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Nonprofit Budgeting Explained

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3 views32 pages

Nonprofit Budgeting Explained

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jwjord

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Chapter 10 Budgeting 487

Chapter Capital expenditures ordinarily have an impact on operating costs. For this
reason, there is an important link between the capital budget and the operating
budget. For example, if a capital expenditure was approved because it would
lead to some labor savings, senior management must be certain that line man-
10 agers include those labor savings in their operating budgets. Similarly, if the
capital budget includes some expenditures for new equipment as part of a new
program, there no doubt will be new operating costs and new revenues asso-
ciated with the new program. Senior management should expect these to be
included in the operating budget.

Budgeting General Nature of the Operating Budget

The operating budget is always for a specified period, usually one year, al-
though some organizations use a different time frame.2 For example, some
A budget is a plan expressed in monetary terms. There are essentially three states, such as Nevada, prepare a biennial (once every two years) budget. By
types of budgets: (1) the capital budget, which lists and describes planned contrast, some theaters have semiannual budgets: one for the winter season
capital acquisitions, (2) the cash budget, which summarizes planned cash re- and one for the summer season.
ceipts and disbursements, and (3) the operating budget, which describes
planned operating activities. Relationship between Strategic Planning and Budgeting
The general character of the budgeting process in a nonprofit organization
In concept, operational budgeting follows, but is separate from, strategic
is similar to that in a for-profit one. There are significant differences in em-
phasis, however. This chapter focuses on both the similarities and the differ- planning. The budget is supposed to be a "fine tuning" of an organization's
ences. We put most of our emphasis on the operating budget. The capital programs for a given year. It incorporates the final decisions on the amounts
budget is derived more or less automatically from decisions made during the to be spent for each program, and specifies the organizational unit that is re-
sponsible for carrying out each program. In some organizations, these deci-
strategic planning process, as described in Chapter 9; we discuss it briefly to
sions take place within the context of basic decisions made during the
show its link to both strategic planning and the operating budget. The cash
budget is derived from the operating budget, and forecasts planned cash flows strategic planning process. in most organizations, however, no such clean sep-
on a monthly (or sometimes more frequent) basis during the operating year. aration between strategic planning and budgeting exists. Even organizations
that have a well-developed strategic planning process frequently discover cir-
We do not discuss the cash budget in this chapter.'
cumstances during budgeting that require revisions of program decisions. In
organizations that have no recognizable or separate strategic planning activity,
The Capital Budget program decisions are made as part of budgeting.
Despite this overlap, it is useful to think about the two activities separately
The capital budget contains a list of capital projects that are proposed for fi- because they have different characteristics. As discussed in Chapter 9, strate-
nancing during the coming year. In effect, the capital budget includes all ac- gic planning decisions typically have multiyear consequences. The purpose of
quisitions of long-lived assets planned for the year. budgeting, by contrast, is to decide on the details of the actual operating plan
In most organizations, items to be included in the capital budget emerge for a year. Budgeting requires careful estimates of expenses and revenues, us-
from decisions made during the strategic planning process. If the total ap- ing the most current information on prices of both outputs and inputs. More-
proved capital expenditures are larger than can be financed, senior manage- over, a budget usually is formulated within a ceiling of estimated available
ment must reduce the capital budget. Since capital projects affect program resources.
execution for years to come, such reductions require careful consideration.
2
Budget (or fiscal) years end in different months of the calendar year. In colleges and
universities, for example, the fiscal year usually ends June 30, July 31, or August 31. In
nongovernment organizations, the budget year is usually the calendar
year. In the federal
"'The Menotomy Home Health Services" case in Chapter 4 required the preparation of a government, the fiscal year ends September 30. In many state and local governments the
cash budget. fiscal year ends June 30.
Chapter 10 Budgeting 487

Budgeting General Nature of the Operating Budget

Since a budget is a plan against which actual performance is compared, Spending Flexibility
senior management must be certain that it corresponds to individual responsi- In a for-profit company, a budget is a fairly tentative statement of plans. It is
bility centers. As such, the budget provides a basis for measuring the per- subject to change as conditions change, and such changes, particularly in the
formance of responsibility center managers. If a program is to be used as a volume and mix of sales, can occur frequently during the year. Furthermore,
basis for performance measurement, senior management generally must des- there is general agreement on the way managers should react to such changes;
ignate it as a responsibility center. Otherwise, responsibility for many of a pro- they should make revised plans that are consistent with the overall objective
gram's elements may be too diffused throughout the organization to permit the of profitability.
measurement of the performance of any given manager. In many nonprofit organizations, conditions are more stable and predictable.
In a university, the number of students enrolled in September governs the pat-
Two-Stage Budgets tern of spending for the whole year. A hospital gears up for a certain number of
This chapter refers to the operating budget as if there were only one. In gov- beds, and, although there may be temporary fluctuations in demand, these or-
ernment organizations and some other nonprofit organizations, there actually dinarily do not cause major changes in spending patterns. A federal agency or
are two budgets. a public school system has a certain authorized program or set of programs for
1. The legislative budget is essentially a request for funds. It does not cor- the year that it must carry out. Under these circumstances, the budget is a fairly
respond to the budget that is prepared in a for-profit company. Its closest accurate statement of both its activities and the resources to be used. It is there-
counterpart is the prospectus that a company prepares when it seeks to raise fore important to prepare the budget carefully. Much time, including much
money. Most media reports about government budgets relate to the legislative senior-management time, should be devoted to it.
budget, and many textbook descriptions of government budgeting focus on
this budget. Components of the Operating Budget
2. The management budget is prepared after the legislature has decided on
the amount of funds that is to be provided (or, if the legislature is dilatory, it is
The numerical part of the operating budget (which is often supplemented by
prepared as soon as the executive branch can make a good estimate of what
explanatory text) consists of three components: (1) revenues, (2) expenses and
the legislature eventually will approve). This budget corresponds to the budget expenditures, and (3) output measures.
prepared in a for-profit company; that is, it is a plan showing the amount of
authorized spending for each responsibility center. If the amount of revenue is Revenues
known within reasonable limits , the management budget can be an accurate
reflection of the organization's plans for the year. Our discussion concerning As we discussed in Chapter 2, the general purpose of a nonprofit organization
the operating budget focuses almost exclusively on this management budget. is to provide as much service as it can with available resources. In many non-
profit organizations, the total amount of resources (revenue) in any given
budget year is, for all practical purposes, confined within quite narrow limits.
Contrast with For- Profit Companies The approach to budgeting, therefore, is to decide how best to spend it. This
Budgeting is an important part of the management control process in any suggests that the basic approach to budgeting should be, first, to estimate the
organization. It is even more important in a nonprofit organization than in a available resources-that is, revenues-and, second, to plan spending to
for-profit company, however, for two reasons-cost structure and spending match those resources.
flexibility. Most managers would agree that the policy of anticipating revenues first,
and then budgeting expenses below or equal to them, is fiscally sound. The
Cost Structure policy also provides a bulwark against arguments, often made by highly artic-
In a for-profit company, particularly a manufacturing company, many costs ulate and persuasive people, that an organization should undertake a program
are engineered. The amount of labor and the quantity of material required to even though it cannot afford to do so.
manufacture products are determined within close limits by design and engi- In federal or state governments, application of this principle requires that
neering specifications. Consequently, little can be done to affect these costs public managers make careful estimates of the level of funds that the legisla-
during the budgeting process. By contrast, in most nonprofit organizations ture is likely to appropriate. In state and municipal governments, it requires
many costs are discretionary; that is, the amount to be spent can vary widely judgment as to feasible taxation and other revenues. In other organizations, it
depending on management's decisions. Many of these decisions are made dur- requires estimating the revenues to be derived from fees charged to clients,
ing the budget formulation process. gifts and grants, endowment earnings, and other sources.
488 Part Three Management Control Systems Chapter 70 Budgeting 489

Since a budget is a plan against which actual performance is compared, Spending Flexibility
senior management must be certain that it corresponds to individual responsi- In a for-profit company, a budget is a fairly tentative statement of plans. It is
bility centers. As such, the budget provides a basis for measuring the per- subject to change as conditions change, and such changes, particularly in the
formance of responsibility center managers. If a program is to be used as a volume and mix of sales, can occur frequently during the year. Furthermore,
basis for performance measurement, senior management generally must des- there is general agreement on the way managers should react to such changes;
ignate it as a responsibility center. Otherwise, responsibility for many of a pro- they should make revised plans that are consistent with the overall objective
gram's elements may be too diffused throughout the organization to permit the of profitability.
measurement of the performance of any given manager. In many nonprofit organizations, conditions are more stable and predictable.
In a university, the number of students enrolled in September governs the pat-
Two-Stage Budgets tern of spending for the whole year. A hospital gears up for a certain number of
This chapter refers to the operating budget as if there were only one. In gov- beds, and, although there may be temporary fluctuations in demand, these or-
ernment organizations and some other nonprofit organizations, there actually dinarily do not cause major changes in spending patterns. A federal agency or
are two budgets. a public school system has a certain authorized program or set of programs for
1. The legislative budget is essentially a request for funds. It does not cor- the year that it must carry out. Under these circumstances, the budget is a fairly
respond to the budget that is prepared in a for-profit company. Its closest accurate statement of both its activities and the resources to be used. It is there-
counterpart is the prospectus that a company prepares when it seeks to raise fore important to prepare the budget carefully. Much time, including much
money. Most media reports about government budgets relate to the legislative senior-management time, should be devoted to it.
budget, and many textbook descriptions of government budgeting focus on
this budget. Components of the Operating Budget
2. The management budget is prepared after the legislature has decided on
the amount of funds that is to be provided (or, if the legislature is dilatory, it is
The numerical part of the operating budget (which is often supplemented by
prepared as soon as the executive branch can make a good estimate of what
explanatory text) consists of three components: (1) revenues, (2) expenses and
the legislature eventually will approve). This budget corresponds to the budget expenditures, and (3) output measures.
prepared in a for-profit company; that is, it is a plan showing the amount of
authorized spending for each responsibility center. If the amount of revenue is Revenues
known within reasonable limits , the management budget can be an accurate
reflection of the organization's plans for the year. Our discussion concerning As we discussed in Chapter 2, the general purpose of a nonprofit organization
the operating budget focuses almost exclusively on this management budget. is to provide as much service as it can with available resources. In many non-
profit organizations, the total amount of resources (revenue) in any given
budget year is, for all practical purposes, confined within quite narrow limits.
Contrast with For- Profit Companies The approach to budgeting, therefore, is to decide how best to spend it. This
Budgeting is an important part of the management control process in any suggests that the basic approach to budgeting should be, first, to estimate the
organization. It is even more important in a nonprofit organization than in a available resources-that is, revenues-and, second, to plan spending to
for-profit company, however, for two reasons-cost structure and spending match those resources.
flexibility. Most managers would agree that the policy of anticipating revenues first,
and then budgeting expenses below or equal to them, is fiscally sound. The
Cost Structure policy also provides a bulwark against arguments, often made by highly artic-
In a for-profit company, particularly a manufacturing company, many costs ulate and persuasive people, that an organization should undertake a program
are engineered. The amount of labor and the quantity of material required to even though it cannot afford to do so.
manufacture products are determined within close limits by design and engi- In federal or state governments, application of this principle requires that
neering specifications. Consequently, little can be done to affect these costs public managers make careful estimates of the level of funds that the legisla-
during the budgeting process. By contrast, in most nonprofit organizations ture is likely to appropriate. In state and municipal governments, it requires
many costs are discretionary; that is, the amount to be spent can vary widely judgment as to feasible taxation and other revenues. In other organizations, it
depending on management's decisions. Many of these decisions are made dur- requires estimating the revenues to be derived from fees charged to clients,
ing the budget formulation process. gifts and grants, endowment earnings, and other sources.
490 Part Three Management Control Systems Chapter 10 Budgeting 491

Discipline Required for a Revenue-First Policy such as tenured faculty appointments, when they will be financed by hard
Carrying out a revenue-first policy requires considerable discipline in two re- money. By contrast, revenue from annual gifts or short-lived grants for re-
spects. First, it requires a careful and prudent estimate of total revenues from search projects is soft money. In a recession, gifts may drop drastically and
all sources, including clients, grants, contracts, third-party payers, and en- grantors may decide not to renew their grants. Managers must be careful about
dowment earnings. Once this figure has been established, it is "locked in" making long-term commitments that are financed with soft money.
Second, it requires a commitment to engage in cost cutting if necessary.
Exceptions to the Revenue-First Policy
That is, if the first approximation to the budget indicates a deficit, the least
painful course of action is to anticipate additional sources of revenue that will The policy that budgeted revenue sets the limit on expenses is not applicable
eliminate it. This is a highly dangerous course of action. If the original rev- under certain conditions. Some of these are discussed below.
enue estimates have been made carefully, all feasible sources of revenue were
The Federal Budget The considerations mentioned above do not apply to
included. New ideas that arise subsequently may produce additional revenue,
the federal budget. This budget may be either a surplus or a deficit. The amount
but the evidence that they will do so usually is not strong. If they do not pro-
of either is determined by the administration's conclusion (with the concur-
duce the additional revenue, operations may proceed without taking the steps
rence of the Congress) as to the proper fiscal policy in a given year. The federal
needed to balance revenues and expenses. The safer course of action is to take
government rarely plans for a balanced budget.
whatever steps are necessary to bring expenses into balance with revenues.
Discretionary Revenue In some organizations, management has an ability
Some churches and religious organizations adopt a "God will provide" ap-
Example to increase revenues. For example, it may be able to increase revenues from
proach to budgeting. Many have discovered, much to their dismay, that
the Lord works in mysterious ways. current gifts by an intensified fund-raising effort. This idea of "spending
money to make money" is the nonprofit counterpart of a for-profit company's
During one fiscal year, the Baltimore Ballet budgeted its expenses first, and marketing budget. To the extent that this argument is valid, it is appropriate to
then compared them with estimates of earned revenue. The excess of ex- speak of discretionary revenue as well as discretionary expenses. Ordinarily
penses over earned revenue was deemed "to be raised" through contrib- such opportunities are not of major significance, however. In most situations,
utors. This sum was overly optimistic as were estimates of earned revenue. the organization has already used all the fund-raising devices that it can think
Although monthly statements indicated unfavorable revenue and expense of, and managers must take the probable revenues from such efforts as a
variances, no corrective action was taken by the board for eight months. given, not subject to major upward revision.
The result was a deficit of several hundred thousand dollars.; Anticipated Revenue Some organizations such as universities, research in-
stitutes, and social service agencies include anticipated grant revenues in their
Preliminary versus Final Budgets budgets. This is because they frequently apply for grants, but do not learn
Some college and private school boards approve a preliminary budget in early whether the funds will be approved until well into the fiscal year. If the budget
summer, just prior to the beginning of their fiscal year. This gives department were prepared only on the basis of known revenues, key professional staff
heads the spending authority needed to prepare for fall classes. In September, might be laid off, obtain employment elsewhere, and not be available if the
once actual enrollments are known with almost total certainty, they prepare a grant is awarded. Thus, some organizations decide to incur deficits in antici-
final budget. This final budget uses total revenue as the ceiling for total ex- pation of receiving grant awards. Such a strategy is risky and clearly can be
penses. Such a process works if the total revenue is known with considerable sustained only if grants of sufficient magnitude are received.
certainty early in the fiscal year, and if line managers have enough discre- Some years ago, New York University embarked on a major expansion
Example
tionary items in their budgets (such as part-time faculty) so they can make program. Substantial amounts of additional revenue were obtained from
cuts if necessary. additional enrollments, fund-raising campaigns, and government grants.
Several years later, funds from all these sources began to shrink. Instead of
Hard and Soft Money
cutting costs to meet the lower level of revenues, however, deficits were
A college with a reasonable expectation of meeting its enrollment quota can permitted, which reached a peak of $14 million. Drastic steps were finally
count on a certain amount of tuition revenue; this is hard money. Income from taken to bring costs in line with revenue, but by then a considerable por-
endowment is also hard money. It is prudent to make long-term commitments, tion of the university's capital had been dissipated?
3 From a report by Rosemary Dougherty ( personal correspondence). 4Condensed from a report in Science, December 8, 1972, pp. 1072-75.
490 Part Three Management Control Systems Chapter 10 Budgeting 491

Discipline Required for a Revenue-First Policy such as tenured faculty appointments, when they will be financed by hard
Carrying out a revenue-first policy requires considerable discipline in two re- money. By contrast, revenue from annual gifts or short-lived grants for re-
spects. First, it requires a careful and prudent estimate of total revenues from search projects is soft money. In a recession, gifts may drop drastically and
all sources, including clients, grants, contracts, third-party payers, and en- grantors may decide not to renew their grants. Managers must be careful about
dowment earnings. Once this figure has been established, it is "locked in" making long-term commitments that are financed with soft money.
Second, it requires a commitment to engage in cost cutting if necessary.
Exceptions to the Revenue-First Policy
That is, if the first approximation to the budget indicates a deficit, the least
painful course of action is to anticipate additional sources of revenue that will The policy that budgeted revenue sets the limit on expenses is not applicable
eliminate it. This is a highly dangerous course of action. If the original rev- under certain conditions. Some of these are discussed below.
enue estimates have been made carefully, all feasible sources of revenue were
The Federal Budget The considerations mentioned above do not apply to
included. New ideas that arise subsequently may produce additional revenue,
the federal budget. This budget may be either a surplus or a deficit. The amount
but the evidence that they will do so usually is not strong. If they do not pro-
of either is determined by the administration's conclusion (with the concur-
duce the additional revenue, operations may proceed without taking the steps
rence of the Congress) as to the proper fiscal policy in a given year. The federal
needed to balance revenues and expenses. The safer course of action is to take
government rarely plans for a balanced budget.
whatever steps are necessary to bring expenses into balance with revenues.
Discretionary Revenue In some organizations, management has an ability
Some churches and religious organizations adopt a "God will provide" ap-
Example to increase revenues. For example, it may be able to increase revenues from
proach to budgeting. Many have discovered, much to their dismay, that
the Lord works in mysterious ways. current gifts by an intensified fund-raising effort. This idea of "spending
money to make money" is the nonprofit counterpart of a for-profit company's
During one fiscal year, the Baltimore Ballet budgeted its expenses first, and marketing budget. To the extent that this argument is valid, it is appropriate to
then compared them with estimates of earned revenue. The excess of ex- speak of discretionary revenue as well as discretionary expenses. Ordinarily
penses over earned revenue was deemed "to be raised" through contrib- such opportunities are not of major significance, however. In most situations,
utors. This sum was overly optimistic as were estimates of earned revenue. the organization has already used all the fund-raising devices that it can think
Although monthly statements indicated unfavorable revenue and expense of, and managers must take the probable revenues from such efforts as a
variances, no corrective action was taken by the board for eight months. given, not subject to major upward revision.
The result was a deficit of several hundred thousand dollars.; Anticipated Revenue Some organizations such as universities, research in-
stitutes, and social service agencies include anticipated grant revenues in their
Preliminary versus Final Budgets budgets. This is because they frequently apply for grants, but do not learn
Some college and private school boards approve a preliminary budget in early whether the funds will be approved until well into the fiscal year. If the budget
summer, just prior to the beginning of their fiscal year. This gives department were prepared only on the basis of known revenues, key professional staff
heads the spending authority needed to prepare for fall classes. In September, might be laid off, obtain employment elsewhere, and not be available if the
once actual enrollments are known with almost total certainty, they prepare a grant is awarded. Thus, some organizations decide to incur deficits in antici-
final budget. This final budget uses total revenue as the ceiling for total ex- pation of receiving grant awards. Such a strategy is risky and clearly can be
penses. Such a process works if the total revenue is known with considerable sustained only if grants of sufficient magnitude are received.
certainty early in the fiscal year, and if line managers have enough discre- Some years ago, New York University embarked on a major expansion
Example
tionary items in their budgets (such as part-time faculty) so they can make program. Substantial amounts of additional revenue were obtained from
cuts if necessary. additional enrollments, fund-raising campaigns, and government grants.
Several years later, funds from all these sources began to shrink. Instead of
Hard and Soft Money
cutting costs to meet the lower level of revenues, however, deficits were
A college with a reasonable expectation of meeting its enrollment quota can permitted, which reached a peak of $14 million. Drastic steps were finally
count on a certain amount of tuition revenue; this is hard money. Income from taken to bring costs in line with revenue, but by then a considerable por-
endowment is also hard money. It is prudent to make long-term commitments, tion of the university's capital had been dissipated?
3 From a report by Rosemary Dougherty ( personal correspondence). 4Condensed from a report in Science, December 8, 1972, pp. 1072-75.
492 PartThree Management Control Systems Chapter 10 Budgeting 493

Short-Run Fluctuations When managers expect short-term revenue fluctu- EXHIBIT 10-1 Estimated
ations around an average, it is appropriate to budget for the average revenue, Examples of Types of Actual Budget
rather than for the specific level of revenue in a given year; that is, in some Budgets-Municipal 2001 2002
years expenses may exceed revenue if in other years revenues exceed ex- Public Safety
penses by a corresponding amount. Indeed, some nonprofit organizations con- Activities ($000) A. Line-Item Budget
sciously adopt a "countercyclical" fiscal policy as a strategy. They reason that Wages and salaries .......................... $4,232 $4,655
when the economy is in a downswing, more clients who cannot pay will need Overtime .................... ........ 217 72
their services, with the opposite effect taking place during economic expan- Fringe benefits ....... ................ . 783 861
sion. They thus plan to incur deficits in bad times and surpluses during good Retirement plan .......................... 720 792
times. This strategy must be carefully managed. If, for example, the policy is Operating supplies ............. . . 216 220
overly conservative, it deprives current clients of services. Conversely, as is Fuel ...................................... 338 410
the case with uncertain revenue, if management assumes that next year will be
Uniforms.... 68 70
Repairs and maintenance ..................... 340 392
better, and when this doesn't happen, that the following year surely will be
Professional services ......................... 71 0
better, the institution may be headed for disaster.
Communications..........' .................. 226 236
Vehicles.. ........................... 482 450
The Promoter Occasionally, the amount of resources available can be in-
Printing and publications ..................... 61 65
creased by a dynamic individual. The governing board thereupon authorizes Building rental ........ ................... 447 450
an operating budget in excess of current revenues in anticipation of the new Other .................................... 396 478
resources that the promoter will provide. Such a decision is obviously a gam- Total ................................ $8,597 $9,151
ble. If it works, the institution may be elevated to a permanently higher
B. Program Budget.
plateau. If it doesn't work, painful cutbacks may be necessary to bring ex-
penses back in line with revenues. Crime control and investigation ................ $2,677 $2,845
Traffic control .......... ................. 1,610 1,771
Deliberate Capital Erosion There are situations where the current revenue Correctional institutions ..................... 470 482
Inspections and licenses ....................... 320 347
is deliberately not regarded as a ceiling, and part of the organization's perma-
Police training .............................. 182 180
nent capital is used for current operations. This may represent a gamble in an-
Police administration ......................... 680 704
ticipation of new resources as described above, or it may reflect a conscious Fire fighting ................................ 1,530
1,427
policy to go out of existence after the capital has been consumed. Fire prevention ........... ................... 86 92
In effect, any budget with a deficit is consuming permanent capital. Thus, Fire training.....' ................ _ ..... . . . ... 64 70
decisions to use permanent capital for current operations should be made with Fire administration .........................:: 236 260
great care. No organization can live beyond its means indefinitely. Other protection.............. .............. 563 560
General administration ....................... 282 310
Example One university had its schools organized as profit centers. Each school was Total ................................ $8,597 $9,151
responsible for achieving a balanced budget every year. One year, when a
school was facing its third substantial deficit in three years, the university's
central administration informed the school's dean that the deficit would focuses on programs and program elements that represent the activities for
be financed with the principal from the school's endowment fund. Faced which the funds are to be spent. Examples of each type for the public safety
with the prospect of capital erosion, the dean balanced the budget. department of a municipality are shown in Exhibit 10-1. Although the focus
of a program budget is on programs, condensed element information-such
as the amount of personnel costs, supplies, and other operating costs-is usu-
Expenses and Expenditures ally shown for each program as well.
There are two general formats for the spending portion of the budget. The The program budget permits a decision maker to judge the appropriate
traditional format is called the line-item budget, although this term is not de- amount of resources for each activity, and hence the emphasis to be given to
scriptive because every budget has items arranged in lines. A line-item that activity. It also permits senior management to match spending with meas-
budget focuses on expense elements; that is, wages, fringe benefits, supplies, ures of each activity's planned outputs. These are important advantages of the
and other types of resources. The other format is called a program budget. It program budget format.
492 PartThree Management Control Systems Chapter 10 Budgeting 493

Short-Run Fluctuations When managers expect short-term revenue fluctu- EXHIBIT 10-1 Estimated
ations around an average, it is appropriate to budget for the average revenue, Examples of Types of Actual Budget
rather than for the specific level of revenue in a given year; that is, in some Budgets-Municipal 2001 2002
years expenses may exceed revenue if in other years revenues exceed ex- Public Safety
penses by a corresponding amount. Indeed, some nonprofit organizations con- Activities ($000) A. Line-Item Budget
sciously adopt a "countercyclical" fiscal policy as a strategy. They reason that Wages and salaries .......................... $4,232 $4,655
when the economy is in a downswing, more clients who cannot pay will need Overtime .................... ........ 217 72
their services, with the opposite effect taking place during economic expan- Fringe benefits ....... ................ . 783 861
sion. They thus plan to incur deficits in bad times and surpluses during good Retirement plan .......................... 720 792
times. This strategy must be carefully managed. If, for example, the policy is Operating supplies ............. . . 216 220
overly conservative, it deprives current clients of services. Conversely, as is Fuel ...................................... 338 410
the case with uncertain revenue, if management assumes that next year will be
Uniforms.... 68 70
Repairs and maintenance ..................... 340 392
better, and when this doesn't happen, that the following year surely will be
Professional services ......................... 71 0
better, the institution may be headed for disaster.
Communications..........' .................. 226 236
Vehicles.. ........................... 482 450
The Promoter Occasionally, the amount of resources available can be in-
Printing and publications ..................... 61 65
creased by a dynamic individual. The governing board thereupon authorizes Building rental ........ ................... 447 450
an operating budget in excess of current revenues in anticipation of the new Other .................................... 396 478
resources that the promoter will provide. Such a decision is obviously a gam- Total ................................ $8,597 $9,151
ble. If it works, the institution may be elevated to a permanently higher
B. Program Budget.
plateau. If it doesn't work, painful cutbacks may be necessary to bring ex-
penses back in line with revenues. Crime control and investigation ................ $2,677 $2,845
Traffic control .......... ................. 1,610 1,771
Deliberate Capital Erosion There are situations where the current revenue Correctional institutions ..................... 470 482
Inspections and licenses ....................... 320 347
is deliberately not regarded as a ceiling, and part of the organization's perma-
Police training .............................. 182 180
nent capital is used for current operations. This may represent a gamble in an-
Police administration ......................... 680 704
ticipation of new resources as described above, or it may reflect a conscious Fire fighting ................................ 1,530
1,427
policy to go out of existence after the capital has been consumed. Fire prevention ........... ................... 86 92
In effect, any budget with a deficit is consuming permanent capital. Thus, Fire training.....' ................ _ ..... . . . ... 64 70
decisions to use permanent capital for current operations should be made with Fire administration .........................:: 236 260
great care. No organization can live beyond its means indefinitely. Other protection.............. .............. 563 560
General administration ....................... 282 310
Example One university had its schools organized as profit centers. Each school was Total ................................ $8,597 $9,151
responsible for achieving a balanced budget every year. One year, when a
school was facing its third substantial deficit in three years, the university's
central administration informed the school's dean that the deficit would focuses on programs and program elements that represent the activities for
be financed with the principal from the school's endowment fund. Faced which the funds are to be spent. Examples of each type for the public safety
with the prospect of capital erosion, the dean balanced the budget. department of a municipality are shown in Exhibit 10-1. Although the focus
of a program budget is on programs, condensed element information-such
as the amount of personnel costs, supplies, and other operating costs-is usu-
Expenses and Expenditures ally shown for each program as well.
There are two general formats for the spending portion of the budget. The The program budget permits a decision maker to judge the appropriate
traditional format is called the line-item budget, although this term is not de- amount of resources for each activity, and hence the emphasis to be given to
scriptive because every budget has items arranged in lines. A line-item that activity. It also permits senior management to match spending with meas-
budget focuses on expense elements; that is, wages, fringe benefits, supplies, ures of each activity's planned outputs. These are important advantages of the
and other types of resources. The other format is called a program budget. It program budget format.
494 PartThree Management Control Systems Chapter 10 Budgeting 495

Link to the Capital Budget these estimates, and (4) approval of the budget. The review process may lead
If the operating budget is prepared on an expenditure (rather than expense) to revision of the original estimates, so the proposed budget may be recycled
basis, it may include amounts for equipment and other long-lived assets. several times before being approved. In this regard, timing is an important con-
When this is the case, only buildings and major capital acquisitions will be in- sideration. If the budget is prepared too far in advance, it will not be based on
cluded in the capital budget. the most current information. If, on the other hand, not enough time is allowed,
When the operating budget is prepared on an expenditure basis, senior the process may be rushed and incomplete. In the federal government, for ex-
management should make a clear distinction between the types of items in- ample, the budgeting process starts about six months before the budget is sub-
cluded in these two budgets. Otherwise, there is a temptation to balance the mitted to the Congress, and well over a year before the budget year begins. In
operating budget by moving some items from it into the capital budget. less complex organizations, the period is considerably shorter.

Example Some years ago, officials in New York City made many maneuvers to hide Dissemination of Guidelines
the true operating deficit. One was to shift operating items to the capital Senior management usually begins the budgetary process by formulating the
budget where they presumably would be financed by bonds rather than budget guidelines and disseminating them to operating managers. Senior man-
by current revenues. An extreme example was vocational education ex- agement needs to give considerable attention to these guidelines; if the budget
penses, which were shifted to the capital budget on the grounds that stu- is formulated on the basis of unrealistic assumptions, it may have to be redone
dents would enjoy the benefits for many years to come and that with consequent wasted effort.
vocational education was therefore a long-lived asset! If approved programs exist, one guideline is that the budget should be con-
sistent with them. This does not necessarily mean that the budget should con-
Output Measures sist only of approved programs, since this can be frustrating for operating
managers. Moreover, desirable innovations may come to light if managers are
The third component of a budget is information about planned outputs. As we
permitted to propose activities that are not part of approved programs. These
describe in Chapter 12, output information usually consists of process (or
workload) measures and results measures. Some organizations commit them- unapproved activities should be clearly distinguished from those in the ap-
proved programs, however, and operating managers should understand that
selves to specific results measures as part of the budgetary process.
the chances for approval of new programs during budget formulation are
Example In one public school system, principals' budgets were determined in slight. Any other impression downgrades the importance of strategic planning.
part by a combination of expected enrollments and centrally mandated Even if there are no formal programs, senior management should make op-
student-teacher ratios; these ratios are process or workload measures. The erating managers aware of the constraints within which the budget is pre-
principals also committed themselves to achieving certain levels of read- pared. These constraints can be expressed in an overall statement such as
ing scores for students completing different grades. Senior management "budget for not more than 105 percent of the amount spent this year," or they
believed that these results measures indicated how well teachers achieved can be stated in much more detail. These details might include:
the school system's objectives.
• Planned changes in the activities of the organization.
An article on university budgeting lists several output criteria that can be • Assumptions about wage rates and other prices.
used to determine merit salary increments for faculty: dollar amounts of • Conditions under which additional personnel can be requested.
research grants generated, number of Ph.D.s graduated, number of jour-
nal publications, and teaching quality.' These criteria help to link the • Number of personnel who may be promoted.
budget to a university's objectives. • Services to be provided by support responsibility centers.
• Planned productivity gains.
Steps in the Operations Budgeting Process In the absence of guidance to the contrary, the usual assumption is that next
year's activities will be similar to this year's.
The principal steps involved in the operations budgeting process are: (() dis- In addition to the substantive guidelines, there are also guidelines about the
semination of guidelines, (2) preparation of the budget estimates, (3) review of format and content of the proposed budget. These are intended to ensure that
the budget estimates are submitted in a fashion that both facilitates analysis
'Allen G. Schick, "University Budgeting : Administrative Perspective, Budget Structure, and and permits their subsequent use in comparing actual performance with
Budget Process ," Academy of Management Review 10, no. 4 ( 1985), pp. 794-802. planned performance.
494 PartThree Management Control Systems Chapter 10 Budgeting 495

Example Some years ago, officials in New York City made many maneuvers to hide Dissemination of Guidelines
the true operating deficit. One was to shift operating items to the capital Senior management usually begins the budgetary process by formulating the
budget where they presumably would be financed by bonds rather than budget guidelines and disseminating them to operating managers. Senior man-
by current revenues. An extreme example was vocational education ex- agement needs to give considerable attention to these guidelines; if the budget
penses, which were shifted to the capital budget on the grounds that stu- is formulated on the basis of unrealistic assumptions, it may have to be redone
dents would enjoy the benefits for many years to come and that with consequent wasted effort.
vocational education was therefore a long-lived asset! If approved programs exist, one guideline is that the budget should be con-
sistent with them. This does not necessarily mean that the budget should con-
Output Measures sist only of approved programs, since this can be frustrating for operating
managers. Moreover, desirable innovations may come to light if managers are
The third component of a budget is information about planned outputs. As we
permitted to propose activities that are not part of approved programs. These
describe in Chapter 12, output information usually consists of process (or
workload) measures and results measures. Some organizations commit them- unapproved activities should be clearly distinguished from those in the ap-
proved programs, however, and operating managers should understand that
selves to specific results measures as part of the budgetary process.
the chances for approval of new programs during budget formulation are
Example In one public school system, principals' budgets were determined in slight. Any other impression downgrades the importance of strategic planning.
part by a combination of expected enrollments and centrally mandated Even if there are no formal programs, senior management should make op-
student-teacher ratios; these ratios are process or workload measures. The erating managers aware of the constraints within which the budget is pre-
principals also committed themselves to achieving certain levels of read- pared. These constraints can be expressed in an overall statement such as
ing scores for students completing different grades. Senior management "budget for not more than 105 percent of the amount spent this year," or they
believed that these results measures indicated how well teachers achieved can be stated in much more detail. These details might include:
the school system's objectives.
• Planned changes in the activities of the organization.
An article on university budgeting lists several output criteria that can be • Assumptions about wage rates and other prices.
used to determine merit salary increments for faculty: dollar amounts of • Conditions under which additional personnel can be requested.
research grants generated, number of Ph.D.s graduated, number of jour-
nal publications, and teaching quality.' These criteria help to link the • Number of personnel who may be promoted.
budget to a university's objectives. • Services to be provided by support responsibility centers.
• Planned productivity gains.
Steps in the Operations Budgeting Process In the absence of guidance to the contrary, the usual assumption is that next
year's activities will be similar to this year's.
The principal steps involved in the operations budgeting process are: (() dis- In addition to the substantive guidelines, there are also guidelines about the
semination of guidelines, (2) preparation of the budget estimates, (3) review of format and content of the proposed budget. These are intended to ensure that
the budget estimates are submitted in a fashion that both facilitates analysis
'Allen G. Schick, "University Budgeting : Administrative Perspective, Budget Structure, and and permits their subsequent use in comparing actual performance with
Budget Process ," Academy of Management Review 10, no. 4 ( 1985), pp. 794-802. planned performance.
496 PartThree Management Control Systems Chapter 10 Budgeting 497

Preparation of Budget Estimates volume. (The amount reported in the budget would be the total cost of food
service at the estimated number of meals served.)
In many organizations, managers at the lowest levels are responsible for pre-
paring a budget for their activities. This "participatory" budgeting approach Despite the logic of developing the budget from workload estimates and
contrasts with the practice of "imposed" budgeting in which budgets are pre- unit costs, the budget guidelines may prohibit increases above a certain
pared by top-level staffs and then imposed on operating managers. Under amount, regardless of the workload. This requirement overrides the workload
participatory budgeting staff assistants may help managers by making calcu- calculations. The manager may point out, however, that the budgeted amounts
lations and filling out the forms, but the basic decisions that are reflected in are inadequate to carry out the planned workload so that trade-off decisions
the proposed budget are made by operating managers, not by staff. can be made.

Relation to Programs Advanced Techniques

If an approved program exists, the expense budget usually is constructed by Various analytical techniques, such as the use of subjective probabilities, pref-
fine-tuning the estimated program costs. For new programs, this involves as- erence theory, multiple regression analysis, and models, have been advocated
signing program responsibility to responsibility centers and constructing as an aid to budget formulation. For a variety of reasons, few of these are used
careful cost estimates in each responsibility center. For example, a research- in practice.
and-development program may be budgeted at $400,000 simply by estimat- Budget Detail
ing that it will require four professional work years at $100,000 a work year.
In constructing the budget, the salaries of professionals and the other support Many dollar amounts in the budget are the product of a physical quantity
costs that make up the overall estimate of $100,000 per work year will be times a cost per unit. For example, personnel costs are a product of the num-
stated. The resulting total will approximate $400,000 but will vary somewhat ber of staff times average compensation. These amounts should be shown sep-
from this estimate as the costs are examined in more detail. arately because of a breakdown of quantities and unit costs both facilitates
review of the budget and also is useful in subsequently analyzing differences
Arriving at Budget Amounts between budgeted and actual expenses.
In addition to the numbers, the proposed budget usually includes explana-
If the current level of spending is used as a starting point, the budget can be
tory material. In particular, if additional personnel are requested, a justifica-
constructed by adjusting for:
tion may be required.
• Changes in wage rates and prices.
• Elimination of unusual factors that may have affected current spending.
Review of Budget Estimates
The budget review and approval process has both a technical and a behavioral
• Changes in programs. dimension. Although the two are closely related, we discuss them separately
• Possible adjustments in certain discretionary items (such as expenses for to illustrate the important distinctions.
attendance at conventions) that may have been mandated in the guidelines.
Technical Aspects
The technical aspects of the process usually are carried out by budget analysts,
Variable Budgets
who are quite different in makeup from the program analysts discussed in
If the workload for the budget year can be estimated and if unit costs are avail- Chapter 9. A program analyst usually does not work under tight time con-
able, the budget can be constructed so as to include this estimate . In a welfare straints, and is less interested in accuracy than a budget analyst. He or she is
office, for example, if the number of cases can be predicted, the number of more interested in judging, even in a rough way, the relation between costs
budgeted social workers can be found by using a standard number of cases per and benefits of a proposed program. A budget analyst, by contrast, must be
social worker. Other elements of cost can be estimated as a function of the concerned with accuracy, but also must work under great time constraints,
number of social workers. possess a feel for what is the right amount of cost, and be able and willing to
If revenues and expenses vary with volume, as happens with, say, food get to the essence of the calculations quickly.
service costs, the expense budget may be stated in terms of a fixed amount
plus a variable rate per unit of volume (e.g., $300,000 + $5 per meal). It is ap- Time Constraints An important, but sometimes overlooked, fact about the
propriate to budget, say, food service in a hospital or a private school in this review process is that not much time is available for it. The proposed budgets
fashion because the revenue from patient care or student board varies with for every responsibility center must be examined in the space of, at most, a
496 PartThree Management Control Systems Chapter 10 Budgeting 497

Relation to Programs Advanced Techniques

If an approved program exists, the expense budget usually is constructed by Various analytical techniques, such as the use of subjective probabilities, pref-
fine-tuning the estimated program costs. For new programs, this involves as- erence theory, multiple regression analysis, and models, have been advocated
signing program responsibility to responsibility centers and constructing as an aid to budget formulation. For a variety of reasons, few of these are used
careful cost estimates in each responsibility center. For example, a research- in practice.
and-development program may be budgeted at $400,000 simply by estimat- Budget Detail
ing that it will require four professional work years at $100,000 a work year.
In constructing the budget, the salaries of professionals and the other support Many dollar amounts in the budget are the product of a physical quantity
costs that make up the overall estimate of $100,000 per work year will be times a cost per unit. For example, personnel costs are a product of the num-
stated. The resulting total will approximate $400,000 but will vary somewhat ber of staff times average compensation. These amounts should be shown sep-
from this estimate as the costs are examined in more detail. arately because of a breakdown of quantities and unit costs both facilitates
review of the budget and also is useful in subsequently analyzing differences
Arriving at Budget Amounts between budgeted and actual expenses.
In addition to the numbers, the proposed budget usually includes explana-
If the current level of spending is used as a starting point, the budget can be
tory material. In particular, if additional personnel are requested, a justifica-
constructed by adjusting for:
tion may be required.
• Changes in wage rates and prices.
• Elimination of unusual factors that may have affected current spending.
Review of Budget Estimates
The budget review and approval process has both a technical and a behavioral
• Changes in programs. dimension. Although the two are closely related, we discuss them separately
• Possible adjustments in certain discretionary items (such as expenses for to illustrate the important distinctions.
attendance at conventions) that may have been mandated in the guidelines.
Technical Aspects
The technical aspects of the process usually are carried out by budget analysts,
Variable Budgets
who are quite different in makeup from the program analysts discussed in
If the workload for the budget year can be estimated and if unit costs are avail- Chapter 9. A program analyst usually does not work under tight time con-
able, the budget can be constructed so as to include this estimate . In a welfare straints, and is less interested in accuracy than a budget analyst. He or she is
office, for example, if the number of cases can be predicted, the number of more interested in judging, even in a rough way, the relation between costs
budgeted social workers can be found by using a standard number of cases per and benefits of a proposed program. A budget analyst, by contrast, must be
social worker. Other elements of cost can be estimated as a function of the concerned with accuracy, but also must work under great time constraints,
number of social workers. possess a feel for what is the right amount of cost, and be able and willing to
If revenues and expenses vary with volume, as happens with, say, food get to the essence of the calculations quickly.
service costs, the expense budget may be stated in terms of a fixed amount
plus a variable rate per unit of volume (e.g., $300,000 + $5 per meal). It is ap- Time Constraints An important, but sometimes overlooked, fact about the
propriate to budget, say, food service in a hospital or a private school in this review process is that not much time is available for it. The proposed budgets
fashion because the revenue from patient care or student board varies with for every responsibility center must be examined in the space of, at most, a
Chapter 10 Budgeting 499
498 Part Three Management Control Systems

few weeks. This is in contrast with the strategic planning process in which one Behavioral Aspects
program, covering only a small fraction of the organization's activities, can be In estimating the labor cost of making shoes, there is little ground for dis-
examined in depth. Because there is not enough time to do otherwise, man- agreement on the part of well-informed people: the cost of each operation can
agers typically take the level of current spending as the starting point in ex- be estimated within close limits, and the total labor cost can be found by
amining the proposed budget. Although the burden of proof to justify amounts adding the costs of each operation and multiplying by the number of pairs of
above that level is on the budgetee, there is an implication that budgetees are shoes. As noted above, such engineered costs constitute a relatively large
"entitled" to the current level. This practice is widely criticized (it sometimes fraction of the costs of an industrial company. By contrast, discretionary
is called the blight of incrementalism), but there is little that can be done about costs-costs for which the optimal amount is not known, and often is un-
it as a practical matter, simply because of time pressure. The place for a more knowable-constitute a relatively large percent of the budget of a nonprofit
thorough analysis of spending needs is the strategic planning process. organization. Since there is no scientific way to estimate the amount of dis-
cretionary costs, these costs do not lend themselves to analysis by the budget
Methods of Analysis Frequently, proposed budgets are first reviewed by the staff. Rather, the budget amounts must be determined through negotiation.
budget staff, which then makes recommendations to line managers. This re- Negotiation is also required because there is no objective way to decide
view has two aspects, one relating to mission programs, and another to sup- which requests for funds have the highest priority.
port programs. On one level, this negotiation process can be thought of as a zero-sum
If a mission program is new, little can be done to change the revenue and game. Specifically, in many organizations, each budgetee negotiating with a
expense estimates during the budget review process. Not only has a rough particular supervisor is competing with all other budgetees who report to that
budget ordinarily been agreed to during the strategic planning phase, but there supervisor for a share of the resources the supervisor controls. In instances
is no experience with actual operations of the program that can be used as a where resources are not abundant, such an arrangement generally produces a
basis for assessing the adequacy of the budget. great deal of conflict and game-playing by budgetees in order to obtain as
If a mission program is ongoing, the appropriateness of actual and pro- large a share of resources as possible.
posed expenses can be analyzed. Many budget analysts develop unit cost Senior management can eliminate the zero-sum aspect of this process, and
guidelines that assist them in judging proposed increases in items such as potentially lessen conflict, by decentralizing the budgetary process and in-
staffing and supplies for a program. For example, a budget analyst, whose creasing the number of budgetary decisions to be made. Doing so tends to re-
programs include restaurant inspections for a state department of public duce the stakes in such a way that each budgetee can gain something.
health, knows that each inspector should cover a certain number of restaurants On another level, the process of negotiation in a decentralized budgetary
in a year. By obtaining information on the number of new and closed restau- process has been described as a two-person, nonzero-sum gamer The players
rants, the analyst can judge the adequacy of proposed staffing levels. are the budgetee, who is advocating a proposed budget, and the supervisor,
The budget analyst also focuses on support programs. If the entity's size who must approve, modify, or deny the request. Except for the lowest eche-
will change because of mission program decisions, corresponding adjustments lon, all managers are supervisors at one stage in the budget process, and they
must be made in the current level of spending for support activities. After become budgetees in the next stage. Even senior management becomes a bud-
making adjustments for changes in size, a budget analyst also can make a getee in presenting the budget to the outside agency or board that is responsi-
careful review of the details of support activities, using the adjusted current ble for providing the funds. Although in one sense a new game is played each
levels of spending as a starting point. year, there are important carryover consequences from one year to the next.
There is a tendency for support costs to creep upward, especially in afflu- The judgment that each party develops in one year about the ability, integrity,
ent organizations. Because of this, analysts make special efforts to detect and and forthrightness of the other party affects attitudes in subsequent years.
eliminate unnecessary increases in these costs. If unit costs or ratios can be As in any negotiation, the two parties have a common interest in reaching
calculated, a comparison of these with similar numbers in other responsibility a satisfactory outcome, but they usually have conflicting interests in what that
centers, or with published data for other organizations, may be helpful. In the outcome should be. The essence of this conflict is that budgetees generally
absence of such a basis for comparison, reviewers frequently rely on their feel want as large a budget as possible, and supervisors usually want to cut the pro-
for the appropriateness of the requested amounts. posed budget as much as they safely can.
Finally, the analyst makes comparisons among the unit costs of similar ac-
tivities within the organization. The budget is checked for consistency with
the guidelines; wage rates and costs of significant materials are checked for 6Schick, "University Budgeting," pp. 794-802.
reasonableness; and other checks-including the simple but essential check of 'See G. H. Hofstede, The Game of Budget Control (Assen , Neth .: Van Gorcum & Co
arithmetic accuracy-are made. 1967). This book is a classic in the management literature.
Chapter 10 Budgeting 499
498 Part Three Management Control Systems

few weeks. This is in contrast with the strategic planning process in which one Behavioral Aspects
program, covering only a small fraction of the organization's activities, can be In estimating the labor cost of making shoes, there is little ground for dis-
examined in depth. Because there is not enough time to do otherwise, man- agreement on the part of well-informed people: the cost of each operation can
agers typically take the level of current spending as the starting point in ex- be estimated within close limits, and the total labor cost can be found by
amining the proposed budget. Although the burden of proof to justify amounts adding the costs of each operation and multiplying by the number of pairs of
above that level is on the budgetee, there is an implication that budgetees are shoes. As noted above, such engineered costs constitute a relatively large
"entitled" to the current level. This practice is widely criticized (it sometimes fraction of the costs of an industrial company. By contrast, discretionary
is called the blight of incrementalism), but there is little that can be done about costs-costs for which the optimal amount is not known, and often is un-
it as a practical matter, simply because of time pressure. The place for a more knowable-constitute a relatively large percent of the budget of a nonprofit
thorough analysis of spending needs is the strategic planning process. organization. Since there is no scientific way to estimate the amount of dis-
cretionary costs, these costs do not lend themselves to analysis by the budget
Methods of Analysis Frequently, proposed budgets are first reviewed by the staff. Rather, the budget amounts must be determined through negotiation.
budget staff, which then makes recommendations to line managers. This re- Negotiation is also required because there is no objective way to decide
view has two aspects, one relating to mission programs, and another to sup- which requests for funds have the highest priority.
port programs. On one level, this negotiation process can be thought of as a zero-sum
If a mission program is new, little can be done to change the revenue and game. Specifically, in many organizations, each budgetee negotiating with a
expense estimates during the budget review process. Not only has a rough particular supervisor is competing with all other budgetees who report to that
budget ordinarily been agreed to during the strategic planning phase, but there supervisor for a share of the resources the supervisor controls. In instances
is no experience with actual operations of the program that can be used as a where resources are not abundant, such an arrangement generally produces a
basis for assessing the adequacy of the budget. great deal of conflict and game-playing by budgetees in order to obtain as
If a mission program is ongoing, the appropriateness of actual and pro- large a share of resources as possible.
posed expenses can be analyzed. Many budget analysts develop unit cost Senior management can eliminate the zero-sum aspect of this process, and
guidelines that assist them in judging proposed increases in items such as potentially lessen conflict, by decentralizing the budgetary process and in-
staffing and supplies for a program. For example, a budget analyst, whose creasing the number of budgetary decisions to be made. Doing so tends to re-
programs include restaurant inspections for a state department of public duce the stakes in such a way that each budgetee can gain something.
health, knows that each inspector should cover a certain number of restaurants On another level, the process of negotiation in a decentralized budgetary
in a year. By obtaining information on the number of new and closed restau- process has been described as a two-person, nonzero-sum gamer The players
rants, the analyst can judge the adequacy of proposed staffing levels. are the budgetee, who is advocating a proposed budget, and the supervisor,
The budget analyst also focuses on support programs. If the entity's size who must approve, modify, or deny the request. Except for the lowest eche-
will change because of mission program decisions, corresponding adjustments lon, all managers are supervisors at one stage in the budget process, and they
must be made in the current level of spending for support activities. After become budgetees in the next stage. Even senior management becomes a bud-
making adjustments for changes in size, a budget analyst also can make a getee in presenting the budget to the outside agency or board that is responsi-
careful review of the details of support activities, using the adjusted current ble for providing the funds. Although in one sense a new game is played each
levels of spending as a starting point. year, there are important carryover consequences from one year to the next.
There is a tendency for support costs to creep upward, especially in afflu- The judgment that each party develops in one year about the ability, integrity,
ent organizations. Because of this, analysts make special efforts to detect and and forthrightness of the other party affects attitudes in subsequent years.
eliminate unnecessary increases in these costs. If unit costs or ratios can be As in any negotiation, the two parties have a common interest in reaching
calculated, a comparison of these with similar numbers in other responsibility a satisfactory outcome, but they usually have conflicting interests in what that
centers, or with published data for other organizations, may be helpful. In the outcome should be. The essence of this conflict is that budgetees generally
absence of such a basis for comparison, reviewers frequently rely on their feel want as large a budget as possible, and supervisors usually want to cut the pro-
for the appropriateness of the requested amounts. posed budget as much as they safely can.
Finally, the analyst makes comparisons among the unit costs of similar ac-
tivities within the organization. The budget is checked for consistency with
the guidelines; wage rates and costs of significant materials are checked for 6Schick, "University Budgeting," pp. 794-802.
reasonableness; and other checks-including the simple but essential check of 'See G. H. Hofstede, The Game of Budget Control (Assen , Neth .: Van Gorcum & Co
arithmetic accuracy-are made. 1967). This book is a classic in the management literature.
500 PartThree Management Control Systems Chapter 10 Budgeting 501

A budgetee's desire for resources is particularly troublesome in responsibil- Similarly, budgetees need to be able to also trust their superiors. A budget or-
ity centers whose output cannot be reliably measured. Under these circum- dinarily is based on certain assumptions about the external world; these as-
stances, not only are budgetees motivated to acquire as many resources as they sumptions often prove to be wrong. If budgetees do not trust their supervisors
can, but it is extremely difficult for supervisors to measure the effectiveness of to recognize this fact, they will be reluctant to make realistic estimates. In-
their use of the resources. This phenomenon has been analyzed by economists deed, they may be so afraid of their supervisors that they cannot enter into a
in socialist countries where it is crucial to understanding the budget preparation give-and-take collaboration with them.
process.
Role of the Analyst In general, both senior management and lower level
The following factors were considered particularly significant in the budget line managers must trust the budget analysts' recommendations as to the de-
Example
preparation process in Hungary: (1) a good manager wants to do the job tails of the budget. If the analysts' calculations indicate that four, not five,
properly and therefore wants all the resources that may be needed to ac- new employees are needed for a new function, these calculations ordinarily
complish it, (2) the manager wants the operation to run smoothly and for must be accepted. If each of these detailed decisions is challenged, the whole
this purpose needs slack in order to meet peaks in demand; (3) the man- process will bog down. Moreover, as the budget goes up the chain of com-
ager wants the unit to be viewed favorably in comparison with other units mand, decision makers may have difficulty identifying and concentrating on
and therefore wants the resources to be up to date; (4) the manager's key issues. In short, the budget process will work smoothly only if line man-
power and prestige is perceived as being related to the size of the respon- agement has confidence in the judgment of the budget analysts. The solution,
sibility center, and, in contrast with profit centers, there is no penalty in if such confidence is lacking, is to reeducate, or in the extreme, replace the
having too many resources in a discretionary expense center. analysts.
For these reasons, the manager's desire for resources is insatiable. More-
over, if supervisors grant all the budget requests this year, it is likely that Rules of the Game and Budget Ploys As in any game, rules exist for the
the requests next year will be even larger." budget process; many of these rules are unwritten. Moreover, they vary con-
siderably from organization to organization. They also depend in large part
upon the size of the organization and the relationships between supervisors
Role of Professionals The attitude of professionals is also an important fac-
tor. For example, in a hospital, the budgetee may be a physician and the super- and budgetees.
visor a hospital administrator. Physicians are primarily interested in improving One study of budget games that managers play in manufacturing organ-
Example
the quality of patient care, improving the status of the hospital as perceived by izations identified five major activities: (1) understating volume estimates,
their peers, and increasing their own prestige. Their interest in the amount of (2) undeclared (or understated) prices increases, (3) undeclared (or un-
costs involved generally is secondary. By contrast, hospital administrators are derstated) cost reduction programs, (4) overstated expenses (such as for
primarily interested in costs, although they realize that costs must not be so low research), and (5) undeclared extensions of a product line. A principal rea-
that the quality of care or the status of the hospital is impaired. Thus, the two son given by one manager was "senior management just doesn't have the
parties weigh the relevant factors considerably differently. time for checking every number you put into your plans ... so one strat-
egy is to 'pad' everything. If you're lucky, you'll still have 50% of your
Role of Norms The budget process is most effective when the two parties con- cushions after the plan reviews."9 Similar, sometimes identical, games are
form to certain norms. In general, effective behavior by supervisors includes:
played in many nonprofit organizations.
• Trusting their subordinates. Even when the formal rules are clear, the budget game frequently is char-
• Assuming their subordinates are competent and have goodwill and honesty. acterized by certain ploys. To play the budget game well, each party should be
familiar with these ploys and the appropriate responses to them.
• Allowing subordinates to develop their own solutions to budget-related
Ploys can be divided into two main categories: (1) internal-those used
problems. primarily within an organization, and (2) external-those used between the
• Not feeling threatened if a subordinate does not agree with them. head of the organization and the legislative body or governing board that
authorizes funds for the organization. External ploys are well described in
• Sharing information with subordinates.

• Not forcing their personal goals onto subordinates.

'See Janos Kornai, Economics of Shortage (Amsterdam , Neth.: North-Holland Publishing, 'Christopher K. Bart, "Budgeting Gamesmanship," The Academy of Management Executive
1980), especially pp. 62-64 and 191-95. 2, no. 4 (1988), pp. 285-94.
500 PartThree Management Control Systems Chapter 10 Budgeting 501

• Not forcing their personal goals onto subordinates.

'See Janos Kornai, Economics of Shortage (Amsterdam , Neth.: North-Holland Publishing, 'Christopher K. Bart, "Budgeting Gamesmanship," The Academy of Management Executive
1980), especially pp. 62-64 and 191-95. 2, no. 4 (1988), pp. 285-94.
S02 PartThree Management Control Systems chapter 10 Budgeting 503

Wildavsky's The Politics of the Budgeting Process.1° Some internal ploys are Budget Approval
given in the Appendix at the end of this chapter. The final set of discussions is held between senior management and whatever
body has ultimate authority for approving the organization's plans-trustees
The Commitment The end product of the negotiation process is an agreed-
upon budget that represents a commitment by both the budgetee and the su- or similar groups for private nonprofit organizations, or legislatures for public
ones. After approval, the budget is disseminated throughout the organization
pervisor. Some organizations go so far as to state this commitment in the form
and becomes the authorized plan to which managers are expected to adhere
of a formal contract, in which the budgetee agrees to deliver specified services
for an agreed-upon sum of money. This becomes the amount in the approved unless compelling circumstances warrant a change.12
budget.
By agreeing to the budget estimates, the budgetee says, in effect: "I can and Use of Models
will operate my responsibility center in accordance with the plan described in
this budget." By approving the budget estimates, the superior in effect says, Many budgetary analyses can benefit from a model that describes both the es-
"If you operate your responsibility center in accordance with this plan, you sential variables in the situation being studied and the relationships among
will be doing what we consider to be a good job." Both statements contain them. Such a model need not be complicated; indeed, the use of models has
the implicit qualification, "subject to adjustment for unanticipated changes in been greatly facilitated by the use of spreadsheet software.
circumstances."
Example Exhibit 10-2 shows a simple financial model that focuses on the relation-
In the one and one-half months that elapsed following its submission on ships of important variables for the instructional program of a college. All
Example
May 10, 1985, the fiscal year 1986-87 budget for New York City became the "initial values" are entered except one: tuition per student. The equa-
obsolete because of changes in circumstances. Among the changes were: tions in the spreadsheet are established in accordance with the college's
(1) a tentative union agreement covering the city's uniformed employees, policies concerning section sizes, faculty workloads, faculty salaries, the
which necessitated wage increases of 6 percent; (2) receipt of notice from number of nonteaching faculty, and other expenses.
the state of New York that the city's estimates of state aid were unrealistic; With this information, the college can solve for the amount of tuition
(3) a refinancing of the city's general obligation bonds; (4) an agreement per student necessary to put the model into "equilibrium." It is in equilib-
between the state and the city to jointly finance a housing program; (5) a rium in the sense that the revenues available for instruction equal the costs
budget resolution passed by the U.S. Congress, which, among other of instruction. The first management decision equation does this, indicating
things, made it clear that the Federal General Revenue Sharing Program that the tuition and fee figure would need to be $10,174.
would likely be terminated; and (6) the city received two additional Alternatively, tuition could be entered into the model at the level set by
months of revenue collection information as well as indications of final real senior management and the trustees, and the model could be used to
property assessments, that resulted in changes in its local revenue esti- solve for the number of students needed to reach equilibrium (i.e., to
mates for the budget year. As a result, the city submitted a revised finan- break even). The second management-decision equation does this, using
cial plan on June 26, 1985. a tuition and fee figure of $9,800. The number of students needed for
equilibrium is 1,632.
To reinforce this commitment, some nonprofits "reward" programs for
beating their budgets with a sharing of the savings. The program managers By changing the unknown in a management-decision equation, or by
can use the savings for activities such as purchasing extra equipment, paying changing the college's policy concerning section sizes, faculty workloads,
for training, or hiring a part-time person to carry out a discretionary task. They or salaries, this model could be used to answer many questions: By how
claim that the reward system provides staff with an incentive to cut costs." much, for example, could we increase average faculty compensation if we
reduced (a) the number of sections by X, (b) the number of nonteaching
Clearly, senior management must be careful not to put such a heavy focus on
faculty by Y or (c) nonfaculty instruction costs by P. If we increased the
budgetary savings that insufficient attention is given to quality. We discuss
course offerings, by how much would tuition have to be increased? What
this matter in greater detail in Chapter 11.

'2Some people refer to actual operations as "executing the budget." This is an unfortunate
10Aaron Wildavsky, The Politics of the Budgetary Process, 2nd ed. (New York: Harper Collins, term because it implies that the operating manager's job is to spend whatever the budget
1992). says can be spent. A better term is executing the program. This implies that the manager's
"Peter C. Brinckerhoff, "How to Save Money Through Bottoms-Up Budgeting," Nonprofit primary job is to accomplish program objectives. The budget simply shows the resources
World 14, no. 1 (1996). available for this purpose.
S02 PartThree Management Control Systems chapter 10 Budgeting 503

'2Some people refer to actual operations as "executing the budget." This is an unfortunate
10Aaron Wildavsky, The Politics of the Budgetary Process, 2nd ed. (New York: Harper Collins, term because it implies that the operating manager's job is to spend whatever the budget
1992). says can be spent. A better term is executing the program. This implies that the manager's
"Peter C. Brinckerhoff, "How to Save Money Through Bottoms-Up Budgeting," Nonprofit primary job is to accomplish program objectives. The budget simply shows the resources
World 14, no. 1 (1996). available for this purpose.
S04 PartThree Management Control Systems Chapter 10 Budgeting SOS

EXHIBIT 110-2 College Financial Model for each diagnosis, expected efficiency measures and factor prices for
physician-ordered services, and fixed facility costs. Such a model would
permit decision makers to determine where and how expenditures might
be reduced by focusing on specific "cost drivers." Reductions could take
umb er of students . . ^..
f
de t . f_.-
am ber o f aunts (o sections) perstudent
stud ent per rf 3 a
place, for example, by avoiding the treatment of certain types of cases,
image number of students persection 3 .. , .. , L by changing physician treatment protocols, by seeking improved admin-
umber of sections offered per year:... . istrative efficiency, or by guaranteeing certain factor prices. The model
tuber of FTE facu lty .... ........... could permit analysts to test the impact of each of these options, as well
umber of sections per FTE teaching faculty per yi as combinations of options, on total costs. Such an approach is being
amber of Fit teaching faculty needed per year used in some hospitals.
umber of FTE non teaching fictlty per year (sabb
department head buyoud^ ) w
stage comp per faculty . .. . . Summary Many aspects of operations budgeting in nonprofit organizations are similar to
those in for-profit companies. Perhaps the most important difference is on the rev-
enue side of the budget. Many nonprofit organizations are not "self-financing."
Because of this, they must be careful to forecast their revenues accurately, and to
assure themselves that expenses will not exceed revenues. Although there are
some exceptions to this rule, and most organizations can have a year or two where
expenses exceed revenues, the effective result of such a policy is to erode the or-
ganization's capital.
Some other differences between nonprofit and for-profit organizations are
(1) the presence of two-stage budgets in some nonprofit organizations, (2) the ex-
s'av
istence of soft money and the uncertainty about grant revenue in some nonprofits,
per Stu
(3) the need for output measures as well as measures of revenue and expenses, and
nt variable
(4) the role of professionals.
of students needed = n+ $9,800 .:.
In all organizations, the budget frequently has a "gamelike" quality to it. Be-
cause of this, the players have developed many ploys to assure their success in the
would happen if we increased the number of students by 10 percent? game. These ploys are described in some detail in the Appendix.
Moreover, beginning with this simple model, we can refine the analysis
by substituting a frequency distribution of section sizes for the average
section size, by substituting a distribution of faculty compensation by rank %I[I[('I 14 Iis
for the overall average, by bringing in noninstruction costs, or by being
more specific about any of several other variables.
Computer models such as this are available for many types of nonprofit or-
Some Budget Ploys
ganizations, and spreadsheet packages can be adapted to meet managers' Internal ploys used in the budget game can be divided into roughly four
needs in a wide variety of circumstances. Frequently these models serve to categories:
quantify an organization's policy decisions, and require analysts, senior man-
1. Ploys for new programs.
agement, and governing bodies to determine which variables are policy driven
and which can be formula driven. In so doing, the models help to bring con- 2. Ploys for maintaining or increasing ongoing programs.
siderable discipline to an organization's financial analyses, and add a great
3. Ploys to resist cuts.
deal of power to the decision-making processes undertaken by senior man-
agement and the board. 4. Ploys primarily for supervisors.
The operating budget for a hospital or health maintenance organization There is some overlap among the categories, with some relating to strate-
Example
could be determined by a model that incorporates morbidity estimates gic planning as well as to budgeting. Each ploy is described briefly, and an
(types and number of cases expected), physician treatment protocols appropriate response is given.
S04 PartThree Management Control Systems Chapter 10 Budgeting SOS

EXHIBIT 110-2 College Financial Model for each diagnosis, expected efficiency measures and factor prices for
physician-ordered services, and fixed facility costs. Such a model would
permit decision makers to determine where and how expenditures might
be reduced by focusing on specific "cost drivers." Reductions could take
umb er of students . . ^..
f
de t . f_.-
am ber o f aunts (o sections) perstudent
stud ent per rf 3 a
place, for example, by avoiding the treatment of certain types of cases,
image number of students persection 3 .. , .. , L by changing physician treatment protocols, by seeking improved admin-
umber of sections offered per year:... . istrative efficiency, or by guaranteeing certain factor prices. The model
tuber of FTE facu lty .... ........... could permit analysts to test the impact of each of these options, as well
umber of sections per FTE teaching faculty per yi as combinations of options, on total costs. Such an approach is being
amber of Fit teaching faculty needed per year used in some hospitals.
umber of FTE non teaching fictlty per year (sabb
department head buyoud^ ) w
stage comp per faculty . .. . . Summary Many aspects of operations budgeting in nonprofit organizations are similar to
those in for-profit companies. Perhaps the most important difference is on the rev-
enue side of the budget. Many nonprofit organizations are not "self-financing."
Because of this, they must be careful to forecast their revenues accurately, and to
assure themselves that expenses will not exceed revenues. Although there are
some exceptions to this rule, and most organizations can have a year or two where
expenses exceed revenues, the effective result of such a policy is to erode the or-
ganization's capital.
Some other differences between nonprofit and for-profit organizations are
(1) the presence of two-stage budgets in some nonprofit organizations, (2) the ex-
s'av
istence of soft money and the uncertainty about grant revenue in some nonprofits,
per Stu
(3) the need for output measures as well as measures of revenue and expenses, and
nt variable
(4) the role of professionals.
of students needed = n+ $9,800 .:.
In all organizations, the budget frequently has a "gamelike" quality to it. Be-
cause of this, the players have developed many ploys to assure their success in the
would happen if we increased the number of students by 10 percent? game. These ploys are described in some detail in the Appendix.
Moreover, beginning with this simple model, we can refine the analysis
by substituting a frequency distribution of section sizes for the average
section size, by substituting a distribution of faculty compensation by rank %I[I[('I 14 Iis
for the overall average, by bringing in noninstruction costs, or by being
more specific about any of several other variables.
Computer models such as this are available for many types of nonprofit or-
Some Budget Ploys
ganizations, and spreadsheet packages can be adapted to meet managers' Internal ploys used in the budget game can be divided into roughly four
needs in a wide variety of circumstances. Frequently these models serve to categories:
quantify an organization's policy decisions, and require analysts, senior man-
1. Ploys for new programs.
agement, and governing bodies to determine which variables are policy driven
and which can be formula driven. In so doing, the models help to bring con- 2. Ploys for maintaining or increasing ongoing programs.
siderable discipline to an organization's financial analyses, and add a great
3. Ploys to resist cuts.
deal of power to the decision-making processes undertaken by senior man-
agement and the board. 4. Ploys primarily for supervisors.
The operating budget for a hospital or health maintenance organization There is some overlap among the categories, with some relating to strate-
Example
could be determined by a model that incorporates morbidity estimates gic planning as well as to budgeting. Each ploy is described briefly, and an
(types and number of cases expected), physician treatment protocols appropriate response is given.
506 Part Three Management Control Systems Chapter 10 Budgeting 507

Ploys for New Programs tinental ballistic missiles, so there was included in the budget for the mis-
sile program an amount to provide for construction of a new office build-
ing. Initially this building was used by a contractor in the missile program,
1. Foot in the Door but eventually it became a general-purpose Air Force office building.

Description Response
Sell a modest program initially, with the idea of concealing its real magnitude Break down programs so that such items become visible.
until after it has gotten under way and has built a constituency.
3. Divide and Conquer
Example In a certain state, the legislature was sold on a program to ed-
ucate handicapped children in regular schools rather than in the special Description
schools then used . The costs were said to be transportation costs and a
Seek approval of a budget request from more than one supervisor.
few additional teachers. Within five years, the definition of handicapped
had been greatly broadened, and the resources devoted to the program Example The City Planning Commission in New York City was organized
were four times the amount originally estimated. so that each member was supposed to be responsible for certain specified
areas . The distinctions were not clear, however, so budgetees would deal
Response
with more than one supervisor, hoping that one of them would react
This ploy can elicit either of two responses: (a) detect the ploy when it is pro- favorably.
posed, consider that it is merely a foot in the door and that actual costs even-
tually will exceed estimates by a wide margin, and therefore disapprove the Response
project (difficult to do); or (b) hold to the original decision, limiting spending Responsibilities should be clearly defined (easier said than done).
to the original cost estimate despite pleas for more funds (effective only if the
ploy is detected in time). Caution
In some situations, especially in research, it is dangerous to have a single de-
Variations cision point. It is often desirable to have two places in which a person with a
One variation of this ploy is buying in; that is, underestimating the real cost of new idea for research may obtain a hearing. New ideas are extremely difficult
a program. An example is the B-I bomber program. In the early 1980s, this to evaluate, and a divided authority, even though superficially inefficient,
program was estimated to cost $11.9 billion. The Air Force submission for the lessens the chance that a good idea will be rejected.
B-1 bomber for FY 1983 "certified" that the cost of the program was $20.5
billion. However, two independent audit groups within the Pentagon esti- 4. Distraction
mated its cost as $23.6 billion and $26.7 billion, respectively. The Congres-
sional Budget Office estimated the cost at $40 billion. Description
Another variation is bait and switch; that is, initially requesting an inex- Base a specific request on the premise that an overall program has been ap-
pensive program but increasing its scope (and cost) after initial approval has proved when this is not in fact the case (difficult, but not impossible, to use
been obtained. This differs from the "foot in the door" ploy in that the changes successfully).
in the program take place before the program begins rather than after it has
Example At a legislative committee, a university presented arguments
been operating for a while.
to replace buildings prior to implementing an approved plan for dou-
bling the capacity of a certain professional school. The argument was that
2. Hidden Ball
newer buildings would be more useful and efficient than the existing
Description
buildings. The merits were discussed in terms of the return on investment
arising from the greater efficiency of the new buildings. This discussion
Conceal the nature of a politically unattractive program by hiding it within an went on for some time until a committee member asked who had ap-
attractive program. proved the plan for expansion of the school in the first place. It turned
Example Some years ago the Air Force had difficulty in obtaining funds out that the expansion had never been approved; approval of the new
for general-purpose buildings but found it easy to get funds for intercon- buildings would have de facto approved the expansion.
506 Part Three Management Control Systems Chapter 10 Budgeting 507

Description Response
Sell a modest program initially, with the idea of concealing its real magnitude Break down programs so that such items become visible.
until after it has gotten under way and has built a constituency.
3. Divide and Conquer
Example In a certain state, the legislature was sold on a program to ed-
ucate handicapped children in regular schools rather than in the special Description
schools then used . The costs were said to be transportation costs and a
Seek approval of a budget request from more than one supervisor.
few additional teachers. Within five years, the definition of handicapped
had been greatly broadened, and the resources devoted to the program Example The City Planning Commission in New York City was organized
were four times the amount originally estimated. so that each member was supposed to be responsible for certain specified
areas . The distinctions were not clear, however, so budgetees would deal
Response
with more than one supervisor, hoping that one of them would react
This ploy can elicit either of two responses: (a) detect the ploy when it is pro- favorably.
posed, consider that it is merely a foot in the door and that actual costs even-
tually will exceed estimates by a wide margin, and therefore disapprove the Response
project (difficult to do); or (b) hold to the original decision, limiting spending Responsibilities should be clearly defined (easier said than done).
to the original cost estimate despite pleas for more funds (effective only if the
ploy is detected in time). Caution
In some situations, especially in research, it is dangerous to have a single de-
Variations cision point. It is often desirable to have two places in which a person with a
One variation of this ploy is buying in; that is, underestimating the real cost of new idea for research may obtain a hearing. New ideas are extremely difficult
a program. An example is the B-I bomber program. In the early 1980s, this to evaluate, and a divided authority, even though superficially inefficient,
program was estimated to cost $11.9 billion. The Air Force submission for the lessens the chance that a good idea will be rejected.
B-1 bomber for FY 1983 "certified" that the cost of the program was $20.5
billion. However, two independent audit groups within the Pentagon esti- 4. Distraction
mated its cost as $23.6 billion and $26.7 billion, respectively. The Congres-
sional Budget Office estimated the cost at $40 billion. Description
Another variation is bait and switch; that is, initially requesting an inex- Base a specific request on the premise that an overall program has been ap-
pensive program but increasing its scope (and cost) after initial approval has proved when this is not in fact the case (difficult, but not impossible, to use
been obtained. This differs from the "foot in the door" ploy in that the changes successfully).
in the program take place before the program begins rather than after it has
Example At a legislative committee, a university presented arguments
been operating for a while.
to replace buildings prior to implementing an approved plan for dou-
bling the capacity of a certain professional school. The argument was that
2. Hidden Ball
newer buildings would be more useful and efficient than the existing
Description
buildings. The merits were discussed in terms of the return on investment
arising from the greater efficiency of the new buildings. This discussion
Conceal the nature of a politically unattractive program by hiding it within an went on for some time until a committee member asked who had ap-
attractive program. proved the plan for expansion of the school in the first place. It turned
Example Some years ago the Air Force had difficulty in obtaining funds out that the expansion had never been approved; approval of the new
for general-purpose buildings but found it easy to get funds for intercon- buildings would have de facto approved the expansion.
508 Part Three Management Control Systems Chapter 10 Budgeting 509

Response 7. Implied Top-Level Support

Expose the hidden aims, but this is sometimes very difficult.
Description
5. Shell Game The budgetee says that, although the request is not something that he person-
ally is enthusiastic about, it is for a program that someone higher up in the or-
Description ganization asked to be included in the budget (preferably this person is not
well known to, and more prestigious than, the budgetee's superior). The bud-
Use the statistics to mislead supervisors as to the true state of affairs. getee hopes that the supervisor will not take the time to bring this third party
Example The budgetee was head of the Model Cities program for a cer- into the discussion.
tain city. He wanted available funds to be used primarily for health and
Response
education programs but knew that his superiors were more interested in
"economic" programs (new businesses and housing). He drew up the fol- Examine the documentation. If it is vague, not well justified, or nonexistent,
lowing table: check with the alleged sponsor.

Note
Source
In a related ploy, the end run, the budgetee actually goes to the supervisor's
Purpose Federal Other Total boss without discussing the matter with the supervisor first. This tactic should
Health and education ......... $2,000,000 $ 15,000 $2,015,000 not be tolerated.
Economic .................. 50,000 2,300,000 2,350,000
8. You' re to Blame
The budgetee emphasized to the mayor and interested groups that over half
Description
the funds were intended for economic purposes. The catch was that the source
of "other" funds was not known, and there were no firm plans for obtaining Imply that the supervisor is at fault, and that defects in the budget submission
such funds. This was not discovered by the supervisor until just prior to the therefore should be overlooked.
deadline for submitting the request for federal Model Cities funding, at which Example It is alleged that the supervisor was late in transmitting budget
time the budgetee successfully used the delayed buck ploy (No. 17). instructions or that the instructions were not clear, and that this accounts
for inadequacies in the justifications furnished.
Response
Careful analysis. Response
If the assertion is valid, this is a difficult ploy to counter. It may be necessary
6. It's Free to be contrite, but arbitrary, in order to hold the budget within the guidelines.
(It also may be necessary to reexamine one's management style.)
Description
Argue that someone else will pay for the project so the organization might as 9. Nothing Too Good for Our People
well approve it.
Description
Example States often decide to build highways, reckoning the cost is
Used, whether warranted or not, to justify items for the personal comfort and
low since the federal government reimburses 95 percent of the cost. These
safety of military personnel, for new cemeteries, for new hospital equipment,
states overlook the fact that maintenance of the highway is 100 percent a
for research laboratory equipment (especially computers), and for various fa-
state cost.
cilities in public schools and colleges.

Response Response
Require analysis of the long-run costs, not merely the costs for next year. This Attempt to shift the discussion from emotional grounds to logical grounds by
technique , called life-cycle costing, is becoming increasingly popular. analyzing the request to see if the benefits are even remotely related to their
508 Part Three Management Control Systems Chapter 10 Budgeting 509

Response 7. Implied Top-Level Support

Response Response
Require analysis of the long-run costs, not merely the costs for next year. This Attempt to shift the discussion from emotional grounds to logical grounds by
technique , called life-cycle costing, is becoming increasingly popular. analyzing the request to see if the benefits are even remotely related to their
510 Part Three Jrnnogeinent ControlSysiems Chapter 10 Budgeting 511

cost. Emphasize that in a world of scarce resources, not everyone can get all 13. Call It a Rose
that is deserved.
Description
10. Keeping Up with the Joneses Use misleading, but appealing, labels.

Example Example The National Institutes of Health were unable to obtain ap-
Minneapolis must have new street lights because St. Paul has
them. proval for the construction of new buildings but were able to build an-
nexes. It is said that Building 12A (the annex) is at least double the size of
Response Building 12.
Analyze the proposal on its own merits.
Response
Look behind the euphemism to the real function. If the disguise is intentional,
11. We Must Be Up to Date
deny the request and discourage recurrence.

Description
14. Outside Experts
This differs from Ploy No. 10 in that it does not require that a "Jones" be
found and cited. The argument is that the organization must be a leader and Description
must therefore adopt the newest technology. Currently, this is a fashionable The agency hires outside experts to support its request, either formally in
ploy for computers and related equipment, for hospital equipment, and for lab- hearings, or informally in the press.
oratory equipment.
Response
Response Determine whether these experts are biased, either because they have connec-
Require that a benefit be shown that exceeds the cost of adopting the new tions with the agency or because they are likely to benefit if the request is ap-
technology. proved. Seek other experts with contrasting views.

Caution
Ploys for Maintaining or Increasing Ongoing
Sometimes the state of the art is such that benefits cannot be conclusively
demonstrated. If this leads to a deferral of proposals year after year, opportu- Programs
nities may be missed.
15. Show of Strength
12. If We Don't, Someone Else Will
Description
Description Arrange demonstrations in support of a request; occasionally, threaten vio-
Appeal to people's innate desire to be at least as good as the competition. lence, work stoppages, or other unpleasant consequences if the request is not
approved.
Example A university budgetee argued that a proposed new program
was breaking new ground , and was important to the national interest. She Response
stated that if her university didn't initiate the program , some other uni- Have fair criteria for selecting programs, and have the conviction to stand by
versity would. Moreover, the other university would obtain funds from the your decision.
appropriate government agency, and thus make it more difficult for her
university to start the program later on. 16. Razzle- Dazzle
Response Description
Point out that a long list of possible programs have this characteristic , and the Support the request with voluminous data, arranged in such a way that their
university must select those few that are within its capabilities. significance is not clear. The data need not be valid.
510 Part Three Jrnnogeinent ControlSysiems Chapter 10 Budgeting 511

cost. Emphasize that in a world of scarce resources, not everyone can get all 13. Call It a Rose
that is deserved.
Description
10. Keeping Up with the Joneses Use misleading, but appealing, labels.

Caution
Ploys for Maintaining or Increasing Ongoing
Sometimes the state of the art is such that benefits cannot be conclusively
demonstrated. If this leads to a deferral of proposals year after year, opportu- Programs
nities may be missed.
15. Show of Strength
12. If We Don't, Someone Else Will
Description
Description Arrange demonstrations in support of a request; occasionally, threaten vio-
Appeal to people's innate desire to be at least as good as the competition. lence, work stoppages, or other unpleasant consequences if the request is not
approved.
Example A university budgetee argued that a proposed new program
was breaking new ground , and was important to the national interest. She Response
stated that if her university didn't initiate the program , some other uni- Have fair criteria for selecting programs, and have the conviction to stand by
versity would. Moreover, the other university would obtain funds from the your decision.
appropriate government agency, and thus make it more difficult for her
university to start the program later on. 16. Razzle- Dazzle
Response Description
Point out that a long list of possible programs have this characteristic , and the Support the request with voluminous data, arranged in such a way that their
university must select those few that are within its capabilities. significance is not clear. The data need not be valid.
Chapter 10 Budgeting 513
S1Z Partlhree Management ControlSystens

Example A public works department submitted a 20-page list of repairs 19. Sprinkling
to municipal buildings that were said to be vitally needed, couched in
highly technical language. This was actually a "wish list," prepared with- Description
out a detailed analysis. "Watering" was a device used in the early 20th century to make assets and
profits in prospectuses for new stock offerings look substantially higher than
Response they really were. "Sprinkling" is a more subtle ploy, which increases budget
(a) Ask why the repair budget should be greater next year than in the current estimates by only a few percent, either across-the-board or in hard-to-detect
year. (b) Find a single soft spot in the original request and use it to discredit areas. Often it is done in anticipation that the supervisor will make arbitrary
the whole analysis. reductions, so that the final budget will be what it would have been if neither
the sprinkling nor the arbitrary cuts had been made.
17. Delayed Buck
Response
Description Since this ploy, when done by an expert, is extremely difficult to detect, the
Submit the data late, arguing that the budget guidelines required so much de- best response is to remove the need for doing it; that is, create an atmosphere
tailed calculation that the job could not be done on time. in which the budgetees trust the supervisor not to make arbitrary cuts.

Example The budget guidelines requested a "complete justification" of

requested additions to inventory. The motor vehicle repair shop of a state Ploys to Resist Cuts
did not submit its budget on time. At the last minute, it submitted an
itemized list of parts to be ordered, based on a newly installed system of
calculating economic order quantities. It argued that its tardiness was a 20. Make a Study
consequence of getting the bugs out of the new system (which was in-
stalled at the controller's instigation), but that it was generally agreed that Description
the economic order quantity formula was the best way of justifying the The budget guidelines contain a statement that a certain program is to be cur-
amount of parts to be purchased. tailed or discontinued. The budgetee responds that the proposed action should
not be taken until its consequences have been studied thoroughly.
Response
This is a difficult ploy to counter. Complaining about the delay may make the Response
supervisor feel better but will not produce the data. One possible response, de- Make the study; be persistent; supplement with other ploys.
signed to prevent recurrence, is to penalize the delay by making an entirely
arbitrary cut in the amount requested, although this runs this risk that needed 21. Gold Watch
funds will be denied.
Description
18. Reverence for the Past When asked in general terms to cut the budget, propose specific actions that
do more harm than good.
Description
Example This well-known ploy derives its name from an incident that
Whatever was spent last year must have been necessary to carry out last year's
occurred when Robert McNamara was with the Ford Motor Company. In
program; therefore, the only matters to be negotiated are the proposed incre-
a period of stringency, all division heads were asked to make a special ef-
ments above this sacred base.
fort to cut costs. Most responded with genuine belt tightening. However,
Response one division manager, with $100 million sales, reported that the only cost
reduction opportunity he had found was to eliminate the gold watches
As a practical matter, this attitude must be accepted for a great many programs
that were customarily given to employees retiring with 30 or more years
because there is not time to challenge this statement. For selected programs,
there can be a zero-base review (see Chapter 15). of satisfactory service.
Chapter 10 Budgeting 513
S1Z Partlhree Management ControlSystens

Example The budget guidelines requested a "complete justification" of

Response Response
If the basic premise is accepted, the budget process cannot proceed rationally,
Reject the proposal. (In the example, disciplinary action was also taken with
respect to the division manager) for the supervisor tends to be a generalist and the budgetee a specialist. The
supervisor should insist that the expert express the basis for his or her judg-
ment in terms that are comprehensible to the generalist.
22. Arouse Client Antagonism
Description
25. End Run
When a budget cut is ordered, cut a popular program, hoping to provoke com- Description
plaints from clients that will pressure the supervisor to restore the program. A Go outside normal channels to obtain reversal of a decision.
classic case is known as the "Washington Monument elevator ploy," where
the manager of the Washington Monument proposes to cut the monument's Example In Massachusetts in the early 1980s, many hospitals that had
budget by eliminating its elevator service, knowing that doing so will arouse been denied a certificate of need (CON) to engage in capital building
considerable antagonism from hundreds of thousands of visitors each year. projects asked their state legislators to introduce a bill overriding the deci-
sion by the public health council (an executive branch agency) and per-
Example When Mayor Abraham Beame was asked in 1975 by the fed. mitting the project to proceed. Other legislators, knowing that the next
eral government to reduce spending in New York City to avoid bank- CON denial might be in their district, supported their colleagues, and the
ruptcy, he responded by dismissing 7,000 police officers and firefighters entire CON process was weakened.
and closing 26 fire houses. Many people believe he did this to inflame
public opinion against budget cuts. It did have this effect, and the order Response
was reversed. If the end run is made to the legislature or an equivalent powerful body, the ex-
ecutive probably has no choice except to grin and bear it (pressures for a veto
Response
frequently are hard to muster). In other cases, anyone who attempts an end run
Try to redirect client attention by publicizing areas where cuts are feasible. should be reprimanded and the request denied, because attempts to go outside
proper channels upset the authority of the whole budgetary process.
23. Witches and Goblins
Ploys Primarily for Supervisors
Description
The budgetee asserts that if the request is not approved, dire consequences
will occur. It is used often by the House Armed Services Committee in its 26. Keep Them Lean and Hungry
reports to Congress. For example, an antiballistic missile system was recom-
mended as a counterdefense to the "Talinin System" that the Soviets were Description
alleged to be building. In fact, the Soviets were not building such a system. The supervisor tells the budgetee that the latter's organization will work
harder and possibly more effectively if it doesn't carry so much fat.
Response
Analysis based on evidence rather than on emotion. Response
Show that the analogy with human biology is false, or go along with the anal-
24. We Are the Experts ogy and show that the cuts represent muscle rather than fat.

Description 27. Productivity Cuts

The budgetee asserts that the proposal must be accepted because he or she has
expert knowledge that the supervisor cannot possibly match. This ploy is used Description
by professionals of all types: military officers, scientists, professors, physi- It is assumed that many capital expenditures are made with the intention of cut-
cians, and clergy. ting operating costs. Although few systems permit individual cost reductions to
Chapter 10 Budgeting 515
514 Part Three ,'Nnnagernent Control Systems

Description 27. Productivity Cuts

The budgetee asserts that the proposal must be accepted because he or she has
expert knowledge that the supervisor cannot possibly match. This ploy is used Description
by professionals of all types: military officers, scientists, professors, physi- It is assumed that many capital expenditures are made with the intention of cut-
cians, and clergy. ting operating costs. Although few systems permit individual cost reductions to
516 Part Three Management Control Systems Chapter 10 Budgeting 517

be identified, it is reasonable to assume that they, together with continuing 30. Closing Gambits
management improvements, should lead to lower operating costs in the aggre-
gate. Some organizations therefore reduce personnel-related costs by about 1.5 Description
percent from the previous year's level. In the entire economy, productivity in- The supervisor uses various tactics to bring the negotiation to a close. A sim-
creases by about 3 percent annually. The lower percentage assumes that non- ple one is simply to glance at his or her watch, indicating that time is valuable.
profit organizations are only half as susceptible to productivity gains as the Another is to "split the difference" between the amount requested and the
economy as a whole. amount the supervisor initially wanted to approve. Still another is the proposal
In some organizations the cost reductions can be specifically traced. to settle on a small amount now, with an indication that a larger amount will
When an organization makes a large capital expenditure to convert its be considered later on.
recordkeeping to computers, this presumably results in lower operating
costs, and the planned savings should be specifically identified. If an ap- Response
proved program for, say, 1991 contains an item for the installation of a new Suggest that another meeting be scheduled to complete the negotiation. If this is
computer system that is designed, in part, to reduce clerical expenses begin- not possible, be sure to clarify in writing those decisions that have been made.
ning in 1993, the budgeted clerical expenses in 1993 should reflect the
promised reduction. 31. Program Elimination
Response
Description
Point out that dismissals are politically expedient, and retirements and resig- The dean of a business school was not in favor of a small program that had been
nations may not be rapid enough to permit costs to be reduced to the desired developed by the school's department of accounting. However, the program had
level. considerable support both from the school's faculty and from the local account-
ing community. It also produced an annual contribution of several hundred
28. Arbitrary Cuts thousand dollars for the university. To eliminate the program formally would
have required obtaining faculty approval, which the dean knew he could not ob-
Example The supervisor, who was director of research of a large com- tain. Thus, when asked by the university's central administration to cut the
pany, followed the practice of reducing the budget for certain discretionary school's budget, the dean cut the budget of this program to such an extent that it
items (travel, publications, professional dues) in certain departments by ap- could not survive. One year later, the program was no longer in existence.
proximately 10 percent. Although the supervisor did this on a purely ran-
dom basis, he achieved a reputation for astute analysis. Response
Initiate a process for budget reductions that requires faculty approval for any
Response
amount greater than some small percentage in any given program.
Challenge the reason for the cuts (but the items tend to be so unimportant and
difficult to defend that such challenges may consume more time than they are
worth.)

Suggested Anthony, Robert N. "Zero-Base Budgeting : A Useful Fraud?" The Government

29. I Only Work Here Accountant, Summer 1977, p. 7.
Additional
Description Readings Harmer, W. Gary. "Bridging the GAAP between Budgeting and Accounting."
Governmental Finance, March 1981 , pp. 19-24.
The supervisor says she cannot grant the budgetee's request because it is not
within the scope of ground rules that her superiors have laid down. Lynch, T. D. Public Budgeting in America, 5th ed. Englewood Cliffs, NJ:
Prentice Hall, 1995.
Response
McLeod , It K. "Program Budgeting Works in Nonprofit Organizations."
Ask that the issue be brought to the appropriate decision-making authority. Harvard Business Review, September-October 1971.
This, of course, relies on a good relationship (trust) between the budgetee and
the supervisor. Rabin, J.. ed. Handbook of Public Budgeting. New York: Marcel Drekker. 1992.
516 Part Three Management Control Systems Chapter 10 Budgeting 517

Suggested Anthony, Robert N. "Zero-Base Budgeting : A Useful Fraud?" The Government

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Nonprofit Budgeting Explained

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Nonprofit Budgeting Explained

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Chapter 10 Budgeting 487

Budgeting General Nature of the Operating Budget

Budgeting General Nature of the Operating Budget

Relation to Programs Advanced Techniques

Relation to Programs Advanced Techniques

• Not forcing their personal goals onto subordinates.

• Not forcing their personal goals onto subordinates.

Response 7. Implied Top-Level Support

Response 7. Implied Top-Level Support

Example The budget guidelines requested a "complete justification" of

Example The budget guidelines requested a "complete justification" of

Description 27. Productivity Cuts

Description 27. Productivity Cuts

Suggested Anthony, Robert N. "Zero-Base Budgeting : A Useful Fraud?" The Government

Suggested Anthony, Robert N. "Zero-Base Budgeting : A Useful Fraud?" The Government

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