FINANCIAL MANAGEMENT FOR PUBLIC, HEALTH, AND NOT …

[Pages:13]THIRD

EDITION

FINANCIAL MANAGEMENT FOR PUBLIC, HEALTH, AND

NOT-FOR-PROFIT ORGANIZATIONS

Steven A. Finkler, Ph.D., CPA

Professor Emeritus of Public and Health Administration, Accounting, and Financial Management

The Robert F. Wagner Graduate School of Public Service New York University

Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

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CONTENTS

Preface 19 Acknowledgment 23 About the Author 24

Part I Introduction: Setting the Stage 25 Chapter 1 Introduction to Financial Management 25 Introduction 25 What is Financial Management? 26 What is Public Finance? 27 Market Failure 28 Redistribution 28 Taxes and Expenditures: Efficiency and Equity 28 Public Sector Resource Flows 30 Governments 30

THE FEDERAL GOVERNMENT 30 STATE AND LOCAL GOVERNMENTS 34

The Health Care Services Industry 36 The Not-for-Profit Sector 37 The International NGO Sector 41 Why Public, Health Care, and Not-for-Profit in One Book? 41 , Why Should Public Service Organizations Worry about Financial Management? 42 Should Public Service Organizations Earn a Profit? 43 Corporate Income Taxes 44 Ongoing Case Study 44 The Setting 44

Summary 45 ? Preview 46 ? Key Terms from This Chapter 46 ? Questions for Discussion 47 ? Suggested Readings 47 Appendix 1-A: Fund-Raising 48

Part II Planning 52 Chapter 2 Planning for Success: Budgeting 52 Introduction 52 Mission 53 Strategic Plan 54 Long-Range Plan 54 Budgets 56

Contents

Special Purpose Budget 57

CASE STUDY: SPECIAL PURPOSE BUDGET 58

LESSONS FROM THE CASE 62

The Master Budget 63

THE OPERATING BUDGET 63

THE FINANCIAL BUDGET 69

The Budget Process 73

THE BUDGET CYCLE 73

BUDGET PRESENTATION 77

A BUDGET TIMELINE 77

Political Realities in the Budget Process 79

Behavioral Aspects of the Budget Process 79

Budgets and Motivation 80

Incentives 81

Unrealistic Expectations 82

Case Study: Developing a Government Budget 83

Summary 92 ? Preview 92 ? Key Terms from This Chapter Questions for Discussion 94 ? Problems 94 ? Case Study: The DMV 97 ? Case Study: Denison Specialty Hospital--Parti Suggested Readings 102

93 ? 100 ?

Chapter 3 Additional Budgeting Concepts 103 Introduction 103 Line-Item and Responsibility Center Budgets 104 Centralization versus Decentralization 105 Program and Functional Budgets 107 Program Budgets 107 Functional Budgets 108 Budgeting Techniques 109 Flexible Budgeting 109 Performance Budgeting 111

EXAMPLE 112 RETURN ON INVESTMENT ANALYSIS 112

Zero-Based Budgeting 113 Forecasting 115

FORECASTING WITHOUT THE BENEFIT OF HISTORICAL DATA 115 FORECASTS BASED ON HISTORICAL DATA 116

Using Budgeting Techniques 118 Additional Governmental Budgeting Issues 118

Tying Managers'Hands 119 Budget Reserves 120 Communicating with the Public 121

Summary 121 ? Preview 122 ? Key Terms from This Chapter 122 < Questions for Discussion 124 ? Problems 125 ? Case Study: Denison Specialty Hospital--Part II 130 ? Suggested Readings 132

Appendix 3-A: A Performance Budget Example 133 Appendix 3-B: Forecasting Using Historical Data 137

Contents

Chapter 4 Understanding Costs 146

Introduction 146

Basic Concepts and Definitions 147

Cost Behavior 151

Fixed versus Variable Costs 151

Cost Graphs and the Relevant Range 152

The Impact of Volume on Cost per Unit of Activity 153

Outsourcing and Marginal Cost Analysis 155

Break-Even Analysis 157

Break-Even Analysis Example 158

Break-Even with Multiple Products 160

Additional Break-Even Applications 161

SOLVING FOR FIXED COST, PRICE, AND VARIABLE COST 162

BREAK-EVEN AND FIXED REVENUES 163

M A R G I N OF SAFETY 163

Managerial Implications of Break-Even Analysis 164

Break-Even Analysis Cautions 164

Cost Measurement 165

Cost Allocation 165

SELECTING THE BASE FOR OVERHEAD RATES 166

ALLOCATION FROM SUPPORT CENTERS TO MISSION CENTERS 166

DIRECT DISTRIBUTION 168

THE STEP-DOWN METHOD 169

?/

OTHER ALLOCATION APPROACHES 172

ALLOCATING COSTS TO UNITS OF SERVICE 172

Activity-Based Costing and Activity-Based Management 172

REFLECTIONS ON ABC

175

The Theory of Constraints 177

Summary 178 ? Preview 179 ? Key Terms from This Chapter 179 ? Questions for Discussion 180 ? Problems 181 ? Case Study: Mead Meals on Wheels Center--Parti 184 ? Suggested Readings 185

Appendix 4-A: Additional Break-Even Analysis Issues 186

Chapter 5 Capital Budgeting 189 Introduction 189 Why Do We Need A Separate Capital Budget? 190 Definition of Capital Assets: Theory and Practice 191 Why Do Capital Assets Warrant Special Attention? 192 The Time Value of Money 193 Compounding and Discounting 194 Present Value versus Future Value 196

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Time Value of Money Calculations 196 Using Calculators for TVM Computations 198 Annuities 199 Cash Flow versus Revenue and Expense 202 Using Computer Spreadsheets for TVM Computations 202

SKIPPING THE FUNCTION WIZARD 204

Investment Analysis 206

Net Present Cost 206

Annualized Cost 208

Net Present Value 211

Internal Rate of Return 213

LIMITATIONS OF IRR 215

Selecting an Appropriate Discount Rate 216

INFLATION 217

UNCERTAINTY 217

Cost-Benefit Analysis 217

DETERMINING PROJECT GOALS 218

ESTIMATING PROJECT BENEFITS 218

ESTIMATING PROJECT COSTS 219

DISCOUNTING COST AND BENEFIT FLOWS 219

COMPLETING THE DECISION ANALYSIS 219

Other Techniques of Capital Budgeting 220

Summary 221 ? Preview 221 ? Key Terms from This Chapter 221 ? Questions for Discussion 223 ? Exercises (TVM) 223 ? Problems 223 Case Study: Mead Meals on Wheels Center--Part II 226 ? Suggested ?Readings 227

y

Appendix 5-A: Using Time Value of Money (TVM) Tables 228

Appendix 5-B: Using Computer Spreadsheets for Time Value of Money Calculations--Examples 234

Chapter 6 Long-Term Financing 240 Introduction 240 Equity Financing 240 Retained Earnings 241 Issuance of Stock 241 Taxation 242 Contributions 242

CAPITAL CAMPAIGNS 243

Long-Term Debt 243 Long-Term Notes 244 Mortgages 244 Bonds 245

W H Y ARE BONDS USED? 246 GOVERNMENT-ISSUED BONDS 247 COUPON AND ZERO COUPON BONDS 248 TERM VERSUS SERIAL BONDS 248

Contents 11

CALL PROVISIONS 249 CALCULATING BOND PAYMENTS AND VALUES 249 CALCULATING THE INTEREST RATE FOR A SERIAL BOND--NIC AND TIC 251

Capital Leases 253

ADVANTAGES OF LEASING 255 DISADVANTAGES OF LEASING 256

Summary 257 ? Preview 257 ? Key Terms from This Chapter 257 ? Questions for Discussion 259 ? Exercises (TVM) 259 ? Problems 259 Suggested Readings 260

Part III Implementation and Controlling Results 261

Chapter 7 Managing Short-Term Resources and Obligations 261

Introduction 261

Working Capital Management 262 Short-Term Resources 263

Cash 263

SHORT-TERM CASH INVESTMENT 264 CASH BUDGETS 265 CONCENTRATION BANKING 266 MAINTAINING SECURITY OVER CASH 267 -

Marketable Securities 267

INVESTING OBJECTIVES 268 SUITABLE SHORT-TERM INVESTMENTS 268 UNSUITABLE SHORT-TERM INVESTMENTS 271

Liquidity Management 272

Accounts Receivable 273

EARLY DATA COLLECTION 274

J

CREDIT POLICIES 274

ONGOING DATA COLLECTION 275

THE BILLING PROCESS 275

AGING OF RECEIVABLES 275

LOCK BOXES 277

ELECTRONIC PAYMENT 277

Inventory 277

' PERIODIC VERSUS PERPETUAL INVENTORY 278

ECONOMIC ORDER QUANTITY 278

JUST-IN-TIME INVENTORY 279

Short-Term Obligations 280

Accounts Payable 280

Payroll Payable 281

Short-Term Debt 282

Taxes Payable 282

Summary 283 ? Preview 283 ? Key Terms from This Chapter 284 ? Questions for Discussion 285 ? Problems 286 ? Case Study: The Case of the Missing Check 287 ? Suggested Readings 288

Appendix 7-A: Economic Order Quantity 289

Appendix 7-B: Credit Terms 292

12 Contents

Chapter 8 Accountability and Control 294 Introduction 294 Management Control Systems 295 Measures of Performance 296 The Balanced Scorecard 299

BALANCED SCORECARD ELEMENTS 299 BALANCED SCORECARDS AND PUBLIC SERVICE ORGANIZATIONS 299 BALANCED SCORECARD BENEFITS 300

IMPLEMENTING BALANCED SCORECARDS 300

Triple Bottom Line Performance 300 Controlling Quality 301

Cost of Quality Report 301 Total Quality Management 302 Six Sigma 302 Quality Control Charts 302 Variance Analysis 303 Understanding Why Variances Happened 304 Variance Analysis Mechanics 305

THE TOTAL VARIANCE 305 DEPARTMENT VARIANCES 306 LINE-ITEM VARIANCES 306

Flexible Budget Variance Analysis 307

THE VOLUME VARIANCE 308 THE PRICE, OR RATE, VARIANCE 308 THE QUANTITY, OR USE, VARIANCE 309

CALCULATING THE VOLUME, PRICE, AND QUANTITY VARIANCES 309

Determination of the Causes of Variances 312 Aggregation Problems 312 Exception Reporting 313 Fixed and Variable Costs 313 Investigation and Control of Variances 314 Revenue Variances t 314

EXAMPLE 315

Performance Measures 317 Ethics 317

A Code of Ethics 317

COMPETENCE 318 CONFIDENTIALITY 318 INTEGRITY 318 OBJECTIVITY 319

The GFOA Code 319 Gray Areas 320 Safeguarding Resources 320 Elements of a Control System 321

AUDIT TRAIL 321

Contents 13

RELIABLE PERSONNEL 322 SEPARATION OF FUNCTIONS 322 PROPER AUTHORIZATION 323 ADEQUATE DOCUMENTATION 323 PROPER PROCEDURES 323 PHYSICAL SAFEGUARDS 324 BONDING, VACATIONS, AND ROTATION OF DUTIES 324 PERFORMANCE AUDITS 324

COST-EFFECTIVENESS ANALYSIS 325

The Sarbanes-Oxley Act 325 The Form 990 327

Summary 328 ? Preview 328 ? Key Terms from This Chapter 328 ? Questions for Discussion 330 ? Problems 330 ? Case Study: Gore Mountain 332 ? Case Study: Rutland City Band 334 ? Case Study: Taos Museum of Southwestern Arts and Crafts 335 ? Suggested Readings 337 Appendix 8-A: The Mechanics of Flexible Budget Variance Analysis 339

Part IV Reporting Results 344

Chapter 9 Taking Stock of Where You Are: The Balance Sheet 344 Introduction 344 The Framework for Financial Accounting 346 The Fundamental Equation of Accounting 347 Assets 348 Liabilities 350 Owners' Equity 351 Generally Accepted Accounting Principles 352 The Entity Concept 353 Monetary Denominator 354 Objective Evidence and the Cost Convention 354 Conservatism 355 The Going Concern Concept 356 The Principle of Materiality 356 The Accrual Concept 357 International Financial Reporting Standards 358 Fiscal Years 359 Balance Sheet Elements 359 Assets: A Closer Look 360 Cash 360 Marketable Securities 360 Accounts Receivable 361 Inventory 361 Prepaid Expenses 362 Fixed Assets 362

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