountable owner for each step in the internal budget process; identify potential bottlenecks in the process; and inform each stakeholder in the budget process of the nature of their responsibilities. In particular, this helps ensure line areas understand their responsibilities in meeting the timetable for preparation and review. Appendix A provides an illustrative template for developing budget guidelines, including budget policies. 3.2. Effective budget construction An organisation s approach to constructing an internal budget is influenced by many factors, such as the predictability of its operations, extent of change required and the time and resources available to complete the process. Key considerations in constructing internal budgets include the extent to which: the budget is driven through top-down direction or built from bottom-up participation; the budget is derived incrementally from previous budgets; each aspect of the budget must be justified anew; or the budget is constructed through a focus on the cost of inputs or a focus on the delivery of outputs; and budget processes are automated. 3.2.1. Budget top-down, bottom-up or both The internal budget may be constructed top-down where the strategic planning process drives development of the budget or bottom-up, where the budget rolls up from operating units and staff preparing it. In practice, most organisations adopt a hybrid of the top-down and bottom-up approaches where senior management set broad goals and constraints and operational managers are involved in the allocation of resources within these goals and constraints. Most organisations adopt a hybrid of the top-down and bottom-up approaches. Developing and implementing a comprehensive internal budget The relative advantages and disadvantages of each approach are illustrated in Figure 7. Figure 7: Comparison of budget setting approaches Time and cost to develop budget Low High Risk of under or over allocation of budget Low High Risk of inconsistent priorities Low High Risk of unrealistic budget estimates Low High Potential for lack of ownership Low High Key: = Top-down = Bottom-up = Hybrid 35
The hybrid approach is generally preferred as: there is greater commitment to, and ownership of, the budget setting process as all levels of management contribute to the process; it encourages a broad, organisation-wide perspective consistent with government priorities as senior management set the strategic targets and constraints which then cascade down through the organisation; it leads to a greater understanding of how the actions and demands of individual areas impact the organisation as a whole; and the detailed budget is constructed by those that are responsible for delivering the services. However, an ineffective hybrid approach can result in significant amounts of time and effort being spent in negotiation and iteration, with senior management ultimately having to impose budget cuts to satisfy organisational constraints. Approaches to mitigating this risk include: involving line management in the target setting process; providing opportunity for operational areas to submit proposals for funding priorities early. These proposals are reviewed and vetted prior to resource allocation; ensuring organisational goals, constraints and planning assumptions are clear and communicated at the beginning of the budget process and throughout the budget cycle; incorporating longer term goals and constraints to guide managers in allocating resources; and integrating budget priorities and allocations into the strategic and operational planning cycle. There are circumstances where a largely bottom-up budgeting approach might be appropriate to an organisation. In particular: when an organisation has undergone substantial change (for example, after machinery of government changes or where there has been a redirection of government priorities) and a bottom-up approach is useful in setting the budget baseline; when an organisation s operations change significantly year to year, for example, project based organisations; or as a periodic zero based retesting of budget assumptions and resource allocations, for example, on a triennial basis. A primarily top-down budgeting approach is the most appropriate approach in some circumstances, for example, where a organisation has to identify substantial budget savings in a short space of time or in circumstances where additional budget discipline is needed. 3.2.2. Determining the budget approach Most organisations prepare budgets using one or a combination of the following methods: incremental budgeting (otherwise referred to as traditional budgeting); zero based budgeting; activity based budgeting; or performance based budgeting (including program based budgeting and output based budgeting). Table 4 describes the key characteristics of each method, and their main advantages and disadvantages. 36 Developing and Managing Internal Budgets Better Practice Guide
Table 4: Budget development methodologies Method Incremental or traditional budgeting Characteristics Description: The previous year s budget or actual results provide a base line for the current year, adjusted for the removal or addition of one-off budget impacts, the addition of new measures, the removal of lapsed programs and otherwise updated for indexed changes, such as inflation adjustments and productivity gains. Advantages: close linkage to the way external budgets are adjusted; relatively simple and easy to understand; and provides managers with a stable and consistent approach to budgeting. Disadvantages: assumes activities are largely unchanged from last year; promotes spending to meet the budget rather than focusing on identifying savings and efficiencies; and not readily adaptable to changed organisational priorities. Zero based budgeting Description: Requires preparation of the next year s budget as if it was a new, rather than continuing, budget. That is, every aspect of the budget must be justified. This method endeavours to redirect efforts and funds from lower priority current programs to higher priority new programs, improve efficiency and effectiveness and therefore reduce spending. Advantages: greater alignment of resource allocation to output and program delivery; Disadvantages: increased complexity, requiring greater time and cost to deliver budget; and Developing and implementing a comprehensive internal budget more adaptive to changing priorities and circumstances; active involvement of operational managers; and increased workload may not be justifiable where an organisation s activities experience little fluctuation. focuses on value for money as each budgeted amount must be justified. 37
Method Activity based budgeting Characteristics Description: Concentrates on factors that drive costs and justifies expenditure on the basis of activities performed in relation to pre determined drivers. Places responsibility on the manager with responsibility for the driver. Advantages: enables managers to input and measure budgets in operational terms; provides opportunities to examine work practices and eliminate non value-adding activities; and Disadvantages: greater complexity as it requires managers to understand what activities drive their budget and estimate activity volume. close linkage to operational planning. Performance based budgeting Description: The various performance based budgeting approaches begin with an assessment of what the organisation is trying to achieve. The activities required to achieve each output are identified and costed (generally using activity based budgeting). Advantages: links resources (inputs) to the organisation s deliverables (outputs); strongly integrates the budget and strategic and operational plans; greater alignment to source of appropriation funding; and close linkage to external performance measures in Portfolio Budget Statements. Disadvantages: greater complexity in aligning organisational and output responsibilities and in allocating corporate costs; budgets are ineffective if performance measures are not clearly articulated up-front; greater time and effort involved in collecting output and program indicators; and allocation of internal costs (for example corporate overheads) can be arbitrary unless the organisation has effective allocation approaches. Conceptually, a budgeting approach with elements of zero based budgeting and performance based budgeting would generally be considered better practice. Conceptually, a budgeting approach with elements of zero based budgeting and performance based budgeting would generally be considered better practice as the budget links to the organisation s goals, priorities and outputs and has been fully justified. However, given the complexity, time and cost associated with these methods, they are not practicable for all organisations. This is particularly the case for organisations that exhibit little change year-to-year where the cost is unlikely to be justified. 38 Developing and Managing Internal Budgets Better Practice Guide
Some techniques organisations use to incorporate zero based and performance based concepts into their budgeting practices include: limiting the use of zero based budgeting to a select number of discretionary cost items (for example, suppliers) or to a select number of programs; applying full zero based budgeting on a periodic basis (for example, triennially) rather than every year; and applying performance based budgeting using a limited number of cost drivers as intuitive proxies that is, key drivers (such as headcount) which are likely to explain the majority of activity and provide a reasonable approximate of other activity in the absence of more specific drivers. 3.2.3. Automate internal budget processes Systems and tools used by organisations to construct the internal budget can have a significant impact on the timeliness and quality of the internal budget. Larger organisations with a mature budget function often use integrated software tools to manage internal budget processes. This may comprise a budget-capable Financial Management Information System, or specialised budgeting and reporting tools. Sophisticated tools facilitate the development of the internal budget and provide timely financial and management information throughout the organisation. Nonetheless, the use of spreadsheets for all or some internal budget processes remains common. 13 The advantage of spreadsheets is that they are available across the organisation, and are well understood and adaptable. Spreadsheets also leverage off existing technology that exists within an organisation and, as such, may represent a cost-effective option, especially for smaller organisations. However, as a budgeting tool, the spreadsheet has a number of limitations around data integrity, integration, change control, multi-user access and size restrictions. Further, the use of spreadsheets can have a significant hidden cost through time spent on activities such as maintaining and updating models and the manual consolidation of budget submissions. To facilitate the production of timely and consistent budgets, organisations limit the amount of manual intervention. As detailed in Table 5, it is important that an organisation s budgeting systems include adequate environment and application based controls to help ensure they remain available as required, operate as intended, are understood by users, and are not changed without proper authorisation, documentation and testing. As a budgeting tool, the spreadsheet has a number of limitations around data integrity, integration, change control, multi-user access and size restrictions. To facilitate the production of timely and consistent budgets, organisations limit the amount of manual intervention. Developing and implementing a comprehensive internal budget 13 ibid., p.19. The report highlighted that in excess of 85 per cent of survey respondents used spreadsheets for some or all internal budgeting processes. 39
Table 5: Better practice functionality and control for budget systems and tools BUDGET SYSTEM ENVIRONMENT Budget systems are incorporated into an organisation s information technology planning, and are subject to appropriate governance and review. Access to budget systems and tools is appropriately restricted. Changes to budget systems and tools, including assumptions and calculations, are governed centrally. Budget programs, data and documentation are backed up on a regular basis. Comprehensive and up-to-date documentation is maintained for the administration and use of budget systems and tools. Adequate segregation of duties exists between budget input and budget approval. Budget systems and processes are included in disaster recovery and business continuity arrangements. Workflow technology is used to manage the budget setting process. BUDGET INPUT BUDGET PROCESS BUDGET OUTPUT Data collection is standardised across the organisation. Direct entry of budgets by operational areas. Built-in data integrity and reasonableness checks. Automated interfaces between source systems and budgeting system(s) which are reconciled. Automatic consolidation capability. Tracking of budget adjustments by account, area, program, funding source and reason. Standardised reporting across the organisation. Ad-hoc reporting and drill down capability. Budgets are integrated with forecast and actual data, including the ability to report in a single document or file. Ability to create multiple iterations and scenarios in budget development. It is essential that internal budget system and tools are re evaluated on a periodic basis. It is essential that internal budget system and tools are re-evaluated on a periodic basis (for example, every three years) so that they remain appropriate to the efficient and effective development of the internal budget. 40 Developing and Managing Internal Budgets Better Practice Guide
3.3. Effective oversight, review and communication Involvement and commitment of senior management is critical to developing an effective internal budget. One approach to involving senior management is through the establishment of a budget committee (often the same as, or a subcommittee of, the executive committee) to oversight the internal budget process. The functions of a budget committee include: developing budget strategies and priorities; approving timetables and allocation of responsibilities; approving budget guidelines; oversighting budget preparation; providing policy advice and strategic analysis to the Chief Executive; evaluating budget bids, including alignment with the organisation s priorities; recommending final approved budgets; and conducting ongoing assessments of budget processes. Involvement and commitment of senior management is critical to developing an effective internal budget. As mentioned in Part 3.1: Effective planning and coordination, primary responsibility for coordinating the budget process typically resides with the Chief Financial Officer (CFO). It is essential that the CFO has sufficient authority to ensure that budget guidelines and policies are being complied with throughout the organisation. This includes a requirement that the CFO is consulted by operational areas on significant budgeting issues within the organisation, particularly new budget initiatives. It is important that organisational and area budgets are subjected to quality assurance review before being submitted to senior management. This enables senior management to focus on priorities and trade-offs rather than data quality. Quality assurance is generally performed by the finance area, but may also involve internal audit or specialist assistance, especially for new or complex budget initiatives. The use of checklists can assist in the timely and consistent quality assurance of submitted estimates. Checklists are likely to be more effective when they incorporate a range of data integrity and reasonableness checks and also analytical review procedures (including both trend analysis and ratio analysis 14 ). It is important that organisational and area budgets are subjected to quality assurance review before being submitted to senior management. Developing and implementing a comprehensive internal budget Involvement of line areas in budget construction does not end when they have submitted their budget. Invariably, changes are required at the organisational level once budgets are consolidated to accommodate resource constraints or evolving priorities. When this occurs, it is important that managers have been consulted and understand why changes have been made. Collaboration and trust between areas involved in the budget setting process is critical and provides less incentive for managers to inflate budgets. Making internal budgets available as soon as practicable after approval, enables managers to take timely action to achieve budget targets. Recording approved budgets in an organisation s Financial Management Information System supports the timely communication of internal budgets. To effectively communicate the internal budget, organisations can prepare a summary of the budget and make it available to all relevant stakeholders. Ideally, the summary would include an overview of key financial goals, initiatives and financial results by budget allocation, using charts and graphs to better illustrate important points. Appendix B provides an example of an illustrative budget summary. Collaboration and trust between areas involved in the budget setting process is critical and provides less incentive for managers to inflate budgets. 14 Trend analysis refers to the comparative analysis of an organisation s financial information over time to identify patterns. Ratio analysis refers to the calculation and comparison of different sets of financial information to identify relationships between different activities. 41
42 Developing and Managing Internal Budgets Better Practice Guide
Part 4 Monitoring and evaluating budgeting performance Contents 4. Monitoring and evaluating budgeting performance 44 4.1. Monitor and report against internal budgets 44 4.1.1. Report budget performance 44 4.1.2. Assist managers assess budget performance 45 4.1.3. Phase the budget to provide meaningful comparisons 45 4.1.4. Analyse and explain budget variances 47 4.2. Revising the internal budget 50 4.2.1. Frequency of budget updates 50 4.2.2. Revising internal budget allocations 50 4.2.3. Understanding and tracking changes in internal budgets 51 4.3. Forecasting to manage gaps between budget estimates and actual results 52 4.4. Review and improve internal budget processes 54 4.4.1. Measure internal budget accuracy and timeliness 55 4.4.2. Identify opportunities for improvement 56 Monitoring and evaluating budgeting performance 43
Monitoring and evaluating 4. budgeting performance Organisations monitor and evaluate actual results against approved budgets to guide current and future decision-making and hold managers accountable for performance. Key processes to effectively manage approved budgets include: monitoring and reporting against internal budgets on a consistent and regular basis to assess whether targets are being met, to guide decision-making and enforce accountabilities; revising the internal budget through a controlled and coordinated process that maintains clear lines of accountability between budget estimates and actual results; forecasting to manage gaps between budget estimates and actual results to quickly identify and respond to changes in the external environment or internal activities; and reviewing and improving internal budget processes by monitoring the accuracy and timeliness of budget setting processes to identify areas for improvement. 4.1. Monitor and report against internal budgets Monitoring budget accuracy is the responsibility of all managers. To measure budget performance, organisations monitor the extent to which budget estimates match actual results. This helps ensure financial control and identify where change is required. Monitoring budget accuracy is the responsibility of all managers. Effective monitoring of budget performance requires that managers are provided with relevant, timely and accurate information appropriate to their level of responsibility. It also requires managers to provide clear and consistent feedback in a timely manner about underlying causes and effects of budget variations, as well as planned actions to manage variations for which they are accountable. 4.1.1. Report budget performance Internal reporting processes follow the monthly financial close and typically involve the finance area preparing or releasing details of actual results against budget to line management for evaluation and explanation. Results of this process are summarised and provided to senior management to assist decision-making at the organisation level, and to the Department of Finance and Deregulation to enable whole of government reporting. It is important that results of senior management s review and analysis of budget performance are communicated to relevant operational managers. Reviewing actual results against budget estimates on a regular basis is critical to effective monitoring and reporting of budget performance. Reviewing actual results against budget estimates on a regular basis monthly for most organisations using a process that is understood across the organisation is critical to effective monitoring and reporting of budget performance. Careful design of financial reports is fundamental to effective review and analysis of budget versus actual information. For example, financial reports should be easily understood, user-friendly and relevant. 15 The effectiveness of internal financial reporting is likely to be enhanced when reports are prepared for each level of budget-accountability and summarised appropriately for each level of management. When output and organisational accountabilities differ (for example, where a manager has both branch and output responsibilities), budget-to-actual financial reports should be designed to enable the assessment of budget accuracy against both accountabilities. 15 Relevance means that financial information is only provided to managers who control, or have stewardship over, the activities impacting on the information and also that they are expected to act on the information. 44 Developing and Managing Internal Budgets Better Practice Guide
Better practice organisations provide managers with details of actual results against budgets within three days of the close of each period. Standardising reporting across the organisation is ideal and is made easier when managers source actual and budget data directly from the same financial system. In organisations with responsibility for capital expenditure projects or capital grant programs, monitoring budget estimates against actual results helps identify project variations (such as cost overruns or delays in key milestones) early enough to take corrective action. Routine reporting of detailed information on individual projects, such as milestones, percentage of completion and phasing of total projected costs, provides decision-makers with useful information on current and future impacts of project activity. In organisations with a large number of projects, this information should be presented on a summarised basis with more detailed information provided by exception, that is, where projects are not progressing to plan. Better practice organisations provide managers with details of actual results against budgets within three days of the close of each period. To provide a comprehensive analysis of achievement against goals and targets, it is essential that financial information is complemented by non financial performance indicators, including efficiency and effectiveness measures. 16 4.1.2. Assist managers assess budget performance As previously mentioned managers with operational responsibility are generally in the best position to assess current and expected budget performance for functions under their control or stewardship. In addition to year-to-date and monthly budget-to-actual results, it is important that managers have direct access to reports which show: out-year forward estimates to examine future risks and prospects; comparative results for the same period in previous years to assist with the identification of trends that may affect current and forecast budget performance; key financial ratios and percentage comparisons (both budgeted and actual) to highlight key issues; and budget-to-actual data on underlying drivers for example, budget-to-actual staffing numbers. It is useful to identify external factors likely to impact budget performance and monitor them regularly (for example, economic indicators and demographic movements). Results of such analysis could then be provided to relevant managers to factor into their analysis of program and budget performance. 4.1.3. Phase the budget to provide meaningful comparisons Phasing involves apportioning the approved budget over sub-periods within the relevant budget period according to a recognised pattern of expenditure (or revenue). Internal budgets are typically phased using monthly intervals. Phasing the internal budget assists managers with the timely identification and analysis of budget variances. In phasing the current year budget, it is important to adjust for known fluctuation factors where material, including where cash and accrual timings differ. To support the rolling assessment of budget impacts it is useful to prepare phasings for the next one to two financial years. Advantages of comparing actual year-to-date results to a properly phased budget include: removing known timing variances, which allows managers to focus on real or unanticipated variances; It is useful to identify external factors likely to impact budget performance and monitor them regularly. Phasing the internal budget assists managers with the timely identification and analysis of budget variances. Monitoring and evaluating budgeting performance identifying likely underspends or overspends before year-end so that management can take appropriate action to deliver outputs within legal limits, including the redistribution of resources where appropriate; early detection of errors in monthly financial reporting processes, for example, where accrued revenues and expenses are unreported for one or more months; 16 Performance reporting by Australian Government organisations is outside the scope of the guide. 45
greater precision in forecasting the organisation s working capital needs; and identifying ineffective or unnecessary expenditure within the organisation (for example, disproportionate unplanned capital or operating spending towards the end of the financial year to meet annual budget targets). Organisations adopt differing approaches to budget phasing, based on the nature of the underlying budget item. Organisations often adopt differing approaches to budget phasing, based on the nature of the underlying budget item. For example, appropriation revenue, depreciation and some transfer payments can exhibit little monthly fluctuation and, as such, a simple pro-rating of the annual budget is appropriate. However, for capital expenditure, revenue from independent sources and discretionary expense items, budget phasing should specifically account for any foreseeable fluctuations. Table 6 provides a list of factors that influence phasing of common departmental budget elements (that is, factors impacting on the timing of revenues and expenditures). Table 6: Internal budget phasing potential foreseeable fluctuation factors Budget element Budget phasing accounts for: Income statement Employee expenses: Salaries Leave entitlements Supplier expenses Grant expenses Depreciation Planned staff movements and certified agreement increases. Seasonal holiday periods. Contract milestones. Price escalation factors. Seasonal usage requirements (for example, air-conditioning and heating). Timing of grant agreements and milestones. Planned capital acquisitions and disposals. Balance sheet Cash Property, plant and equipment Employee provisions: Accrued salaries Leave entitlements Supplier payables The budgeted cash balance is derived from movements in the various cash flow elements as discussed below. Planned capital acquisitions and disposals. Monthly timing of pay dates. Seasonal holiday periods and planned staff movements. Scheduled payment terms. Cash flow statement Appropriation receipts Employee payments Supplier payments Purchases of property, plant and equipment Planned drawdown schedules (which sometimes correlate to pay run dates). Monthly timing of pay run dates (for example, months with three fortnightly pay dates rather than two). Planned staff movements (for example, redundancies). Scheduled certified agreement increases. Contract payment terms. Scheduled annual payments (for example, insurance). Planned capital acquisitions. Contract payments terms for assets under construction. 46 Developing and Managing Internal Budgets Better Practice Guide
Operational managers are commonly in the best position to identify factors influencing budget phasing as they are aware of the day-to-day operations of the organisation. Analysis of historical data may also assist managers identify trends, including seasonal impacts. Although generally more difficult to interpret, external measures also provide insight into the operating environment to support appropriate phasing of internal budgets. For example, the annual State of the Service Report 17 prepared by the Australian Public Service Commission provides an analysis of demographic and structural patterns and trends in Australian Public Service staffing. This information is of value to organisations when identifying staffing trends and developments for inclusion in budget assumptions. External measures provide insight into the operating environment to support appropriate phasing of internal budgets. 4.1.4. Analyse and explain budget variances In addition to monitoring and reporting actual-to-budget results, it is important to evaluate and explain reasons for variations. This involves considering what changed since the budget was set, why and, more importantly, implications for the organisation and, where relevant, the government and community. It is important to evaluate and explain reasons for variations. As detailed in the Table 7, analysis of budget variance information serves many purposes, ranging from holding managers accountable through to the assessment of the efficiency and effectiveness of service delivery arrangements. Table 7: Issues to consider when analysing budget variances Purpose Accountability for variances Management of variances Description Understanding and explaining why the variance has occurred and what is being done to manage it. This often includes an assessment of the validity of original planning assumptions. Evaluating implications of the variance for future financial performance and financial sustainability of the organisation and the outcomes, outputs and programs provided by the organisation and taking appropriate management action. Continuous improvement in budgeting Continuous improvement in outcome, output and program delivery Utilising variance information to improve budgeting practices. Utilising variance information to assess the efficiency and effectiveness of current service delivery mechanisms and improve current budgeting practices. In addition to the focus on accountability for, and management of, individual budget variances, undertaking formal reviews of consolidated variance information on a periodic (say quarterly) basis enables organisations to challenge underlying budget assumptions and estimation techniques. The explanation of budget variances better supports and guides decision-making when accompanied with sufficient non financial information. Ideally, the explanation: focuses on key financial results; refers to the influence of underlying key planning assumptions (such as salary rates, indexation factors, and productivity gains) or drivers (such as quantity, price, and timing) rather than merely the nature of the variances; identifies causes of variances, including the extent to which they are due to internal or external factors; Formal reviews of consolidated variance information on a periodic basis enables organisations to challenge underlying budget assumptions and estimation techniques. Monitoring and evaluating budgeting performance 17 The most recent report was: Australian Public Service Commission (2007), State of the Service Report 2006 07, Canberra, November 2007. 47
identifies impacts on the organisation and key stakeholders in output terms (for example, programs impacted) with an assessment as to whether the impacts are permanent or temporary; clearly identifies what, if any, action will be taken to address or manage variances and expected outcomes of those actions; and projects expected impacts on the area s, organisation s and government s key financial results for the current and future financial years, including an assessment of risks associated with the projected outcome. It is important to evaluate whether the variance is temporary or whether it will have ongoing consequences. It is important to evaluate whether the variance is temporary (for example, due to timing) or whether it will have ongoing consequences. If the variance is ongoing, assessing the impact on the current year budget and future years will assist the organisation determine whether remedial action is required. Forecasting is a useful means of projecting revised outcomes without changing the underlying budget. Part 4.3: Forecasting to manage gaps between budget estimates and actual results provides further discussion. The availability of internal guidance on the analysis and explanation of budget variances helps ensure a consistent approach to commentary across the organisation. Figure 8 provides a framework for analysing and explaining budget variances. The extent of analysis and explanation undertaken is dependent on the size of the budget variance, its complexity and any likely impacts on the organisation s current year or future activities. Figure 8: A framework for analysing and explaining budget variances Based on expected outcome detail projected current year and future budget impacts. 7. PROJECTED VARIANCE 1. CURRENT VARIANCE 2. UNDERLYING DRIVER Identify current variances for key financial results. Assess underlying reasons for the variance. Explain expected outcome for the current and future financial years. 6. EXPECTED OUTCOME 3. CAUSE Identify causes of the change in the underlying driver. Explain what action, if any, will be taken and when. 5. ACTION 4. CURRENT IMPACT Explain the impact on the organisation s outputs and programs. 48 Developing and Managing Internal Budgets Better Practice Guide
Element Consideration 1. Current variance What is the impact on: resourcing; and financial and non financial results. 2. Underlying driver Are the underlying key planning assumptions still valid, or has the variance resulted from a discrepancy in: timing (for example, milestones); quantity (for example, full time equivalents, beneficiary numbers); price (for example, salary rates, inflation, average claim size); structure (for example, restructures); or revenue or expenditure recognition, measurement and disclosure policies. 18 3. Cause Was the variance caused by: events which were controllable or uncontrollable? a deliberate decision or unanticipated event? internal or external factors? supply or demand side issues? 4. Current impact What outputs and programs are impacted? Without further action, is the variance permanent or temporary. If temporary, will it turn around in the current financial year? 5. Action Will the organisation: modify service delivery? renegotiate arrangements? rephase or redistribute resources? accept the variance and continue to monitor? 6. Expected outcome After action has been taken, what is the expected outcome on: current year outputs and programs? current year resources? future year outputs, programs and resources? 7. Projected variance After action has been taken, what is the expected financial impact on: agency resourcing? projected underspend or overspend? future year outputs, programs and resources? What risks are associated with the projection? Monitoring and evaluating budgeting performance 18 Refer to part 2.5: Harmonise budgeting and reporting. 49
4.2. Revising the internal budget For Australian Government organisations, the budget is not just a planning tool. It also becomes a statement of intent in terms of spending and priorities, with linkages to the external budget for which the organisation is held accountable to the Parliament. However, the budget is based on a set of assumptions that generally does not exactly match actual results. In monitoring budget performance, organisations seek to maintain an appropriate balance between providing senior and line management with meaningful information to make real-time decisions while, at the same time, limiting the frequency of updates to the internal budget. 4.2.1. Frequency of budget updates Organisations may plan whole-of-organisation internal budget updates to coincide with the external budget cycle, including updates to coincide with the mid-year update and other formal updates. This provides the opportunity for formal consideration of the impact of government decisions, new projects and changes in the external environment on the organisation s own priorities, activities and allocations. It also helps ensure the internal budget remains consistent with the latest external budget provided to Government. Additional budget updates are warranted when unforseen events or structural changes render the original budget irrelevant, for example, machinery of government changes. Budget updates should not be undertaken simply to adjust for actual results not meeting expectations or if original estimates were wrong. Internal budget transfers should be authorised by senior management and be counter signed or recommended by the CFO, or by an approved delegate in the CFO s unit. However, updates should not be undertaken simply to adjust for actual results not meeting expectations or if original estimates were wrong. Such revisions may lead to blurred accountability, hide poor budgeting practices, and create a disconnection between the internal and external budget. 4.2.2. Revising internal budget allocations Without revising the overall budget, organisations require flexibility to internally transfer funds and resources between areas or projects to reflect changed priorities, both internal and external (for example, the government s), or to accommodate relative changes in funding requirements provided the transfers are permissible under the organisation s funding structure. 19 In most cases, internal budget transfers should be authorised by senior management and be counter signed or recommended by the CFO, or by an approved delegate in the CFO s unit. Alternatively, forecasts can be used for managing and monitoring budget revisions without changing the original budget. Part 4.3: Forecasting to manage gaps between budget estimates and actual results discusses forecasting. Reporting changes to the internal budget to those affected within the organisation and key external stakeholders helps ensure the changes are properly understood and, as necessary, that use of the budget is adjusted. The timing and manner in which this is done depends on the stakeholder group and the level of materiality of changes. 19 A key consideration when transferring funds is whether this is permitted under the outcomes and outputs framework and appropriation acts. 50 Developing and Managing Internal Budgets Better Practice Guide
Better Practice Tip: Approving internal budget transfers Use a standard question based approval template to help ensure transfers are adequately justified and appropriately documented. Matters to address and document before an internal budget transfer is approved include: 1 Is the transfer permissible under the organisation s funding structure? 2 Has the reason for the transfer been sufficiently justified, for example, is it due to program delays? 3 Is the transfer required to implement a specific government decision or a decision made by the organisation s executive team? 4 Does the requesting area have sufficient funding to meet its commitments if the transfer is not approved (including from other program activities contributing to the same budget outcome)? 5 Is there sufficient unexpended appropriation at the outcome level (not just at the output or program level) to enable the transfer? 6 Should the funding be re-phased from the area s forward year appropriation? 7 Have the affected areas adjusted their plans and targets to reflect the impact of the transfer? 8 Does the requesting area have appropriate financial delegations to spend the funds transferred? 9 Will the transfer have a net impact on the organisation s budget balances, either in the current or future periods? 10 Has the transfer been recommended by an appropriate official? 4.2.3. Understanding and tracking changes in internal budgets The internal budget is, overall, a forward-looking plan. However, it is also important that managers analyse and track what has changed since the budget was set. This assists in monitoring budget performance, reporting to Government and identifying common budget variations that are likely to be best addressed through changes to existing processes. It is desirable that organisations implement procedures to track and understand what has changed since the last budget update with sufficient detail to identify individual variations by area, program and cost element. Maintaining accurate historical documentation of budget adjustments also assists organisations improve the accuracy of the budget process by facilitating the identification of trends and common areas of budget variation. Maintaining accurate historical documentation of budget adjustments assists organisations improve the accuracy of the budget process. Monitoring and evaluating budgeting performance 51
Better Practice Tip: Track budget variations The Department of Finance and Deregulation s Central Budget Management System (CBMS) requires Australian Government GGS organisations to update external budgets through a journal based adjustment process, 20 with separate journals for each program and for each type of variation. Adopting a similar process for updating internal budgets provides an audit trail for accountability purposes. A journal based approach also assists organisations to identify causes and effects of budget variances and movements for decision-making purposes. 4.3. Forecasting to manage gaps between budget estimates and actual results Effective forecasting processes quickly identify and respond to changes in the external or internal environment and assist organisations manage gaps between targets and actual results. The purpose of a forecast is to provide an objective and realistic assessment of likely budget results on the basis of actual trends, current assumptions, and plans. It is a periodic estimate that reflects changes and impacts actually being experienced within an organisation and within the wider community. Forecasting is more than just an extrapolation of variances. It provides managers with the tools and information to identify underlying drivers and, as a result, likely impacts on the current year and beyond. Forecasts provide an updated view of the likely outcome without amending the underlying budget. The interpretation of forecasts is more effective when the organisation has considered the phasing of the original budget for the current and next financial year. A budget forecast is typically prepared in circumstances where a budget-to-actual variation has been identified. Forecasts provide an updated view of the likely outcome without amending the underlying budget. However, a monthly review of forecasts is also a useful means of identifying potential budget variations that are anticipated but have not yet arisen. With a focus on responsiveness, the planning horizon for forecasting is typically less than that of the internal budget. Some organisations focus on the current year they finalise the annual budget, review it on a monthly basis and re-project the balance of the annual results. Better practice organisations use a rolling planning forecast that extends beyond the current financial year, for example, a rolling horizon of six to eight quarters, adding new periods as the current period ends. Monthly or quarterly forecasts are prepared for the current year and quarterly forecasts for the next financial year. The interpretation of forecasts is more effective when the organisation has considered the phasing of the original budget for the current and next financial year. Similar to the internal budget process, an effective forecasting process is based on: using the same chart of accounts as budget and actuals reporting to help ensure consistency, although typically a simplified forecasting model would be employed by summarising and reducing the number of items comprising the forecast; the direct capture of forecasting inputs from operational managers who are closer to operational activities. In this way, operational managers own and are accountable for their forecasts; an integrated calendar which sequences budgeting, reporting and forecasting activities in a logical fashion; and rigorous governance processes and control over data to ensure reliability. 20 Under a journal based approach, each budget change is prepared using a separate journal document. This provides an audit trail showing the full impact of each adjustment on the budgeted income statement, balance sheet and cash flow statement. 52 Developing and Managing Internal Budgets Better Practice Guide
While the analysis of comparative results for the same period in previous years assists in the identification of trends that may affect current and forecast budget performance, a driver based approach to forecasting is more likely to result in a forecast that reflects the current underlying nature of the organisation and the external environment. For a forecast to be meaningful, its cycle time must be short enough that the results will be useful to management for developing contingency plans, taking corrective action and advising stakeholders. For example, if an organisation develops forecasts on a monthly cycle, but requires two weeks to develop each forecast, the results are unlikely to be useful. Unlike the budget, which is usually developed well in advance of the period to which it relates and requires rigorous layers of preparation, review and approval, the forecast is primarily a communication tool to support rapid and flexible decision making. However, while fast reaction underpins useful forecasting, it remains important to also focus on making reasonably accurate predictions. It is possible to complete a forecasting process within three to five days of actuals data being available. To achieve this, it is vital that organisations: understand that forecasting is a means of enabling them to manage the gap between budget estimates and actual results, rather than treating forecasting as another target-setting process; keep modelling calculations and relationships relatively simple so that managers understand the model and do not get a false sense of precision; restrict their focus to those activities or budget elements that are material and most open to change (for example, discretionary costs or headcounts); forecast account aggregates or summaries. The forecast should be consistent with, but to a lesser level of detail to, the original budget or the general ledger. For example, the number of forecast line items is restricted to key line items so that more time can be spent on analysis; update the forecast on a periodic or ongoing basis, by exception, rather than through a complete bottom-up update; and provide concise commentary focused on insights and trends. A driver based approach to forecasting is more likely to result in a forecast that reflects the current underlying nature of the organisation and the external environment. While fast reaction underpins useful forecasting, it remains important to also focus on making reasonably accurate predictions. Forecasting inherently contains a degree of uncertainty. As such, the use of range forecasts (expected forecast as well as upper and lower limits), scenario planning and sensitivity analysis can assist the organisation to understand the range of potential outcomes. 21 Arguably the most important element of the forecasting process is that senior management promote a culture of honest forecasting; where forecasting reflects a best estimate of the future. Do not dwell on the quality of the original estimates when analysing forecasts, rather focus instead on what action needs to be taken. Table 8 illustrates some of the key differences between budgeting and forecasting practices. Monitoring and evaluating budgeting performance 21 Scenario planning involves an investigation into the implications of several options. Sensitivity analysis involves an investigation into how projected performance varies along with changes in key assumptions for each option. 53
Table 8: Differences between budgeting and forecasting Practice Objective Comparison of budgeting and forecasting The objective of internal budget processes is to establish limits, set budget performance targets and allocate resources. Whereas The objective of forecasting is to manage gaps between budget estimates and actual results, reallocate resources and revise expected outcomes. Considerations Key questions addressed in internal budget processes include: what are our priorities? What are our targets? What are our sources of income? How best do we allocate resources? Whereas Key questions addressed in forecasting include: where are we now and why? What does this mean? What are we going to do about it? What will this achieve? Horizon The internal budget is prepared on an annualised basis (with monthly phasing) with forward year projection. Whereas The forecast is prepared on a rolling basis. Level of detail The internal budget is financial statement based (summarised for each level of management). Whereas The forecasting process focuses on key (summary) measures that drive the organisation. Frequency and nature of update Revisions of the internal budget are limited to formal updates and approved changes and are undertaken through a formal process. Whereas The forecast is reviewed on a regular basis and is updated as necessary. Construction timeframe Preparation of internal budgets spans one or more months and is generally completed in advance of the performance year. Whereas Preparation of forecasts should be updated within three to five days of month-end results being available. The forecast is updated throughout the performance year. 4.4. Review and improve internal budget processes A continuous improvement culture will help ensure that the internal budget process is efficient and effective and remains relevant to the organisation s needs and priorities. Measuring budget accuracy and timeliness on an ongoing basis and periodically conducting more formal reviews are two ways to identify areas for improvement. 54 Developing and Managing Internal Budgets Better Practice Guide
4.4.1. Measure internal budget accuracy and timeliness Monitoring the accuracy and timeliness of budget estimates over time, rather than monitoring the achievement of results for a fixed period, enables the identification of areas for improvement. In this respect, it is important that organisations measure accuracy and timeliness on a rolling basis rather than simply year-to-year, thereby creating less incentive for managers to manipulate results or spend up at year end. Managers are more likely to take responsibility for achieving accuracy and timeliness targets where the indicators have been agreed with them in advance and are limited to those budget elements (costs) over which they have control. Monitoring the accuracy and timeliness of budget estimates over time enables the identification of areas for improvement. Under a rolling approach, budget (and forecast) accuracy is monitored periodically within the year and again once final actual results are known. For example: the monthly and year-to-date actual results are compared to the monthly and year-to-date budget phasing for key budget measures (for example, net cost of services). Variances are typically shown in absolute and percentage terms; and once the final actual results for the full year are known, results are compared to the budgeted full year results for each of the preceding budget updates with a view to assessing whether actualto-budget variances are improving in percentage terms with each update. Measuring an individual s budgeting performance (that is, their performance in developing accurate budgets) involves an assessment of the accuracy of budgeting and forecasting over the period compared to actual results. In general, budget accuracy should improve as the timing of each update gets closer to the known result. This is illustrated in the following example. 22 Better Practice Tip: Measure budget accuracy over time The Department of Finance and Deregulation reports annually on the accuracy of budget estimates for the Australian Government General Government Sector. 23 This includes key performance targets for each iteration of the budget cycle as follows: one per cent difference between first forward year estimated expenses and final outcome (this budget is finalised 14 months before the commencement of the actual year); 0.5 per cent difference between budget estimated expenses and final outcome (this budget is finalised two months before the commencement of the actual year); 0.3 per cent difference between revised estimated expenses at Mid-Year Economic and Fiscal Outlook and final outcome (this budget is finalised around six months into the actual year); and 0.25 per cent difference between revised estimated expenses at budget time and final outcome (this budget is finalised approximately two months before the end of the budget year). In addition to having target accuracy indicators for each budget update, a key element of this approach is the expectation that budget accuracy improves over time. Monitoring and evaluating budgeting performance 22 While taken from the external budgeting environment, the example can be similarly applied to an organisation s internal budget, particularly when there is a close alignment of internal and external budgeting updates as detailed in Part Two of the guide. 23 Refer to Department of Finance and Administration (2007), 2006-2007 Annual Report, Chapter 4, Table 1, which includes performance information for the outcome of Sustainable Government Finances. 55
4.4.2. Identify opportunities for improvement Undertaking periodic formal reviews (at least annually) helps identify opportunities to improve the efficiency and effectiveness of budget-setting processes and associated timeframes. Conducting such reviews will also help ensure that budget processes continue to meet the requirements of the government and management. It is important that stakeholders outside of the finance area are involved in formal reviews of the budget function. This helps ensure that stakeholder priorities are identified and enhances stakeholder support for the budget setting process. Ideally, reviews will involve representatives from both senior management and line management. There is also merit in consulting external stakeholders to assess satisfaction given the close link between internal and external budget. Better Practice Tip: Review key planning and budgeting assumptions To improve the accuracy of internal budgeting, and therefore reduce the average magnitude of variances between budget estimates and actual results, it is essential that budget reviews consider the appropriateness of key planning and budgeting assumptions. This will enable organisations to better understand key budget drivers and increase the robustness of future assumptions and therefore internal budgets. It is useful to compile internal metrics on the accuracy and timeliness of budget estimates to benchmark performance. To assist in the review of budget development processes, it is also useful to compile internal metrics on the accuracy and timeliness of budget estimates to benchmark performance over time and, where possible, to similar organisations. Table 9 provides a listing of possible benchmarks. A better practice is to capture benchmarking information on an ongoing basis as part of internal budget processes for example, inclusion of benchmarking questions in budget submission templates (such as the time taken to complete internal budgets). Table 9: Benchmarking the internal budget function Benchmark metric Cost of preparing the budget as a percentage of total departmental costs Staff involved in budget preparation as a percentage of total staff Days to develop and approve budget User satisfaction with budget process Level of detail in the budget template Budget accuracy over time Description (Cost of budgeting, comprising full time equivalent staff (FTEs), direct costs and overheads) / (Total departmental expenses) (Budget FTE) / (Total FTE) Elapsed time, measured from the start of budget processes until budget approval Conduct qualitative surveys of users involved in internal budget processes Number of line items and level of detail for each line item Measure and compare the accuracy of budget processes over an appropriate timeframe (distinguishing between the impact of exogenous and endogenous variances) 56 Developing and Managing Internal Budgets Better Practice Guide
Part 5 Appendices and Glossary of terms Contents A Illustrative template guidelines for internal budget processes 58 B Budget summary illustrative structure 60 C Internal budget processes better practice checklist 64 Glossary of terms 70 Appendices 57
A Illustrative guidelines for internal budget processes The following template provides a list of potential contents for a set of internal budget guidelines. The extent that each organisation adopts these contents, including the emphasis given to each component, depends on their individual circumstances. Section Foreword Potential component Statement from the Chief Executive Statement from the Chief Financial Officer Introduction Purpose Background Scope Organisational overview, outputs and programs Linkage to organisational planning framework Linkage to external budget processes Summary of changes since last budget update Strategy Organisational goals and objectives Fiscal priorities and constraints Budget position (surplus / deficit) Sources of income Key budget performance indicators and measures Output and program management Process Governance framework Budgeting approach Budget systems Budget hierarchy Reporting framework Roles and responsibilities Chief Executive Budget committee Chief Financial Officer Budget coordinators Budget preparers Timeline Planning, budgeting and financial reporting cycle Key budget deadlines Calendar of budget processes and responsibilities 58 Developing and Managing Internal Budgets Better Practice Guide
Section Financial policies Potential component Budgeted revenue Revenue recognition, measurement and disclosure policies Revenue classifications Revenue allocation Treatment of one-off revenues Key assumptions Indexation and productivity arrangements Budgeted expenditure Expenditure recognition, measurement and disclosure policies Expenditure classifications Costing principles Costing methodology Cost drivers Cash and accrual impacts Key assumptions and standard costs Indexation and productivity arrangements Capital budget Linkage to asset management plan Distinguishing between operating expenses and capital assets Asset categories Project costing Budget rules Framework for budget decisions Approval arrangements Group and organisational budget responsibilities Budget data entry processes New or additional funding submissions Revenue retention and carryover arrangements Treatment of budget savings and underspends Internal transfers Capital investment business case arrangements Minor capital requests Unforseen and urgent circumstances Use of contingency reserves Appendices Appendix A Budget Checklist Appendix B Budget Templates Appendix C Frequently Asked Questions Appendix D Glossary of Terms Appendix E Contacts Appendices 59
B Budget summary illustrative structure Chief Executive Message: Key Priorities: Priority one Priority two Priority three Key Budget Initiatives: Initiative one Initiative two Initiative three Key Budget Results Actual Budget Projection 20X1 20X2 20X3 20X4 20X5 $m $m $m $m $m Income 479.5 487.3 505.5 497.3 487.4 Expenses (478.3) (483.3) (507.5) (497.3) (487.4) Operating Result 1.2 4.0 (2.0) 0.0 0.0 Net Assets 45.0 49.0 47.0 47.0 47.0 Net operating payments (458.3) (453.3) (495.5) (507.3) (469.4) Net capital payments (18.0) (26.0) (4.0) (16.0) (12.0) Administered expenses (1,122.0) (1,155.7) (1,190.3) (1,226.0) (1,262.8) Administered payments (1,099.6) (1,178.8) (1,166.5) (1,250.6) (1,237.6) Analysis of departmental expenses by month 50 40 $m 30 20 10 0 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Employees Suppliers Depreciation 60 Developing and Managing Internal Budgets Better Practice Guide
Departmental expenses by output Output 4 ($55.7m) Output 1 ($138.9m) Output discussion Output 4 ($55.7m) Output 3 ($202.8m) Output 2 ($85.9m) Output 3 ($202.8m) Output 2 ($85.9m) Output 1 ($138.9m) Program expenses Transfer payment a 347 90 Program discussion Subsidy program b Grant program c 231 231 60 143 Departmental Budget Grant program d 58 50 Grant program e 116 80 Subsidy program f 173 60 0 100 200 300 400 500 $m Administered Programs Departmental Budget Appendices 61
Staffing levels Group A Group B Group C Group D Corporate Group Total 20X2 Budget 565 534 260 220 94 1,673 20X1 Estimated Actual 568 545 250 181 80 1,624 Staffing discussion Capital Budget Actual Budget Projection Total 20X1 20X2 20X3 20X4 20X5 $m $m $m $m $m $m Capital Projects Project A 4.0 4.0 Project B 3.0 3.0 Project C 2.0 2.0 4.0 Project D 3.0 4.0 3.0 10.0 Minor purchases 0.5 0.3 0.6 0.6 0.8 2.8 Total capital purchases 4.5 6.3 4.6 5.6 2.8 23.8 Sources of funds Equity injection 2.0 3.0 2.0 7.0 Depreciation reserve 2.0 2.5 2.5 3.0 2.5 12.5 Other 0.5 0.8 2.1 0.6 0.3 4.3 Total sources of funds 4.5 6.3 4.6 5.6 2.8 23.8 Key capital projects 62 Developing and Managing Internal Budgets Better Practice Guide
Budget analysis by group Group A Description (include a summary of the main budgeting outcomes for the group) 20X2 budget priorities (include the main budget priorities to be delivered over the year) Key budget changes (include main changes in budget from previous years, such as new policy proposals or machinery of government changes) Key performance indicators (include key budget performance indicators, such as accuracy of budgets and phasings or delivery of outputs and programs) Departmental expenses budget summary 180 165 161 150 120 $m 90 60 30 0 20X1 20X2 Average Staffing Levels 600 568 565 500 400 ASL 300 200 100 500 40 Outputs 30 Output 3 ($40.4m) 20 20X1 20X2 Output 2 ($40.4m) 10 Output 1 ($120.1m) 0 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Employees Suppliers Output 1 ($120.1m) Depreciation Programs administered Grant program e 58 18 Grant program c 231 143 0 50 100 150 200 250 300 350 400 $m Administered Programs Departmental Budget Departmental Budget Administered Programs Appendices 63
C Internal budget processes better practice checklist The following table provides a checklist of the internal budget practices covered in the guide. Organisations should assess the extent that individual practices in this checklist are relevant, appropriate and cost-effective in light of their circumstances. By way of example, a rating of Absent for any one practice may be appropriate if the organisation has compensating practices in place, or it is not cost-effective to adopt the practice. Established Developing Absent Part 2 Embedding the internal budget into organisational planning and management Integrate the internal budget into organisational planning (Part 2.1) 1 Internal budgets closely align to strategic planning processes. 2 Internal budgets are developed and approved at the same time as organisational plans. 3 Internal budgets support each level of planning and performance management. 4 Planning and budgeting processes source information from the same data sets. Align internal budgeting with organisational roles and responsibilities (Part 2.2) 5 Budget allocations are clearly assigned to accountable officers or positions. 6 Officers are only held accountable for budget allocations where they have the responsibility and authority to take action. 7 Ownership of budget source data and key budget assumptions is clearly assigned within the organisation. 8 Allocated budgets show the full net cost of services and distinguish between those items that the responsible manager has direct control over from those where control is indirect. 9 The organisation has adopted a reliable costing approach to attribute indirect costs to outputs and programs. 10 Operational managers are consulted in the establishment of cost attribution rules and identification of key cost drivers. 11 All elements of the budget, including balance sheet items, are allocated to operational managers so that they can view the full financial impact of their decisions. 64 Developing and Managing Internal Budgets Better Practice Guide
Established Developing Absent 12 For any budget elements that have not been allocated to operational managers, a formal risk assessment has been undertaken to identify compensating controls and help ensure that each unallocated budget element is managed. Integrate operational and capital budgets (Part 2.3) 13 The organisation has prepared a long term assessment of its capital priorities and associated funding requirements (a capital budget). 14 The timeframe covered by the capital budget encompasses the expected useful life of current and planned asset purchases. 15 The capital budget links to, and flows from, the organisation s asset management plan. 16 The organisation uses the asset register to assess useful lives and replacement values to estimate capital replacement costs each year. 17 Capital and operating budgets are integrated so that managers can assess the whole of life cost of capital investment decisions. 18 The organisation requires all new major capital investment and capital replacement proposals to be supported by an appropriate business case. Align internal and external budgets (Part 2.4) 19 Consistency is maintained between the internal and external budgets throughout the external budget cycle. Harmonise budgeting and reporting (Part 2.5) 20 Consistent policies and formats are adopted for reporting budget and actual information. 21 Budget accounting policies are consistent with external reporting requirements and standards. Engage stakeholders in internal budget processes (Part 2.6) 22 Planning and coordination of internal budget processes includes representation from across the organisation. 23 The Chief Financial Officer reports directly to the Chief Executive on the development and management of the organisation s internal budget. Appendices 65
Established Developing Absent 24 Managers understand and agree to their role in the internal budget process and their responsibilities have been clearly articulated in their performance agreements. 25 Managers with budget responsibilities have been provided with training or guidance on the: organisation s internal budget processes, including its budget policies and guidelines; operation of the organisation s budget system; and Australian Government s budgeting and financial management framework. 26 Operational managers are able to submit budgets on the basis of operational drivers. 27 Managers with budget responsibility have access to appropriate systems and tools to assist in developing their budget. 28 The organisation provides opportunities for managers with budget responsibilities to interact and share knowledge on budgeting practices. 29 There is sufficient visibility of that part of the organisation s internal budget attributed to whole of government activity. Part 3 Developing and implementing a comprehensive internal budget Effective planning and coordination (Part 3.1) 30 The organisation s internal budget policy articulates budget priorities and constraints and communicates the organisation s framework for budget development and decision-making. 31 The internal budget is prepared on a multiyear basis consistent with the organisation s strategic and capital planning processes. 32 The organisation has a timetable that: identifies information required for internal budget processes; describes deliverables in detail; incorporates key checkpoints; and identifies key deadlines and milestones. 33 The organisation clearly articulates responsibility for budget coordination and preparation. 66 Developing and Managing Internal Budgets Better Practice Guide
Established Developing Absent 34 The organisation has appropriate contingency arrangements if key budget staff or systems are unavailable. 35 The organisation has issued guidelines and instructions that contain: budget policies; priorities and assumptions on which the budget is based; roles and responsibilities; timeframes and deadlines; and protocols for budget development. Effective budget construction (Part 3.2) 36 The organisation uses a combination of topdown direction and bottom-up participation to develop the internal budget. 37 The organisation has considered incorporating concepts of zero based and performance based budgeting into their budgeting approach. 38 The organisation uses fully integrated budgeting and reporting software, which incorporates sufficient controls and functionality to meet the needs of users. For example: the system is subject to appropriate governance and review; changes to budget systems and tools are centrally governed, including changes to assumptions and calculations; adequate segregation of duties exists between budget input and budget approval; operational areas are able to enter data directly into the system; budget data is regularly backed-up; interfaces to other financial systems are reconciled on a regular basis; the system supports tracking of adjustments; and the system provides managers with access to ad-hoc reporting tools and the ability to drill-down through the budget data. 39 The internal budget system and supporting tools have been evaluated in the last three years to assess if they remain appropriate for the efficient and effective development of the internal budget. Appendices 67
Effective oversight, review and communication (Part 3.3) 40 The organisation has established a budget committee to oversight internal budget processes. 41 The Chief Financial Officer has sufficient authority to ensure that budget guidelines and policies are being complied with throughout the organisation at all levels. 42 Operational areas are required to consult with the Chief Financial Officer on all significant budgeting issues, including new budget initiatives. 43 Quality assurance checks are undertaken before budgets are submitted to the budget committee or senior management for deliberation. 44 Managers are consulted on changes to budget submissions before the conclusion of the internal budget process. 45 Approved budgets are communicated to managers as soon as practicable after the conclusion of the internal budget process. 46 The organisation prepares a summary of the approved internal budget for relevant stakeholders. Part 4 Monitoring and evaluating budgeting performance Monitor and report against internal budgets (Part 4.1) 47 The organisation monitors and reports budget estimates against actual results on a regular basis. 48 Internal financial reports are prepared for each level of accountability and summarised appropriately for each level of management. 49 Managers are provided with details of actual results against budget within three days of the close of each period. 50 Financial information is presented with operational (non financial) information to obtain a balanced view of performance. 51 Monthly phasings are prepared to apportion the total approved budget in accordance with foreseeable patterns of expenditure (or revenue), including seasonal factors. Established Developing Absent 68 Developing and Managing Internal Budgets Better Practice Guide
Established Developing Absent 52 Managers with budget responsibility analyse and explain budget variances on a regular basis. 53 The organisation has a range of internal guidance to help ensure a consistent approach to analysing and explaining budget variances. Revising the internal budget (Part 4.2) 54 The organisation plans whole of organisation updates to its internal budget to coincide with the external budget cycle. 55 Transfers between internal budget allocations are: adequately justified; appropriately documented; and authorised by senior management. 56 Changes to the budget are reported to those affected within the organisation. 57 The organisation maintains accurate documentation of budget adjustments. Forecasting to manage gaps between budget estimates and actual results (Part 4.3) 58 The organisation prepares forecasts on a regular basis to identify and respond to gaps between budget estimates and actual results. 59 The organisation prepares forecasts on a rolling basis that extend beyond the current financial year. 60 The forecasting process is completed within three to five days of actual data being available. 61 Senior management promote a culture of honest forecasting; that is the forecast reflects a best estimate. Review and improve internal budget processes (Part 4.4) 62 The organisation regularly reviews the timeliness and accuracy of internal budget processes. 63 Managers are consulted on the establishment of budgeting timeliness and accuracy indicators. 64 Performance of internal budget processes is benchmarked over time and against similar organisations. Appendices 69
Glossary of terms Activity based budgeting Bottom-up budget Budget Capital budget Chief Executive Chief Financial Officer Controllable cost Forecast Incremental or traditional budgeting Internal budget Operating budget Operational managers Outcomes An approach to budgeting that focuses on factors that drive costs and justifies expenditure on the basis of activities. A budget which is developed from the bottom up where budget holders develop bids for resources and all bids are considered before decisions are made about the final budget. A budget is the financial plan of an organisation s operations and a tool to control the allocation and management of resources. A budget of expenditure on capital items including non current assets, investments, and internally developed assets such as software. The capital budget also includes expected sales or disposals of assets. The person who holds the highest office in the organisation and has ultimate responsibility for the organisation s performance. The person with overall responsibility for financial planning and financial management activities in the organisation. This includes roles in strategic planning, development of accounting policies, budget development (internal and external), management reporting, financial statement preparation and managing the Financial Management Information System. A cost that can be influenced by its budget holder. An estimate of the actual financial outcome for the balance of the current accounting period or a forthcoming period based on actual performance to date and other information available to the budget manager. An approach to budgeting where the previous year s budget or actual results provide a base line for the current year. This base line is adjusted for known changes in activity level, inflation or percentage based efficiency targets. The internal budget shows an organisation s expected financial performance, financial position and cash flows disaggregated by area of responsibility. Developing an internal budget involves making decisions on the allocation, use and administration of resources to achieve the organisation s objectives. A budget of the revenues and expenses expected in the forthcoming accounting period. Managers whose main responsibilities are delivering the programs and outputs of the organisation. They are also referred to as line managers or program or output managers. The results, impacts or consequences of actions taken by the Government and Australian Government organisations on the Australian and international community. 70 Developing and Managing Internal Budgets Better Practice Guide
Output based budgeting Outputs Performance based budgeting Top-down budget Variance analysis Zero based budgeting An approach to developing a budget that is driven by the outputs required to be delivered by an organisation. The budget is established by understanding the relationship between the outputs and the resources required to deliver the outputs. The goods and services produced by organisations on behalf of government. An approach to developing a budget that is based on an assessment of what the organisation is trying to achieve. The activities required to achieve the outcome are then identified and costed (generally using activity based budgeting). A budget that is imposed by the executive of the organisation with limited opportunity for the budget holder to participate in the budget setting process. In some organisations it is based on predefined rules, agreed formulas or based on planned activity levels. The evaluation of performance by analysing differences between planned, budgeted or standard outcomes and actual expenses or revenues. A method of budgeting that requires each cost element to be specifically justified, as though activities to which the budget relates were being undertaken for the first time. Without approval the budget is zero. Appendices 71
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