Prior to the introduction of PFM/IC the role of the head of finance would be largely limited to that of financial controller including that of bookkeeper. The head of finance would be the main channel of communication with the ministry of finance and in those countries which have separated the responsibility for the capital or investment budget from the current budget, with the ministry responsible for the capital or investment budget too. A principle responsibility of the head of finance would be the development of the budget but in many developing and transition economy countries that budgetary role would usually be limited to the assembly of the budget in accordance with the ministry of finance and other central ministry requirements. The head of finance would not be expected to advise the manager on the appropriateness of the budget or on the linkages between the budget and expected performance (if the latter linkage is considered at all). The focus of accounting would be on financial accounting with little or no attention paid to management accounting (including costing).

However, with the introduction of PFM/IC the role of the head of finance would be expanded considerably. This chapter describes that expanded role. Where there is a separation of the current and investment budgets the head of finance will be expected to bring these together so that each manager is aware of the total availability of resources. Again, the head of finance will have a key role in raising manager financial awareness and be expected to analyse the available budgetary resources over cost centres, cost drivers and any other form of analysis that a manager requires. Finance staff therefore will need to have the expertise and information to enable them to properly support the management of organisations, not least in providing managers with the financial information they require to deliver greater efficiency and effectiveness. That will involve the extensive development of cost and management accounting, as well as the reallocation of budgets to meet the needs of managers. The head of finance will also need to develop an advisory role to support managers in interpreting financial information, especially in the context of performance and to help them analyse information so that they are able to fulfil their responsibilities to deliver objectives and performance standards efficiently and effectively. This applies to both expenditure and income. It will mean that financial information systems will require development so that they can meet not only the needs of the ministry of finance but also those of the manager. Other responsibilities of the head of finance will include advising the manager on the difference between fixed and variable costs and on the management of fixed costs, not least because fixed costs dominate the budget. The head of finance should undertake the monitoring of both financial and operational performance and provide an assessment of the short- and long-run financial resilience of the organisation.

As the civil (or local government) service will have a responsibility to support the political level of management in the development of policy the head of finance is likely to be an important contributor to that process. An appreciation of cost and affordability should be important components in policy decision making.

8.1 The Significance of Financial Management

8.1.1 Financial Management in Public Organisations

Public service organisations are unlike many private sector organisations because they are highly diverse and complex and their objectives can be difficult to define with precision. There is no equivalent to market share or return on capital or profitability or other commonly used market-based measures that a head of finance should be constantly monitoring. Public service organisations are also usually very much larger than private commercial organisations and often more complicated organisationally. Current or ongoing expenditure is usually financed from taxation or for some activities an element of funding will be raised from charges. Current expenditure should not be financed from borrowing because that will result in structural deficits. On the other hand, investment expenditure will usually be financed from borrowing rather than from internally generated funds or from investment capital. There will be no share capital. In some countries these various sources of funds may be supplemented from grant aid, for example, from the European Union, and where this occurs special rules may be applied to demonstrate how such funds have been used. Heads of finance should have a thorough appreciation of the different sources of finance and where it is appropriate to use those different resources.

The accounting arrangements will traditionally have been based upon cash but there is an increasing tendency to move towards accruals-based accounting systems but only for financial reporting purposes. Budgets are almost always prepared on a cash basis. Because of the different approaches to funding, budgets have always assumed a much more dominant role in the public sector than in the private sector. Effective public financial management does not require the development of accrual accounting or variants of the cash and accrual accounting bases. As has been shown earlier in this guide, accrual accounting, unless properly implemented with a well-trained management, can be a cause of additional risk from a public financial management perspective and is not a pre-condition to an improvement in the quality of public financial management.

A major problem in managing public expenditure at the organisation level arises from these features of public expenditure:

  • The policy objectives upon which a public organisation intends to spend money are not always capable of precise definition.

  • The outputs of a service cannot always be easily measured.

  • There is not always a clear relationship between resource inputs and the benefits which flow from the use of those resources.

  • Public services, unlike private services, do not serve a ‘niche’ market: they should be comprehensively available to the whole group or area that they are aimed at.

  • Public services also must be reliable, that is, available in all circumstances subject to any policy changes, and this means that inevitably sufficient delivery resources should be available to secure delivery even with changes in operational circumstances. Consequently, for many public services some excess capacity must always be available, although how much is a matter for managerial judgement.

These features are why public services are not provided by the market. A consequence of these features is that ‘financial awareness’ is not an inherent characteristic of public sector management. A further complication is that many of the problems that public sector organisations seek to address cannot be solved by a single public sector organisation and require cooperation between public organisations, such as other ministries and local governments (always very difficult to achieve in practice), and sometimes also with private sector organisations, such as charities. The timescales for achievement are frequently inconsistent with the timescales for resource availability. However, heads of finance should always be aware of ‘avoidable costs’ and that the factors above should not provide an excuse for a head of finance not to pursue a rigorous assessment of the costs of providing public services.

A principal concern of a head of finance has traditionally been to ensure that expenditure is controlled so that budgetary allocations are not overspent and that decisions about spending conform to legal and regulatory requirements. An important aim has been to prevent the misuse of public funds. However, given the increasing importance of public expenditure and the size of many public sectors, a single focus upon ‘financial and budgetary control’ is no longer adequate. Much greater regard should be had to the quality of public expenditure and that requires a more sophisticated approach to public financial management focussing, as far as possible, upon what is being achieved for the input of resources. Heads of finance should also be concerned about the future sustainability of public services and that will mean having a concern for the long-run future financial viability of the organisation.

8.1.2 Financial Management, Decision Making and the Role of the Head of Finance

As has been explained previously, a core principle of PFM/IC is that operational decision making is delegated to operational managers. They are the managers who are nearest to the problem and have the greatest need for operational information, both financial and performance. They are also those most likely to be more familiar with the risks and problems that affect the arrangements for the delivery of a service. Such officials probably also will be best placed to judge the value of the expenditure and corresponding opportunities, provided they have the information and support that they require to make good quality decisions. The accountability arrangements for such officials (and for subordinate organisations where they are involved) should reflect the delegation arrangements.

An essential feature of that information and support that such managers need is that derived from effective financial management. An important element of the PFM/IC reform is driving higher standards of financial management and ensuring that finance is integral to decision making at the very highest levels in public organisations. Finance leadership in a line ministry or other public organisation is central to this. The head of finance should be the principal financial adviser to the management and most particularly to the top operational manager, the state secretary or equivalent. In this leadership role the head of finance must ensure that financial standards are maintained and that the finance function is developed so that it is able to provide the information managers at all levels require in a timely manner. An important requirement of the head of finance is that he/she should possess excellent interpersonal skills, have experience of managing what is likely to become, especially in larger ministries a large, complex finance function, and have a considerable appreciation of the political context in which public organisations operate.

Financial management therefore goes well beyond exercising financial and budgetary control. The management information that managers require includes the full costsFootnote 1 of the services and activities that they are responsible for and what drives those costs, then ensuring that this understanding will be used to better inform decision making. This means that a head of finance identifies, with managers, the information they require, not least to ensure that services and activities are delivered efficiently and effectively (and the same applies to the arrangements for the collection of income). This will mean that a responsibility of the head of finance will be the development of management accounting and costing systems relevant to the needs of the manager.

The head of finance should have a specific responsibility for:

  • The management of overall organisation spending with individual managers being responsible for the management of their own specific areas.

  • Supporting managers in generating improvements in value for money by raising standards of financial management.

  • Raising financial awareness amongst all levels of management; this means creating amongst managers a better understanding of the costs of activities and services they are responsible for and ensuring that this understanding will be used to better inform decision making.

  • Monitoring the delegation arrangements to ensure that the financial conditions attached to delegation are fully observed.

  • Developing techniques for forecasting so that an appreciation exists of the long-run costs of policy and investment decisions as well as changes in the operational environment caused by legislative, demographic, environmental and other factors.

  • Have an appreciation of the services, activities and proposed developments of other public organisations so that cross organisation efficiencies can be exploited.

  • Development of financial and operational strategies.

  • Assisting managers in the development of budgets and for local government advising on local taxation policies.

  • Accounting and financial reporting.

A state secretary (or equivalent) has a responsibility to support the political level of management with the development of policy and the strategy for the implementation of policy. This support will largely be based upon the practical experience of operational management. To develop effective policy the politician requires information about costs and in particular what drives costs. The politician also requires an appreciation of how proposed policies are likely to fit with the budgetary envelope likely to be available to the organisation as well as upon the future finances of the organisation. This will be important information in negotiations with the ministry of finance about the implementation of a proposed new policy. The head of finance should have a central role in providing that information.

The personal qualities of the head of finance should include the skills and personality to act as financial adviser to the most senior operational management officials and where a management team exists, to that team. He/she should have an ability to communicate and manage; strong problem-solving skills and ability to make decisions based on accurate and timely analysis; a high level of integrity and dependability; good delegation skills; an ability to show and exercise good judgement, to make recommendations and to implement decisions. Also, because there is likely to be a large volume of data the head of finance should have an ability to determine what is important and what is not.

8.2 Functions of the Head of Finance Prior to the Application of PFM/IC

8.2.1 The Background

With traditional systems of public administration, financial considerations generally are not central to decision making except in one respect which is to secure budgetary and financial control. Managers are not required to constantly search for ways of improving efficiency and effectiveness in the delivery of public services or activities nor indeed are tools and advice available to enable them to do so. (There may be ‘token’ requirements in legislation but mostly these will have no substantive meaning.) Nor are managers required to look forward to assess the financial impact that current and future policy developments as well as any external factors, such as environmental or demographic change, may have upon the longer run financial resilience of the organisation. Similarly, the stock of public assets is not treated as something to be managed so that effective use is made of this very important resource. The asset stock is not usually regarded as a manageable resource. Accounting is primarily a bookkeeping function dominated by the need to maintain budgetary control. The budgetary analysis will be determined by the requirements of the ministry of finance with the manager having little or no say in that analysis. There will be little or no management accounting to meet the needs of individual managers. In countries with traditional systems of public administration, budgets are usually based upon historical information and then sometimes adjusted for inflation. (In reality, budgets are frequently prepared hurriedly with little time for detailed analysis and the previous year’s budget is then repeated with no amendment to reflect changing circumstances. So quality is not necessarily a defining characteristic.) The detailed formulation of the budgets and the budgetary calculation processes may be specified by the ministry of finance leaving little or no discretion to the manager of the service or activity. As some key budgetary elements may be determined centrally by a ministry of finance or another central ministry, they may not be within the discretion of the manager responsible for the delivery of the budget. An example of this would be personnel budgets. In some countries, even relatively minor budgets may also be determined centrally, such as vehicle fuel consumption and as noted in a previous chapter even the allowance made for water consumption by individual members of staff. Because the structure of the budget and hence the financial control processes will be determined by the ministry of finance, this in turn affects the design of the accounting system and the information which is available to the manager of the service or activity. Overoptimistic assumptions about income, both taxable and non-tax income, can also be a feature of budgeting.

A consequence of poor quality budgeting, and particularly instability of funding, is that heads of finance are frequently engaged in crisis or ‘cut-back’ management to accommodate unforeseen circumstances and emerging deficits during the year.

8.2.2 A Summary of the Responsibilities of the Head of Finance Before the Introduction of PFM/IC

The primary responsibilities of the head of finance with a traditional system of public administration reflect the more limited role of a state secretary (see Chap. 7) and include:

  • Leading the promotion and delivery throughout the whole organisation of good financial and budgetary control so that public money and public assets are always safeguarded, used only in accordance with the approved budget, that spending complies with the relevant laws and regulations and that it occurs only for public purposes.

  • Ensuring that financial regulations issued by the ministry of finance are fully observed throughout the organisation, including the segregation of duties.

  • In cooperation with financial information systems experts and internal audit, introducing appropriate measures to prevent and detect fraud and corruption and that all financial and personal information systems are protected against electronic or other forms of attack.

  • Supporting the state secretary in the development of the budget by assembling the budget documents prepared by the different departments or units of a ministry or local government (but not necessarily be involved in any assessment of what level of finance is actually required); reviewing budgetary demands to ensure that the calculations are consistent with any requirements specified by the ministry of finance (i.e., not to assess the quality of those budgetary demands); informing the head of the organisation of the budgetary requirements and discussing the details of the budget with the ministry of finance in order to correct any mistakes or misunderstandings; revising the budgetary calculations if the ministry of finance requires reductions in order to conform with a budgetary ceiling, but not making any decisions about or advising on where those reductions should fall; once the budget is agreed, informing the budget holders of the sums available for spending.

  • Preparing cash flow calculations and agreeing them with the ministry of finance or treasury and then maintaining cash flow control in accordance with the ministry of finance or treasury requirements.

  • Monitoring actual spending against the budgetary provision to ensure no overspending occurs or, that where overspending is likely to occur, that appropriate approvals for variations are obtained (virement) and similarly with variations to actual against forecast cash flow.

  • Checking that orders for goods and services are consistent with the procurement legislation.

  • Checking all invoices to ensure that they have been properly certified. This means ensuring that delegated financial authorities are respected and that the goods and services have been supplied in accordance with the specification. The relevant documents would then be passed to the appropriate minister or deputy minister or other senior official to sign (with equivalent arrangements in local government).

  • Issuing payment orders to the ministry of finance or treasury for the appropriate minister or deputy minister or other senior official to sign (or equivalent arrangements in local government).

  • Collecting revenues that are due such as rents, concessions, charges for services, income from sales of non-financial assets, and so on, or if not directly responsible for revenue collection, monitoring revenue collection activity (and in local government this would apply to local taxation income, but probably not for central government).

  • Advising the state secretary on current expenditure trends against the budget and when authority for variations needs to be sought.

  • Maintaining the financial records of the organisation in the format prescribed by the ministry of finance.

  • Ensuring that where grant aid funds are provided that any financial conditions accompanying such aid funds are followed.

  • Preparing on behalf of the state secretary any financial reports (annual, semi-annual, quarterly) required by the ministry of finance.

Variations to this list of responsibilities may occur depending upon local circumstances. For example, a head of finance may have a responsibility for the transfer of funds from a ministry to a second-level organisation or a non-governmental organisation (NGO) and then act as a financial controller to ensure that such funds are not overspent or are spent in accordance with any accompanying conditions.Footnote 2 Where the budget includes a medium-term perspective, a head of finance may be involved in the calculation of forward year forecasts although frequently this just involves an adjustment for anticipated inflation beyond the base year. A head of finance may also be involved in preparing forecasts of the future ongoing costs of new investment. The extent of the head of finance’s role in preparing any financial statements and supporting documents will depend upon whether a single set of financial statements is published for the government as a whole or each public organisation is required to publish a separate set of financial statements. Again, these responsibilities will be affected by whether a cash- or modified cash-based, modified accrual- or accrual-based accounting system is in place. The head of finance may also have a responsibility for treasury management, particularly for the investment of short-term (e.g., overnight) funds, especially where there is no centralised treasury single account. Otherwise, that responsibility will lie with the ministry of finance or treasury.

The head of finance will usually have no role in the assessment of the appropriateness of the budgets of second-level bodies, other than for the purpose of assimilating those budgets into the budget proposals for a ministry as a whole (or a local government) or for the review of the financial performance of a state-owned enterprise which a ministry is responsible for supervising.

Little or no management or cost accounting is likely to exist and the head of finance is unlikely to be required to analyse the budget or accounting information in a way that would facilitate the development of efficient and effective management. There would be no long-term financial planning (which should not be confused with medium-term budgeting). The head of finance would not be required to act as a financial adviser to the manager other than for financial and budgetary control purposes.

The advice of the head of finance is unlikely to be sought in the development of policy and the head of finance is unlikely to have the type of information available that would enable the head to make an effective contribution other than to the possible impact upon budgetary limits.

In summary, the principal functions of the head of finance would be to act as bookkeeper and financial controller. These are important responsibilities and are consistent with the requirements of public financial administration as described in Chap. 3, but they are not sufficient with the development of the managerial culture implicit in the introduction of PFM/IC.

8.3 The Responsibilities of a Head of Finance with the Introduction of PFM/IC

8.3.1 The Changed Background

The most important changes affecting the role of the head of finance following the application of PFM/IC are that the head of finance must respond both to the development of a managerial culture and to the consequences of a greater focus on the interests of the stakeholders. This latter is demonstrated by the linkage between PFM/IC and improvements in transparency and corporate governance. These changes have a significant impact upon how financial information is analysed, utilised and made available both internally to operational managers and externally to stakeholders. The budgetary analysis arrangements required by the ministry of finance, which dominate traditional arrangements, are unlikely to be adequate for operational managerial purposes and the information required for public financial reporting purposes is unlikely to be relevant to the needs of most stakeholders. Traditional financial reporting arrangements will not in general facilitate transparency about how an organisation has utilised available public resources when compared with the achievement of objectives. The operational manager as has been shown previously, if he/she is to be effective, will require that financial information is provided in different ways, that is, it will need to be interpreted, classified, analysed, reported and summarised differently for management and stakeholder reporting purposes compared with that for year-end financial reporting and ministry of finance budgetary control purposes. With traditional pre-PFM/IC public administration systems these managerial and stakeholder needs have not been regarded as important, or recognised at all, because ‘control’ has been the driving factor rather than ‘management’ with ‘control’ and reporting being focussed upon the requirements of the ministry of finance. The responsibility of the operational manager to achieve objectives efficiently and effectively will not have been a central requirement. With the application of PFM/IC the control of inputs remains important but there is an added focus upon achieving the outputs (i.e., the objectives of the organisation) and doing so efficiently and effectively. To do that there has to be effective management. Heads of finance with traditional systems of public administration have not therefore expected to be trained professional financial managers in the way they would be expected to be in a managerial environment. Consequently, with the introduction of PFM/IC the responsibilities and approach to finance must change significantly to complement the adoption of a managerial approach to the delivery of public services.

An aim of the finance function within each public organisation should be to drive improvements which support the delivery of high-quality efficient and effective public services. To do this the head of finance should seek to provide management-focussed advice, that is, to respond to the manager’s needs and to provide those specialist financial services that the manager requires. An example would be specialist management accounting information. A further aim should be to ensure that the capital stock of the organisation is used efficiently and effectively. This includes not just assets but also ensuring that the levels of debtors and creditors are being effectively managed.

As a manager operating in a managerial environment will require different forms of analysis to those provided by conventional budgetary documents, the determinant of that analysis should be the manager rather than the ministry of finance. The adviser to the manager for this purpose should be the head of finance for the organisation. This requires the development of an operational partnership between the manager and the finance official. In addition to this for effective financial management with a focus upon efficiency and effectiveness, the manager will require detailed information about operational performance. This is likely to require the development of new information systems and the linking of operational performance information with financial information. This will mean that cost and management accounting information the manager will require will affect the range of financial support available to the manager. Consequently, this is likely to affect how that information is provided and the specialist skills and analyses that will be required. For example, each hospital or major educational establishment will require particular forms of financial analytical information. That need, in turn, may affect how the finance function is organised. Thus, should the whole finance function be centred on the head of finance or should particular managers (such as of a hospital or a major college or university) have their own finance staffs. If the latter they, in turn, would need to liaise with the ministry or local government head of finance. (This is discussed in Sect. 8.7 below.)

Appreciating these requirements also shows that with the introduction of PFM/IC the professionalisation of financial management is a necessary condition. The role of head of finance as well as of operational management with PFM/IC is more demanding and hence more time consuming than that expected with traditional public administration arrangements. A higher level of technical knowledge is required as well as considerable experience of the operational environment.

For the finance role to be effective in a PFM/IC-dominated environment the head of finance must ensure that the core financial processes, systems and management information provide the information the manager requires. As that information is likely to differ from manager to manager, the head must ensure that consistent financial standards and policies are applied and that managers are familiar with them and regard them as relevant to their operational environment. To achieve that the head of finance must ensure that expert people are employed in finance departments and that they have a clear career structure and opportunities for training and development exist (see Sect. 8.5 below). The organisation structure should promote collaboration with management and knowledge sharing. Finance officials should strive to become trusted partners of the management at all levels in the organisation. A main point that should come to be appreciated is that: “Finance is not just about money: it is about whether our organisations are delivering expected policy outcomes on time and to budget. This means we need to understand how policy and strategy connect through to delivery performance, and how risks and opportunities are identified and managed.”Footnote 3

8.3.2 The Key Changes That the Head of Finance Should be Prepared for, Including Support to Managers

With PFM/IC a key change, as was pointed out above, will be in the information that a manager requires and which the finance department will be expected to provide. This will involve not only different budgetary analyses but also the provision of cost and management accounting information where required by management to complement financial accounting information. This is part of the process of preparing financial information for operational managers in a form that is required by the manager. The analysis of budgetary information should be designed so that information is provided in a form that allows for the interpretation of that information for managerial purposes. The management accounting reports should provide accurate and timely financial and performance information to managers. This is to enable them to make short-term and long-term decisions about the achievement of the objectives of the organisation, including whether it is doing so efficiently and effectively and at the same time containing expenditure and income within prescribed budgets.

In practice, line ministry managers will require considerable support in developing a managerial approach to managing public money and not least over how to achieve improvements in efficiency. This is likely to be entirely new to them and will require advice and training on how expenditure and income should be analysed. For example, an operational manager may require analysis over cost drivers and cost centres, the development of appropriate cost accounting techniques (see a later section of this chapter) and so on. The head of finance should be able to provide that advice.

Management accounting differs from financial accounting. Financial accounting provides the information to a ministry of finance and to the management of an organisation primarily for budgetary control purposes and to enable the ministry of finance to prepare the annual financial statements. That information will be organised to suit the needs of the ministry of finance, rather than those of the manager. Cost accounting provides an analysis of the actual costs of service operations, processes, activities or products and the analysis of variances from the detailed budgets for those individual activities and where standard costs are calculated variances from those standard costs. (A standard cost is the estimated cost of a providing a service, activity or product.)

In summary, with PFM/IC the financial information system must provide two basic analyses of information:

  1. (i).

    The information the ministry of finance requires to enable it to be confident that budgetary control is being maintained and therefore spending is consistent with the budget law approved by parliament and that it can complete the government wide chart of accounts (CoA) used for financial reporting purposes. This CoA should be used by all ministries, second-level bodies and other public organisations of the government for financial accounting purposes. It would also be used by a ministry of finance for international statistical reporting purposes.

  2. (ii).

    The information managers (both political and civil service) within ministries, second-level bodies and other public organisations require for management and policy development purposes. How it will be organised will depend upon the requirements of individual managers, that is, not the ministry of finance and it could be different for operational managers and political-level managers.

The analyses that will be required will be more complex where there is a separation of the current budget from the investment budget with reporting to two different ministries. Managers will require detailed information about both budgets and meet what may be the different control requirements of different ministries.

The head of finance must ensure that these two forms of analysis utilise the same basic accounting information.Footnote 4 Consequently, the coding structure should be devised in such a manner that it can provide both the information that the manager needs and that required by the ministry of finance for its purposes. (Very often coding structures are devised simply to meet the needs of the ministry of finance and then only for budgetary control purposes.)

The operational manager will require the management and cost accounting information necessary to enable him or her:

  • To maintain budgetary, financial and cash control over the area of activity for which he/she is responsible;

  • To understand how well each part of the organisation for which the manager is responsible is performing and

  • At the same time fulfil the responsibility for delivering objectives and performance standards and doing so efficiently and effectively.

Thus, the head of finance in conjunction with the operational managers in an organisation will need to develop a financial analytical system, that is, a management accounting system, specifically designed to meet the needs of each manager’s area of responsibility. Therefore, the coding structure should be designed to provide the information that individual managers may need as well as the ministry of finance.

8.3.3 The Head of Finance and the Development of Policy, Including Securing Short- and Long-Run Financial Resilience

With the managerial information requirements that should be developed with the implementation of PFM/IC the head of finance should be able to make an effective contribution assisting the state secretary support the political leadership in the development of policy. As the role of the civil service in policy making is to provide advice on how political ideas can be converted into practical public services able to be delivered within budget and in such a manner as to be capable of being maintained within a longer term forecast financial framework for the organisation, the financial contribution is extremely important.

Effective policy can only be developed if it is accompanied by an analysis of the financial consequences of that policy including the identification and impact of the relevant cost drivers (such as pupil/teacher ratios or penal policy). The head of finance should be able to contribute to that policy making role. For this contribution to be effective the head of finance must gain the confidence of the head of operational management, (the state secretary) and the policy maker.

Both the political head of a ministry or local government or other public organisation and the head of the operational management within that organisation should also be concerned about the short- and long-run financial resilience of the organisation.

What is meant by financial resilience? In simple terms, this is the ability, from a financial perspective, to respond to changes in delivery or demand without placing the organisation at risk of financial failure. This means having the ability and flexibility to forecast and manage both expenditure and income to meet requirements as they change while delivering a balanced budget. What are the key indicators of financial resilience? They will depend upon the type of service that a public organisation is providing and the circumstances in a country under which a public organisation is operating. Each present a risk to the viability of an organisation. A head of finance together with the head of operational management should assess and report to the political head of the organisation on the financial resilience of the organisation following the assessment, because the result may have a major impact upon existing and future policy.

In assessing financial resilience an aim will be to identify those factors,Footnote 5 which might impact upon the longer run finances of the organisation. A result should be that consideration is given through the development of contingency plans to how costs should be managed in the event of adverse financial circumstances emerging, as periodically they inevitably will. This approach would be much more effective and facilitate the more efficient utilisation of resources than simply reacting to a financial crisis without any pre-planning. Short-, medium-term and longer run finances will be affected by such factors as an economic downturn, increases in interest rates, the impact of legal changes, technological change, environmental change and, where foreign aid is significant, changes to the level of that foreign aid. Another feature in assessing financial resilience will be to ensure that new development proposals can be introduced without impacting adversely upon the ability of the organisation to maintain its current services and assets. In assessing new development proposals a factor that should be considered should be how that new policy could be affected if in the future, economies have to be made because of changed economic circumstances or a failure to generate the revenues that underpin the budget.

Of course, the head of finance will need to continue to provide the information the ministry of finance requires and to ensure that the budgetary and cash flow controls established by the ministry of finance are fully observed, that is, through the financial accounting system. But such controls are nowhere near enough to secure financial resilience. Short-run financial resilience requires that flows of service delivery activity are consistent with the availability of finance, both domestic and foreign aid, not simply that budgetary controls are observed. This means that commitments must be fully recorded even though no actual payments may have been made. Therefore, an important element of financial management is to ensure that payments and commitments together do not cause budgets to be exceeded. Consequently, the head of finance and the manager together should review budgets monthly and re-forecast the likely outturn for the remainder of the financial year. In practice in many developing and transition economy countries, particularly in southern and eastern Europe, financial reports are prepared only three monthly and no re-forecasting occurs at all. Consequently, towards the end of the year the risk is that the manager suddenly finds that the budget will be overspent and that a supplementary budget is required or short-run cuts must be made to the provision of services and activities. Either way the result is inefficient management. Three monthly financial reporting does not allow sufficient time to make realistic service or activity adjustments to ensure that budgets are not overspent and that is why activity and spending should be reviewed monthly. Re-forecasting enables managers to take decisions earlier in the year to avoid overspendings occurring or to ensure that unused funds are not hurriedly spent at the end of the year, merely to utilise a budgetary allowance irrespective of the merits of that expenditure. Spending should also be linked with performance, that is, is the spending achieving the objectives? Over- or under-spending on its own is not a sufficient indicator and the responsibility of the head of finance and the manager is to link spending with performance. This will indicate whether there is genuine under- or overspending, or merely if overspending, increased inefficiency.

The argument put to this author in some southern and eastern European countries is that there is no need for short-run financial planning because there can be no budgetary overspending. This is because ‘the treasury control system would prevent it’ and therefore effective budgetary control exists. This, however, ignores the point that commitments may be entered into particularly affecting future periods and that arrears of payments to creditors can and do exist as one of the processes for ensuring that overspending does not occur (or more accurately can be concealed). Therefore, the fact that the ministry of finance treasury control system prevents overspending does not mean that there is effective budgetary control; it can merely disguise the fact that such overspendings are occurring and the consequences are being borne by the following year’s budget or by the creditor, that is, the private element of the economy. (This can be accompanied by price inflation as creditors seek to recoup their added costs.)

Many ministries and local governments establish second-level organisations. A further factor therefore that the head of finance should be concerned about is the financial management of such organisations, whether agencies or state-owned public corporations. A state secretary (and the political level of management) should want to ensure that not only are the objectives of such organisations consistent with the policy expectations of the first-level organisation but that all second-level organisations are managed in such a manner that their objectives and performance standards are delivered efficiently and effectively and that they do not incur liabilities which could have an adverse effect upon the first-level organisation. The head of finance should ensure that he/she is well informed about the quality of financial management in such second-level organisations so that, in turn, the state secretary and/or the political level of management can be properly informed (see also Chap. 12).

Longer run financial resilience depends upon the quality of all those processes that involve finance including the relevant corporate governance arrangements such as:

  • The realism of forecasts of costs and savings plans;

  • The realism of projected income streams;

  • The quality of performance monitoring;

  • Where cash reserves are a factor in financial planning that such reserves are not used to finance long-run developments and that they are maintained at a level which is appropriate given the uncertainties that are likely to affect the financial resilience of the organisation;

  • The compatibility between the different development plans for the different services and the medium-term and long-run financial plans for the organisation. And if such plans do not exist, then they should and the head of finance should encourage their preparation;

  • The operational environment including a willingness to recognise the importance of ‘challenge’ by the head of finance and the recognition by top operational and political management of the importance of maintaining financial discipline.

In Annex 2 to this chapter the different criteria which should be considered in assessing financial resilience are discussed.

8.3.4 Accountability and Transparency

A feature of PFM/IC is increased accountability and transparency. The COSO framework referred to in Chap. 5 is described in detail in Chap. 11, included reporting objectives. These objectives are about both internal and external reporting and accountability and transparency. They relate to financial and non-financial reporting. The factors in the COSO framework specifically referred to include reliability, timeliness and transparency but the framework recognises that other factors may be relevant as well depending upon local requirements, and for public sector organisations, this should include information about whether violations have occurred to budgetary allocation limitations. Bearing in mind that the COSO framework applies to private sector companies, application to the public sector could introduce a range of additional requirements. Not the least of these requirements would be those expected by parliament to enable it to fulfil its scrutiny responsibilities. Transparency also embraces the information required by civil society and how that information is presented. The linkage of finance with objectives and performance will be key elements in accountability and transparency.

The head of finance will have a responsibility to prepare the annual financial statements of the organisation or alternatively provide the information that the ministry of finance requires to enable it to complete the financial statements of the whole of government. These statements will be subject to external audit, whether they are published separately for each organisation or sent to the ministry of finance for consolidation into a government wide set of financial statements.

Financial statements, especially consolidated financial statements, do not provide the information that stakeholders, not least parliaments, usually require about the operation of individual public organisations. From a corporate governance point of view this is inadequate and information should be published in a form which is accessible to the user or stakeholder in each public organisation and that information should inform the reader about much more than the finances of the organisation. This may require the publication by each organisation of an annual report which specifically addresses the interests of the stakeholder and demonstrates how public funds have been used against budgets, the level of performance achieved against objectives set, the factors which are likely to affect performance into the future, details of strategically important matters such as sustainability, ethics, values and/or corporate social responsibility and information on environmental matters (exactly what should be published will depend upon the scope of the responsibilities of the organisation) and also the strengths and weaknesses of the internal control arrangements (see also Chap. 13 on the statement of internal control).

The head of finance has a key role in enabling management to fulfil its accountability and transparency responsibilities. This raises the question as to whether in addition to the conventional financial statements, if an organisation is to fulfil the accountability and transparency requirements envisaged by COSO, it should also publish separate financial and performance reports to complement consolidated financial statements published by the ministry of finance?

The department responsible for the application of PFM/IC should issue guidance on how ministries, local governments and other public organisations should meet accountability and transparency requirements. Particular attention in developing the reporting specification should be paid to the needs of parliament so that parliament has an opportunity to appreciate the extent to which the government and/or individual public organisations have met their objectives and performance standards. This is not simply about under- or overspending compared with budgetary approvals.

8.3.5 Managing Costs

Maintaining financial resilience as well as improving efficiency and effectiveness also depends very heavily upon a public organisation’s ability to manage its costs. Improving efficiency and effectiveness very often requires that difficult decisions are required, not least in attacking what are often deemed to be the fixed costsFootnote 6 of an organisation. Those fixed costs can include employee pay (not least because of the contractual arrangements with employees and perhaps a political unwillingness to change the level of the number of employees), social benefits, the costs of servicing debt, the costs of maintaining assets which may be out of date or are inefficient to use or which are surplus to requirements or cannot be adapted to meet modern conditions (such as medical facilities) and staffing. Yet it is these ‘fixed’ costs that dominate budgets and which often cause so much difficulty when budgetary changes are required.

How budgets are developed will, or should, also be affected by the development of PFM/IC. For example, budgetary calculations should reflect the underlying performance information and the management/political policies. To manage costs an operational manager should not simply be concerned with how much individual transactions cost but with what causes those costs to be what they are, that is, what is it that drives the costs and can those cost drivers be changed. Consequently, in developing budgets regard should be had to the identification and impact of those cost drivers. Substantive cost management should be aimed at those cost drivers, rather than simply at cost totals. Managers should be judged therefore not just by their ability to keep costs within a defined budgetary allocation but also by their ability to deliver performance and at the same time to identify and manage those factors that drive those costs. (Changing cost drivers may not always be possible for an operational manager and political authority may be needed and that of course shifts the responsibility to the politician and away from the operational manager.)

Associated with the identification of cost drivers by those responsible for the development of budgets within ministries delivering public services is also the need to ensure that ministry of finance officials responsible for negotiating budgets (and if there is a separate budget for investment, the officials of the ministry responsible for that budget) in turn have an appreciation of what drives costs. That will require close coordination between those officials and the head of finance within ministries responsible for the delivery of public services. Unless officials from these central ministries have an appreciation of what drives costs in individual ministries, the risk for them is that they will not be able to make effective judgements about the appropriate allocation of budgetary resources.

A related factor is that individual ministries or other public organisations may not be totally in control of their own costs, and decisions made by other ministries and public organisations can influence them. An important responsibility of the head of finance is to ensure that he/she is aware of such possibilities. For example, should a decision be made to increase significantly the number of police by the responsible ministry that will influence the budgets of other ministries such as those responsible for the court system, for prisons, for the probation service, for the maintenance of family cohesion where there may be an increase in the arrest of the main family income earners.

8.3.6 The Role of the Head of Finance as a ‘Check’ on Managerial Aspirations and as a Reviewer of the Utilisation of Assets

The head of finance will also be the person who acts, either directly or through the state secretary, or equivalent, as a ‘check’ on the aspirations of managers (political and appointed) because their proposals are not financially viable. The head of finance may also wish to secure transparency and accountability by publishing information those managers may prefer to not disclose. These responsibilities may put the head of finance into conflict with managers, even political managers within an organisation, and this will require that the head of finance has the support of the state secretary in a ministry (or equivalent in local government) for the actions proposed to be taken. What should not happen is that the head of finance allows another official to determine the content of a financial report or advice. In extreme circumstances a head of finance may need to discuss the circumstances with the external auditor and/or with the ministry of finance. The overriding responsibility of the head of finance is to secure the financial integrity of the organisation and to make clear where there is a possibility of that financial integrity being compromised. Financial integrity is central to the determination of the reputation of an organisation and to public confidence in the organisation.

A further important role of the head of finance with PFM/IC, which has been referred to above, should be to have regard, inter alia, to the stock (value!) of the assets that an organisation owns and the utilisation of those assets. The head of finance therefore ought to be engaged in balance sheet management. This requires much more than the recording of the assets. Balance sheet management would be an entirely new concept which should be a critical part of any change to accrual accounting but even without that the head of finance should ensure that asset records are not only maintained for control purposes (in one respect this is a minor element) but more importantly to ensure that those assets are fully and effectively used. This is an essential element of PFM/IC. This is not about the delivery of public services but the efficient and effective use of resources.

Consequently, each head of finance of a public organisation should ensure that the managers of that organisation have due regard to the stock of assets and the extent of their utilisation and if not fully used what are the possible alternatives, which may include an alternative use by either the present owner or by transfer to another public sector body or ultimately sale. A further feature of the need for effective asset management has been demonstrated in an IMF Country Report on Ireland:

The lack of asset surveys, together with issues concerning valuation and ownership, present a challenge for the management and maintenance of public assets. With no solid estimate of the capital stock, the amount that should be provided for maintenance and rehabilitation of the assets is unclear. Currently, funding of maintenance is provided on a relatively ad hoc basis, and anecdotal evidence gives a clear sense of premature deterioration in assets. The absence of systematic data on the stock of assets is also likely to present a challenge when asset sales take place. A current example is the planned combination of three hospitals into a single national paediatric hospital in Dublin. Two of the hospitals to be replaced are owned by private orders, though these have been state funded for decades, while the third is a state hospital.Footnote 7

This is a clear example of the importance of asset management and of the implications for future liabilities. None of this though means that effective asset management depends upon the development of accrual accounting. It does not and what is more important is the maintenance of accurate asset records coupled with a managerial determination to ensure that assets are used in the most efficient and effective manner or are disposed of. (The experience of this author is that a weakness in many countries of the approach to accrual accounting is that the arrangements for the identification of the current values of assets are inadequate and a need for a current valuation is regarded as unnecessary because the written down original cost is regarded as appropriate. This ignores how changes in the distribution of asset values occur with changes in circumstances and not least changes in demand for certain types of assets in particular locations over time. Accrual accounting can also require complex valuation arrangements to be adopted, for example, for infrastructure assets and spare parts when valuing plant and equipment, and a reality is that valuation expertise is not always available.)

8.3.7 A Summary of the Role of the Head of Finance with the Introduction of PFM/IC

In summary, the head of finance with PFM/IC will still have the responsibilities of bookkeeper and financial controller and those other responsibilities which may exist under the pre-PFM/IC arrangements. However, with PFM/IC the head of finance in addition must develop those additional financial services and provide the advice and information that will meet the needs of the policy maker and the operational managers at all levels in the organisation. The state secretary (or equivalent in a local government) should ensure that all these elements of financial management exist. In addition, the head of finance will have a key role in developing the information required for external reporting and the development of transparency. The head of finance will also be responsible for securing the financial integrity of the organisation, both in the short and long run.

Four consequences of this expansion in the role of the head of finance and the development of PFM/IC are that he/she:

  • Needs to develop financial analytical skills, including costing, financial forecasting skills and financial appraisal skills.

  • Has the technical capacity to apply financial reporting standards and other transparency requirements (which may include how information is to be presented to ensure that it is accessible).

  • Has the personality and knowledge to challenge managers and those in authority, to justify the decisions that they may be making. Close cooperation with the state secretary or equivalent is essential and very importantly, maintaining the confidence of the state secretary or equivalent is equally essential.

Appointments should be based upon competence, not political affiliation, and the head of finance should be able to provide impartial advice, not least to the political level of management (in other words there are no political constraints determining the nature of that advice).

8.4 The Head of Finance Role in Developing a Financially Aware Operational Management

8.4.1 The Centrality of the Role of Head of Finance

With PFM/IC finance has a much more significant role than with the traditional arrangements for public financial administration. The head of finance responsibility is to support the head of operational management (e.g., a state secretary), develop a financially aware organisation and support the head of operational management in creating a managerially oriented organisation aiming to improve efficiency and effectiveness in the delivery of public services and activities and in meeting the objectives of the organisation. The head of finance therefore will need to become a key adviser to management at all levels in the organisation on the financial implications of proposed policy and investment decisions, on the costs of current operational activities, on the efficiency and effectiveness of those operations and similarly on income generating activities, as well as on the utilisation of the assets of the organisation.

The responsibility of the head of finance is to push out the boundaries of financial management knowledge. The focus upon outputs with PFM/IC rather than simply upon control of inputs creates new areas of financial management development. As performance information is developed over time the opportunities for strengthening the relationships between inputs and outputs will grow and the head of finance should be a key contributor to driving improvements in performance measurement.

These changes will affect the status and authority of the head of finance. The head of finance responsibility changes from simply acting as a channel providing information to assessing information critically and at times to resist managerial proposals and/or to make clear why objections are being made. These are reasons why the head of finance should be a member of the top management team of an organisation or, if such a team does not exist, should be a key adviser to the state secretary (or head of a local government service). An assumption is that the state secretary (or equivalent in local government) is, in turn, a key adviser to the politically appointed officials on the development and strategy for the application of policy and that advice will include financial advice.

In considering the role of the head of finance a useful model is to compare it with that of the finance director within a private company. The finance director would have a very senior role on the board of management and the same should be true in principle within public sector organisations, even though the organisational circumstances may be different. Without that status and authority, finance is likely to be treated simply as a control function.

The analysis in this chapter also serves to demonstrate that to improve efficiency and effectiveness, the control of expenditure against the traditional budgetary analysis required for ministry of finance purposes is not sufficient. It may achieve budgetary control but this form of control does not tell a manager anything about efficiency and effectiveness or whether what has been spent has achieved was what was expected to be achieved when the budget was agreed. In other words, the traditional approach to budgetary control tells the manager (and the ministry of finance) nothing about the outputs that are expected to be achieved for the inputs.

Overall, the head of finance should provide financial leadership throughout the organisation including the promotion of financial literacy and awareness. With PFM/IC finance assumes a much greater significance within an organisation and the head of finance has a key role in making clear to managers at all levels the importance of finance as a main driver in improving managerial discipline within the organisation, in the search for improvements in efficiency and effectiveness and of the importance of finance to the development of effective strategic and business planning. The financial integrity of the organisation is central to its overall reputation and the maintenance of financial integrity depends very heavily upon the capability and authority of the head of finance.

8.5 The Training of Heads of Finance

What is set out above represents a considerable list of additional responsibilities falling upon the head of finance compared with those which exist with pre-PFM/IC arrangements. If these responsibilities are to be properly applied, they will require the development of a professional cadre of financially trained officials. If the organisation were operating in the private sector, this need would be taken for granted, but that usually does not occur in public sector organisations. The message from this though is that the PFM/IC reform is unlikely to be successful unless a commitment exists to secure the training that many current heads of finance are likely to require. (A need for specialist training for internal auditors is accepted in most countries, yet the same perception does not appear to exist for the technically much more specialist, more demanding and higher status role of a head of finance.) Therefore, a consequential responsibility of a ministry of finance should be to prepare a development plan for the strengthening of finance departments so that they have the complementary skills to support the managers. This plan should include ensuring that heads of finance and their senior staff members have knowledge of the legal framework and regulations affecting finance, an understanding of the principles of PFM/IC (as, e.g., identified in this guide), the theory and practice of accounting, financial planning and the development of financial strategies including long-term financial strategy (see section on business and strategic planning and strategic financial planning below), all aspects of costing and how and when it can be used (see section on cost accounting below), all aspects of budgeting, investment appraisal, the management of income (including taxation in those organisations which have their own taxation resources, such as local governments), financial reporting and audit, the identification and management of risk and especially fiscal risk, the exercise of financial leadership and the provision of advice to managers and policy makers.

A discussion of these different areas of knowledge is included in a publication by the Chartered Institute of Public Finance and Accountancy (CIPFA).Footnote 8 Exactly what technical skills will be required will depend upon the business of a particular organisation. However, an important operational risk for a head of finance is that he/she becomes absorbed in the various techniques and loses sight of the main responsibility flowing from the development of PFM/IC which is the provision of financial advice and support to management at all levels in an organisation. Therefore, an important feature in the training of heads of finance should be in management and in the ‘softer management skills’ such as communications, negotiation, presentation and networking.

8.6 Accrual Accounting and Its Impact upon Financial Management and Financial Reporting

A factor which could affect the financial management and reporting arrangements is the introduction of accrual accounting. Considerable pressure exists on countries to harmonise financial reporting by adopting the international public sector accounting standards, IPSASs (although for European countries a set of European standards are being developedFootnote 9). These standards are not designed for management accounting purposes. However, should countries decide to adopt these standards, heads of finance would need to become familiar with them and decisions would have to be made about how they would impact upon the management accounting arrangements. Consequential decisions would also have to be made about whether the budgeting arrangements should be converted to an accruals basis or not, and if not, arrangements would have to be made to reconcile systematically the results of two different bases for the provision of financial information. Very few developed economy countries have adopted accrual budgeting.

Again, the head of finance will need to recognise the impact that a change to accrual accounting will have upon the information available to managers particularly about the utilisation of assets and the management of debtors and creditors. Ideally accrual accounting reform should be accompanied by a managerial reform like that required for the PFM/IC reform in order to create the managerial environment which would require managers to utilise the accrual accounting information to improve the quality of public financial management.

What can be said though is that an unwise decision would be to adopt these accrual accounting standards at the same time as adopting PFM/IC because the impact upon management accounting arrangements and hence upon both managers and heads of finance would be significant.

8.7 The Organisation of the Finance Function

Given the additional responsibilities falling upon managers and the head of finance with the introduction of PFM/IC, an important factor that should be considered is how the finance function should be organised. Traditionally in most countries the finance function has been centralised for each organisation. This may continue to be appropriate for small organisations but with larger public organisations such as ministries of defence, internal affairs, social services, health and education (as well as in large cities) there is the possibility of decentralising the finance function. Individual top managers of large-scale services or activities may require the support of their own ‘in-house’ financial experts if they are to perform their responsibilities effectively. For example, the manager of a major police department will require a finance office capable of working with him/her to identify cost centres and of analysing costs over those costs centres and their activities as well as comparing cost centre performance. This is even though there will be a finance officer employed within a ministry of the interior. Or again, the manager of a hospital or a university will want to identify the costs of different departments of a hospital or university as well as the activities within those departments, such as the utilisation of operating theatres or the costs of particular types of educational courses or of treating certain types of patients. This is even though there will be a finance officer in the senior management team of the health and education ministries. Each of these major organisations will require their own cost analyses and the management accounting information should be capable of providing such information.

The question that flows from this is if finance staffs are to be decentralised should they be members of the finance department of the organisation as a whole or should they be members of the staff of the relevant manager? The answer will depend upon local circumstances. There is no right or wrong answer but if the answer is that the decentralised finance staff should be members of the staff of the relevant manager, they would be the principal point of liaison about financial matters between the central finance organisation and the individual manager’s area of responsibility. Consequently, they would need to retain the confidence of the head of finance of the organisation as a whole and meet the same professional standards expected of the centralised finance organisation.

This is a complex question to consider and it may be appropriate to seek external advice perhaps through an aid agency or a specialist organisation but that advisory organisation should have experience of public sector management and not merely bring forward proposals based upon how private organisations manage their business. The political dimension applying in the public sector should not be overlooked.

One other factor that should also be considered is the extent to which the ministry of finance should be involved with the appointment (and dismissal) of the head of finance. This chapter illustrates the significance of this role and the extent of responsibility for supporting all levels of management. These responsibilities may occasionally lead to conflict between the management, both political and operational, and the head of finance where a manager wishes to undertake an activity or incur expenditures which the head of finance may regard as inappropriate. In such circumstances the ministry of finance may feel that should such a conflict occur, it should be consulted and therefore the ministry of finance may wish to issue a decree or some other form of regulation requiring this to happen. (Where the operational managers are politically appointed the head of finance could become especially vulnerable.) This potential for conflict, regrettable though it might be, could also cause the ministry of finance to take the view that it should be consulted over the appointment or proposed dismissal of the head of finance. (See also Chap. 5.)

Overall, though, there is the question as to whether, given the significance of the role of head of finance, the ministry of finance should prepare a ‘scheme of service’ for finance officials. Also, as part of that, should it develop a forum where heads of finance could meet together to discuss common problems as well as emerging policies that could have a particular impact upon the role of the head of finance.

8.8 Costing

Costing is a development of management accounting. Its purpose is to identify the cost of providing a service, or activity, or individual product. Costing is an essential tool in the development of the budget as well as in the day-to-day financial management of an organisation. Costing is a subject that a head of finance should be particularly familiar with although the evidence available to this author from at least European and European neighbourhood countries is that there is little or no familiarity with this subject.

The objective of costing is to help managers decide on the most cost efficient method of delivering services or activities by identifying the determinants of cost and how costs vary in different circumstances. As part of this managers will also need to know the comparative costs and performance of different units of activity providing the same type of service or activity such as regional offices or schools or different regional or district police centres so that they are able to question why performance and costs differ where essentially the same service is provided by different cost centres. Cost accounting can provide the manager with the information to determine which are the efficient parts of a business and which are not. It can be used by managers to establish how to deliver services at lower costs and at the same time maintain volumes and quality; it allows a manager to assess the value of a proposed investment (and disinvestment). Using costing, the manager also can be provided with the type of analysis which would enable the manager to decide upon what would be an appropriate charge for a service (where such charges are levied). This would then enable policy makers and managers to determine who would be the beneficiaries of any consequential subsidies and therefore whether they regarded this as appropriate or not.

Cost accounting therefore provides the information a manager requires to:

  • Make decisions about the efficient allocation of resources and where to make investment choices.

  • Formulate the financial impact of policy proposals for incorporation in the budget.

  • Control operational activities more effectively.

  • Plan and manage services where demand is likely to vary depending upon local circumstances (e.g., changes in the patterns and types of crime).

  • Make decisions about what is the appropriate charge to levy for a service or activity and the distribution of the resulting subsidies if that charge is to be below cost.

  • Compare the costs and performance of each element of activity with other similar activities (e.g., the costs and performance of operating theatres in different hospitals) in order to determine efficiency and effectiveness and to determine the most economical level of performance (e.g., for an operating theatre, say, 16 hours a day rather than 24).

  • Assess the comparative costs of public and private service delivery, that is, whether to contract out or not.

All of this will also help to improve the quality of budgets as well as how well resources are being used.

One of the most important questions to ask is what is meant by cost? ‘Cost’ is much more than the financial allocation for budgetary purposes. The definition of cost depends upon the decision the manager is trying to make. The manager should be clear about the cost object and this can be a unit of service or activity, a process, a service itself, an organisational unit or a user of a service or activity. The manager manages the inputs that drive the costs but the actual cost driver is the policy which generates the costs in the first place. Examples have been given in previous chapters such as the cost of educating a pupil (which in turn depends upon the pupil/teacher ratio), but could be extended to cover the cost of a school (which depends upon the school building and maintenance policy as well as decisions about class sizes), the cost of a particular teaching activity, such as language teaching (which depends upon the educational policy), the cost of educating different age groups of children (which also depends upon educational policy), the cost of educating children from different social backgrounds, children with disabilities and so on (which all depend upon educational policy). Or to take another service, the costs of holding prisoners, the costs analysed over different types of prisoners, such as male, female, child, mentally disturbed, high risk, low risk and any other categories the prison managers require (all of which depend upon penal and judicial policy).

Costs can include ‘direct costs’ and ‘indirect costs’. Direct costs are those costs that can be attributed to a single cost object (e.g., a child or a school or a prison). Indirect costs cannot be traced in full to one cost object and therefore must be shared between two or more cost objectives (as would, e.g., the costs of a specialist classroom teacher if the cost object was a pupil). Indirect costs also can be called overheads and the definition of an overhead can change depending upon the ‘cost object’ the manager is concerned about.

Costs can also have different characteristics. They can be classified as:

  • Variable costs (e.g., varying with the number of pupils).

  • Fixed costs (e.g., costs which normally do not vary with the number of pupils such as the school building).

  • Semi variable costs (e.g., utility costs which include a fixed cost element and a variable element depending upon usage).

  • Semi fixed costs (e.g., where the number of pupils increases beyond classroom capacity and additional space is required—can also be called ‘stepped costs’).

Costs can also be avoidable by providing a service or activity in a different manner from that adopted in the past.

There are a range of costing techniques or systems that can be employed and which is the most appropriate depends upon the circumstances. The main costing techniques include:

  • Absorption costing

  • Unit costing

  • Job costing

  • Process costing

  • Activity-based costing

  • Marginal costing

  • Relevant costing

  • Standard costing

  • Life cycle costing

Where costing techniques are to be used, the head of finance should be required to prepare an analysis of the results and provide advice in the form of a commentary to the manager rather than just present the manager with a set of information. A working partnership between the manager and the head of finance is essential. What is also required is a management accounting information system which enables cost and relevant performance information to be collected which, as has been pointed out above, will require not only a much more elaborate analysis of expenditure and income but also other analyses, including the preparation of timesheets to show how individual members of staff have allocated their time.

However, developing management accounting including costing is only worth investing in if there is a genuine desire and willingness for managers to focus on improving efficiency and effectiveness. The main point of the information that is produced is to enable the manager to more effectively control the service or activity for which the manager is responsible (i.e., exercise managerial discipline), to challenge present practice and to make reforms which will improve efficiency and effectiveness and to make service delivery more responsive to changing circumstances.

The exercise of operational managerial discipline and challenging present practice can be a cause of friction and dispute (including political opposition). For the operational manager to do this effectively will require considerable managerial skill and as has been pointed out previously, the independence of operational management from political interference. This manager should also be supported by the head of finance and the provision of such support to management, assuming that the head of finance agrees with what the manager wishes to do, should be an essential feature of the head of finance/manager relationship.

Heads of finance should be familiar with these different types of costing with the extent of familiarity required depending upon the business of the organisation. Which costing techniques should be applied will depend upon the circumstances.

8.9 The Head of Finance and Strategic and Business Planning and Strategic Financial Planning

A distinction should be made (which has been pointed to previously) between longer term financial planning and medium-term budgeting. The introduction of PFM/IC with its emphasis upon strategic planning, strategic financial planning and business planning will require the head of finance to become much more involved in these activities and the financial analysis of policy developments and new investment proposals. As part of strategic planning, very importantly, the head of finance will need to identify and assess the future costs of demographic, legal, technical, economic and environmental changes. An assessment should also be made of the impact of existing policies, recent investment decisions which may not yet have come on stream, proposed policies and investments, the costs of renewing existing investments, such as buildings and equipment or other infrastructure investments, and the maintenance of existing investments and any other factors which are likely to affect the long-run future financing of the organisation. The head of finance should also be aware of the policies of other public organisations that could have financial implications for his/her own organisation. Against this forecast of costs would be set the likely income that will be available from budgetary and other sources, including foreign aid (considering the risks that have been referred to previously, see Chap. 6, about the continued availability of foreign aid). This may affect medium-term budgets but the objective of longer term financial planning is to prepare an assessment of the future financial health of the organisation taking into account all its known or likely commitments. Such an assessment will, at a minimum, provide key evidence during budget negotiations with the ministry of finance and will also inform the political head of the organisation about the feasibility of the policies that are being proposed, especially given the likelihood of the availability of budgetary resources.

This type of analysis provides to the political head of the organisation (the minister or mayor) a financial perspective that would not otherwise be available and therefore allows them to make judgements about what may or may not be affordable, no matter how politically desirable a particular policy may be. It also demonstrates that economies may well be needed to be made in the relatively near future and therefore a requirement from a ministry of finance to cut costs does not come as a surprise resulting in hasty and inefficient decisions. Of course, such long-run forecasts will be tentative but if properly prepared such forecasts provide a broad perspective that is very important for the effective management of public organisations. This will be particularly true for social and environmental programmes, such as social services or in deciding how to respond to the impact of climate change. Demographic analysis will also help determine the future cost of pensions policies. 

As part of the long-run financial planning the head of finance should aim to identify any factor, such as the state of the economy or levels of unemployment, affecting the finances of the organisation over the current, medium and longer term. An organisation that does not plan to match expenditure and revenues over these periods will very quickly get into financial difficulty making it necessary to undertake those short-term and undesirable and inefficient decisions.

A state secretary should therefore be concerned to ensure that the head of finance identifies any factors, commitments and policies which could cause significant variations to occur or might damage income earning activities, not just in the current year but also in the future and whether those commitments and policies are unlikely to be financeable from future budgetary resources.

With PFM/IC service managers should be expected to prepare strategic plans for the services for which they are responsible. These should always be accompanied by a financial assessment with the head of finance being a key contributor advising on the long-run financial implications of such plans.

Strategic financial planning would also enable managers to take longer term decisions about how to develop strategies to deal with the possibility of future budgetary restrictions. Related to this is an increasing requirement that for proposed new laws and regulations a fiscal impact assessment should be undertaken showing the financial consequences they will have on public and private expenditures and revenues. Such an impact assessment, if it is to be effective, will require close cooperation between a head of finance and the service managers responsible for the drafting of such laws and regulations.

Quite separately, the head of finance should ensure that managers within the organisation prepare a business plan when proposing new activities (and indeed also update regularly existing business plans). A business plan is in effect a mission statement that sets out the vision, structure and methods that are to be employed to achieve a particular business objective. Business plans have the following benefits:

  • Enable management to think through the proposal for service development or modification in a logical and structured way.

  • Requires that the proposer of the service development or service modification defines the objectives and performance standards that will be applied.

  • Requires the proposer to make judgements about the demand for the service or how it will be received by the service beneficiaries (which may require the production of evidence through market research).

  • Defines the stages for the achievement of the objectives and performance standards and hence the overall timescale for achievement.

  • Explains how the proposed service or modified service will be delivered and its relationship with existing services (if any).

  • Explains the resources that will be required such as investment resources, staffing, equipment, transport and when they will be needed.

  • Requires the development of a budget for the proposed service development or modification.

  • Through the definition of the stages enables senior management to plot progress against the plan.

  • Facilitates decision making by the civil or local government service and political leadership by providing the operational and financial information that is essential to effective decision making but in doing so also provides the opportunity for senior decision makers including the ministry of finance (and/or the ministry responsible for investment) to challenge the assumptions contained in the business plan.

  • Explains how the proposal will be integrated into the budget for the organisation or if it cannot be integrated, the additional funds, both current and investment, that will be needed.

This analysis of the role of the head of finance with the introduction of PFM/IC emphasises that the head of finance should be a significant contributor to the development of the business of the organisation and all aspects of its financial management. To regard the role as one limited to bookkeeping and financial control, as occurs with traditional systems of public administration, is a serious mistake.

8.10 Summary

Introducing PFM/IC significantly changes the role of finance within an organisation. Finance becomes central to decision making, whether of policy and strategy or of operational activity. The head of finance should be a leader ensuring that all operational managers within the organisation become financially aware. Traditional financial control remains important, although the form of it may change. There is much more to financial management than simply maintaining financial and budgetary control. PFM/IC impacts upon the type of financial information that an operational manager requires. Traditional financial accounting designed to meet the financial reporting and international statistical reporting responsibilities of the ministry of finance does not provide the information that a manager requires. The head of finance should develop management accounting systems, including costing. Costing is valuable not only for managers to assess value for money but also in the development of the budget by identifying and assessing the financial implications of cost drivers. The development of operational management will also impact upon how the budget is analysed because if each manager is to be responsible for ensuring that control over their budget is maintained, as they should be, they must know what the available budget is. The budgetary analysis that meets the needs of the ministry of finance is unlikely to meet the needs of the manager.

The additional financial information that is required for effective management is also the type of information that will be required for policy making. Therefore, the head of finance can have an important role in supporting the state secretary (or equivalent) in advising the political level of management in the development of policy and the strategy for the implementation of that policy.

PFM/IC also affects the ‘discipline’ applying within an organisation. It affects not only how operational managers behave because it introduces much tighter constraints, but as finance becomes central to policy making and to business and strategic planning it affects the political level of management. Effective financial management also requires that regard is had to the long-run financial resilience of the organisation. An important responsibility of the head of finance is to identify and analyse how different factors, both internal and external, are likely to affect the finances of the organisation over the longer term. This may result in the head of finance objecting to proposals even though there may be a managerial desire to implement them.

Another factor is that where a public organisation is responsible for second-level organisations, the operational management of the first-level organisation, including the head of finance, should ensure that the objectives of such second-level organisations are consistent with those of the first-level organisation, that the finances of those second-level organisation are well managed (no matter how they are financed) and that the objectives of these organisations are delivered efficiently and effectively.

The head of finance should also ensure that neither the first- nor second-level organisations should enter arrangements which would expose them to fiscal risks without a full consideration of those risks including the impact they would have if they matured.

PFM/IC has an emphasis upon accountability and transparency. Traditional methods of financial reporting are unlikely to be adequate to meet the requirements of the international standards (i.e., those specified by COSO). Each public organisation ought to publish an annual report showing how it has used its financial resources, its performance against its objectives and how effective its internal control arrangements have been (see also Chap. 13).

The head of finance has a key role in the development of strategic financial planning and in other planning exercises such as strategic planning and business planning.

Introducing PFM/IC consequently means that the role and responsibilities of the head of finance will be significantly enhanced. The role becomes a professional financial management role and, in most countries, this will require the development of specific training arrangements. These enhanced responsibilities of the head of finance can only be effectively undertaken if the head is able to withstand political pressure so that he/she can offer independent impartial advice. The head of finance should work closely with the most senior official (e.g., the state secretary or equivalent) and this is especially important where the advice of the head of finance is contentious. The head of finance should operate within the context of a civil or local government service which is not politicised.

Because of the significance of finance in management an issue that will need to be addressed is how should the finance function be organised? Should it be centralised or decentralised because certainly in larger organisations managers will require specialist technical support and advice. This should be matter for local decision.

Another factor that should be considered is whether the appointment and dismissal of the head of finance should be solely a responsibility of a particular organisation or whether the ministry of finance should be consulted.