Stephen L. DesJardins Professor & Director Center for the Study of Higher and Postsecondary Education Presented to the School of Education Research Advisory Committee Luncheon November 17, 2009 The Conceptual Basis for Budgeting at the University of Michigan

Objectives Provide overview of budgeting methods and how budgeting works in institutions of higher education Discuss history & philosophy of activity-based budgeting models Examine University of Michigan’s budget system and model

Provide overview of budgeting methods and how budgeting works in institutions of higher education

Discuss history & philosophy of activity-based budgeting models

Examine University of Michigan’s budget system and model

Fund Accounting Method of accounting & presentation where assets & liabilities are grouped according to the purpose for which they are used Display how money is spent, rather than how much profit was earned For-profit orgs have one set of self-balancing accounts or a general ledger Nonprofits can have more than one general ledger depending on their needs

Method of accounting & presentation where assets & liabilities are grouped according to the purpose for which they are used

Display how money is spent, rather than how much profit was earned

For-profit orgs have one set of self-balancing accounts or a general ledger

Nonprofits can have more than one general ledger depending on their needs

Fund Accounting (cont’d) Categories where we account for education & educationally-related activities Primary Programs Instruction and research Supporting Programs Academic support and student services Operations & Maintenance of Plant Scholarships, Fellowships

Categories where we account for education & educationally-related activities

Primary Programs

Instruction and research

Supporting Programs

Academic support and student services

Operations & Maintenance of Plant

Scholarships, Fellowships

Difference Between Budgeting and Finance Budgeting is about planning and resource allocation and is typically short run oriented Finance is about management, accounting, investment, and control and is often more forward looking

Budgeting is about planning and resource allocation and is typically short run oriented

Finance is about management, accounting, investment, and control and is often more forward looking

Role of Budgets Translate the organizations strategic plans into annual objectives and policy actions Budgets are the institution’s formal financial plan Budgets communicate institutional priorities Dave Berg statement about priorities They are often used as tools of control by administrators

Translate the organizations strategic plans into annual objectives and policy actions

Budgets are the institution’s formal financial plan

Budgets communicate institutional priorities

Dave Berg statement about priorities

They are often used as tools of control by administrators

Budget Systems & Models Budget systems are broad and include all discretionary elements Including authority and values of decision makers System includes budget model Should be flexible enough to override problems generated by the budget model Budget model is set of rules for arranging the elements of a budget Rule: ICR is allocated as revenue to unit that generates the research. Rules can be changed by leadership

Budget systems are broad and include all discretionary elements

Including authority and values of decision makers

System includes budget model

Should be flexible enough to override problems generated by the budget model

Budget model is set of rules for arranging the elements of a budget

Rule: ICR is allocated as revenue to unit that generates the research.

Rules can be changed by leadership

Budgeting Models Zero-based budgeting Need to justify budget each year Incremental budgeting Resource allocation based on previous period Activity-based budgeting Allocation decisions made based on activities that incur costs/produce revenue Responsibility centered budgeting/mgmt

Zero-based budgeting

Need to justify budget each year

Incremental budgeting

Resource allocation based on previous period

Activity-based budgeting

Allocation decisions made based on activities that incur costs/produce revenue

Responsibility centered budgeting/mgmt

Activity-Based Budgeting Managerial framework to carry out internal budgeting and financial reporting activities Designed to promote broadest stewardship of the university’s financial resources Primary goals to enhance capacity to generate additional revenues & encourage/reward innovation, creativity, and efficiency

Managerial framework to carry out internal budgeting and financial reporting activities

Designed to promote broadest stewardship of the university’s financial resources

Primary goals to enhance capacity to generate additional revenues & encourage/reward innovation, creativity, and efficiency

History in IHEs Created at Penn in early 70s when University was near bankrupt Pres. Myerson needed to get budget under control & charged group to create new system Robert Zemsky, Professor of Education, was one of originators System devised to control expenses Founders quickly observed that it was even stronger driver of revenue creation

Created at Penn in early 70s when University was near bankrupt

Pres. Myerson needed to get budget under control & charged group to create new system

Robert Zemsky, Professor of Education, was one of originators

System devised to control expenses

Founders quickly observed that it was even stronger driver of revenue creation

Activity-Based Budget Principles Org divided into responsibility centers Revenue-generating: Schools, Resource Centers, Auxiliary Enterprises Non-revenue-generating: Administrative Service Centers Centers credited with revenues generated Revenue-generating centers expected to: Fund the direct cost of own operations Cover net cost of operating Administrative Service Centers Maintain internal budget balance

Org divided into responsibility centers

Revenue-generating: Schools, Resource Centers, Auxiliary Enterprises

Non-revenue-generating: Administrative Service Centers

Centers credited with revenues generated

Revenue-generating centers expected to:

Fund the direct cost of own operations

Cover net cost of operating Administrative Service Centers

Maintain internal budget balance

Role of “Value Theory” MC = MR + EMU MC is extra cost associate with increased output/activity; MR is marginal revenue & represents instrumental value “ Contribution margin” (MR – MC); crass? EMU is “effective marginal utility” representing the intrinsic value of output

MC = MR + EMU

MC is extra cost associate with increased output/activity; MR is marginal revenue & represents instrumental value

“ Contribution margin” (MR – MC); crass?

EMU is “effective marginal utility” representing the intrinsic value of output

Example Suppose SOE wants to expand a program (EMU>0) even though MC>MR (contribution margin is negative) Implies high value at the margin Other high contribution margin (MR>MC) program(s) that faculty do not value as highly (EMU is -) at the margin can help fund the above program Entails both positivist & normative aspects

Suppose SOE wants to expand a program (EMU>0) even though MC>MR (contribution margin is negative)

Implies high value at the margin

Other high contribution margin (MR>MC) program(s) that faculty do not value as highly (EMU is -) at the margin can help fund the above program

Entails both positivist & normative aspects

Implications Resource allocation depends not only on market forces but also on IHEs values Dynamic tension between these Value knows no bounds, but are often constrained by fiscal realities Cross-subsidies reflect IHEs preferences Without these there is little room for discretion Efficiency matters Optimizing program size/quality at lower cost results in less cross subsidization, allows for resources to be used for other purposes

Resource allocation depends not only on market forces but also on IHEs values

Dynamic tension between these

Value knows no bounds, but are often constrained by fiscal realities

Cross-subsidies reflect IHEs preferences

Without these there is little room for discretion

Efficiency matters

Optimizing program size/quality at lower cost results in less cross subsidization, allows for resources to be used for other purposes

Michigan’s “UB” Model Implemented 98-99; revised often Hybrid of “activity-based” models Activities lead to automatic flows of resources/costs to units doing work Revenue follows revenue-generating activity & units get most revenues Activities create increased costs in units & indirectly to administrative areas Associated costs rise as revenues increase

Implemented 98-99; revised often

Hybrid of “activity-based” models

Activities lead to automatic flows of resources/costs to units doing work

Revenue follows revenue-generating activity & units get most revenues

Activities create increased costs in units & indirectly to administrative areas

Associated costs rise as revenues increase

Logic of “UB” Benefits/costs (sources/uses) of activities most clearly seen where undertaken In “units” (schools & research units) Allocation decisions best decided by them Local leadership & central planners can envision budget opportunities & threats Enrollment declines signal problems quickly Creates incentives for RCs to innovate, yet may result in RC-centric behavior Provost’s role is to prevent this

Benefits/costs (sources/uses) of activities most clearly seen where undertaken

In “units” (schools & research units)

Allocation decisions best decided by them

Local leadership & central planners can envision budget opportunities & threats

Enrollment declines signal problems quickly

Creates incentives for RCs to innovate, yet may result in RC-centric behavior

Provost’s role is to prevent this

Role of Central Discretion Maintaining central discretion helpful in recent years Encouraged creation of contingency fund used to buffer mid-year rescissions in State appropriations Goal: Build fund to 1% of the General Fund budget

Maintaining central discretion helpful in recent years

Encouraged creation of contingency fund used to buffer mid-year rescissions in State appropriations

Goal: Build fund to 1% of the General Fund budget

Revenue Allocation Revenue flows to the unit generating it Tuition attribution example 50/50 split for undergraduates (was 75/25) 75% enrollment/25% instruction unit for grads Candidates: 100% to enrollment unit Res/non-res tuition avg. so units get same mix, regardless of actual enrollment mix Remove incentive to admit/enroll on residency Incorps differences in unit tuition rates Aligns with differential instructional costs in units

Revenue flows to the unit generating it

Tuition attribution example

50/50 split for undergraduates (was 75/25)

75% enrollment/25% instruction unit for grads

Candidates: 100% to enrollment unit

Res/non-res tuition avg. so units get same mix, regardless of actual enrollment mix

Remove incentive to admit/enroll on residency

Incorps differences in unit tuition rates

Aligns with differential instructional costs in units

Cost Attribution Centrally-awarded FinAid attributed based on same distribution as tuition Assessments based on avg. amounts per HCE rather than actual provided to unit’s students Rackham aid different for MA/PhD Aid is University priority that should be supported across the campus Goal: Admit students based on academic criteria, not financial circumstances Units pay expenditure taxes Flow to Provost to increase funds for flexible allocation

Centrally-awarded FinAid attributed based on same distribution as tuition

Assessments based on avg. amounts per HCE rather than actual provided to unit’s students

Rackham aid different for MA/PhD

Aid is University priority that should be supported across the campus

Goal: Admit students based on academic criteria, not financial circumstances

Units pay expenditure taxes

Flow to Provost to increase funds for flexible allocation

Space Costs Central assesses utilities & plant operations Plant includes maintenance, custodial, grounds & landscaping, refuse and recycling Buildings metered to charge actual costs Assessed per sq. ft. occupied for grounds, maintenance, custodial, refuse/recycling All assessed through accounting system

Central assesses utilities & plant operations

Plant includes maintenance, custodial, grounds & landscaping, refuse and recycling

Buildings metered to charge actual costs

Assessed per sq. ft. occupied for grounds, maintenance, custodial, refuse/recycling

All assessed through accounting system

Taxes Expenditure taxes flow to Provost Source/use financial categories are used to construct the tax base All taxes are levied on an adjusted expenditure base, with a two-year lag Three tax types and 6 tax rates UP 2%; research 11%; general 24%

Expenditure taxes flow to Provost

Source/use financial categories are used to construct the tax base

All taxes are levied on an adjusted expenditure base, with a two-year lag

Three tax types and 6 tax rates

UP 2%; research 11%; general 24%

Role in Budgeting Tax revenues grow with activity Provides discretionary funds for Central to make reallocations based on their priorities and values Permits these choices without explicitly cutting budgets in one unit to raise them in another Can be used to increase admin unit budgets too

Tax revenues grow with activity

Provides discretionary funds for Central to make reallocations based on their priorities and values

Permits these choices without explicitly cutting budgets in one unit to raise them in another

Can be used to increase admin unit budgets too

GF Supplement Support provided to unit beyond the net of revenues & costs Some units have more capacity to capture resources & do not need a positive GFS In a unit’s budget, the GFS is where central policy decisions are reflected Used to “hold harmless” when rules of model change

Support provided to unit beyond the net of revenues & costs

Some units have more capacity to capture resources & do not need a positive GFS

In a unit’s budget, the GFS is where central policy decisions are reflected

Used to “hold harmless” when rules of model change

2005 Budget System Review Interviewed > 100 deans, budget administrators, faculty & administrators Autonomy needs to be balanced with alignment to university goals and priorities. Balancing financial responsibility with the encouragement of risk is essential. Communicating principles of budget system & model to the wider university community is important Too much emphasis placed on year-to-year changes rather than taking longer view of strategic allocation of resources

Interviewed > 100 deans, budget administrators, faculty & administrators

Autonomy needs to be balanced with alignment to university goals and priorities.

Balancing financial responsibility with the encouragement of risk is essential.

Communicating principles of budget system & model to the wider university community is important

Too much emphasis placed on year-to-year changes rather than taking longer view of strategic allocation of resources

Summary Hybrid of activity-based & discretionary budget Provides Provost more discretion than previous systems/models Generates more variation in % changes in unit budgets than did the incremental system Allows leaders to see fiscal implications of activities at unit level Yet allows flexibility to determine how to adjust to fiscal circumstances in light of University's missions Well designed for active Provost who is willing to reallocate resources towards the academic mission and among academic units

Hybrid of activity-based & discretionary budget

Provides Provost more discretion than previous systems/models

Generates more variation in % changes in unit budgets than did the incremental system

Allows leaders to see fiscal implications of activities at unit level

Yet allows flexibility to determine how to adjust to fiscal circumstances in light of University's missions

Well designed for active Provost who is willing to reallocate resources towards the academic mission and among academic units

Budget Information UM budget detail from OBP http://sitemaker.umich.edu/obpinfo/budget Budget documents http://www.provost.umich.edu/budgeting/index.html http://www.provost.umich.edu/budgeting/ub_model.html

UM budget detail from OBP

http://sitemaker.umich.edu/obpinfo/budget

Budget documents

http://www.provost.umich.edu/budgeting/index.html

http://www.provost.umich.edu/budgeting/ub_model.html

Summary IHEs budget differently than firms Activity-based budgeting is relatively new phenomenon Michigan’s budget model is a hybrid and current model emerged after some experimentation Budget information & data is on-line for you to examine

IHEs budget differently than firms

Activity-based budgeting is relatively new phenomenon

Michigan’s budget model is a hybrid and current model emerged after some experimentation

Budget information & data is on-line for you to examine

Background Materials

Zero-Based Budgets Requires that the budget be justified each year, instead of just making adjustments to the prior years budget Advantages: Can focus attention on the actual resources required produce outcome Can be useful for shaking up a process that may have grown stale and counterproductive over time Help to identify specific objectives, quantify them, & consider cost effective ways of achieving them which may lead to better resource allocation

Requires that the budget be justified each year, instead of just making adjustments to the prior years budget

Advantages:

Can focus attention on the actual resources required produce outcome

Can be useful for shaking up a process that may have grown stale and counterproductive over time

Help to identify specific objectives, quantify them, & consider cost effective ways of achieving them which may lead to better resource allocation

Advantages of ZBB (cont’d) May be astonished at expenses that should not be there Facilitates participation in the budgeting process May engender partnership between the finance professionals and decision makers Complies with management’s directive not to blindly follow last year figure

May be astonished at expenses that should not be there

Facilitates participation in the budgeting process

May engender partnership between the finance professionals and decision makers

Complies with management’s directive not to blindly follow last year figure

Disadvantages of ZBB May substantially increase time & expense of preparing budget Substantial commitment by all in order to ensure you don’t make matters worse Success hinges strongly on leadership that is dedicated to the task Reviewer of the budget should not have a pecuniary interest in maintaining the status quoa as they will try to protect their interests. Involves a lot of time so do not conduct every year; may prove impossible to manage

May substantially increase time & expense of preparing budget

Substantial commitment by all in order to ensure you don’t make matters worse

Success hinges strongly on leadership that is dedicated to the task

Reviewer of the budget should not have a pecuniary interest in maintaining the status quoa as they will try to protect their interests.

Involves a lot of time so do not conduct every year; may prove impossible to manage

Incremental Budgets Allocation of resources is based on allocations from the previous period Advantages: Relatively simple to use and easy to understand The budget is stable and change is gradual. Managers can operate their departments on a consistent basis. Conflicts should be avoided if departments can be seen to be treated similarly. Co-ordination between budgets is easier to achieve. The impact of change can be seen quickly

Allocation of resources is based on allocations from the previous period

Advantages:

Relatively simple to use and easy to understand

The budget is stable and change is gradual.

Managers can operate their departments on a consistent basis.

Conflicts should be avoided if departments can be seen to be treated similarly.

Co-ordination between budgets is easier to achieve.

The impact of change can be seen quickly

Cons of Incremental Budgets Unlike ZBB, assumes activities/methods will continue; no accounting for changing circumstances Doesn’t provide incentive to develop new ideas/to innovate “ Spend it or lose it mentality” so can’t reduce costs Budget may no longer relate to levels of activity/type of work actually being done Priority for resources may have changed since inception Slack may be built in so budget easier to work to, get more power

Unlike ZBB, assumes activities/methods will continue; no accounting for changing circumstances

Doesn’t provide incentive to develop new ideas/to innovate

“ Spend it or lose it mentality” so can’t reduce costs

Budget may no longer relate to levels of activity/type of work actually being done

Priority for resources may have changed since inception

Slack may be built in so budget easier to work to, get more power

What is a “Unit”?

Model Operational Level UB model not developed to provide template to guide budgeting within schools Academic leadership closest to circumstances make best decisions concerning those circumstances Dean/leadership has better sense (than Provost) of budgets needed to accomplish activities undertaken

UB model not developed to provide template to guide budgeting within schools

Academic leadership closest to circumstances make best decisions concerning those circumstances

Dean/leadership has better sense (than Provost) of budgets needed to accomplish activities undertaken

Budget Process @ MI November–- Send request to State December—University process & planning parameters defined February—Budget planning documents submitted (“the request”) April—Budget conferences between Provost & Executive Officer June—Final allocations determined as budget development finalizes July—Regents approve budget

November–- Send request to State

December—University process & planning parameters defined

February—Budget planning documents submitted (“the request”)

April—Budget conferences between Provost & Executive Officer

June—Final allocations determined as budget development finalizes

July—Regents approve budget

Head Count Equivalent HCE is derived figure used for purposes of tuition attribution. It is the headcount of students registered in given term & pursuing academic program offered by a unit. If student is registered in multiple programs, student is divided equally between the units that "own" the academic programs regardless of the number of units taken in each school/college.

HCE is derived figure used for purposes of tuition attribution. It is the headcount of students registered in given term & pursuing academic program offered by a unit. If student is registered in multiple programs, student is divided equally between the units that "own" the academic programs regardless of the number of units taken in each school/college.