by John Kind

Budgeting in the public sector

At the present time, budgeting in the public sector could not be more challenging. The details of the spending review announced by the government in October 2010 indicate that, over the next four financial years, there will be no increase in public expenditure after allowing for inflation. As a consequence and as the Treasury highlighted, a complete re-evaluation of the public sector’s role in providing services is required.

In particular, resources will need to be prioritised against strict criteria to ensure greater value for money in public spending. The criteria are

  • Is the activity essential?
  • Does central government or a local authority need to fund the activity?
  • Does the activity provide substantial economic value?
  • Can the activity be targeted to those who need it most?
  • In what ways can the activity be provided at lower cost?
  • In what ways can the activity be provided more effectively?
  • Can the activity be provided by a non-state provider, such as a voluntary organisation?

The practical application of these criteria means that the traditional, ‘incremental’ method of public sector budgeting is unlikely to be adequate. A ‘zero based’ mindset will be required. As the Chancellor of the Exchequer commented, ‘we need to rethink how government – central and local – spends its money’. This means that a complete re-assessment of public service provision and, therefore, public sector budgeting is underway.

Differences between the private and public sectors

The budgeting task in the public sector can be even more demanding than in the private sector. This is because the objectives of an organisation such as a hospital are extremely wide ranging and they can be competing – dealing with out-patients, treating the elderly, running an accident and emergency service and carrying out operations. Arriving at decisions about resource allocation, in this situation, is a complex process.

In the private sector, objectives are more focused – typically, they are to do with enhancing shareholder value, which is all about increasing revenues, controlling costs and maximising cash flows.

In the public sector, it can be difficult to define the relationship between inputs and outputs. In the case of the hospital, for example, a given number of doctors and nurses – the inputs – may or may not be able to cope with the varying and unpredictable demands of patients. What is easier to assess is the expenditure required to run a particular hospital department at an agreed level of service and to compare that with the appropriation or budget that is actually available.

In the private sector, the output can be measured in terms of revenue (the value of the goods and services delivered to customers). The input can be worked out by calculating the costs or expenditure required to produce that revenue.

Another important difference between private and public sector budgeting is the degree of consultation and information sharing. In a commercial organisation, the budgeting process is internal. The stakeholders are the executives involved in and affected by the budget.

In a public sector organisation, a much more wide-ranging stakeholder engagement process is required. As well as the staff directly involved, many other interested parties need to be consulted: the business community, local politicians, private citizens, trade unions and voluntary organisations. These groups need to be given the opportunity to challenge budget proposals before they are finalised.

What is incremental budgeting?

Traditionally, public sector budgeting has relied on the ‘incremental approach’. This means that the previous year’s budget is carried forward to the next budget round. The next budget is adjusted for known factors, including new legislative requirements, performance indicators, such as response times, and the anticipated levels of cost and salary inflation. The process is called ‘incremental’ because it is concerned with incremental or marginal adjustments to the existing budget.

According to the Chartered Institute for Public Finance and Accountancy (CIPFA), a significant characteristic of incremental budgeting is negotiation and compromise. And there will be a strong political dimension as well.


A school will have a large proportion of its budget taken up with teachers’ salaries. Let’s say these come to £1.5m. For next year’s budget, the Head Teacher thinks that she will need to employ two new staff members to teach science at a salary of £30,000 each. Existing staff members will be given a pay increase of two per cent.

Assuming that the two new staff will receive the increased pay levels, the Head Teacher’s budget for staff salaries next year will be £1.59m [(£1.5m + £30,000 + £30,000) x 1.02].

With incremental budgeting, the Head Teacher does not have to justify existing salary levels. If she can prove that there is an increase in the number of science lessons equivalent to two new teachers’ working hours, the additional cost can be validated. There is no incentive to try and reduce salaries or, indeed, any other costs. Expenditure may be incurred this year just for the sake of it, given that an under-spend this year may lead to a reduced budget next year.

All this means that managers are not encouraged to challenge the ways in which they operate. Inefficiencies from previous periods may be carried forward into future periods. Incremental budgeting, therefore, tends to focus on the past rather than the future.

What is zero-based budgeting (ZBB)?

With ZBB, the budgeting process starts from a base of zero. No reference is made to the previous period’s budget and the actual performance achieved. All the budget headings – salaries, rent and rates, maintenance and so on – start with a balance of zero. Under incremental budgeting, the starting point is last year’s expenditure. With ZBB, every activity is reviewed in detail, with all expenditure requiring justification and approval rather than just the incremental expenditure. More...

Budgeting technicalities in the public sector

Below are some of the budgeting technicalities that apply in the public sector.

Accounting methods

What method of accounting is used in the public sector? There are two possibilities. One is to budget for and record transactions when cash is actually received and paid. The second possibility is to adopt the principle of ‘accrual accounting’, which is standard practice in the private sector. Under ‘accrual accounting’, revenue or income is recognised during the time period when it is due. This may not be the same period as when the cash is received. Similarly, expenditure incurred is recognised according to the time period to which it relates, which may not be the same period as when the cash is paid out.

In the public sector, ‘accrual accounting’ is now the norm.

  • A city council expects the revenue or income from council tax to be £10m for the 2010/2011 financial year. The cash expected to be received from local residents is £9.5m, since a minority of residents are expected to be late in paying. From a budgeting perspective, the budgeted revenue is £10m, even though the cash receipts are estimated at only £9.5m.
  • A county council expects road maintenance and repair costs to be £30m during 2010/2011. The cash actually spent in 2010/2011 was £28m, since a number of contractors were late in submitting their invoices. From a budgeting perspective, the budgeted expenditure is £30m, even though only £28m was paid out during the financial year.

What is ‘carry-over’?

This is the right to use an unspent appropriation beyond the time period for which it was originally granted. Some or all of cash that has not been spent in the current financial year can be transferred to the next financial year.

For example, if budgeted expenditure for 2010/2011 was £3m for local authority housing repairs, but only £2.7m was spent, the remaining £0.3m can be carried forward into the 2011/2012 budget period.

Current practice in the public sector is that ‘carry-over’ may be allowed, subject to Treasury approval. Each case may need to be reviewed on its merits according to local guidelines.

What is ‘virement’?

The word ‘virement’ comes from French (‘virer’ is the act of turning) and is the swapping of a budget appropriation from one budget line to another budget line.

For example, if there is 2011/21012 budget appropriation of £1.5m for staff training, part of that £1.5m can be transferred to another expense category, such as repairs and maintenance. This means that the budget for training will be reduced by, say, £0.5m and the budget for repairs and maintenance will be increased by the same amount.

Virement is not allowed unless the detailed rules and regulations of the relevant public sector organisation are followed.

Quick tips

If you are involved in preparing a ‘public sector’ budget and then getting it approved, don’t forget to

  • Start the budgeting process as early as you can
  • Adopt a ‘can do’ approach to change
  • Support arguments about your budget proposals with evidence, marshalling all the relevant facts and figures to win support
  • Influence the budget decision makers. Most local councils, for example, have a small number of important decision makers whose views matter more than others. These will include the Chief Executive, the Leader of the Council and the Chair of the Finance Committee.

Where to look for more information

  • HM Treasury: the web site provides full details of the government’s approach to public expenditure and the budgeting guidelines that will need to be used.
  • The Northern Ireland Assembly – an unlikely reference source, but there is an excellent document on Budgeting and Budgeting Methods.
  • The Association of Chartered Certified Accountants (email: info@acca.global.com, telephone 020 7059 5000).
  • CIPFA (The Chartered Institute of Public Finance and Accountancy). CIPFA is the only accountancy body in the UK specialising entirely in public sector finance.
  • Cost-benefit analysis by Layard and Glaister, Cambridge University Press, 2nd edition offers a very thorough introduction to the principles of CBA.