Influence Of Stakeholder

The topic of budgeting and financial resources often strikes fear in the hearts of community college administrators and faculty, as they believe it is an arcane and complex art understood only by accountants and financial specialists. This chapter attempts to demystify the basic concepts involved in budgeting and addresses approaches to budgeting, cost allocation, and using budgets for planning and control.

Community College Budgeting and Financing Demystified

David S. Murphy, Stephen G. Katsinas

Contrary to what many fear, budgeting is neither an arcane nor a complex art. Rather it is a multipurpose management tool, and although accoun- tants are involved in the preparation of a budget, the budget should always represent the administration’s expectations and plans. After all, budgets are simply an aggregate forecast of expected financial events and transactions over a period of time.

At a time when revenue streams have been restricted and more atten- tion is being focused on the cost of higher education, budgeting is a critical component of the planning and control process. Table 2.1 summarizes the revenue pressure that is being placed on community colleges (Kirshstein & Hurlburt, 2013). As shown in Table 2.1, total revenues per full-time equiva- lent (FTE) student declined by 2.1% from academic year 2000 to academic year 2010, with a notable increase in dependency on tuition rather than gov- ernment support. The proportion of revenues per FTE student accounted for by government (federal, state, and local) appropriations and grants de- clined by 8.3% from 2000 to 2010 (in constant 2010 dollars). In contrast, tu- ition as a proportion of total revenue increased by almost the same amount (8.1%). Accurate and transparent budgeting is especially critical as state support remains unpredictable and institutions grow increasingly depen- dent on student tuition and fees.

A budget should result from and be tied directly to the documents that flow from the strategic planning process; the long-range strategic plan should support an institution’s mission and vision statements as well as the

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18 BUDGET AND FINANCE IN THE AMERICAN COMMUNITY COLLEGE

Table 2.1 Average Public Community College Revenue per Full-Time Equivalent Student, by Source, 2000 and 2010

Percent of Total Revenue2000

Revenue (US$)

2010 Revenue (US$)

Percent Change 2000 2010

Revenue source Net tuition 2,324 3,269 40.66 18.5 26.6 State and local appropriations 7,095 5,712 −19.49 56.6 46.6 Federal appropriations plus

federal, state, and local grants and contracts

1,646 1,821 10.63 13.1 14.8

Other sources 1,252 1,310 4.63 10.0 10.7

Total operating revenue 12,317 12,112 −1.66 98.2 98.7 Private and affiliated gifts, grants,

contracts, investment returns, and endowment income (PIE)

222 158 −28.83 1.8 1.3

Total operating revenue (with PIE) 12,539 12,270 −2.15 100.0 100.0

Note: Data are drawn from Kirshstein and Hurlburt (2013). PIE = “private and affiliated gifts, investment returns and endowment income” (Kirshstein & Hurlburt, 2013, p. 6). Data reflect con- stant 2010 dollars.

goals and objectives that it has set. Goldstein (2005) noted that a budget is “. . . a map guiding an institution on its journey in pursuit of its mis- sion” (p. 1). Implementation of the long-range plan may require capital in- vestments for physical facilities and equipment. Thus, the long-range plan serves as the basis for the development of a long-range capital budget. The capital budget, prepared with at least a five-year planning horizon, identi- fies both the projected costs of capital projects and the expected funding sources for those projects.

The long-range plan should also provide the basis for the development of a one-year operating plan. The operating plan should answer the ques- tion “What needs to be accomplished this year so that we make progress toward our long-range goals?” This plan provides the direction for the de- velopment of a one-year operating budget, which has two purposes. First, it formalizes the financial plan (both revenues and expenditures) for a fis- cal year. Second, it provides a basis for performance measurement. Without a budget it is impossible, at the end of the fiscal or academic year, to an- swer the question “How well did we do?” Thus, a budget provides both a financial road map and a measuring stick against which performance can be gauged.

If budgets are not derived from plans, there is a risk that an institu- tion will set goals and objectives during the planning cycle that it either has no intention of meeting or that it will not be capable of meeting. Although lofty goals and objectives may be formalized in long- and short-range plans,

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an institution’s spending pattern, which details where the money actually goes, shows what it really values. As Guskin and Marcy (2003) observed, “Ultimately, an annual budget process of an institution represents the only concrete statement about alignment of an institution’s practice with its vi- sion of the future” (p. 19). Budgeting is not an ancillary process; it is a critical success factor for successful planning and control.

This chapter describes four key elements of institutional budgeting: the cycle of budgeting activities that connects revenues and expenditures to institutional goals; the challenges of allocating costs across institutional offices and academic units; the use of variance reports to analyze planned versus actual expenditures; and the effect that the fiscal requirements of accrediting bodies have on institutional budgeting. The chapter concludes with a brief discussion of factors that may impede the use of budgeting as an analytic tool for planning and fiscal control.

The Budgeting Cycle

The budgeting cycle, which includes a series of activities leading to the es- tablishment of a college’s operating budget, begins with the establishment of goals and objectives for the fiscal year, as well as assumptions that will guide the development of the budget. Goals and objectives should be de- rived from the operating plan, based on the long-term strategic plan. A bud- get is a forecast, and so assumptions are made about demand for services, prices, and sources and amounts of revenues and costs. These assumptions are key to the development of a viable budget; in fact a budget is only as good and accurate as the assumptions made prior to its development.

The budgeting cycle begins with the establishment of budgetary as- sumptions. These assumptions include projected retention, graduation, and attrition rates; the expected inflation rate; and, perhaps most important of all, the demographic and other assumptions used to develop an enrollment forecast. Historical enrollment trends can be used to model fall-to-spring and spring-to-fall enrollment patterns and to project future student head- count. Retention and graduation rates are then used to adjust projected fall and spring headcounts. Target headcounts for new freshmen, transfer stu- dents, and returning students are then computed as percentages of the ad- justed headcounts. The enrollment forecast is the key to the budget because it drives the revenue budget. In addition, the revenue budget, which is based on the enrollment forecast, expected changes in tuition rates, and projected state and local tax support, provides the spending constraint. Most institu- tions are required to operate within a balanced budget and can’t spend more than the revenues they generate. Thus, the revenue budget establishes the spending cap.

Unit budget requests provide guidance for determining how revenue will be allocated to line items or, in the case of responsibility center budget- ing, to programs and units. A responsibility center is an organizational unit

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with an administrator who is responsible for actions taken, costs incurred, and results. The key issue facing administrators at this stage of the budget- ing process is how to allocate scarce resources equitably while at the same time allocating funds in a way that will lead to long-term goal attainment.

Revenue is not collected evenly over an academic year. In fact, a ma- jority of the revenue is collected at the beginning of each academic term. However, some states have moved or are moving to funding models where, in some cases, the majority of the revenues are collected near the end of the term. Thus, it is important that the budget for cash receipts forecasts both the amount and timing of cash receipts. Cash disbursements, however, oc- cur more evenly over the academic year. By understanding the amount and timing of both cash receipts and cash disbursements, administrators can de- termine the potential need for short-term financing (i.e., short-term loans).

The revenue and expenditure budgets, along with their respective cash budgets, are then packaged into the operating budget. This cycle does not incorporate the budgeting of capital expenditures which, while usually done separately, will affect the operating budget to the extent that some of the funding for capital projects will be derived from operating funds.

Cost Allocation and Budgeting

One of the most difficult issues in both budgeting and internal financial reporting is the selection of the most appropriate budgeting and reporting units. This selection will determine the nature and extent of financial infor- mation that is provided to decision makers within the college. Unit budget requests, including requests for personnel, form the basis for the prepara- tion of the expenditure budget and subsequently for financial reporting. The budgeting approach used, as discussed in Chapter 3 of this volume, will determine what budgeting and reporting units are used.

The determination of budgeting and reporting units also affects deci- sions concerning how and at what levels to allocate costs. In incremental or line-item budgeting, the line item becomes the salient reporting entity but may not be particularly useful for administrative decision making and control, other than to control expenditures. For example, a line item may be established in the budget for a specific department for copying costs. Reporting by responsibility centers under a responsibility center budget- ing approach (discussed in Chapter 3 of this volume) provides more useful information for decision making and financial control, because each cen- ter is under the control of a specific administrator who has decision rights over resource use, and because the effects of decisions can be mapped to results. In addition, reporting by responsibility center provides a more ac- curate measure of the cost of performing a specific set of activities.

Responsibility centers, in addition to being classified as either cost cen- ters (which incur costs but do not generate revenues) or self-supporting centers (which generate revenues that can be used to support their own

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activities as well as the activities of cost center), can also be classified as support-focused or student-centered units. Support-focused units are orga- nizational units that provide services to other units within the college, but that do not provide direct services to students. A student-centered unit is an organizational unit that provides educational or ancillary services directly to students. Support-focused units are often also cost centers, whereas self- supporting units are most often student-centered units.

Examples of support units include those that are responsible for the operation and maintenance of the physical plant and those that are respon- sible for institutional support functions, including “general administrative services, central executive-level activities concerned with management and long range planning, legal and fiscal operations, space management, em- ployee personnel and records, logistical services such as purchasing and printing, and public relations and development” (“Institutional support,” n.d.). Academic departments and student services are examples of student- centered units. The cost allocation question is whether or not support- center costs should be allocated to student-centered units and, if so, how those costs should be distributed. The allocation of support-center costs to student-centered units provides the administrators of student-centered units with a more complete picture of the total cost of education. It also helps them realize that support-center services are not “free,” and it pro- vides an incentive to control the use of those services. In addition, the al- location of support-center costs makes it possible to compare the full cost of service provision with corresponding institutional objectives. All activ- ities have associated costs, nothing is free, but not all activities add value or lead to institutional goal attainment. Administrators should identify and eliminate non-value-adding activities (and their associated costs) as well as activities that do not lead to the attainment of long-range strategic goals. Al- though the allocation of support-center costs to the student-centered units has some significant advantages, it also encumbers those administrators of the student-centered units with costs over which they have no control.

As noted above, the decision to allocate costs from support-focused units to self-supporting student-centered units raises the question of how to most appropriately allocate those costs. In general, the allocation of costs from one organizational unit to another should be based on a cause-and- effect relationship. That is, the activities of the unit to which costs are being allocated should, in a measureable way, cause the generation of costs in the unit from which costs are to be allocated. This implies that the activities and costs of each cost or support center must be analyzed to determine the most appropriate activity measure or cost driver to use for cost allocation.

Consider, for example, the allocation of physical plant costs to aca- demic units. Physical plant costs may be related in some way to student credit hour (SCH) generation by academic units. However, physical plant costs may be more a function of square feet of building space assigned to or used by the various units. If the cause-and-effect relationship between

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physical plant costs and square feet used is stronger and more direct than the relationship between SCH generation and physical plant costs, square feet used should be adopted as the allocation base for physical plant costs. The use of cost drivers (the metric used to allocate costs) that do not have a clear cause-and-effect relationship with cost generation in the support unit can result in inaccurate and misleading cost assignment.

Other Budgeting Issues

Two other issues that are often encountered in budgeting for higher educa- tion involve budgeting for the effects of grants and contracts, and budgeting for intraentity transfers. Grants and contracts may be awarded for general expenditures, or they may be earmarked for a specific use. Funds received for general expenditure may be included in the revenue budget, and then the corresponding expenditures are made in accordance with administra- tive intent. When grants and contracts are received for a specific function or program, it is necessary to determine if the funds supplement or replace existing funding sources. If the funding document specifies that the funds must supplement but not replace existing funds, then no funds can be re- allocated from the function or program that received the grant or contract. If, on the other hand, a grant or contract can be used to replace current funds, then some or all of the replaced funds can be reallocated during the budgeting process and used to support other activities.

Often one department (e.g., the college relations department) provides services to other organizational units within the institution. This presents an interesting costing and budgeting problem. Two common budgeting so- lutions for dealing with internal service departments, like college relations, are to provide the department with a budget and then to expect it to pro- vide “free” services to other organizational units. The problem with this ap- proach is that it does not require organizational units that request services to think about the cost of the services; after all, the service is perceived as being free. The other approach is to provide each organizational unit with budgeted funds for internal service activities like the development of a mar- keting brochure for a new program. The “cost” of the design of the brochure has been transferred from the college relations department to the requesting department. In theory, this results in more reasoned use of internal resources because administrators become aware of the cost of the service that they are requesting.

Transferring the cost of internal services from the department that pro- vides the service to the requesting departments presents another interesting accounting problem, that of price setting. In short, should the price of the internal service be set so that it covers the direct, measurable costs of the ser- vice provided, or should it cover the full cost of the internal service. The full cost would include the direct costs and allocated indirect or overhead costs

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as well. Both methods have advantages and disadvantages and, because accounting is really a behavioral science, may lead to different consump- tion decisions.

Using Budgets for Planning and Control

As noted above, budgets are tools for both planning and control. The con- trol component of budgeting is often overlooked. The simplest form of budgetary control is to compare the budget with actual performance and to identify both favorable and unfavorable deviations from the budget. Table 2.2 presents a simple, line-item-focused budget variance report. This report shows whether or not actual performance was congruent with the budget. However, it does not explain what caused deviations from expecta- tions. To do that, further analysis is required.

Table 2.2 Budget Variance Report—Revenue and Expenditures per FTE Student

Budget Budget (US$)

Actual (US$)

Variance (US$)

Percent Variance

Revenue Net tuition 3,000 2,800 (200) −6.7 State and local appropriations 5,700 5,400 (300) −5.3 Federal appropriations and FS&L

grants 1,800 1,200 (600) −33.3

Other sources 1,200 1,310 110 9.2

Operating revenue 11,700 10,710 (990) −8.5 PIE 200 150 (50) −25.0

Total operating revenue 11,900 10,860 (1,040) −8.7

Expenditures Instruction 4,000 4,800 (800) −20.0 Research 50 30 20 40.0 Student services 1,200 1,000 200 16.7 Public service 500 400 100 20.0 Academic support 1,000 850 150 15.0 Institutional support 1,800 1,925 (125) −6.9 Operations and maintenance 1,200 1,300 (100) −8.3 Net scholarships and fellowships 1,500 1,300 200 13.3

Education and general expenditures 11,250 11,605 (355) −3.2 Other 600 500 100 16.7

Total operating expenditures 11,850 12,105 (255) −2.2

Change in fund balance 50 (1,245) (785) −1,570.0

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Table 2.3 Budget and Actual Summary for Faculty Salaries

Budget Actual Variance

Number of FTE faculty 200 192 8 Average salary cost per faculty member (US$) 62,000 65,300 (3,300) Total faculty cost (US$) 12,400,000 12,537,600 (137,600)

Negative numbers in this variance report indicate unfavorable vari- ances. Revenue variances are unfavorable (negative) when actual revenue is less than budgeted revenue. Expenditure variances are unfavorable (neg- ative) when actual expenditures exceed budgeted expenditures. A budget variance report does not answer questions; it directs attention. For example an administrator might ask the question, “Why was instructional cost per FTE student $4,800 when we budgeted $4,000?” The next step in the ad- ministrative control process would be to formulate a hypothesis about what could have caused that variance, gather data, and test the hypothesis. This type of analysis helps administrators learn from both successes (favorable budget variances) and failures (unfavorable budget variances).

A more in-depth analysis can be performed by examining the factors used in budgeting and in generating actual costs. For example, assume that the budget assumptions forecast 200 FTE faculty members with an average cost (salary, taxes, and benefits) of $62,000. Assume also that an analysis of payroll at the end of the budget cycle indicates that the community college employed 192 FTE faculty members at a total cost of $12,537,600 or an average of $65,300 per FTE. This information is summarized in Table 2.3.

As shown in Table 2.3, there was an unfavorable faculty salary variance of $137,600 because actual faculty salaries exceeded the budgeted faculty salaries by that amount. Although this total variance shows that the institution spent more than it had budgeted, the total variance is incapable of explaining what caused the variance. To understand that, it is necessary to unpack the total variance into its two components: a faculty salary rate variance (FRSV) and an FTE efficiency variance (FTEEV). A rate variance explains the effect of paying faculty members more (or less) than had been budgeted. The efficiency variance explains the effect of using more (or fewer) FTE faculty members than had been budgeted. The calculation of both is explained below.

Given that

Budgeted total faculty cost = budgeted FTE faculty count ∗ budgeted average FTE salary

and

Actual total faculty cost = actual FTE faculty count ∗ actual average FTE salary

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we can compute the two additional variances by holding either faculty count or average salary constant and varying the other variable. The FRSV is computed as

FRSV = actual FTE faculty count ∗ (budgeted average FTE salary − actual average FTE salary)

or, using the data from Table 2.3,

FSRV = 192 ∗ ($62,000 − $65,300) = −$633,600.

The negative variance is unfavorable and in this case indicates that the institution spent $633,600 more on faculty salaries because of the $3,300 increase in the actual average FTE salary over the budgeted amount.

The FTEEV is computed by holding the average FTE faculty salary constant at the budgeted amount and varying the FTE faculty headcount. This is computed as

FTEEV = budgeted average FTE salary ∗ (budgeted FTE faculty count − actual FTE faculty count)

or, using the data from Table 2.3,

FTEEV = $62,000 ∗ (200 − 192) = $496,000.

This variance is favorable because the institution used eight fewer fac- ulty members than budgeted and consequently spent $496,000 less than budgeted. The variances are summarized as (a) FRSV ($633,600, unfavor- able); (b) FTEEV ($496,000, favorable); and (c) total variance ($137,600, unfavorable).

The total variance computed here is the same as that shown in Table 2.3. However, this analysis helps better explain what caused the $137,600 unfavorable total variance. Paying faculty members more than budgeted costs the institution $633,600 more than budgeted. This was offset by re- ducing the number of FTE faculty members, an action that reduced actual expenditures, when compared to the budget, by $496,000, resulting in a to- tal variance of $137,600. This analysis highlights the effects of tradeoffs that administrators often have to make. The same type of analysis can be per- formed on any budgeted item when data on budgeted and actual amounts are available along with data on cost drivers (i.e., the activities that cause costs to be incurred).

Requirements of Government and Accrediting Bodies

Budgeting is a key component, although not the only one, in financial control. Governments (both federal and states) hold public institutions

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accountable for the use of allocated funds. For example, institutions that receive federal funds are subject to specific reporting requirements and may even be subject to federal audits. In addition, accrediting bodies re- quire that colleges and universities comply with standards for financial management. For example, section 3.10 of the Principles of Accreditation established by the Southern Association of Colleges and Schools Com- mission on Colleges (SACSCOC, 2012) identifies standards for financial management:

3.10.1. The institution’s recent financial history demonstrates financial sta- bility. (Financial stability) 3.10.2. The institution audits financial aid programs as required by federal and state regulations. (Financial aid audits) 3.10.3. The institution exercises appropriate control over all its financial re- sources. (Control of finances) 3.10.4. The institution maintains financial control over externally funded or sponsored research and programs. (Control of sponsored research/external funds). (p. 32)

SACSCOC Standard 3.10.3 requires that colleges and universities ex- ercise appropriate control of all financial resources. Planning for the expen- diture of financial resources through the budgeting cycle is part of this pro- cess. So too is the preparation, analysis, and use of budget variance reports. The preparation of a budget is a wasted administrative exercise if the bud- get is not subsequently used to monitor performance and to make decisions about future actions.

Conclusion

Budgeting is a critical component in the administrative cycle which encom- passes planning, the implementation of plans, monitoring results, and man- aging activities so that goals and objectives are met. A budget should be the financial control tool used to implement both short-range and long-range plans. However, budgeting fails to fulfill this role when there is a lack of congruence between institutional plans and the budget. This occurs when the strategic planning focus is not carried forward and used as the basis for developing budgetary goals, objectives, and assumptions.

The use of line-item or incremental budgeting also gets in the way of employing the budgeting process as a strategic management tool. When not sufficiently tied to the institution’s planning process, line-item or incremen- tal budgeting tends to perpetuate decisions that were made in the past and at the same time ignore current goals and objectives. The budgeting process itself may become a roadblock in the way of achieving strategic goals and objectives when this occurs.

Finally, although budgeting is usually viewed as a fairly technical and analytic process, it is subject to what Collins, Munter, and Finn (1987) have

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called “budgeting games,” which are used by individuals to further their per- sonal goals at the expense of institutional goal attainment. These “games” include, among others, the “all-or-nothing” strategy, in which advocates for a particular institutional function claim that if their budget requests are not fully funded, the function will have to be abandoned; the “friendship” ploy, in which individuals exploit personal friendships to secure the funding they want; or the “sacrificial lamb” approach, in which unneeded items are in- cluded in the budget with the understanding that they be “sacrificed” when requested or that they will provide a cushion if no “sacrifice” is ultimately required. All lead to the failure of budgeting as a strategic tool, and they often occur in tandem with information asymmetry—the possession of pri- vate information by an individual that is not shared with a decision maker and the knowledge of which would have been relevant to decision making. This kind of behavior often manifests itself in the turf battles and empire building that are often reflected budget requests. Administrators must not allow the technical and analytic intricacies of budgeting to blind them to the behavioral side of budgeting and the resulting problems that may emerge.

References

Collins, F., Munter, P., & Finn, D. (1987). The budgeting games people play. The Ac- counting Review, 62, 29–49.

Goldstein, L. (2005). College & university budgeting: An introduction for faculty and aca- demic administrators (3rd ed.). Washington, DC: National Association of College and University Business Officers.

Guskin, A., & Marcy, M. (2003). Dealing with the future now: Principles for creating a vital campus in a climate of restricted resources. Change, 35(4), 10–21.

Institutional support. (n.d.). Glossary. Retrieved from Integrated Postsecondary Educa- tion Data System website: http://nces.ed.gov/ipeds/glossary/?charindex=I

Kirshstein, R. J., & Hurlburt, S. (2013). Revenues: Where does the money come from? Washington, DC: American Institutes for Research. Retrieved from http://www .deltacostproject.org/sites/default/files/products/Revenue_Trends_Production.pdf

Southern Association of Colleges and Schools Commission on Colleges (SACSCOC). (2012). The principles of accreditation: Foundations for quality enhancement. Decatur, GA: Author. Retrieved from http://www.sacscoc.org/pdf/2012PrinciplesOf Acreditation.pdf

DAVID S. MURPHY is the chairperson of the Accounting and Economics Depart- ments at Lynchburg College, Lynchburg, VA, and a senior fellow at the Education Policy Center of the University of Alabama, Tuscaloosa, AL.

STEPHEN G. KATSINAS is a professor in the Department of Educational Leader- ship, Policy, and Technology Studies, and director of the Education Policy Center at the University of Alabama, Tuscaloosa, AL.

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