PFM is the process wherein the Govt.

unit or
agency
Employ the means to Obtain and allocate the
resources/money based on implied and
articulated priorities
Utilize methods and controls to effectively
achieve publically determined ends

It determines the scope and content of fiscal

policies
It establishes general guidelines to ensure
funds are spent honestly
It provides organizational structure to
effectively carry out fiscal duties

Both the sectors finance operations

Effectively manage the flow of funds
Seek debt funds
Large purchases require competitive bidding
Have systems of employee pension plans
Have unions

Differences
End objectives
Raising of resources
No payment for services under the govt.
Quasi public agencies render services on
break even
NFP agencies with heavy deficits may
become bankrupt

Specify goals: what is wanted ?(Priorities,

policies/Need of the people/companies/
Industries)
Quantify benefits (measure the wants)
Maximize benefits
The primary objective is to maximize
benefits for any given set of resources

Planning- defines goals and priorities

Programming- selects activities to achieve
goals
Budgeting- develops the work plan and
allocates resources to achieve goals
Financing- seeks financial resources to
execute the plan

Controlling-ensures carrying out of activities

according to work plan
- Purchasing
-Accounting
-Auditing
-Reporting
Evaluating-assesses the utility and
congruence(Similarities) between stated
goals and achieved results

Specifically, the Main Components/elements of PFM are:

- Financial Planning: revenue and expenditure analysis
is essential for planning
- Control: measurement & evaluation of program
activities
- Cash Management: minimize opportunity costs

Forecasting- approximation(Estimate) are

used for planning and measuring variances
Investments- in securities
Financial Analysis
Cost Analysis includes expenditures, human
resources, and time

Budgeting- a control tool to assure

accountability , financial integrity(honesty), and
legal compliance
Debt administration
Accounting and reporting
Financial Management Information system
Performance evaluation

In brief, pfm
Seeks to satisfy the needs within the
financial constraints
Allocates resources and tracks performance
Keeps scores and presents to users of
information
Manages risk and uncertainty, and
Plans finance, identifies sources of fund

CFO
-Plans
-Prepares budgets
-Reports
-develops for measuring
programs

Governing body
-determines fiscal policy
- Approves the budget
-Adopts revenue and
expenditure
authorization
measures
- Holds the CFO accountable

Decentralized system of fin.

decision making: Fin activities
separately administered by
separate units
Centralized financial Decision
making
- Financial functions under one
unit
- Promotes policy integration
- Integrated decision making
- Minimizing divide responsibility

Guidelines for organizing Fin Adm

- Standards for effective leadership
- guidelines for effective
operation( promoting co ordination,
minimizing duplication), effective use of
resources
- ways of measuring accountability to
citizens( financial discipline, clear line of
responsibility, capacity to implement
policies, opportunity for citizens to
participate in budgets)
- Use of information technology and world
class fin. practice.

Financial Planning
Budget preparations and expenditure control
Develops accounting systems and procedures
Reporting for Financial management-control
performance
Maintenance of asset control system

Investment Management
Financial Liaison
Staff Training
Fiscal health analysis
Suggest ways of expanding
resources
Negotiate in trade union
contracts

Practices useful for a world class

financial organization
- develop a control system to
achieve accountability
- exhibit strong leadership
- training to change
organizational culture

Continually examine the ability

of the fin. organization to meet
its mission
Eliminate inefficient practices
and use outsourcing
Continually organize finance
function to add value (integrate
mgt function)

Design FMIS
Re engineer existing practices
Organize financial data for user
needs
Assemble a finance team with
skills
Build a finance organization that
attracts best talents with career
opportunities

Financial Condition: The ability of an

organization to meet its financial obligations (Or
ability to finance services on a continuing basis).
The organizations ability to pay its obligations
determines a good/bad FC
The ability to pay is commonly called solvency in
finance.
The four levels of solvency are: cash solvency,
budgetary solvency, long term solvency, &
service solvency

The ability to generate sufficient cash to pay

for current liabilities (Cash Solvency)
The ability to collect sufficient revenues to
pay for expenditures/expense (budgetary
solvency)
The ability to pay off long term liabilities
(long term solvency)
The ability to financially support a desired
level of services ( service solvency)

Cash flow problems: generally due to one or

more of these conditions
- Billings are not frequent enough or occur
at the wrong time of the year in relation to
expenditure demands.
- Cash collections are not occurring fast
enough
- Unpaid (receivable) amounts are
increasing

Causes of budgetary problems:

- problems with budget estimates
-Change in conditions affecting actual revenue or
expenditure levels.
- weak control over revenue,expenditure, or
information system
- increase in expenditure at a faster rate than
revenue
-use of non recurring exp for that of recurring nature
- decisions taken with lack of cost effectiveness
- external factors (state or federal mandates, natural
calamities, reduction in population/industry, weak
economy)

Causes of long term solvency problems

the same causes of budgetary problems, Plus,
- deteriorating infrastructure and fixed assets
-inadequate funding provisions for LTL
-failure to properly account for LTL
- lack of proper planning/budgeting for multiyear
obligations(Compultion / responsibility)

Causes of service level solvency problems:

chronic budgetary problems result in cuts
to essential services. In addition,
- stagnant or shrinking tax base
- lack of revenue growth
- deteriorating infrastructure
-budget inflexibility
- inadequate cost accounting system

Features to be considered in evaluating FC

Physical condition of the local infrastructure
such as roads, etc
Reliance for financial assistance on other
organizations
Pension liabilities, especially unfunded
obligations
Impact of inflation on fixed costs of govt
Ability to pay off debts

Improving financial condition:

- the less advanced the fiscal stress, the
easier the fix . Early detection & correction
are important.

Periodic financial condition analysis can be

an effective tool for early detection of
negative fiscal trends

Traditional fin. statements are insufficient as

a basis for evaluating the financial health of
communities.

Information relating to data such as reliance

on outside revenue sources, uncontrollable
revenues, per capita income trend, physicalplant replacement etc is not found in
financial statements.

How to measure fin. Condition?

A good financial condition measure should satisfy
at least three criteria
- A measure must assess a specified element of
financial condition ( measurement validity)
- the elements used should be consistent &
objective( measurement reliability)
- the measure and supporting data should be
affordable to obtain ( measurement
affordability)

Elements to be considered in monitoring FC:

the state of the national economy,(GDP)

local business and economic
conditions(WPI/CPI)
population (Per Capita Income)
employment (Backlog)
Indicators are used to evaluate financial
conditions.

Indicators are quantified changes about the

environment, organizational, and financial
factors.
Select indicators that are suitable for the govt
and interpret their significance.
Financial indicators can provide snapshots of per
capita ratios, revenue collection efforts,
expenditure levels, results of operations, fund
balances, and cash level

E.g of indicators:
Expenditure per capita: Exp/population
How much money is spend on per person by the
government
Liquidity :Cash/current liability
cash ratio of 1.00 and above means that the COuntry
will be able to pay all its current liabilities in
immediate short term

Employees per capita: employees/population

"The employment population ratio is the best
measure of labor market conditions.It
should be above 50 %
Depreciation: Depreciation exp/depreciable
assets
Debt service: Debt service/Net op.revenue
Receiving a ratio of less than 40% means that
the potential borrower has an acceptable
level of debt.

Important Terms
Fixed costs: personal costs & debt service
Intergovernmental revenue
Once the ratios are obtained,
they can be compared to internal or external
benchmarks.
Internal benchmark may be set by policy
(e.g. Tax % on total tax to be collected).
External benchmarks are stds set by
convention or practice. (Industry norms)

Trend analysis is another tool for identifying

the causes of fiscal problems
It indicates whether the most recent year is
the continuation of an upward or downward
trend.
A multiyear analysis can identify those years
that were unusual
Peer comparison makes comparisons of
similar financial organizations (Wer/Wer)

NFPs need to :
replace assets, finance expansion, build up
reserves, though there is no profit.
When there is no surplus, the fund balance has to
be used.
NFPs goal is to provide service. Therefore the
ratios have to be interpreted in the context of
the agencys mission
Make sure that the future generation is not robbed
by present generation (e.g. massive borrowing)

I. Revenue and expenditure per capita

1.

Gross Revenues
Population
2. Gross Expenditure
Population
3. Recurring Revenues (Gross Rev.- Onetime rev)
Population

Less revenue per capita coupled with more

expenditure per capita shows the inability of
govt to maintain service. A decrease in ratio (3)
shows dependent on irregular revenues

2) Fixed Costs : Personal Services and Debt

Service ratios

1. Salaries and Fringe Benefits

Gross Expenditures
2. Debt Service Expenditures
Gross Expenditures
3. Salaries and Fringe Benefits + Debt Service
Gross Expenditures
The higher the ratio, the less flexible the officials
are to respond to economic changes

3. Long-Term Debt
Long Term Debt
Population
Increased levels of debt can mean that the govt
officials have a decreasing level of flexibility in
how they allocate resources (pressure on

Govt)

4. Public Safety=

Public Safety Cost

Gross Expenditures
(often one of the most costly service areas in a
country).

4. Liquidity Ratios

LR provides indicators that reveal the extent of

an agencys ability to meet current and matching
obligations. Liquidity measures the gap between
the current need for cash to settle outstanding
obligations as they become due
1.Current Ratio:
= CA/CL (2)
2. Quick Ratio:
= QA/CL (1)
3. Average collection pd
= 365

Receivable turnover

Tigris Shop is a retail store that sells outdoor

skiing equipment. Tigris offers accounts to all
of his main customers. At the end of the
year, Tigris 's balance sheet shows 20,000 Birr
in accounts receivable, 75,000 Birr of gross
credit sales, and 25,000 Birr of returns. Last
year's balance sheet showed 10,000 Birr of
accounts receivable.

The first thing we need to do in order to

calculate Tigriss turnover is to calculate net
credit sales and average accounts receivable.
Net credit sales equals gross credit sales
minus returns (75,000 25,000 = 50,000).
Average accounts receivable can be
calculated by averaging beginning and ending
accounts receivable balances ((10,000 +
20,000) / 2 = 15,000).
Finally, Tigris accounts receivable turnover
ratio for the year can be like this.

Stronger cash: increase tax/ user charge rates,

changing billing cycles (timing and/or
frequency), improving collection efforts, shifting
payment schedules, improving interest earnings
and borrowing cash
Better Budgeting: improving budget accuracy,
improving structural balance, monitoring results
throughout the year, controlling costs, improving
internal controls and using cost-benefit analysis

Continued Health: . Multi-year financial plans and

long-term capital plans are essential for longterm fiscal health.
Quality Service: Long-term strategies needed to
help restore service quality include expanding
the tax base, developing new revenue sources,
investing in infrastructure, improving budget
flexibility, planning strategically and accounting
for service costs
Other non-local revenues should also be sought.
Work with other governments to obtain
additional state aid, federal aid and sales tax
revenues

Cost benefit analysis assesses the economic

feasibility (Practicability/Possibility) of a
program or policy, or an activity.
It rationalizes decision making by examination of
objectives and the cost and benefit associated
with the program
Useful to judge the economic value of a program
or choose one program among many alternatives
(equivalent to capital projects in budgeting)
Steps:
1. Predict costs and benefits of a project

2.Compare the cost with benefit: this requires

conversion of future values of costs and benefits
to present values
3.Find the Net present Value (NPV)
4.A project is economically feasible when its NPV is
positive
If all projects produce positive NPV, the one
that has larger positive NPV should be chosen
Issues: needs achievable project objective
Objective should be measurable
Benefits must be converted to monetary gain

Tangible Benefits=1,10,000

The system starts to show a positive return during its second year of
operation. The internal rate of return is calculated as follows:
Cumulative PV Benefits + Costs / Cumulative PV Costs
= 133,686 / 348,938
= 0.383
This represents an IRR of 38.3% over the expected lifetime of the system,
or 7.66% per year.

BE Analysis is employed in public sector that are

client oriented airlines, hospitals..
Variable and fixed costs are two key elements in
determining BEP of a project or program.
BEP is determined by using;
Revenue- VC- FC = 0
Or,
BEP = Fixed cost Contribution margin/unit
Contribution margin= revenue VC per unit

Defining revenue
Revenue is the amount of money that is
brought into a company by its business
activities (Sales).
In the case of government,
revenue is the money received
from taxation, fees, fines, intergovernmental grants or transfers (Zoological
Park), securities sales, mineral
rights(Coal,Gold)and resource rights, plus
any sales(Sim Card/Air ticket) that are
made.

Public sector economic activities(Sys of

Production) include:
1. Provision of Public goods and services
(Electricity etc)
2. Allocation of Resources: Distribution of
Wealth(resources), Stabilization, and growth.
Certain goods may be discouraged/encouraged
3.Correction of market imperfections: When
private sector monopolizes, the govt. may take
over (E.g, Public utility service)

Budget depends on the capacity (how much) to tax

A representative tax system should assess the
level of personal income, the value of retail
sales and the value of property to compute fiscal
capacity.
The average tax rate for each base is computed
by dividing the total revenue derived by the total
value of the base.
Revenue Concepts;
Revenue Measure: is legal authorization to raise
revenue
Base: is an event on which revenue is collected.
E.g. income, sales
Base Measurement: Bases have to be measured
to determine the amount of revenue

Exemption(Exclusion) It is a release from an

obligation or something excluded from revenue
base. Eg.Tax exemp. for NFPs
Deduction(Reduction): is an adjustment in a
Base. Eg.TA, charity donations
Rate: Face rate Vs Effective Rate.
Revenue Liability: Adjusted Base (after
deductions) X rate
Credit: is almost a deduction
Revenue Structure: It is a relationship of
different elements. E.g. Gross Base-deductions
= Adjusted base, Adj.BaseX rate = Reve.
Liability, Rev. Liab Credit =Adjusted revenue
liability

Functions of govt revenue include:

1.
Efficient(Right time) generation of resources
2.
Fairness in the distribution of tax
burdens(Logic-Luxurious Items))
Major Taxes: Income Taxes, taxes on goods and
services, property taxes
Non tax revenues: user fee, user charge, fiscal
monopoly(VAT Import Export duties etc) and
utility revenue

Examples of user fees include highway tolls,

parking charges and national park entry fees.

User Charge:Water Supply,Sanitation etc

Rev Adm includes

Finding the base(Eg Income), Placing a value
on that base, Determining a revenue rate;
Actually collecting the revenue, Monitoring
collection procedures, Handling complaints or
appeals, Enforcing revenue collection
Managing Revenue
1. Determining Revenue needs
Revenue requirement is based on expenditure
plans.
Consider the following:
- Political Philosophy(Development
- Poverty Ele.Green Revolu)
- Community growth and development

Expanded and new programs(Metro etc)

Population characteristics and trends
Tax base components (Deductions/Exemptions)
Stability of revenue (Tax Dept.)
Tax efforts (Tax Collection Centers/Employees)
2. Fair(Business not too high or too low) and
equitable distribution(FDI) of tax burdens :
Apply ability to pay.
3. Revenue rate on the base must be responsive to
economic growth.(Demand=Supply)
4.Ensure revenue productivity
5. Revenue neutrality (Same as 2)

6. Easy to comply Revenue System

7. Revenue collection & cash mgt: Accelerate
collections and make sure that adequate cash is
available on time.
8. Maintaining controls over collections: Keep upto-date taxpayer records, make collection and
accounting separate
9. Enforcement of collection: Controlling
delinquency(Uncaring), Discovering non payers,
Auditing Taxpayers

Guidelines
Fees(Zoo) and charges should cover the cost of
service
Design policy to limit the use of one time revenue
source.
Identify unpredictable(Gift/Wealth tax) revenue
sources
Adopt a policy on revenue diversification(WiFi/Data
usage,land line)
Institutionalize multiyear projections (Telecom,
electricity)
Monitor the periodic analysis of revenue sources
Evaluate the rates and base
Periodically examine exemptions to assess the loss
Obtain consensus(agreement) on the revenue
forecast employed to estimate budgetary resources
Prepare a revenue manual.

Steps
Establish the base year, identify the collection
Projection of revenue growth trend and
identification of revenue sources characteristics
Outline the operating policy that makes the base
for revenue forecast(Eg 2000)
Validate the assumptions on which revenue
forecast is made (Same trend)
Select a forecasting method
Up date the forecasting method
Make collections consistent with the projected
revenue

Methods:
1.Expert Opinion Method: Experts in different fields
such as Economics, Accounting, Law etc will be
requested to estimate the revenue
2. Nave Forecasting: The revenue of the most
recent prior year is expected to be realized next
period
3. Best-Guess: A few experts forecast the revenue
based on their education and experience. They
may use different methods
4. Consensus Forecasting : A group of individuals and
Research firms collectively agrees on revenue
yields

This consensus forecast includes data from

numerous research firms as Mercom wanted
to present a combined view, which better
predicts the movement of the markets with
multiple insights and market knowledge.
With the world energy markets currently at a
turning point, a lot may change in the next
three months - Mercom predicts that it will
be in a positive direction for solar.

5. Delphi Forecasting: The Delphi Method

is an example of a qualitative technique
where a group of experts gets together and
reaches a consensus on what will happen in
the future. A questionnaire is sometimes used
to facilitate the process. Two disadvantages
of the Delphi Method are low reliability with
the consensus and inability to reach a clear
consensus.
6. Time Series Model: It depends on the
recent past for projecting revenue. It is
based on historical data with equally
spaced time intervals. By graphing
historical data the pattern of a revenue
source will be identified

6.Trend Analysis (Based on Historical Date): The

analyst calculates the rate of change for one
time period to the next or an average rate of
change. This rate will then be applied to the
most recent revenue yield to compute the
revenue for the next year
Change () = P2-P1
P1
where P1 the base
period, and P2 the following period
Average rate of change =(Pn-P1/P1)
n
, where
P1 the base period, Pn indicates each following
period, and n total periods in the data set

7.Moving Average: This allows the number

of past periods to be added. For a 3 yr
Moving Average, the collections of three
years (20, 25, 30000) will be added and
the total will be divided by 3. When the
next yrs figure is available(45000), add
the recent 3 amounts and divide it by 3

Planning: the process of deciding in advance what

is to be done and how
It involves determining overall missions,
identifying key result areas, and setting specific
objectives as well as developing policies,
programs and procedures for achieving them.
(Kast and Rosezweig).
- a pre requisite for effective financial
management.
Strategic Planning: the process of identifying
public goals and objectives, and deciding on the
resources to be used to attain them.

Eg:
Goal: Directly provide nutritious meals for the homeless of
Addis Ababa
Objective:Interpretation: Adequate supply of nutritious food
for the homeless
s for Goal 1:To cover 50000 homeless people of Addis Ababa
To provide them meals in packets at 100 places two times a
day
To motivate School teachers to complete the taks on time
Strategy:
Lobby Organization and use the money to achieve the
Objectives
Take a homeless person to dinner

The emphasis in strategic planning is

From a broad mission statement,
to statements of more specific goals
and objectives consistent with the organizations
mission
to more explicit policies and
implementing decisions
Strategic planning will be realized only through
management planning.
Mgt Planning involves: design projects and
programs to attain goals,

Mgt planning
the link between strategic
planning and actual performance.
Operational planning: setting standards for
the use of specific resources and on performance
tactics to achieve overall goals of the strategic
plan.

Financial planning process

Involves three major cycles:
Planning cycles, cash management cycle, and management control cycle

(1) Planning cycle: involves (Broader Area)

a) Preparing budget
b) Planning for capital(Funds/resource etc) facilities,
c) Debt financing and how are we going to administer
debt,
d) Analyzing costs by cost benefit and cost effectiveness
analysis
(fixed/variable/controllable/uncontrollable/investme
nt/ etc)

(2) Cash mgt cycle involves (Narrow Area)

a) Analyzing revenue and expenditure
Classify revenue sources and expenditure
based on public service assessment ( historical
data may be used)
a) Forecasting cash flow ( cash budget
preparation/time of availability of cash)
b) Cash mobilization (accelerating collection, control
of disbursement, avail credit facilities)
c) Planning for investments (high return, low risk,
easy convertibility, security selection)
d) Conducting financial assets analysis ( how new
programs are funded, meeting operating expenses,
adequacy of working capital)

(3) Mgt control cycle involves:

Use of accounting ( financial accounting, fund
accounting, and cost accounting) for greater
economy, efficiency, and effectiveness
Expenditure Forecasting; No single accurate
approach for expenditure forecasting
The normal procedure is projecting the cost of
current service based on population change,
inflation, staff, capital cost(Debt.), and
government policy. The base for future service
and provides continuity

Expenditure forecasting Cont

This requires:
Analysis of the major components: personnel services
( the highest cost on govt. sector); materials, supplies, and
equipment; capital improvements (financed by outright
purchase, by borrowing, or a combination of the two)
Forecasting expenditure using standard costs: Commonly used
approach
Procedures:
a)
Identify the cost item (E.g. personnel)
b)
Develop standard cost ( the most desired cost to complete
an activity)
c)
Develop a budget based on the std cost
d)
Make changes for services etc

Procedures..
Budgeting
- A road map showing where the organization is
going (Public and Private Org)
The word is derived from the French word bouge
meaning leather bag
The most common policy document at all levels of
govt. It,
- records the goals and objectives,
- defines govts total service efforts,
- measures performance, impact, and
effectiveness

Budget is a complete plan expressed in financial

terms. It includes estimates of the :
- Services, activities and projects to be
carried out
- Expenditure requirement
- Resources
A budget provides the legal base for spending and
accountability.
Revenue and expenditure information is in
structure to facilitate monitoring(Watch/Observe),
evaluation, and control of financial resources

Objectives of budgeting

Allocating scarce resources

Raising revenue
Stabilizing the economy
Holding operating agencies accountable
Controlling expenditures
Facilitating the transfer of intergovernmental
funds
Achieving planned goals
Managing programs

1.

2.

3.

Be conservative: Build in a safety factor by

tending to underestimate your income and
overestimate your expenses.
Consult other people in setting a budget:
(Experts) Budgeting requires teamwork . The task
of budgeting should be split and allocated among
those individuals who have the best chance of
knowing what expenditure is likely to be needed
and what income is reasonable to expect.
Allow plenty of time: Budgeting is not an activity
that is completed in a few hours. A good budget
may be worked on for several weeks if not months,
adding and changing figures as new information
comes to light.

4. Excellence

in documentation: the budget strive

to produce documents that can be read and
understood by anyone. Useful again in a year's
time when the budgeting process begins again
5. Equitable(Reasonable) and responsible
allocation of resources -a balanced approach
to spending decisions
- Balanced approach to allocating limited
resources
- Shared sacrifice among state agencies and
functions of government
- Minimize additional cuts in human services,
which already have been cut
disproportionately
6. Maximize available revenue -to ensure all
reasonable resources are available

Budget should be comprehensive

1. Include all estimates of revenues and
expenditures.
2.Exp. financed by external loans & grants
Such expenditures should be budgeted in the same
way as other govt expenditures It is advisable to
have one authority (MOF) to deal with loans and
grants.
3.Extra-budgetary funds
These are special funds organized under special
arrangement. E.g. Emergency Fund. These may not
be shown in the budget so as to avoid budget cuts
and budget execution problems.

However, it is better to have a link with the

national budget so as to make the payments only
through the treasury single account.

4. Off-budget expenditures

These are expenditures that are paid not through

the budgets. E.g. Extra Budgetary Funds (EBF),
Expenditure financed by external loans
5. A) Tax Earmarking : EBF may be financed by
earmarked(specific) revenues (road fund, energy
fund).

5.B) User Charges : These are charges for quasi-private

goods. The spending agencies that collect the
revenue are free to retain a portion of the
revenue.
6. Social security funds
Normally, SSF is included in the budget. If not, their
budget should be annexed to the budget of the
central govt and presented to parliament.
Other Forms of Govt Activities with Fiscal Impacts.
1.

Quasi fiscal activities:

These operations undertaken by the govt banks
include interest rate subsidies, support to ailing
industries, payment of govt debts etc. (in budget or
as annex)

2. Govt liabilities and contingent liabilities

1.
2.

3.
4.

5.

Explicit liab. & commitments such as salaries,

pensions, debt etc
Explicit and contingent liabilities(Related with
Explicit) are legal obligations triggered by a discrete
(Separate) event that may or may not occur.
Implicit Liab. : expectations such as road
Implicit & Contingent lia. : are non legal obligations.
E.g. the govt is expected to intervene in case of
natural calamities
Long term obligations except multi year legal
liabilities(Which is in continuation) are not budgeted.

3. Loan guarantees: given by the govt for loans

taken by the agencies. At least the budget should
show it as a contingent liability
4. Govt Lending: made to entities that cannot
afford borrowing at commercial terms. Loans
should be included in gross terms. Interest
subsidies must be budgeted as an expenditure
5. Tax expenditures: revenue foregone because of
preferential provisions of the tax structure. E.g.
exemptions, deductions etc.
The direct impact of tax expenditures should be
budgeted

Accrual Vs Cash budgeting

Accrual: more comprehensive, easier to understand, favored by
credit rating agencies, harder to manipulate, comparable and
consistent, includes liability disclosure (IMF appreciates)
2. Gross Terms: Govt activities (including its business activities),
expenditures and revenues should be shown in the budget in gross
terms
3. Annual nature of the budget (Eg.10 Year Budget)
A longer period may lead to uncertainty
4) Budgeting treatment of Entitlement programs
Entitlement programs or demand-led programs depend on
various economic and demographic parameters. Thus, social security
payments and debt servicing are authorized under special
legislation
1.

Operating Vs capital budgeting

Op Budget is an estimate of expenditures (salaries,
wages, contractual services, materials, and
supplies and other consumables) that must be
balanced against the recommended revenue
program.
-a basis for evaluating competing
requirements for limited financial resources.
- facilitates the scheduling of work
Capital budget : A budget to meet long term needs
for public improvements and the means of
financing these commitments. (often supported
by capital improvement program)

Capital Budgeting is a process used to evaluate

investments in long-term or capital assets.
Capital Assets
have useful lives of more than one year;
analysis requires focus on the life of the asset;
low-cost, long-lived assets are not usually
subjected to the capital Budgeting process;
cost often makes it necessary for the
organization to
finance the asset using long-term financing
from capital
campaigns, mortgages, longterm loans, leases, and equity offerings.

What are capital assets?

They are used in the production or supply of

goods and services (productivity criterion),
Their life extends beyond a fiscal year
(longevity criterion)
they are not intended for resale in the ordinary
course of operations
Their treatment as a capital assets is of value
(materiality principle)

Why Prepare a Capital Budget?

Since the investments are large, mistakes can be

costly.
Since capital acquisitions lock the organization in
for many years, bad investments can hamper
the organization for
many years.
Since capital assets have long lives, they must be
looked
at over their lives. Operating budgets do not do
that.
Value on accrual basis .
Since the cash the organization uses to buy the
capital
asset is not free, managers must include the
cost of that money in their analysis.

Characteristics of CB
1.Capital Expenditure for Long Period: This longterm commitment adds considerably to the risk
of capital budgeting decisions. Most capital
expenditure schemes call for a permanent
commitment of relatively large sums of money
over a number of years.
2.A firms future profitability and growth are
linked to the soundness of its capital expenditure
policy
3. The capital expenditure budget embraces an
organizations plans for replacing, improving and
adding to its capital equipment.

4.good estimates of the rate of return on capital

expenditure projects presuppose an
understanding of the economic concepts that
underlie sound investment decisions.
5. Increases the Breadth of Analysis Leading to
Decision Making
6. As funds are committed over extended periods
of time, there is a need for proper forecasting.
There is an element of uncertainty and risk
which may lie in store for the future. All these
factor have to be properly evaluated in the
process of forecasting. A proper cost-benefit
relationship should also be established.

7. A firm has to assess the capacities of the assets

properly before arriving at its long-term decisions. An
organization should, therefore, plan and fix the
capacities of its assets in which long-term investment
is going to be sunk.
Capital facilities planning
Capital projects should be carried out in accordance
with a system of priorities reflecting both public
needs and the governments ability to pay. A
systematic approach includes the following:
1.Careful planning of capital improvements: Sound
budgetary decisions/Avoid excess debt commitments

2. Strong citizen participation in the capital facilities

planning process
3. Intergovernmental cooperation
4. coordination among the various departments and
agencies
5. Forecast Community Growth And Change
Income levels, household size and other
demographic characteristic provide vital
information as to facility needs and service
expectations. E.g. An aging population needs
special health care facilities
Population may be grouped into different categories
based on age sex etc. to identify their needs.
Programming of CB should be based on priorities.

Steps in developing CB
1.
Inventory and assess the existing condition of
capital assets
2.
Develop alternative projects to meet short and
long term needs
3.
Select alternatives and establish priority
4.
Estimate the required resources
5.
Assess the impact on the govt organizations
financial policies
6.
Establish a monitoring system
7. Initiate a replacement and maintenance
strategy

1.
2.
3.
4.
5.
6.
7.
8.

Determine the investment needs of the organization

Determine the investment opportunities that meets the
needs of the organization
Gather the relevant information concerning the
investment opportunities to be evaluated
Determine the methods to be employed in evaluating
the investment proposals
Calculate the results for the methods using the relevant
information
Determine the criteria to be used for deciding whether
an investment proposal to be accepted or rejected
Determine which investment meets the criteria for
acceptance
Determine the means for financing the investment

CB Analysis aims at identifying the projects with

maximum social benefit. The process consists of
the following steps:
1. Identification of relevant investment
alternatives: clearly understand various
investment choices
2. Estimating the cash flow: Consider cash inflows
and outflows
3. Selection of criteria to apply to cash flow
4. Arrange data and select projects with maximum
social benefits

CB Criteria
1. Simple rate of return ( Average rate of return)
ARR= Average net income Investment
ARR= (Av Cash flow Depr) Investment
If ARR is greater than required rate of return, the
project is accepted
2.Pay Back period : Estimated time required to
recover the investment. The project with short
payback period is selected

3.Net Present Value: NPV =(CF x Pr. Value Factor)

I
Project with positive NPV is accepted. If many
alternatives have positive NPV, the one which the
highest NPV is selected
4. Internal rate of return (discounted rate of
return): Rate of interest equal to NPV of a series
of cash flow payments is equal to zero. If a
projects internal return is greater than the cost
of capital, the project can be accepted
0= - INV +
P1
+ P2
+ Pn
(1+i)
(1+i)2
(1+i)n

Purchasing is concerned in public and NFP

orgns with the acquisition of all goods and
services except those provided directly by
employees of an organization.
It seeks to procure goods and services to
achieve maximum value for the resources
expended.

Objectives of purchasing system

Maintain adequate supply of materials at
all times
Developing measures to evaluate the
purchase performance function
Working individually and collectively with
vendors to achieve cost reductions
Conducting cost-benefit studies to
determine insourcing or outsourcing

Automating procedures to increase efficiency

Develop training programs for purchasers
Employ team-buying and other techniques
for effective performance
Arrange for alternative supply systems
Use a benchmarking system to achieve best
results

Attributes
Should have a purchasing manual
Have a purchase requisition system
A purchase order system to communicate
commitment to vendors and to accounting
and other depts
A list of employees authorized to request
purchases with dollar limits

A pre-audit system before issuing the

purchase order
A system for evaluating bill-type purchases
A system to speed up overdue orders
A system to locate suppliers who can satisfy
purchaser in cost, delivery, quality

Public organizations have to consider..

Items to buy: should be based on activities
Procedures for Buying: A set procedures have
to be developed. Public accountability
should be paid attention
Cost of Purchase: Purchase should be at the
lowest cost

Functions of purchase department

Identifying an ideal source of supply
Decision making on procurement based on
price and market
Follow the legal procedures for
purchasing
Review the policies and procedures
Maintain strong relationship with vendors
Represent the orgn in bidding process
which includes evaluation of bids

Right Quality : Specifications, standards

Right quantity: Quantity requested and
quantity ordered may be different
Right Time: Avoid delays
Source Decision making: right source
Price: Discounts have to be checked
Purchasing negotiations:Skill in negotiations

Specify quantities
Prepare purchase requisition
Selecting sources
Soliciting bids
Analyzing bids
Issuing Purchase orders

Following up purchase orders

Receiving and inspecting goods and services
Making payment for goods
Storage and Inventory control are also
included in the purchasing process

Benefits..
It induces lower prices of goods
Encourages the streamlining management
Improves administrative functions through
better planning and control, standardization
of materials, and improved funding
techniques.

Ensure that goods on the purchase order are

received
Examine the goods to see if they have been
tampered
Check damage in the bill or packing slip
Forward a copy of the receiving report to the
accounting dept.

Common Indicators are:

- Volume of rejected pur. due to defects
- Ratio of price variance to bud.purchase
- Adm. Savings from purchase orders
- Ratio of purchasing employees and
total employees
- Reduction in rush orders
- Cost reduction

Competitive Bidding
Bids are through ad.
There may be many suppliers
Competitive sealed proposals
Formal ad is not there(No general call)
Solicitation of proposals from select
group of vendors

Negotiated bids
Formal ads may or may not be there
Bids are subject to adjustment before final
acceptance.
Used mainly for professional services
Noncompetitive Negotiations
Used when only one source exists

Cost of purchasing includes..

Purchase costs, Ordering costs, Carrying
costs, Stock out costs
EOQ : the right quantity of materials to be
purchased. EOQ= 2AP/C
Safety Stock: guard against late deliveries
and such other problems that would occur
between the placement of an order and
its delivery.

Reorder Point: sum of the average usage

during lead-time plus the safety stock.
RP =
Av. daily usage during lead time
+ safety stock
OR= (Av. Daily usage x Lead Time) +
safety Stock
JIT purchasing: requires accurate inventory
information system, highly efficient
purchasing, very reliable suppliers and an
efficient material handling system.

Reduction in operating costs

Improvement of cash flow
Enhancement of quality
Reduction in inventory obsolescence
Improvement in space utilization
Enhancement of productivity

It involves many interrelated process

1.
Planning: deciding the type of assets
2.
Procurement: Purchasing procedures
3.
Operations and Maintenance
(control,preventive and corrective
maintenance, monitoring, training of staff
to use the asset and record keeping)

4. Replacement
Alternatives such as leasing, outsourcing
etc should also be considered
5. Disposal
Keeping used assets is costly
Disposal should be at the lowest cost

The central register should contain:

Date of acquisition
Description of the asset
Accountability (manager, program etc)
Capacity, useful life, warranties
Actual cost, depreciation rate
Disposal information such as residual
value

CM ensures adequate cash availability

CM secures yield on the short term
investment of cash
CM focuses on the conversion of A/c R to
cash receipts, the conversion of A/c P to cash
payments, the rate at which cash
disbursements clear bank account and what
is done with the cash balances

CM avoids:
Liquidity crisis: when an organization has
insufficient cash to meet its obligations

Inability to accelerate receivable

collections and to deposit

The failure to invest funds:

The cash to be held must be determined on

the basis of two costs:
The opportunity cost of not investing
The cost of collecting and reviewing
information required to invest, disinvest,
borrow or repay loans.
The basic CM problem is to balance these
two types of conflicting costs

The attitude of public managers holding

sufficient cash is changing due to increasing
costs of borrowing and the expansion of
activities.
Today they minimize cash holdings,
accelerate cash inflows & control outflow

Elements of Cash Management:

1. Policy Objectives and Constraints
- Policies set the legal guidelines for
daily
cash management
- Within the policies, the cash manager
should set specific objectives such as cash
levels, desired yield, cash to invest
- Constraints include restrictions on
money collection, payment, investment
by funding agencies etc

2. Forecasting
- is the ability to calculate, predict or plan
- forms the basis for cash budget
- constraints for preparing cash budgets
include : (1) ill coordinated revenue and
expenditures, (2) heavy cash inflow and idle
cash just before the penalty dates

3.Investment Strategy
- what to purchase, when and how long, and
the mix of securities.
- schedules and guidelines for purchasing
securities
- Indicators to assess the cash managers
achievements

4.Bank Relations
- Maintain good relations with banks, loan
associations, security analysts, dealers in
commercial papers
- Select a bank on competitive basis
- Consider the cost of bank services and the
compensating balance requirements

5.Tracking Investments
- Maintain investments using an up-to-date
tracking system of all outstanding
investments.
- The system should be capable of providing
information on money invested, maturity
schedule, yield generated (ing)

6.Cash Flow Planning and Analysis: to manage

cash and cash-equivalent current assets
wisely so as to maintain adequate liquidity.
- Analyze cash flow
- prepare cash flow statements
Methods of preparing CF statement: Direct,
Indirect

Direct: Divides cash flow into: cash flow from

- Operating activities: includes all
revenues, fees, and contributions, and all
cash paid for resources consumed to provide
goods and services.,
- investing activities: involves acquisitions
of long-term assets during a fiscal period.

- Financing activities: reports cash flows

resulting from debt.
( All cash transactions affecting the balance
sheet and income statement are placed in
the appropriate categories).
Indirect method: cash flow is determined from
changes in current assets, current liabilities
and other accounts.

CF using Indirect method

Net Income/Surplus.
+ Depreciation
- Increase in current assets (A/c R &
inventory)
+ Decrease in current assets (a/c R &
Inventory)
+ Increase in current liabilities (A/c P)
- Decrease in current liabilities (A/c P)
= Cash flow from operating activities.

Cash Budget requires identification of

specific receipts and disbursements as
well as relevant dates.
Prepared on a weekly, monthly, quarterly,
or semi annual basis
usually two supporting schedules,
namely a schedule of receipts, and a
schedule of disbursement are prepared
prior to the cash busget

7. Cash Mobilization
a) Accelerating collections:
- Mail, Processing, and clearing floats
- Cost of float=Amt X Op.costXdays/360
Techniques for accelerating collections:
Concentration Banking, Lockbox services,
Preauthorized check

b) Controlling disbursements
- Timing of payments.
- Better control on payments can be made
if bank accounts of various local govts are
brought to one central account
- Consider the disbursement float

c) Controlling bank balances

-Avoid accumulating idle cash in banks
- Banks should be ordered to send reports
on collections and payments daily or at
regular intervals
- Decide on the extra cash

Monitoring and Evaluation

- Important inflows and outflows should be
monitored periodically
- Evaluate the performance of the cash
budget managers
- Make sure that the internal control system
is strong to control cash