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Managing the Budget Process

There are special considerations when managing a budget during a time of financial distress and recovery. This section of the site describes those considerations for the major elements of budget management.

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Line-item controls

Budget transfers

Rescissions

Salary Savings

Budget amendments

Informal Contingencies

Position controls

Formal Reserves

Encumbrance controls

 

Line-item controls

Questions. At what level should controls be established (e.g., at the line-item level, at object of expenditure level, etc.)? What factors should be considered when deciding on the appropriate level of controls?

Answers. Usually, controls at a very low level of the chart of accounts (e.g., line-item level) will cost more to administer and manage than they will bring in benefits. Instead, consider setting controls for major areas of expenditure like operations and maintenance of assets or salaries. More detailed controls focused on specific problem areas, like overtime, might also be helpful.

Then, give managers their spending parameters within those categories. Where possible, try to remove sources of expenditure that are not under a manager’s control from the number they are responsible for managing to. This will make the accountability they are assigned more meaningful and realistic. Then, provide managers with the tools to manage their budget, like good financial reports.

If managers cannot operate within the parameters they have been given, then apply more stringent controls to those that are not meeting their responsibility. For example, these managers may be required to report the reasons for the negative variance and their corrective plan at a public meeting. Or, they may be subjected to controls on lower levels of the budget. No matter the control sanction chosen, there should be a clear path for managers to be reinstated with the less stringent controls, provided that they demonstrate the requisite accountability.

Finally, consider who will operate the controls. If a department has a demonstrated track record of operating and adhering to controls, perhaps it can have larger role in operating them (while adhering to the essentials of good control design, like separation of duties). A greater centralization may be called for when departments do not have a good track record.

Rescissions

Questions. If mid-year budget cuts are needed, what factors should be taken into account when deciding how to make the cuts? Is there a preferred cutback approach?

Answers. For small cuts, (e.g., 5 percent or less), across-the-board cuts may be acceptable because they can be done quickly. Also, even though across-the-board cuts are not targeted or strategic, the magnitude will probably not be large enough to seriously unbalance the organization. For larger cuts, make cuts according to the priorities that were used to originally decide the budget. If the budget was not driven by a strong set of priorities, then don’t try to define priorities in the middle of the year. The situation is probably too tense and rushed to go through a new process that will be seen as credible and legitimate. In this case, use the recovery strategy to guide the cutback decisions as much as possible.

Make judicious use of bridge financing to support sensible cuts (e.g., make a soft landing instead of a crash landing) and use rescissions as an opportunity to target cuts in problem areas. Use scenario planning and forecasts to give the board cutback options that are consistent with the recovery strategy. Look for opportunities to make changes that will benefit the organization in the long term, as well as the short term. When looking for opportunities, be aware of limitations like collective bargaining agreements, but don’t regard them as an insurmountable barrier. It could be that mid-year budget crisis is the catalyst needed to make real changes.

Finally, make sure you are very clear on which cutbacks are a deferral of expenditures and which area requires permanent structural reduction. This way, with good forecasting, you will know what kind of budgetary pressure you may face in the future.

Budget amendments

Questions. Should amending the budget be handled any differently in periods of financial distress? Is there a stronger case for formal versus informal amendment procedures?

Answers. The amendment process can be essentially the same one that has been used in the past. This is because time is critical, so it will likely be easier to streamline an existing process than develop a new one.

The key to a successful budget amendment is contingency plans. Use your regular budget process to develop contingency cutback strategies so you will have them ready if they are needed later in the year.  

Formal amendments are not any more necessary than usual – in fact, they may even be disadvantageous because they require a number of steps that take time away from forecasting, analysis, strategy development, etc. Try to avoid formal adjustments unless the budget reduction is large, likely permanent, and/or in an earmarked source of revenue. A formal amendment might also be called for if the governing board would like to use the process to make a public statement on how the organization is handling financial pressure. If the amendment is to be formal, be sure to take into account important external events that impact the budget, like mid-year tax receipts (e.g., don’t amend the budget before you know what the receipts will be).

Position Controls

Question. How should position control be used in a financial recovery situation?

Answer. Because government personnel costs are significant, there are many nuances for using position controls during financial distress.

A critical factor is how vacancies are budgeted. Assuming zero vacancies will provide some cushion, which might help avoid layoffs later in the year if revenues underperform forecasts. However, a zero vacancy assumption will make it more difficult to balance the budget initially. Whatever the decision, be sure that vacancy assumptions are transparent, widely understood, and that there is clear strategy for how vacancies will be handled during the year (i.e., who approves filling a position, where will vacancy savings go?).

Use position control to make sure you are getting real, permanent savings from cutback tactics. Differentiate between permanent and temporary cuts (e.g., holding a vacancy vs. eliminating a position) and use the position budget to make sure permanent cuts really are permanent by eliminating the positions.

Use position control decisions to realize the long-term recovery strategy. The recovery strategy will often include prioritization of services and a reformed organization structure. Use position control to achieve the envisioned end-state by budgeting and filling positions that are consistent with the recovery strategy. This could work through attrition or layoffs, but the latter is obviously more traumatic to the organization.  

Make sure you have realistic pay ranges and that employees are not being moved too rapidly through them, a situation that might contribute to financial pressure.

Develop a multi-year staffing plan to complement/connect to the multi-year financial plan. The plan need only describe headcount at a high level (e.g., organization-wide). The intent is to generate discussion about the proper level of staffing given community needs, service goals/trends, and available resources.

Encumbrance Controls

Questions. How can encumbrance controls contribute to the recovery process? Are there any particular aspects or elements of encumbrance control that should be emphasized in a financial recovery situation?

Answers. Encumbrance controls might be a vehicle for encouraging buyers to be more aggressive in their negotiations with vendors. For example, the approval process might be amended to require a best-and-final-offer from the top two vendors before making a decision. These sorts of changes are important for encouraging a culture of frugality in the organization.

Encumbrance controls can also be used to help predict end-of-year financial position more precisely. For example, if history tells you that a certain percent of the budget is typically encumbered at year end, but that number is now significantly different, it may signal the need for further investigation.

Budget Transfers

Questions. What is the role of budget transfers in a recovery? How do you ensure transfers are used constructively?

Answers. Transfers can serve as a temporary bridge, but you need a clear idea of where the bridge is leading to. Hence, budget transfers should be guided by a long-term financial strategy. Transfers should also be guided by a policy that governs the length of interfund loans and the interest rate.

If a transfer is intended to be a subsidy, then the governing board should have an explicit policy about planned subsidies in the budget. It is better to know ahead of time that a certain program or fund will need additional support than to discover it at the end of the year. It is also important to recognize in a policy the importance of critical transfers, such as those made to a self-insurance fund. This will help make sure these transfers aren’t targeted as a source for bridge financing.

Have a clear and defensible cost allocation strategy and make sure the definition is consistently applied. Otherwise, cost allocations could turn into hidden subsidies that make it harder to understand and manage financial position.

Salary Savings

Question. What guidelines or policies are recommended for using salary savings during the financial recovery process?

Answer. Primarily, be explicit in your budget assumptions about what your vacancy assumptions are and what the policy is for salary savings. Then be consistent in the application of those assumptions and policies. The content of the assumptions and policies can vary according to local circumstances. For example, if there are strong controls on spending, including controls that proscribe one-time sources from financing ongoing needs and that align special project spending with the organization’s strategic goals, then perhaps departments can be given more discretion over the use of these funds. In other cases, perhaps savings will need to be centralized so that they can be directed to uses specified by the recovery plan. 

Informal Contingencies

Question. How do you manage informal “contingency” funds that are often built into budgets during times of financial distress?

Answer. There should be a pre-defined process and policy for how contingencies will be used. For example, perhaps all contingency uses must be approved by the CEO.

Creating accountability for staying within budget (perhaps including sanctions like those described under line-item controls, will help reduce demand from departments to use the contingencies.

Also, strongly consider taking steps to consolidate contingencies across the budget. Thus, the total contingency in the budget will likely be less (after removing redundancies), making it easier to balance the budget at the beginning of the year.

Formal Reserves

Questions. How do you use reserves in your recovery? What are the keys to a strong reserve strategy?

Answers. Foremost is to adopt a credible fund balance policy with a target reserve size that is seen as legitimate so that the reserve does not become a go-to source of funding to relieve fiscal stress. Key to this is making sure the policy is widely understood and agreed to when it is adopted. Also, the policy should define clear purposes for the reserves and the criteria for using them.

Next, develop skills for good reserve management. Primarily, develop skills for revenue forecasting and analysis and distinguishing between short- and long-term changes in revenue yields and estimating the magnitude of these changes. That will help you recognize and estimate needs to use reserves to cushion financial shocks.

Finally, describe how reserves figure into your recovery strategy. Are they being used as bridge financing? For how long will the reserves be used and in what amount? Where does the bridge lead to? The recovery strategy should also address how to replace reserves that are used, including how they will be replaced and when they will be replaced.

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