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Good practices in budget formulation

 

October 30, 2012

Why is budget formulation important in government?

How is the quality of government budget management evaluated?

The Public Expenditure and Financial Accountability (PEFA) Performance Measurement Framework highlights the four objectives for budget formulation:

  • Credibility of the budget – The budget is realistic and is implemented as intended
  • Comprehensiveness and transparency – The budget and the fiscal risk oversight are comprehensive and fiscal and budget information is accessible to the public.
  • Policy-based budgeting – The budget is prepared with due regard to government policy.
  • Predictability and control in budget execution – The budget is implemented in an orderly and predictable manner and there are arrangements for the exercise of control and stewardship in the use of public funds.

What is the budget formulation process?

Budget formulation differs among countries and levels of government. The budget formulation process typically starts economic analysis and prediction for government revenue. The process follows sets of budget rules during a budget calendar that includes a broad set of financial information.

How does budget planning fit into PFM processes?

Government budget planning begins during the fiscal year and leverages historical and current revenue and expenditure information.  Budget planning processes align, in theWorld Bank Treasury Reference Model, with economic forecasting, debt management and treasury systems. Liquidity and cash management is critical to understanding the expected revenue and expenditure variations in government.

What budget categories are used by governments?

Budget planning categories differ among countries. The processes used can be different depending on the categories. Typical categories include:

How do budget classifications enable budget formulation across categories?

Government budget formulation software can adapt to the planning workflow and categories used by governments through budget classifications. Government budget classifications, often called Charts of Accounts (COAs), represent the underlying meta data for Public Financial Management (PFM).

The COA is made up of a number of hierarchical data segments and is considered the lynchpin of a government’s accounting and reporting system and serves as a key tool to meet its business requirements.

The COA, although appears to be just concerned with classifying and recording financial transactions, is critical for effective budget management, including tracking and reporting on budget execution. The structure of the budget—in particular the budget classification—and the COA have a symbiotic relationship.

The COA structure can be used within the budget formulation software to map:

  • Users and roles to elements in the COA to ensure that planners are only able to see the correct sub-section of data
  • Workflow processes and that the budget formulation process follows government standards for different budget preparation categories
  • Revenue sources such as donors (aid), debt and government revenue can be shown in “fund” source segment or included in the accounting codes
  • Capital, recurrent and salary categories are typically modeled in the accounting (or object) codes
  • Program segment and can be combined with object codes can be used to model public investment projects
  • Organization or location segment can be used to control decentralized budgets across line ministries, government owned enterprises and sub-national governments

What are the major trends in government budget preparation?

How does budgeting differ among developing and developed country governments?

What is fiscal sustainability?

Governments need to develop credible budgets to ensure that long-term spending is sustainable.  Credible budget planning takes into account the four dimensions of fiscal sustainability:

How are credible budgets achieved?

What are Medium Term Expenditure Frameworks (MTEF)?

MTEFs represent rolling plans, normally over three to five years, which move forward each year with the first year representing the budget and the “outer” years representing projections of spending. The purpose of MTEFs is to enable more credible budgets, address fiscal sustainability and better link policy, planning and budgeting for meaningful shifts in spending priorities. However, although there is widespread recognition that this is a promising way forward, in practice establishing MTEFs is difficult, and implementation takes longer than is often anticipated.

MTEFs differ among countries depending on the fiscal context, capacity and tradition. MTEF is an aggregate term that can include:

  • Medium Term Macroeconomic Frameworks (MTMF) to provide a multiple year view on expected and relevant economic activity that can drive
  • Medium Term Fiscal Frameworks (MTFF) to predict the government revenue and expenditure envelop to inform
  • Medium Term Budget Frameworks (MTBF) that provide the basic structure of expenditures based on government priorities that can include
  • Medium Term Sectoral Strategies (MTSS) of specific programs designed to improve economic sectors whose performance can be managed by
  • Medium Term Performance Frameworks (MTPF) that align budgets with desired performance outputs and outcomes

Why are MTEFs challenging?

Traditional approaches to budget reform – multiyear budgeting, output based and accrual budgeting – have been particularly difficult to implement in developing countries and the development landscape is littered with failed reform strategies. Challenges to effective MTEF implementation include:

How does government budget planning software meet unique requirements?

Effective government budget planning software can be configured to meet unique requirements. There are numerous budget management software applications available but, in practice the World Bank and aid agencies have funded the introduction of private sector financial systems, which do not include core budgeting functionalities.

Government budget formulation software must support:

  • Financial functionsincluding the ability to develop budgets in any combined top-down/bottom-up process. Effective budget preparation software can take previous data and adjust by formula (such as reduce by 5% all revenue categories or increase the cost of oil by 10%). The software enables linking budget justification directly with the budget classifications. The budget passed by the legislature, often called the “organic budget law” or “the vote” is automatically integrated with the budget execution/accounting system to ensure proper budget controls.
  • Content. Budget formulation software needs to use data from other sources including importing spreadsheet data directly to the financial budget plan, attaching narrative to budget requests and referencing documents.
  • Workflow: Flexible workflow functions are necessary to follow the government budget calendar and address budget categories. Multiple budget versions are required.
  • Performance: Governments with higher capacity can integrate output and outcome data to the COA and develop scorecards.

What are the inputs for government budget software?

Inputs in the budget formulation process include:

  • Financial transactions from previous years (and the active fiscal year) including the tracking of multi-year commitments that roll-over to subsequent years
  • Budget variances from previous budgets including changes that occurred to the budget during operation such as budget transfers and virements to provide trend information
  • MTEF year 2 and 3 budget estimates to provide a baseline for the working budget
  • Macroeconomic data that predicts government revenue, identifies risks, and creates baseline budget assumptions such as currency exchange rates
  • Cost drivers or established estimates for products and services so that budgets use credible assumptions and align with scenario planning such as analyzing the impact of changing energy costs and currency fluctuations
  • Documents like budget justification, policy information and reports
  • Integration with underlying systems and spreadsheets

What are the outputs for government budget software?

Outputs in the budget formulation process include:

  • Budget controls to be integrated with the treasury system components of the Government Resource Planning (GRP) software for commitment accounting including support for warrants, supplemental budgets, continuing resolutions
  • Scenario plans that enables government to quickly adjust budgets should risk factors come to fruition during the fiscal year
  • Documents generated from the system such as budget books

Why are flexible controls required?

Flexible controls in GRP software are critical for governments to match regulations and enable modernization:

  • Budget laws address high-level budget items in the COA. Therefore, strict control at details or “line item budgeting” is not material to the law
  • Capacity is critical when determining decentralization and needs to be flexible to support more discretion in spending and budget transfers to improve results
  • Allotments, appropriations, warrants and cash controls differ among countries based on legal frameworks, traditions and liquidity
  • Treasury departments provide more value to governments by managing liquidity and adjusting allotments based on surplus and deficit forecasts than approving commitments and transferring amounts among budget line items

What budget control functions are necessary in GRP software?

  • Multiple Controls: numerous controls can operate simultaneously such as cash warrants and annual appropriations
  • Periods: different controls can be active for different time periods, typically from a month to a year
  • Aggregate: controls can operate from detailed line item to high level and where the total of detailed line items could equal or not equal the total for the high level controls
  • Tolerances: discretion enabled for some controls such as the ability to overspend some monthly controls by a fixed amount or a percentage as long as aggregate controls are not overspent
  • Commitment Controls: where tolerances can be applied to commitments and obligations
  • Segregation of Duties: workflow controls to ensure proper separation of duties for spending approvals, payment approvals and budget transfer approvals that meet government fiscal regulations
  • Organization Configurations: support of different control schemes for different government organizations reflecting legal status and organizational capacity

Why not use spreadsheets or simple web applications for budget preparation?

Spreadsheet and simple web applications do not provide sufficient control, error management and integration for budget planning:

  • Version management and approval: versions of budgets and approvals for budgets require more sophisticated software that uses workflow control
  • Controls: budget formulation software is required to create controls, manage segregation of duties integrate with commitment accounting
  • Errors: validation on data input is not sophisticated in spreadsheet and simple web applications resulting in mistakes
  • Historical information: integrated budget preparation and budget execution software provides accurate analytical information for budget planners

What are good practices for budget formulation?

  1. Budgets are the legal embodiment of government policy and is critical in public financial management
  2. Budget formulation practices should match country conditions and human capacity
  3. The Chart of Accounts is critical for effective budget processes
  4. Budget formulation software can help to create more credible budgets that provide fiscal sustainability and internal controls
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Doug Hadden

Doug Hadden

Executive Vice President, Innovation at FreeBalance
Doug is responsible for identifying new global markets, new technologies and trends, and new and enhanced internal processes. Doug leads a cross-functional international team that is responsible for developing product prototypes and innovative go-to-market strategies.

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