Budgeting Budgeting Theory Budgetary Models

Approaches to Budgeting Budgetary Models Fixed Budgeting Flexible Budgeting Rolling Budgets Incremental Budgeting
November Price Base Budgeting Planning Programming Budgeting System (PPBS) Approach Zero Based Budgeting
Performance Based Budgeting Cash Limited Budgets Resource Restricted Budgets Contingency Budgeting Added Value
Budgets Activity Based Budgets Sources of Further Information
August 2007

Budgetary Models
This section analyses and evaluates different types of budgetary model which might be applied to budgetary processes in
public sector organisations.

Approaches to Budgeting Budgetary Models

There are a number of different approaches to budgeting or models which can be applied throughout the public and private
sectors. It is not the intention of this section to suggest that there is a core of theory underlying the development of
budgeting particularly in the public sector nor that there exists a set of equations which comprehensively define all of the
functional relationships in the budgeting process. Indeed Bbudgeting in the public sector is inevitably characterised by a
piecemeal and haphazard development this is not to say, however, that it is not capable of analysis.

The following budgetary models are examined and evaluated below:

fixed budgeting;

flexible budgeting;
rolling budgets;
incremental budgeting;
November price base budgeting;
planning programming budgeting systems;
zero based budgeting;
performance budgeting;
cash limited budgeting;
resource restricted budgeting;
contingency budgeting;
added value budgeting;
activity based budgeting.

The following section considers budgeting models by themes :

Theme: The Alignment of Budgets with Strategic Priorities

Incremental Budgeting

Zero Based Budgeting

Priority Based Budgeting

Decision Conferencing

Planned Programme Budgeting Syatems

Performance Based Budgeting

Participatory Budgeting

Resource Restricted Budgeting

Theme: Budget Preparation in conditions of Uncertainty

Rolling Budgets

Contingency Budgets
Theme: The adjustment of Budgets in respect of fluctuations in activity:

Fixed Budgeting

Flexible Budgeting

Activity Based Budgeting

Theme: The adjustment of Budgets in respect of inflation:

November Price Base Budgeting

Cash Based ( Outturn Budgeting

The Alignment of Budgets with Strategic Priorities

Fixed Budgeting
Fixed budgets are prepared on the basis of a given level of activity which may be expressed in terms of output expenditure
and/or sales. Fixed budgets may change as revisions are made to reflect changing circumstances. They are reasonably easy
to prepare when the level of activity is know or can be predicted with some confidence. In the public services the level of
resourcing often determines the level of activity and may be established in advance of the financial year.

Flexible Budgeting
Flexible budgets identify those variable or semi variable costs and recognise that costs behave in different ways. Some costs
are fixed over time but others may vary.
for planning purposes - where an organisation is unclear or unsure about activity levels;

for control purposes - at the end of each control period the budget can be prepared retrospectively to reflect the
actual level of activity achieved.

They can be prepared on a marginal or absorption costs basis - if the former is used then fixed costs per unit will be fixed in
advance. If absorption costing is used then fixed costs will have to reflect the actual fixed cost absorbed at the level of
activity achieved. Secondly there may be a need for flexible budgets given the nature of cost behaviour in most public sector
organisations. This model has applications in both the manufacturing, service and public sectors, e.g.
in the manufacturing sector plant and equipment costs account for a large proportion of total costs and tend to be

fixed;
labour costs in public sector organisations are often fixed as they are part of a permanent payroll. The only variable
elements may be as a result of overtime.

Rolling Budgets
A rolling budget can be defined as:
"a budget constantly updated by adding a further period, e.g. a month or quarter and removing the earliest period".
A monthly rolling process would involve preparing a budget every month each time rolling forward for one year. The first
month would be planned in great detail with the remaining months being of lesser detail reflecting uncertainty about the long
term future of the organisation. This allows for more precise planning in the first month particularly in respect of working
capital and short term resource usage. On the control side the budget will provide a more reliable standard against which to
judge performance.
The potential advantages of using rolling budgets are that:
they reduce uncertainty in budgeting which is important in highly volatile industries where sales levels and prices

may fluctuate;
managers need to reassess the budget frequently;
more realistic budgets will aid motivation;
planning and control will always be based on up to date information which covers a significant period into the future.

The disadvantages of rolling budgeting are that:

it is time and resource intensive;

managers may find the constant revision of budgets disruptive and unsettling;
continuous updating may not be justified where the changes are not continuous.

As far as the public sector is concerned most of these disadvantages would apply as public bodies normally have to stay
within fixed limits which could make this process somewhat pointless.

Incremental Budgeting
Traditional budgeting approaches in public serviceslocal authorities have been based on the incremental approach. This
involves using the previous years budget, adjusted for known factors (such as new legislative requirements, additional
resources, service developments, anticipated price inflation and pay awards). This means that existing operations and the
current budgeted allowance for existing activities are taken as the starting point for preparing the next annual budget. It is
relatively straightforward and is of most relevance in services where there is little year-on-year change in service activity. It
is called incremental budgeting since the process is mainly concerned with the increment in operations or expenditure that
will be incurred during the next budget period.
A key characteristic of this approach is that budget preparation takes place through a process of negotiation and
compromise. Incremental budgeting is therefore based on a fundamentally different view of decision making than that of
more rational approaches. The process of negotiation between interest groups depends fundamentally on a willingness by
them to negotiate and compromise in the first place. If this consensus breaks down then there is no possible way of
achieving a fair compromise and the incremental process becomes invalid. For this reason this model presupposes the
existence of a fairly stable and democratic form of society.
In summary its main characteristics are therefore:
a reliance on the current year budget to create the next years one;

concentration on multi scale incremental changes in policy from one year to the next;
negotiation and compromise between interest groups to achieve an acceptable budget.

The actual process itself is relatively straightforward. As the next years budget depends on the current one then time is a
major factor. Since implementation specifically precludes the setting of outputs or objectives there is an emphasis on inputs
instead. The key stages are:
establishing the base to do this it is necessary to decide what is committed expenditure and then make

adjustments to reflect unavoidable changes, e.g.

full year effects of staff appointments;
full year effects of the capital programme;
salary increments;
non recurring items which should be removed;
external factors e.g. changes in legislation or government funding regimes.
updating for changes in price levels for labour, goods and services;
adding to the implications of the development budget to reflect proposed savings and growth;
aggregating and producing the new budget.

The merits of incremental budgeting are that:

it is easy to understand as it is retrospective, makes marginal changes and secures agreement through negotiation

and consensus;
it is cheap;
it allows concentration upon key areas of change as far as policy makers are concerned;
in the public sector it is useful because outputs are difficult to define and quantify;
the budget is stable and change is gradual.

Incremental budgeting does, however, have a number of disadvantages:

it is backward looking as it looks to past budgets rather than future organisational requirements;

it does not allow for an overall view of performance;

it does not facilitate identification of budgetary slack which has been identified by Schiff and Lewin as being

something which managers attempt to secure within the overall negotiation process;
the use of simple inflation increases can lead to perverse outcomes because resources must be acquired in uneven
amounts, e.g. two persons must be employed. For other resources, e.g. equipment, resources will tend to be fixed
and committed over very wide range of activity volumes. As long as demand is lower than the capacity supplied by

the committed resource no additional spending will be required;

it is often underpinned by data or service provision which is no longer relevant or is inconsistent with new priorities
and objectives; it encourages inertia and empire building;
it is reactive rather than proactive;
it assumes that existing budget patterns are relevant and satisfactory.

To conclude , there are certain characteristics of public service organisations that tend to lead to support an
incremental approach. Public service organisations are often large and complex with decisions having to be made in a
short time period. Thus it is easier to accept the distribution of most expenditure as given and to concentrate on a few
deviations from the existing pattern. In addition the budget often has to be dealt with at both managerial and
legislative levels. Managers find it easier to communicate a few changes to politicians within the annual decision
making process. Slow adjustment to budgets are often easier to implement than sudden shifts in priorities. It can be
argued that incremental budgeting is a rational approach in the sense that it is better to introduce change gradually ,
monitoring the effects of new initiatives and adjusting if their impact is not the required one.However the major
disadvantage associated with this approach, is that it does not allow for an overall view of performance, and
encourages inertia with inefficient and ineffective uses of resources being perpetuated and creative thinking/new
initiatives being curtailed.

November Price Base Budgeting

The November Price Base budgeting approach was most commonly used in local government up to the early 1990s but has
generally been superseded by more robust models. The November Price Base approach takes the current years budget and
increases it in line with the known pay awards at 31 October of that year affecting the following financial year along with the
organisations own best estimates of price changes up to that date including where appropriate local price movements.
Known increases in taxation e.g. employers National Insurance contributions are also included.
An example, sourced from CIPFA Statistical Information Service shows the November 2005 price base for public sector
organisations and employees.

Document
Title: November 2005 Price Base (Source - CIPFA Statistical Information Service)
This budgetary model does not incorporate assumptions about likely inflation or pay increases which are not known on 31
October in the base service budgets. Instead a provision for inflation and unconfirmed pay awards is held back as a
contingency and released to services budgets during the course of the financial year as and when pay awards or inflationary
pressures become known.
November price based budgeting has become subject to increasing criticism in recent years because it is:
overly administratively complex;

limits the ability of managers to manage their overall budgets;

requires constant revision of budgets as assumptions change.

Zero Based Budgeting

Zero based budgeting (ZBB) was developed in the United States in the early 1960s by Peter Pyrrh working at Texas
Instruments in an attempt to overcome the limitations of incremental techniques. It presumes that budgets can be
recompiled from first principles i.e. from a zero base and focuses on programmes and activities rather than departments or
units.
Jones and Pendlebury have defined it as follows:
Zero based budgeting in its purest form is precisely what its name implies; the preparation of operating budgets from a zero
base even though the organisation might be operating more or less as in previous years the budgetary process assumes that
it is starting anew.
The process is usually applied to new services which, genuinely, are being built up from a zero base. In addition, zero-based
budgeting can be applied to subjective heads such as repairs, maintenance, equipment where service priorities can be
established corporately without reference to previous years budgets. The budget holders should present their requirements
for resources in such a fashion that all funds can be allocated on the basis of cost benefit or similar evaluative analyses. The
cost benefit approach is an attempt to ensure value for money, it questions long-standing assumptions and serves as a tool
for systematically examining and perhaps abandoning any unproductive projects.
The principle characteristics of ZBB are:
the involvement of all executive managers in the budgeting process;

the justification of resources for current and proposed activities;

the determination of objectives;
the assessment of alternative ways of achieving these objectives;
no costs or activities should be factored into plans just because they featured in current or previous ones.

ZBB is best suited to discretionary and support services and thus has extensive potential application to the public sector.
With discretionary costs such as advertising or training managers have some discretion as to the amount they will budget for
the activity in question. There is no optimum relationship between inputs (as measured by the costs) and outputs (measured
by the revenues generated). Furthermore they are not predetermined by previous commitments. In effect managers are free
to determine what quantity of service they are willing to provide and there is no established method for determining the
appropriate amount to be spent in particular periods.
The key stages are to:
define the scope of implementation;

identify decision units;

prepare decision packages (an analysis of a discrete area of activity);
rank packages;
prepare budget;
implement budget.

Define the scope of implementation

A key initial stage is to determine whether the organisation wishes to apply zero based budgeting across the entire
organisation or a defined part. Similarly will the process be a one off exercise or ongoing.
Identify decision units
The key to successful zero based budgeting is to define units at the most appropriate level in the organisation for budget
programming. Decision units must have:
one manager who is clearly responsible for the unit and its activities;

clearly defined and measurable inputs;

clearly defined and measurable outputs which lend themselves to the setting of success criteria in the form of
performance targets.

Prepare decision packages

A decision package is:

"the identification and evaluation of alternative ways of performing programme functions and activities".
There are four key stages to preparing decision packages:
establishing the decision units objectives;

identifying alternative methods of provision e.g. mutually exclusive or incrementally based alternative;
identifying service levels, e.g.

minimum level the zero based below which it is not possible to continue to provide the service which is
normally the statutory minimum level in the public sector;
current level the existing base;
incremental level placed between the current and minimum levels or an improvement over the current

level;
preparing a package for each of the levels being considered which contains a brief justification and a request for
resources.

Rank packages
The next stage of the process requires packages to be reviewed and ranked in order of priority. This can be done by
successive levels of management throughout the organisation. The main difficulties are choosing the right criteria for
determining priorities and secondly the logistics of collating the rankings and producing a consolidated approach for the
organisation as a whole.
The key benefits of using ZBB can be summarised as follows:
it is a systematic reappraisal of the base budget;

it focuses attention on outputs in relation to value for money;

there is involvement of managers at all levels;
it creates a questioning attitude;
there is a clear definition of organisational objectives and goals;
it has the ability to be adapted to changing circumstances;
it enhances knowledge of inputs and outputs;
it improves communication and management consensus;
there is ultimately a better allocation of resources;
underpins much of the thinking behind the current efficiency agenda.

It does have potential disadvantages however:

it is complex and requires special skills and training;

it is expensive and there is a tendency towards bureaucracy and excessive paperwork;

there can be problems with performance measures and priority criteria;
the specification of minimum levels of service is threatening to some managers and may be a demotivating factor;
the process of identifying decision packages and determining their cost, purpose and benefits is extremely time
consuming. Furthermore there can be too many decision packages to evaluate and there can often be insufficient

information to enable them to be ranked;

there may be uncertainty about costs and resources of alternate, untried options.

For these reasons ZBB has never quite achieved the widespread adoption that its proponents envisaged. In practice most
organisations will tend to approximate the principles of this model without applying the full scale approach outlined here e.g.
through the use of priority based incremental budgets. These invite managers to quantify the impact on service delivery if
budgets were increased or reduced by a given percentage. Additional resources are then allocated to those areas which can
demonstrate the greatest benefit in terms of increased outputs from a given percentage growth in their budget.
In January 2006, in the light of the proposed introduction of zero based budgeting to government departments as part of the
2007 Comprehensive Spending Review, CIPFA produced a briefing on zero based budgeting.

Document
Title: Zero Based Budgeting Briefing (CIPFA, 2006)

Priority Based Budgeting

This is a modification of Zero Based Budgeting. The focus is on identifying corporate priorities and allocating
growth and savings accordingly. This requires a thorough ongoing review of departmental services Typically
the review would requires a statement of
Objectives /purpose of the service
Targets/standards the service is trying to achieve.
Various thresholds at which the service could operate
On the basis of this analysis for each unit the elements of spending could be classed as essential/highly
desirable/beneficial. This information would be supplied to the decision makers.
Decision Conferencing

Decision Conferencing is an approach which requires decision makers to explore budgetary decision in a
structured fashion , aided by software which generates an analysis of costs and benefits for each option under
discussion.
Participants identify each key service area and the resources committed to each area. They then discuss the
implications of varying the resources to that service by significant amounts. The costs and benefit ( given a
benefit score)of each level of activity are plotted on a graph with the help of the computer software.
The benefits of the process are said to be that participants get a much better understanding of priorities , the
process in methodical and leads to a package of proposals which can be implemented successfully. However
considerable time and expertise are required to operate the associated computer packages. The focus of the
exercise is largely at service level and it is more difficult to apply across services.
Planning Programming Budgeting System (PPBS) Approach
The planning programming budgeting system (PPBS) approach was developed in the early 1950s as a mechanism by which
non profit making organisations could both obtain information on the efficiency and effectiveness in which it was achieving
its objectives and more importantly provide a sound basis by which available resources should be allocated.
Programme budgeting is primarily a system associated with corporate management which identifies alternative policies,
presents the implications of their adoption and provides for the efficient control of those policies chosen. It embraces several
well established concepts and analytical techniques within the framework of a systematic approach to decision making,
planning, management and control. The principal feature are that it relates to objectives, it relates to outputs, it emphasises
the future and it emphasises choice (Government and Programme Budgeting, IMTA 1973).
The PPBS approach comprises four stages:
Stage 1
review of the organisational activities for the activities being performed the planning process

Stage 2
identification of programmes that can be undertaken to achieve the organisations objectives, e.g. extending
childcare facilities or improving access to social care for senior citizens the structural element

Stage 3
identification and evaluation of alternative methods for achieving the objectives for each specific programme using a
cost benefit analysis or other quantitative approach the analytical element

Stage 4

select the appropriate programme on the basis of cost benefit principles preferably by means of a ranking approach
the corporate planning element.
PPBS offers the following advantages:
it relates cost estimates to programmes using a cross cutting approach rather than simply attributing costs on a

traditional departmental basis;

it reduces departmental barriers and encourages cross working;
managers are forced to identify which activities or programmes they wish to provide and establish a basis for
assessing their suitability or political acceptability;
it provides information to enable managers to assess the effectiveness of their plans, e.g. are the operational
outputs as effective or as well developed as they should be for the inputs used;
resources should be allocated more effectively in line with objectives, needs and priorities;
it aids the corporate approach to management and provides a structural and systematic approach to long term
planning;
individuals can be made responsible for controlling and supervising the programme by relating their roles to
functionally organised responsibility centres.

PPBS was first implemented by the US federal government following the report of the Second Hoover Commission and is
modelled on the original performance budgeting technique. It was extended to the UK in 1964 by the Ministry of Defence
and a number of English local authorities also experimented with the system. From the late 1970s onwards it became
apparent, however, that there were a number of criticisms associated with the model which meant that it ceased to be used
on a broad scale:
PPBS was seen to be too costly and time consuming;

it proved difficult to identify and quantify objectives in the public sector;

Outcomes from activities can be difficult to measure. It is the nature of many public services that outputs are
often intangible such as peoples wellbeing and happiness that would result from reduced crime.

it appeared to depoliticise the political process by taking decision making powers away from elected representatives.

It is difficult to develop budgeting systems on a programme basis. This is because departments often
contribute to more than one Programme . For instance a police authority could have objectives such as
accident prevention and crime prevention. The provision of a police patrol car in an area could contribute
towards both of these programmes, but how should the costs of this be split between two objectives? The
problem is that two budgeting systems would be required:
Departmental for expenditure control in relation to departmental responsibilities e.g. controlling the cost
of the police car fleet
Programme A budget for crime prevention.

Public sector organisations were encouraged to adopt alternative approaches which focused on creating and maintaining
questioning attitudes towards existing standards of service and the self analysis of objectives. Instead they were encouraged
by organisations to plan for the medium term, focus the attention of policy makers upon their main areas of discretion by
isolating real growth from inflation and promote the discussion of alternatives through the effective presentation of relevant
information.

Zero Based Budgeting

Zero based budgeting (ZBB) was developed in the United States in the early 1960s by Peter Pyrrh working at Texas
Instruments in an attempt to overcome the limitations of incremental techniques. It presumes that budgets can be
recompiled from first principles i.e. from a zero base and focuses on programmes and activities rather than departments or
units.
Jones and Pendlebury have defined it as follows:
Zero based budgeting in its purest form is precisely what its name implies; the preparation of operating budgets from a zero
base even though the organisation might be operating more or less as in previous years the budgetary process assumes that
it is starting anew.

The process is usually applied to new services which, genuinely, are being built up from a zero base. In addition, zero-based
budgeting can be applied to subjective heads such as repairs, maintenance, equipment where service priorities can be
established corporately without reference to previous years budgets. The budget holders should present their requirements
for resources in such a fashion that all funds can be allocated on the basis of cost benefit or similar evaluative analyses. The
cost benefit approach is an attempt to ensure value for money, it questions long-standing assumptions and serves as a tool
for systematically examining and perhaps abandoning any unproductive projects.
The principle characteristics of ZBB are:
the involvement of all executive managers in the budgeting process;

the justification of resources for current and proposed activities;

the determination of objectives;
the assessment of alternative ways of achieving these objectives;
no costs or activities should be factored into plans just because they featured in current or previous ones.

ZBB is best suited to discretionary and support services and thus has extensive potential application to the public sector.
With discretionary costs such as advertising or training managers have some discretion as to the amount they will budget for
the activity in question. There is no optimum relationship between inputs (as measured by the costs) and outputs (measured
by the revenues generated). Furthermore they are not predetermined by previous commitments. In effect managers are free
to determine what quantity of service they are willing to provide and there is no established method for determining the
appropriate amount to be spent in particular periods.
The key stages are to:
define the scope of implementation;

identify decision units;

prepare decision packages (an analysis of a discrete area of activity);
rank packages;
prepare budget;
implement budget.

Define the scope of implementation

A key initial stage is to determine whether the organisation wishes to apply zero based budgeting across the entire
organisation or a defined part. Similarly will the process be a one off exercise or ongoing.
Identify decision units
The key to successful zero based budgeting is to define units at the most appropriate level in the organisation for budget
programming. Decision units must have:
one manager who is clearly responsible for the unit and its activities;

clearly defined and measurable inputs;

clearly defined and measurable outputs which lend themselves to the setting of success criteria in the form of
performance targets.

Prepare decision packages

A decision package is:
"the identification and evaluation of alternative ways of performing programme functions and activities".
There are four key stages to preparing decision packages:
establishing the decision units objectives;

identifying alternative methods of provision e.g. mutually exclusive or incrementally based alternative;
identifying service levels, e.g.

minimum level the zero based below which it is not possible to continue to provide the service which is

normally the statutory minimum level in the public sector;

current level the existing base;

incremental level placed between the current and minimum levels or an improvement over the current

level;
preparing a package for each of the levels being considered which contains a brief justification and a request for
resources.

Rank packages
The next stage of the process requires packages to be reviewed and ranked in order of priority. This can be done by
successive levels of management throughout the organisation. The main difficulties are choosing the right criteria for
determining priorities and secondly the logistics of collating the rankings and producing a consolidated approach for the
organisation as a whole.
The key benefits of using ZBB can be summarised as follows:
it is a systematic reappraisal of the base budget;

it focuses attention on outputs in relation to value for money;

there is involvement of managers at all levels;
it creates a questioning attitude;
there is a clear definition of organisational objectives and goals;
it has the ability to be adapted to changing circumstances;
it enhances knowledge of inputs and outputs;
it improves communication and management consensus;
there is ultimately a better allocation of resources;
underpins much of the thinking behind the current efficiency agenda.

It does have potential disadvantages however:

it is complex and requires special skills and training;

it is expensive and there is a tendency towards bureaucracy and excessive paperwork;

there can be problems with performance measures and priority criteria;
the specification of minimum levels of service is threatening to some managers and may be a demotivating factor;
the process of identifying decision packages and determining their cost, purpose and benefits is extremely time
consuming. Furthermore there can be too many decision packages to evaluate and there can often be insufficient

information to enable them to be ranked;

there may be uncertainty about costs and resources of alternate, untried options.

For these reasons ZBB has never quite achieved the widespread adoption that its proponents envisaged. In practice most
organisations will tend to approximate the principles of this model without applying the full scale approach outlined here e.g.
through the use of priority based incremental budgets. These invite managers to quantify the impact on service delivery if
budgets were increased or reduced by a given percentage. Additional resources are then allocated to those areas which can
demonstrate the greatest benefit in terms of increased outputs from a given percentage growth in their budget.
In January 2006, in the light of the proposed introduction of zero based budgeting to government departments as part of the
2007 Comprehensive Spending Review, CIPFA produced a briefing on zero based budgeting.

Document
Title: Zero Based Budgeting Briefing (CIPFA, 2006)

Performance Based Budgeting

There is no single definition of performance based budgeting (PBB) but most of the literature on this subject agrees that the
aim of PBB is to connect performance information with the allocation and management of resources.
It can be argued that the PBB process is a continuum that involves the availability and use of performance based information
at each of the various stages of the budget process; budget preparation, approval, execution, audit and evaluation.
Performance budgets need to contain information on the following elements:
inputs (as measured in monetary terms in budgets);

outputs - units of output;

efficiency/productivity data (cost per activity);

10

effectiveness information (level of goal achievement).

PBB process
The PBB process should begin at policy level with the organisation developing goals and explicit policy objectives. Managers
then need to develop performance measures which reflect the achievement of these goals/objectives.
In budget preparation and approval, baseline data on current and past performance measures is considered together with
target levels of future performance. Decisions are taken which link budget allocations to these goals, objectives and
measures. The budget report will then contain both financial and performance information and describe how these measures
relate to the strategic plan and desired outcomes from the programme. Thus spending plans and performance plans are
aligned at the time of budget creation.
PBB also provides an opportunity for regular and special programme evaluations. During the execution of the programme,
both financial information and performance information should be used. At the end of the budget period performance based
audits can be completed measuring results of the programmes using the same performance measures produced in the
budgeting process.
Aims of PBB
PBB aims to improve accountability because budget reports are based upon projected outputs as well as inputs.
PBB should in theory lead to improved decision making, since spending decisions will be aligned to organisational objectives.
It could also lead to enhanced service delivery since the budget establishes performance targets which managers will strive
to meet.
Practical application of PBB
The US government National Performance Review published a study on best practice in 1997 which identified the following
key conditions for successfully implementing PBB:
1.

Leadership is important. All levels of management should be actively involved in PBB efforts from developing the
organisational mission, objectives and strategies to developing the performance indicators.

2.

An organised, comprehensible framework for PBB should be established, showing how the process works and
providing a calendar with key milestone dates, etc.

3.

Employees must be held accountable not just for actions, but for results. Rewards should be related to performance.
PBB systems should not however be punitive in nature. Where targets are not met the problems should be identified
and adjustment made and re-implementation should be instituted as necessary.

4.

PBB indicators should be substantive, informative and meaningful to all participants and stakeholders.

5.

Progress and accomplishment of results should be communicated to all participants and the public at large.

There are two fundamental questions in assessing the extent to which PBB has been implemented:
1.

To what extent is performance information available?

2.

To what extent is performance information used at each stage of the budget decision making process; budget
preparation, approval, execution and audit/evaluation?

Research shows that few states in the USA have well developed systems. Mathew Andrews (2004) points out that many
states report performance measures alongside their budget. This however is not the same thing as actually using this
information in decision making. Less than 15 states base budgetary decisions on performance data.
In the UK at national level since 1998 there has been the system of public service agreements in place which set out the
aims and objectives of every major government department together with measurable targets. The spending regime places
an emphasis on setting outcome targets.
In UK local government it would be reasonable to assume that best value would act as a stimulus to the adaptation of
performance based budgeting. Best value refers to the duty to secure continuous improvement in the economy, efficiency
and effectiveness of services and has required public authorities to develop performance indicators.

11

Best value has certainly forced authorities to give more prominence to using and publishing performance information in best
value performance plans (BVPPs). However, evidence to date suggests that authorities tend to publish BVPPs and budgets as
separate documents. This does not inspire confidence that the budgeting process and performance management process are
actually integrated. It may be that managers do consider performance objectives at the time of budget creation and
monitoring, but this is a topic which requires detailed research.
Problems in developing PBB
The following issues may explain the slow development of performance based budgeting (PBB):
1.

Public entities need to be clear on what they trying to achieve. Therefore there needs to be clear strategic direction
in the organisation which may not always be the case.

2.

Translating strategic goals and objectives into performance measures can be very difficult. In many public services,
outcomes are difficult to measure and there is a tendency to fall back upon less appropriate output and input
measures.

3.

Systems for collecting cost and performance information may need to be developed. Costing out services can be
difficult and in particular decisions on how to deal with overheads are problematical.

4.

Problems may exist in respect of presenting this information to those making decisions on budgets. Information may
need to be presented in appropriate formats to a variety of users. If information on performance is separated from
accounting operations then this will hinder the ability for it to penetrate the decision making processes associated
with the operations.

5.

There may be procedural problems caused by failure to change existing budgeting rules and processes.
Organisations continue to publish budget and performance in separate documents.

6.

A lack of political acceptance of reform may prevail. Performance information represents a threat to the political
aspect of budgetary decision making since its explicit measurements tend to limit the discretion politicians can
exercise. It has to be said however that in a complex environment of competing interests it is difficult to see how
any rational, planning based system can be expected to totally replace political decision making.

7.

Problems may exist in achieving management acceptance of a performance budgeting process. There are often
problems in defining who is accountable for performance and managers may fear that they will be reprimanded for
failure to achieve published performance targets, and may thus try to avoid being accountable.

It remains to be seen whether these issues can be overcome.

Participatory Budgeting
Participatory Budgeting (PB) is a tool used by local government (and its partners) which brings local communities
closer to the decision making process around the budget.
It aims to give local communities a say in prioritising services or projects through such activity as community-led
debate, neighbourhood votes and public meetings.
The key is for local groups to own the decision making process.
This is discussed further in the Cross Sectoral Budgeting and Corporate Governance Issues section of this volume.

Resources Restricted Budgeting

Resource restricted budgets are similar to Cash Limited ones but are instead applied to particular resources, e.g. staffing
numbers or equipment. It therefore focuses on the supply rather than the demand side. It takes the incremental model and
reverses the order of the steps in the budgetary process. It begins with the supply aspects (i.e. the level of resources
available to meet future needs) and makes the fundamental assumption that these resources are fixed, i.e. there is a limit or
ceiling to the level of spending. Resource restriction can take a number of forms but these essentially adhere to the same
principle.

12

The process offers control over resources in question and provides clear unambiguous direction but tends to ignore the
practicalities of service delivery and may make the service unmanageable because of the restrictions imposed. There will
probably be little reference to service planning and its inflexibility is not appropriate for demand-led services.

Sources of further information

Authority, acceptance, ability and performance based budgeting reforms by M. Andrews - The International Journal

of Public Sector Management, Volume 17, number 4, pp. 332 -344 (2004).
A case study of budgetary reform in the United Kingdom by J. DSouza - Public Administration and Management: An

Interactive Journal, 9(4), pp. 20-44 (2004).

Performance budgeting by Ronald McGill - The International Journal of Public Sector Management, Volume 14, No 5,

pp 376 390 (2001).

Modernity, modernisation and the de-institutionalisation of incremental budgeting in local government by W. Seal Financial Accountability and Management, 19(2), pp. 93-116 (2003).

Budget Preparation in Conditions of Uncertainty

Rolling Budgets
A rolling budget can be defined as:
"a budget constantly updated by adding a further period, e.g. a month or quarter and removing the earliest period".
A monthly rolling process would involve preparing a budget every month each time rolling forward for one year. The first
month would be planned in great detail with the remaining months being of lesser detail reflecting uncertainty about the long
term future of the organisation. This allows for more precise planning in the first month particularly in respect of working
capital and short term resource usage. On the control side the budget will provide a more reliable standard against which to
judge performance.
The potential advantages of using rolling budgets are that:
they reduce uncertainty in budgeting which is important in highly volatile industries where sales levels and prices

may fluctuate;
managers need to reassess the budget frequently;
more realistic budgets will aid motivation;
planning and control will always be based on up to date information which covers a significant period into the future.

The disadvantages of rolling budgeting are that:

it is time and resource intensive;

managers may find the constant revision of budgets disruptive and unsettling;
continuous updating may not be justified where the changes are not continuous.

As far as the public sector is concerned most of these disadvantages would apply as public bodies normally have to stay
within fixed limits which could make this process somewhat pointless.

Contingency Budgeting
Contingency budgeting is often used for new organisations where detailed budgeting cannot draw upon past experience. This
lack of detail is compensated for by a contingency budget to cover as many heads as required.
The use of contingency budgeting ultimately assists in ensuring Best Practice as it requires organisations to evaluate
alternative scenarios and develop contingency plans to ensure that project implementation risk is minimised. Sophisticated
techniques using contingency budgeting are becoming increasingly employed to deliver IT projects where up to 50% of
allocated budgets may be set aside after the determination of essential or minimum expenditures to allow for the

13

implementation of alternative strategies in the event of project failure or delay. In these scenarios budgets are viewed more
as a guide to an efficient expenditure pattern.
Contingency budgeting models have become increasingly prevalent in the public sector within the United States where
annual budgets are subject to direct approval by district or state electors. Under the 1997 Education Law introduced by the
State of New York, for example, school boards are required to place a contingent budget as well as their preferred budget
including proposed growth and savings items before electors to enable them to make informed decisions about tax levies.
The initial stage of contingency budget preparation is to determine what is contingent or mandatory expenditure. In the New
York case for example these are considered to be those expenditures deemed to be absolutely necessary to maintain and
operate schools as well as any statutory items prescribed by law. This minimum expenditure would include all expenditure
associated with:
the maintenance of the education programme including appropriate extra curricular activities;

preserving property;
salary increases for contracted employees who have a negotiated increase;
ensuring the health and safety of all staff and students;

but would exclude items such as;

non self funding cafeteria services;

non recurring items of expenditure in prior year budgets;
costs related to increases in school enrolments;
relative increases in the proportion of the overall budget incurred on administrative costs;
capital improvements and equipment purchases other than those necessary to preserve property and the health and
safety of all staff and students.

The mandated spending cap for the contingency budget would be linked to the retail price index applying in that financial
year. The contingency budget would then function as a fall back budget should the proposed budget be rejected.
Of course, contingency budgeting cannot be sustained long term because of its lack of detail and link to service planning. It
nevertheless provides an importance tools to minimise the risk associated with failure in major capital projects and to
provide a measure of minimum expenditures in situations where resources are restricted.

The Adjustment of Budgets in respect of Fluctuations of Activity

Fixed Budgeting
Fixed budgets are prepared on the basis of a given level of activity which may be expressed in terms of output expenditure
and/or sales. Fixed budgets may change as revisions are made to reflect changing circumstances. They are reasonably easy
to prepare when the level of activity is know or can be predicted with some confidence. In the public services the level of
resourcing often determines the level of activity and may be established in advance of the financial year. Since in many cases
the level of resources is fixed at the start of the year, most budgets can be regarded as fixed budgets.

Flexible Budgeting
A flexible budget is one that is designed to be changed with variations in the level of activity. It involves identifying
variable and semi variable costs at budget preparation time, and changing the budget as activity levels change.
This type of budget is often used in manufacturing industry, where there may be changes from planned level of
production. In this case the budgets for raw materials and components would be flexed to reflect changes in activity
levels.

14

These budgets are rare in public services, because despite changes in demand for services , the budgets are often
fixed at the start of the year . Thus a rationing process takes place, which means that unanticipated demand cannot
be catered for or excessive pressure is placed on the department to deliver the higher volume of service with existing
resources. For instance a hospital pathology department may have a budget that assumes a given level of activity,
but then a government initiative to reduce waiting lists may mean an increase in the number of tests being done. It
may be that the the budget is not flexed to deal with this.

Activity Based Budgeting

This is a development of the Activity Based Costing approach, developed in the private sector. Whereas traditional
budgeting systems assume that overhead costs are driven by the final volume of products and services, ABC tries to
more accurately identify what drives these costs by linking overhead costs to activities and provides more robust
information for budget formulation. To date this has limited application in the public sector due to the lack of detailed
work on activity bases and cost drivers. .
Activity budgets can be designed to reflect an activity based costing approach to the allocation of costs. The main aim of this
approach in the private sector is to more accurately identify product costs where the production process involves a high level
of fixed costs. This can also be applied in the public sector but in practice this is currently an under-developed method of
budgeting in the public sector where limited financial information is currently available on activity bases and cost drivers.
In practice what this actually means is that all costs including overheads are allocated to activities on the basis of the
characteristics which are felt to drive these costs which is a potentially effective way of addressing the issue of high fixed
costs in a public sector environment.
The key stages in activity based budgeting are to:
identify the organisation's activities;

determine the cost drivers;

spread departmental costs to costs drivers;
calculate budgeted activity levels.

The potential advantages of the activity based model are that:

it identifies the cost of activities;

it allows for resource allocation at different activity levels;

it establishes a link between decision making and cost behaviour;
it fits in with control systems.

The potential drawbacks are that:

there may be problems in defining cost drivers;

it is not possible to monitor on a frequent basis in the short term;

it requires a total review of an organisations accounting and possibly managerial systems.

The Adjustment of Budgets in respect of Inflation

November Price Base Budgeting
The November Price Base budgeting approach was most commonly used in Local Authorities up to the early 1990s but has
now been superseded by cash limited budgets in most Local Authorities. The November Price Base approach takes the
current years budget and increases it in line with the known pay awards at 31 October of that year affecting the following
financial year along with the organisations own best estimates of price changes up to that date including where appropriate
local price movements. Known increases in taxation e.g. employers National Insurance contributions are also included.
This budgetary model does not incorporate assumptions about likely inflation or pay increases which are not known on 31
October in the base service budgets. Instead a provision for inflation and unconfirmed pay awards is held back as a
contingency and released to services budgets during the course of the financial year as and when pay awards or inflationary
pressures become known.

The detailed steps are illustrated below

Calculate increase in price levels from last years base budget date up to the current base budget date

Estimate effects of further price increases to the end of the budget period in overall terms

Provide contingency for this amount and retain it centrally

e.g. In preparing budgets at November 2008, with a financial year running from April- March .

15

Original budget for 2008-2009 - 5 employees at 20,000 each at November 2007 Price base.
Employees then received a 5% pay award in July 2008 and it is estimated that they will receive 4% in July 2009
Using The November price basis the budgets would be as follows:
2008-2009 Revised Budget 100,000 + (100000 x .05 x 9/12) = 103,750
2009-2010 Original Budget 100,000 + (100000 x .05 ) = 105,000
(In contingencies an amount of 105,000 x 0.04 x 9/12 = 3,150 would be allowed , but not allocated to the
departmental budget)
November price based budgeting has become subject to increasing criticism in recent years because it limits the ability of
managers to manage their budgets and is administratively complex requiring constant revision of budgets.

The advantage of November priced based budgeting is that it enables the real levels of service to be maintained in
the budget

Cash Limited Budgets

Cash limited budgets involve each service being allocated a set limit or maximum level of net expenditure. Within these
constraints managers generally have a free hand to deliver services within constraints. This method may be appropriate for a
service with primarily fixed costs and can provide incentives to managers to deliver within budget. Conversely, this method
makes no links to service planning and may lead to reduced service quality. Its inflexibility means that it does not have a
practical application for demand-led services.
Cash limited budgets differ from other models in their treatment of assumptions for pay awards and inflationary increases. In
this respect they share much in common with the November price base budgetary model even though the approaches
adopted in each case are radically different. CCash limited budgets include assumptions about inflation and pay awards
which are not yet known within the base estimate unlike the November price base approach which holds the equivalent
sum within contingency as a provision. In this respect budget holders are required to plan their activities so as to ensure that
their net expenditure does not exceed the cash limit set.

This is illustrated with a numerical example which starts under the assumption that it is November 2008 and the
financial year of the organisation runs from April- March . The original budget for 2008-2009 was 5 employees at
20,000 each at November 2007 Price base with the assumption was that there would be a 5% pay award at
July 2008. At November 2008 it is now known that the staff did actually receive a 5% pay award in July 2008 and
it is now estimated that they will receive 4% in July 2009:
The 2008/2009 Original Budget would have already included an allowance for effect of the pay award
2008-2009 Original Budget 100,000 + (100000 x .05 x 9/12) = 103,750
Similarly the 2009-2010 budget will include an allowance for the pay award expected in July 2009.
2009-2010 Original Budget 100,000 + (100000 x .05 ) = 105,000
plus 105,000 x 0.04 x 9/12 =
3,150
Total 2009-2010 Original Budget
108,150

The advantages of this approach is that managers know what their budgets are going to be right from the start and it can
provide incentives for managers to deliver within budget.The disadvantage is that it is not directly linked to service
planning. If inflation turns out to be higher than predicted this may lead to unplanned reductions in the volume of service.
For instance if the July 2009 pay award is actually 7% then to maintain the real value of the budget the budget for
2009/2010 should have been 105,000 + 5512 ( i.e 105,000 x 0.07 x 9/12) = 110, 512

This approach has widespread use in local government as there is a statutory requirement not to budget for a deficit. It is
administratively simpler and less resource intensive than the November price based model and enables managers to have
greater control over their activities as they have greater certainty at the beginning of the financial year about the resources
at their disposal. The use of cash limiting is likely to become the norm, as least in so far as local government is concerned,
due to the increasing tendency for the central government to seek to ring fence funding for certain priority services linked to
the achievement of national targets. This was demonstrated by the reserve power given to the Secretary of State in the
2002 Education Act to require local authorities to set a minimum schools budget. A limited number of Local authorities and

16

NHS Trusts which have demonstrated high levels of performance through the Comprehensive Performance Assessments and
NHS star ratings will be entitled to a reduction in ring fencing and an increase in financial freedoms but the majority of public
sector organisations will still be subject to a significant degree of central control.

Resource Restricted Budgets

Resource restricted budgets are similar to Cash Limited ones but are instead applied to particular resources, e.g. staffing
numbers or equipment. It therefore focuses on the supply rather than the demand side. It takes the incremental model and
reverses the order of the steps in the budgetary process. It begins with the supply aspects (i.e. the level of resources
available to meet future needs) and makes the fundamental assumption that these resources are fixed, i.e. there is a limit or
ceiling to the level of spending. Resource restriction can take a number of forms but these essentially adhere to the same
principle.
The process offers control over resources in question and provides clear unambiguous direction but tends to ignore the
practicalities of service delivery and may make the service unmanageable because of the restrictions imposed. There will
probably be little reference to service planning and its inflexibility is not appropriate for demand-led services.

Contingency Budgeting
Contingency budgeting is often used for new organisations where detailed budgeting cannot draw upon past experience. This
lack of detail is compensated for by a contingency budget to cover as many heads as required.
The use of contingency budgeting ultimately assists in ensuring Best Practice as it requires organisations to evaluate
alternative scenarios and develop contingency plans to ensure that project implementation risk is minimised. Sophisticated
techniques using contingency budgeting are becoming increasingly employed to deliver IT projects where up to 50% of
allocated budgets may be set aside after the determination of essential or minimum expenditures to allow for the
implementation of alternative strategies in the event of project failure or delay. In these scenarios budgets are viewed more
as a guide to an efficient expenditure pattern.

17

Contingency budgeting models have become increasingly prevalent in the public sector within the United States where
annual budgets are subject to direct approval by district or state electors. Under the 1997 Education Law introduced by the
State of New York, for example, school boards are required to place a contingent budget as well as their preferred budget
including proposed growth and savings items before electors to enable them to make informed decisions about tax levies.
The initial stage of contingency budget preparation is to determine what is contingent or mandatory expenditure. In the New
York case for example these are considered to be those expenditures deemed to be absolutely necessary to maintain and
operate schools as well as any statutory items prescribed by law. This minimum expenditure would include all expenditure
associated with:
the maintenance of the education programme including appropriate extra curricular activities;

preserving property;
salary increases for contracted employees who have a negotiated increase;
ensuring the health and safety of all staff and students;

but would exclude items such as;

non self funding cafeteria services;

non recurring items of expenditure in prior year budgets;
costs related to increases in school enrolments;
relative increases in the proportion of the overall budget incurred on administrative costs;
capital improvements and equipment purchases other than those necessary to preserve property and the health and
safety of all staff and students.

The mandated spending cap for the contingency budget would be linked to the retail price index applying in that financial
year. The contingency budget would then function as a fall back budget should the proposed budget be rejected.
Of course, contingency budgeting cannot be sustained long term because of its lack of detail and link to service planning. It
nevertheless provides an importance tools to minimise the risk associated with failure in major capital projects and to
provide a measure of minimum expenditures in situations where resources are restricted.

Added Value Budgets

Added value budgets aim to show how much wealth or value has been created by an organisation's activities and how these
have been shared with the various stakeholder groups, e.g.
service users;

shareholders, investors and private sector partners;

employees;
tax payers;
central government.

They are an extension of the master budget and indicate how the wealth which the budget estimates will be created would
be split between the stakeholder groups with an interest in the organisation.

Activity Based Budgets

Traditional approaches to budgeting are effective for unit level activity costs where the consumption of resources varies
proportionately with the volume of the final output of products or services. However for those indirect costs and support
activities where there is no clearly no defined input-output relationship and the consumption of resources does not vary with
the final output of products or services, traditional budgeting approaches merely serve to authorise levels of spending for
each budgeted item of expense.

18

Activity budgets can be designed to reflect an activity based costing approach to the allocation of costs. The main aim of this
approach in the private sector is to more accurately identify product costs where the production process involves a high level
of fixed costs. This can also be applied in the public sector but in practice this is currently an under-developed method of
budgeting in the public sector where limited financial information is currently available on activity bases and cost drivers.
In practice what this actually means is that all costs including overheads are allocated to activities on the basis of the
characteristics which are felt to drive these costs which is a potentially effective way of addressing the issue of high fixed
costs in a public sector environment.
The key stages in activity based budgeting are to:
identify the organisation's activities;

determine the cost drivers;

spread departmental costs to costs drivers;
calculate budgeted activity levels.

The potential advantages of the activity based model are that:

it identifies the cost of activities;

it allows for resource allocation at different activity levels;

it establishes a link between decision making and cost behaviour;
it fits in with control systems.

The potential drawbacks are that:

there may be problems in defining cost drivers;

it is not possible to monitor on a frequent basis in the short term;

it requires a total review of an organisations accounting and possibly managerial systems.

Sources of further information

Authority, acceptance, ability and performance based budgeting reforms by M. Andrews - The International Journal

of Public Sector Management, Volume 17, number 4, pp. 332 -344 (2004).
A case study of budgetary reform in the United Kingdom by J. DSouza - Public Administration and Management: An

Interactive Journal, 9(4), pp. 20-44 (2004).

Performance budgeting by Ronald McGill - The International Journal of Public Sector Management, Volume 14, No 5,

pp 376 390 (2001).

Modernity, modernisation and the de-institutionalisation of incremental budgeting in local government by W. Seal Financial Accountability and Management, 19(2), pp. 93-116 (2003).

Sources of Further Information

Government and Programme Budgeting (Illinois Municipal Treasurers Association, 2007)

Authority, acceptance, ability and performance-based budgeting reforms (in International Journal of Public Sector
Management) Matthew Andrews (June 2004, vol 17)

CIPFA Scottish Directors of Finance Section., Integration of Service Planning and Three Year Budgeting , IPF 2003

Drury C (2005 (Cost and Management Accounting)

Mc Gill Ronald (2001). Performance Budgeting , The International Journal of Public Sector Management , Volume 14 No 5m
2001 pp376 390, MCB University Press

19

Scholes K and Darwin J (1994). Exploring public sector strategy : a casebook. Sheffield : Sheffield Hallam University.

Seal, W.(2003)Modernity, modernisation and the deinstiutionalisation of incremental budgeting in local government.
Financial Accountability and Management 19(2), pp.93-116

20