Balance the future – balance sheet budgeting

Hear from, Michael Newsome, a client success representative at Questica, as he discusses the importance of balance sheet budgeting and how fully integrated budgets for your city, county, agency or state’s income statement, cash flow and balance sheet can provide a much clearer picture of what the future will hold.


The article will also discuss how the application of this approach in combination with activity-based budgeting can bridge the gap that often exists between near term budgets and long term strategic plans. Plus, we also look at how the time currently devoted to purely mechanical reconciliations can be used to more effectively plan.


Balance the future


I have always been a great believer in balance sheet budgeting, so when I first entered the world of government budgeting, I was surprised to learn that municipalities rarely prepare complete balance sheet budgets. Agreed, most do prepare reserve and debt forecasts, but these are rarely integrated with the revenue and expense budgets that are prepared for the operating budget book.


While there is uncertainty about all future outcomes, it seems uncanny to me that uncertainty should be compounded by the failure to produce fully integrated budgets that provide pro forma statements of cash flow and financial position. Instead, municipalities focus on balancing revenues and expenses. This in itself provides no guarantee that the balance sheet will be balanced and therefore that future cash balances and the accumulated surplus will be sufficient to meet the demands upon them.


Municipalities fail


This is not a purely academic issue. Although rare, the truth is that municipalities fail and not because they failed to produce the budget documents mandated by their governing authorities. While diminishing tax bases combined with an accumulation of debt may be the underlying cause of many municipal failures, I would argue that in most cases it would be possible to predict and address those issues earlier if municipalities made a more concerted effort to budget their future financial positions.


Between January 2010 and August 2015 there were 51 municipal bankruptcy filings in the United States including nine general purpose local government bankruptcy filings. Two of those occurred in California. It is interesting to note that while municipalities in Canada do fail, they are not allowed to file for bankruptcy – instead they are dissolved and merged at the will of their Provincial guarantors.


Cash budgeting and accrual accounting


Another reason why preparing a balance sheet budget will become increasingly important, is the move towards a greater acceptance of accrual accounting among government institutions and accounting standards bodies in both the United States and Canada. If budgets continue to be prepared on a broadly cash basis, while the preparation of financial statements moves in the direction of accrual accounting, the variance reporting that has been a mainstay of budgetary control will become more difficult to understand since many variances will occur simply because of timing differences.


 Focus on activities


Maintaining a focus on the activities required to provide the services to be delivered is always a good thing. When you think of a budget merely as a collection of dollar amounts that are added together, it can give rise to a disconnect between the objectives and priorities of Councils and the budgets that they approve. It should always be possible to say that this is what we are trying to achieve for our citizenry, these are our options for delivery, this is why we are recommending this particular option, and finally, these are the financial consequences of moving forward with that option.


While it is always helpful to focus on activities, this is particularly true when preparing a fully integrated budget. The way those activities are undertaken can have an impact on cash flow and the balance sheet. For example, if the activities associated with the provision of a service are contracted out to a third party, the terms of the contract may give rise to a significant timing difference between when the service is provided and when payment is made; when the costs are expensed and when they are paid. The only way to validate the cash flow consequences is through the preparation of a balance sheet forecast. Similarly, there can be significant timing differences associated with the collection of tax revenues and the activities undertaken to provide services funded by those revenues. Again these timing differences will be reflected in the balance sheet.


Case study


If we take a look at garbage collection and recycling services, there are significant differences in the forecast cash flow and balance sheet depending upon whether those services are undertaken in house, or contracted out to a third party. This is true even when there may be little difference in the forecast income statements for both scenarios. A study prepared by the City of Windsor, Ontario, compared an in house scenario with an outsourced scenario for garbage collection and recycling. Over a seven-year period the in house option had an operating impact of $42.1 million whereas the outsourced option had an operating impact of $38.2 million. This 10% difference may in itself have swayed the Council in the direction of the outsourced option. But the upfront capital costs of $7.4 million associated with the in house option firmly tipped the scale in that direction. Those capital costs had a far more onerous impact on cash flow than would have been apparent from an operating budget projection. Further, they would have required the postponement of major infrastructure projects or an increase in the tax levy.


How Questica can help


Governments are moving generally in the direction of accrual accounting and if variance reporting is to remain relevant, then operating budgets must be prepared on the same basis. However, cash flow forecasting is always a primary concern and it is not possible to validate forecast cash flows without a forecast balanced statement of financial position. With the help of a comprehensive budgeting preparation and management tool like Questica Budget, forecasting and viewing variances becomes updated in real time and improves efficiency and accuracy in your processes.


Discover how Questica Budget, our software solution created specifically for the public sector can help your organization better manage the budgeting and financial statement forecasting process by provide an accurate picture of the organization’s budget when you need it. Sign up for one of our free monthly webinars or request a demo today.