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Memorandum To: From: Date: Re:

TBD Jetmir Troshani Date goes here Trends Paper on Performance-Based Budgeting

Outline Introduction ..................................................................................................................... 1 Performance-based budgeting versus the traditional budgets ..................................... 2 The working of the Performance-Based Budgeting ...................................................... 4 Advantages and disadvantages of Performance-Based Budgeting ............................. 6 Conclusion ...................................................................................................................... 8 References ...................................................................................................................... 9

Introduction Performance-based budgeting has been the center of reforms in both the private and the public sector. However, a substantial ambiguity still remains on how define and implement performance-based budgeting (Aristovnik & Seljak, 2009, p. 3; Robinson, 2007, p. 2). Somewhat close definition is that performance based budgeting apportions resources in accordance with specific achievement or quantifiable results. Performance budgeting can also be defined as systems of planning, budgeting, and appraisal that focuses the link between budgeted funds and expected outcome (Axelrod, 1998, p. 5). Therefore, performance-based budgeting links measurable performance and allocation


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of resources, with the capacity to state the level of achievable output with the injection of additional resources. Nevertheless, output can never be measured accurately (Grizzle, 2001, p. 6). Performance budgeting is result oriented in that it holds different divisions accountable to specific performance standards. This from of budgeting enhances awareness of the kind of services expected by the taxpayer. This type of budgeting is flexible since it allocates resources in lump sum instead of piecemeal budgeting, giving the managers the options in determining how best to attain results (Government Finance Officers Association, 2007, p. 2). Performance based budgeting is also inclusive in that it involves all the stakeholders in the development of strategic plans, identification of preferential areas, and in the assessment of the outcome. Last but not least, performance based entails long-term strategies. By acknowledging the link between strategic planning and allocation of resources, this form of budgeting is geared towards long-term goals (Hatry, 2006, p. 12; Hatry, 2006, p. 7). Performance-based budgeting versus the traditional budgets While performance-based information can provide massive benefit to a country, it can not eradicate the political nature of budgeting. Performance-based budgeting can only provide benefits to a country once it is acknowledged that the connection between performance measures and allocation of resources are involuntary and are subject to political interference (Ingraham & Donald, 2001, p. 3; Joyce, 1999, p. 5). The traditional


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budgeting methods are basically tools for regulating and controlling expenditure. They spell out the amount of money to be spent for a particular purpose (Joyce, 1999, p. 6). As the financial year progresses, line-item budgets dictates that spending must be within the budgeted amount unless formal budgetary amendments are permitted (Lane, 2006, p. 4; Fielding, 1999). While these traditional budgetary methods are useful in helping the management in internal regulation, they are not as beneficial when it comes to policy and decision making. These types of budgets only assure the top management that money has been spent for the approved purpose but do not what the money has accomplished (Melkers, 1998, p. 23; Miller, Hildreth & Rabin, 2001, p. 3). In the traditional budgeting methods, organizations develop long term strategies and break them into annual budgets that are formed as projections. At the end of every fiscal year, actual performance is compared with the projected figures and the variance is determined. Analysis in traditional budgets is considered simple and lacks sophistication in terms of flexibility. Essentially, actual- budget variance are normally used for amending funds for the subsequent plans and budgets, and for tracking performance in different departments (Rubin, 1996, p. 35; Robinson, 2007, p. 4). In contrast, performance-based budgeting is more geared toward policy/decision making. They help in connecting plans, measurements and budgeting (Segal & Summers, 2002, p. 4). They expand the thinking horizon of the policy makers and departmental heads. Performance-based budgeting offers excellent information on the impact of budget decision and provides enhanced budgetary flexibility and motivation for creating budget savings (World Bank, 2003, p. 2). Performance-based budgeting also permits continuous evaluation of the expenditure trends and therefore reinforces


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decision making and oversight. It increases economic accountability to all the stakeholders and supports good governance and evaluation (Joyce, 1999, p. 11; Miller, Hildreth & Rabin, 2001, p.5). Performance budgeting does not mean that the management have to give up all of their control over expenditure; instead it gives them authority to evaluate expenditure all the time. They do so basically to spot check and to rectify specific setbacks. Performance-based budgets also give the common citizens power to hold the elected officials accountable for not attaining the performance target as per the budget and within the money already spent (Segal & Summers, 2002, p. 8). The working of the Performance-Based Budgeting This type of budgeting requires Key Performance Indicators linking resource allocation and performance measures (Lane, 2006, p. 4). Performance-based budgeting is similar to Corporate Performance Management structure, where strategy and planning are linked to implementation and measurement (Hatry, 2006, p. 13). It is balanced scorecard approach in which the Key Performance Indicators are defined and assembled between bases and impacts of budgetary system in which monetary systems and business operations are tracked. In addition, connecting resource allocation with the performance provides vital information on how much money is required to attain a given level of outcome (World Bank 2003, p. 5-6). Numerous public organizations have failed to determine how much it cost to achieve a specific outcome, basically due to challenges arising from the indirect allocation of funds. This necessitated the introduction of activity-based costing structure. Activity-based costing was a dominant concept in the private sector much


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less than the public sector organizations until the inception of performance-based budgeting. Performance-based budgeting has introduced rational but tougher budgeting approach in both sectors (Aristovnik & Seljak, 2009, p. 6). The top companies have incorporated numerous business intelligence applications and procedures to attain corporate performance management (Grizzle, 2001, p. 9). Initially steps in implementing the performance based budgeting involves the formulation of the organizational plans and defining strategies based on major financial and non-financial measurements (Hatry, 2006, p. 5). The measurements and plans form the basis for the next step. The strategies and the budget are communicated to the forefront employees who perform routine activities. The targets and thresholds are then transferred from the planning system to the organizational activities’ evaluation engine that involuntarily notifies the management of any setback (Hatry, 2006, p. 5-6; Ingraham & Donald, 2001, p.10). The performance of the organization is constantly reviewed and re-estimated, and if required, budgetary amendments are made. If the performance of the business massively deviates from the plan, business strategies are re-assessed because a number of of the earlier assumptions may have changed. The ability to establish a performance-based budgeting control depends on the initial understanding of the business through a uniform and consistent data although the organization (Lane, 2006, p. 12). Uniform data ensures that there is a distinct information warehouse where users can follow and assess the path of the strategy. Implementing performance based budgeting in public is not that easy, but given the dynamic nature of the business and political environment it is very significant (Miller, Hildreth & Rabin, 2001, p. 10).


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Most governments use performance data to account for their funds they have appropriated in their projects to the parliament and the general public, besides self regulation. The numerous goals necessitate a number of measures to assess whether the set goals have been achieved given the amount of resources allocated those purposes. State agencies differ significantly in the effort to utilize performance measures as their budgeting/management instrument (Segal & Summers, 2002, p. 13). Advantages and disadvantages of Performance-Based Budgeting Performance-based budgeting has clear objectives. Many organizations experience numerous problems as a result of obscure objectives. Performance-based budgeting necessitates setting up of specific objectives and fundamental goals for the subsequent year. For instance, the goal of many businesses is to generate extra revenues. Generation of extra revenue is not specific and therefore defined goals such as business positioning which can enhance revenue generation is an example of clear objective. Business positioning involves other activities like product promotion which are quantifiable (Robinson, 2007, p. 5). Performance-based budgeting enhances business/organizational accountability. This type of budgeting makes it more difficult for data manipulation or fraud by the people in charge since it tracks all the activities. In essence, performance-based budgeting allows the top management to demand for the results of the laid down strategies or plans within specific period. It exposes the low performing employees or departments necessitating suitable action to avert the same (Segal & Summers, 2002, p. 9). In this case, performance-based budgeting enhances overall business performance since employees have full knowledge of the repercussions involved.


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Performance measures can also identify high-performing parts of the business which requires additional investment to maximize product or service efficiency. Information acquired from the performance based budgeting enable business to adjust their goals in accordance with the prevailing conditions (Grizzle, 2001, p. 7; Segal & Summers, 2002, p. 10). Last but not least, performance based budgeting expands the horizon of thinking. It helps to avert what is known as “black box operations�. Black box operation refers to organizational goals that are restricted to one particular element of the organization. Performance-based budgeting removes such inferior way of thinking and facilitates the expansion of business goals (Miller, Hildreth & Rabin, 2001, p. 11). Nevertheless, there are a number of limitations linked to performance-based budgeting. Performance- based budgeting only emphasizes on goals and targets. For instance, it may set a goal of 200 vehicles to be bought in the company within a particular fiscal year but do no set the limit of expenditure for each vehicle. Therefore, performance based budgeting does not answer the fundamental questions such as the money to be spent on a particular item, and the suitability of the item for the intended purpose. The budget which provides limits answers such question. Budgets with only targets and goals can be excessively indefinable, resulting in imprecise prediction and excessive expenditure (Hatry, 2006, p. 14; Government Finance Officers Association, 2007). Another weakness of performance based budgeting is in the performance measurement. Even if a budget was cohesive and is envisaged to see the project to its completion, defining the completion can prove to be very challenging. Some of the goals set by this form of budgeting are vague. Organization may have contradictory opinions


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on the goals that have been achieved, making it hard to identify the end of a project or it its turning point. Performance based budgeting also does not provide a clear cost framework to be followed and has no room for flexibility problems (Hatry, 2006, p. 15; Aristovnik & Seljak, 2009, p. 4-5). Conclusion Performance budgeting is as systems of planning, budgeting, and appraisal that focuses the link between budgeted funds and expected outcome. Performance-based budgeting has been dominant in the private sector for a very long period of time, but is also gaining access in the public sector. It has numerous advantages over the traditional budgeting methods, however it also have some weaknesses. Despite of these weaknesses, performance based budgeting is a way to go for the future. It should incorporate elements in other budgetary methods to make it an all inclusive budget.


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References Aristovnik, A., & Seljak, J. (2009). Performance budgeting: selected international experiences and some lessons for Slovenia. MPRA Paper 15499. Germany: University Library of Munich. Axelrod, D. (1998). Budgeting for Modern Government. New York: St. Martin's Press. Fielding, S.J. (1999). The Benefits and Threats of PBB: An Assessment of Modern Reform. Public Budgeting and Finance, 19 (3), 3–15. Government Finance Officers Association, (2007). Performance Management: Using Performance Measurement for Decision Making. Recommended Practice 2002 & 2007. Grizzle,G.A.(2001).Performance measures for budget justifications: Developing a selection strategy. In.G. J. Miller, W. B. Hildreth, & J. Rabin (Eds.). Performancebased budgeting. Boulder, CO: West view Press. Hatry, H.P. (2006). Performance Measurement: Getting Results. London: The Urban Institute Press.


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Ingraham, P.W., & Donald, P. M. (2001). Beyond Measurement: Managing for Results in State Government. In Dall Forsythe, ed., Quicker, Better, Cheaper? Managing Performance in American Government. Albany, New York. Rockefeller Institute. Joyce, P. G. (1999). Performance-based budgeting. In R. T. Meyers (Ed.), Handbook of government budgeting. San Francisco, CA: Jossey-Bass Publishers. Lane, C. S. (2006). Performance Based Budgeting – Putting The Pieces Together. Deputy Director, Office of Planning and Budget, Division of Administration, State of Louisiana. Melkers, J. (1998). The State of the States: Performance-based Budgeting Requirements in 47 out of 50. Public Administration Review, 58(1), 22-45. Miller, G. J., Hildreth, W. B., & Rabin, J. (2001). Performance-based budgeting. Boulder, CO: Westview Press. Robinson, M. (2007). Performance Budgeting, Linking Funding and Results. New York: Oxford Press. Rubin, L. (1996). The Politics of Public Budgeting. Chatham, New Jersey: Chatham House. Segal, G., & Summers, A. (2002). Citizens’ Budget Reports: Improving Performance and Accountability in Government. Reason Public Policy Institute, Policy Study No. 292, p. 4. World Bank (2003) Performance-based budgeting: Beyond Rhetoric. Poverty Reduction and Economic Management, 7, 1-4.


Trends Paper on Performance-Based Budgeting