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Budgets and budgeting are an area of competence that is essential for every manager to possess. The budget process is a planning process. Two basic questions concern any manager in preparing budgets:
What is the right level of expenditure to request?
How can that level of budgeting be justified and defended?
Most organizations have a budget calendar often based on either a calendar year or a fiscal year (e.g., July 1 to June 30). For academic institutions, the budget is usually developed in the fall, discussed and integrated at increasingly higher levels in the winter, and adopted in the spring or early summer. Budgeting is increasingly a continuous or year-round task and in many organizations, you are working with several different budgets at the same time:
developing next year's (and sometimes another 3-5 year forward projected budget),
managing the current year budget, and
analyzing the results of the prior year's performance compared to the budget.
Budget terminology you should know:
Line-item budget -- The budget is a series of "lines," each of which represents a different item of expenditure or revenue. One line may be for professional salaries (sometimes referred to as "exempt" because they are exempt from certain federal laws governing payment of overtime); another line may be for non-professional personnel; another may be for equipment or materials. Other lines are for various categories of the operating budget -- supplies, telephone, travel, etc. Even when a more complex budgeting technique is used, the "line item" budget usually exists.
Program budget -- The proposed expenses of the organization are listed (the "lines") and then analyzed by the functions in which they are used. A program budget sets for the proposed expenditures as they relate to each function. The advantage of this kind of budget is that one can see what the money is being used for.
For a library, an example of a program budget would be the following:
Expense Category
Make Collection Available
Current Awareness
Reference Services
Online Searching
Total
Personnel
20,000
5,000
10,000
10,000
45,000
Materials
25,000
--
5,000
--
30,000
Supplies
1,000
200
400
400
2,000
Telephone
--
--
1,000
1,000
2,000
Services
--
--
5,000
4,000
9,000
Total
46,000
5,200
21,400
15,400
88,000
If we omitted the four columns in between and just showed the first and the last, we would have a line-item budget.
Three useful economic concepts are:
Sunk Costs - Something that has already been spent. The importance of the concept is that what has already been spent is irrelevant to current decision making. Just because an organization purchased a costly item that hasn't proved very worthwhile does not mean it will be any more useful if additional monies are spent on it.
Opportunity Costs - Those costs involved in the opportunities foregone by the pursuit of a different alternative. Ex. assume you have a choice to either upgrade your current equipment or to sell it and purchase new. If you choose the first option, there is an opportunity cost connected to the price for which you could have sold it. When examining the two alternatives from a financial perspective, you should take the opportunity cost into consideration.
Net Present Value - In most major decisions, there are effects over time. Net present value allows one to make dollars received or expended in different years commensurate with each other. To calculate net present value, you need to consider the time at which money will be spent (or received) and then the money spent (or received) at that time in terms of today's dollars. Ex. - you plan to enter a consortial agreement whereby all the books you purchase will be provided totally processed and ready for the shelf. The costs involved are 1) purchase of a workstation at $5,000, 2) estimated life of workstation = 4 years, 3) scrap value after 4 years = $1,000. The present processing cost is $10 per book; the expected processing cost is $5 per book. The volume is projected to be about 1,000 books per year for four years. The cost of capital (sometimes called the discount rate or return on investment) is assumed to be about 15%.
To compare the actual costs of the proposed alternative to not making any change the dollars are converted to net present value as follows (adjustment figures from standard cost accounting tables):
Alternative One
(Status Quo)
Alternative Two
(Consortium)
Present Expenditure
Workstation $5,000
Cost of Book Processing
$10 x 1,000 = $10,000
$6.00 x 1,000 = $6,000
Adjustment for Cost of $1 per year for 5 years paid out in uniform stream over the years
$10,000 x 3.52 = $35,200
$6,000 x 3.52 = $21,120
Less the Present Value of $1 received in a lump sum 4 years from now
$1,000 x 0.47 = $(470)
Total Actual Expenditure
$35,200
$25,650
Without making the adjustments, the comparison is $40,000 to $25,000, supposedly a savings of $15,000. Using adjustments to compare amounts in the same dollars, there is still a savings but the amount is considerably reduced -- now less than $10,000 ($9,550).
