Financial Management Manual for ULBs of M.P.- English

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Financial Management Manual for Urban Local Bodies of Madhya Pradesh - English

Financial Management Manual for Urban Local Bodies of Madhya Pradesh - English

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  • 1. Financial Management Manual For Madhya Pradesh Urban Local Bodies Madhya PradeshUrban Administration and Development "Project Utthan" Madhya Pradesh Urban Services for the Poor
  • 2. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshPrefaceAs the urban population is growing at a fast pace and larger share of GDP comes from urban areas,Urban Governance and Development has become the focus of increased attention in the last decade bycentral and state governments and other stakeholders across India. Consequently, Urban Local Bodies,being at the fulcrum of urban management, have received more attention in terms of legal powers andautonomy, financial resources, technical assistance and capacity building inputs to assist urban reformprocesses under various government schemes including JNNURM.Madhya Pradesh Government is at the forefront of the process of improving urban governance andachieving urban development by pursuing a wide variety of innovative urban reforms facilitated by theMadhya Pradesh Urban Services for the Poor (MPUSP) programme. The MPUSP programme, which isan outcome of a partnership between the GoMP and the Department for International Development(DFID) of the United Kingdom, is a major initiative of the GoMP towards implementing municipal reformsand strengthening of Urban Local Bodies (ULBs) in MP.A core area of focus for MPUSP funded reforms has been to improve the financial management of ULBswhich often faced difficulties in implementing prudent and optimal financial management practices in theareas such as: budgeting, costing, expenditure management, receivables management, cashmanagement and other areas of financial management.This Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh was conceived bythe Urban Administration and Development Department (UADD) , Government of Madhya Pradesh(GoMP) as a direct response to these issues. The Manual is probably the first initiative of its kind in Indiaand will not only serve the ULBs of Madhya Pradesh but it will also be useful to all ULBs across thecountry.The manual beside defining financial management and explaining how it can be applied to ULBs, hascovered theoretical and practical aspects of financial management tools/techniques such as: financialanalysis, operating budget, capital budget, cash, receivables, payables and debt management, assetsmanagement, financial information system, internal control etc.It is expected that the ULBs of the MP will adopt and implement these good financial managementpractices which will improve their financial performance and overall financial status. It is envisaged thatthe manual will may be revised in the light of emerging learning and lessons to ensure that it is a usefulliving document. Finally it is hoped that it will pave way to make ULBs financially efficient andsustainable. Commissioner Urban Administration and DevelopmentBhopalDt. 08/11/2011 -2-
  • 3. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshContents1 INTRODUCTION ................................................................................................................................. 101.1 Purpose of this manual .................................................................................................................. 101.2 Target group of users ..................................................................................................................... 101.3 How to use this manual .................................................................................................................. 101.4 Structure of this manual ................................................................................................................. 102 INTRODUCTION TO FINANCIAL MANAGEMENT ........................................................................... 122.1 Defining financial management...................................................................................................... 122.2 Need for financial management in ULBs ....................................................................................... 122.3 Financial management process ..................................................................................................... 133 BUDGETING PRACTICES ................................................................................................................. 153.1 Concepts ........................................................................................................................................ 153.2 Good practices of budgeting .......................................................................................................... 283.3 Policies recommended for adoption............................................................................................... 313.4 Procedures ..................................................................................................................................... 343.5 Case study: Budgetary reforms at Vadodara Municipal Corporation ............................................ 464 CAPITAL IMPROVEMENT PROGRAM AND CAPITAL BUDGETING ............................................. 52 -3-
  • 4. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4.1 Concepts ........................................................................................................................................ 524.2 Good practices of CIP .................................................................................................................... 534.3 Policies recommended for adoption .............................................................................................. 534.4 Procedures ..................................................................................................................................... 544.5 Case study: CIP of Pune Municipal Corporation (PMC) ................................................................ 685 CASH MANAGEMENT........................................................................................................................ 745.1 Concepts ........................................................................................................................................ 745.2 Good practices of cash management ............................................................................................ 755.3 Policies ........................................................................................................................................... 765.4 Procedures ..................................................................................................................................... 786 RECEIVABLE AND PAYABLE MANAGEMENT ............................................................................... 896.1 Concepts ........................................................................................................................................ 896.2 Good practices of receivables and payable management ............................................................. 896.3 Policies ........................................................................................................................................... 906.4 Procedures ..................................................................................................................................... 917 DEBT MANAGEMENT ........................................................................................................................ 977.1 Concepts ........................................................................................................................................ 97 -4-
  • 5. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh7.2 Good practices of debt management ............................................................................................. 987.3 Policies ........................................................................................................................................... 987.4 Procedures ................................................................................................................................... 1007.5 Case Study: Debt management strategy of Vadodara Municiapal Corporation .......................... 1068 ASSET MANAGEMENT .................................................................................................................... 1078.1 Concepts ...................................................................................................................................... 1078.2 Good practices of asset management ......................................................................................... 1098.3 Policies ......................................................................................................................................... 1098.4 Procedures ................................................................................................................................... 1109 EXPENDITURE MANAGEMENT ...................................................................................................... 11510 COSTING PRACTICES ..................................................................................................................... 11810.1 Concepts ...................................................................................................................................... 11810.2 Policies ......................................................................................................................................... 12210.3 Procedures ................................................................................................................................... 12311 INTERNAL CONTROLS.................................................................................................................... 13211.1 Concepts ...................................................................................................................................... 13211.2 Good practices of internal controls .............................................................................................. 135 -5-
  • 6. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.3 Policies ......................................................................................................................................... 13511.4 Procedures ................................................................................................................................... 13612 FINANCIAL MANAGEMENT INFORMATION SYSTEMS ............................................................... 14512.1 Concepts ...................................................................................................................................... 14512.2 Policies ......................................................................................................................................... 14712.3 Procedures ................................................................................................................................... 14813 FINANCIAL ANALYSIS .................................................................................................................... 15113.1 Concepts ...................................................................................................................................... 15113.2 Good practices of financial analysis ............................................................................................. 16613.3 Policies ......................................................................................................................................... 16613.4 Procedures ................................................................................................................................... 16714 PROCUREMENT ............................................................................................................................... 170ANNEXURE 1: FORMATS FOR BUDGETING........................................................................................ 171ANNEXURE 2: FORMAT FOR ASSET MANAGEMENT ........................................................................ 179ANNEXURE 3: FORMATS FOR FMIS ..................................................................................................... 180ANNEXURE 4: TOR CHECK LIST .......................................................................................................... 190 -6-
  • 7. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshList of TablesTable 1: Structure of the Financial Management Manual ........................................................................... 11Table 2: Example of line-item budget for a ULB ......................................................................................... 17Table 3: Advantages and disadvantages of line-item budgeting ................................................................ 18Table 4: Advantages and disadvantages of programme budgeting ........................................................... 21Table 5: Example of zero-base budgeting .................................................................................................. 22Table 6: Advantages and disadvantages of zero-base budgeting .............................................................. 23Table 7: Sample performance measures .................................................................................................... 24Table 8: Advantages and disadvantages of performance budgeting ......................................................... 25Table 9: Forms prescribed in MPMAM for budget layout ........................................................................... 33Table 10: Sample format for listing and linking proposed capital investment works to budget allocations 36Table 11: Format of CIP prepared by PMC ................................................................................................ 72Table 12: Sources of information for Cash Flow forecast ........................................................................... 81Table 13: Format for gathering data for trend analysis ............................................................................... 84Table 14: Illustration on judicious use of investments ................................................................................ 87Table 15: Decision matrix for choosing among long-term financing alternatives ..................................... 105Table 16: Illustration on cost savings through outsourcing ....................................................................... 121Table 17: Illustration showing apportionment of indirect expenses .......................................................... 126Table 18: Physical parameters for costing ................................................................................................ 126Table 19: A typical cost sheet of Water Works Department ..................................................................... 127Table 20 : Format for calculating budget requirements for electricity charges for streetlight service....... 171Table 21: Format for calculating budget requirement for O&M of streetlight service ............................... 172Table 22: Format for calculating budget requirement for fuel expenses for vehicles & other machinery . 174 -7-
  • 8. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 23 : Format for calculating budget requirement for purchase of tyres for vehicles ......................... 175Table 24: BIDS for listing spill over works and for estimating their budget liability ................................... 178 -8-
  • 9. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshLIST OF FIGURESFigure 1: Financial management process ................................................................................................... 14Figure 2: Sample budget calendar .............................................................................................................. 35Figure 3: Decision making process for O& M expenditure ......................................................................... 40Figure 4: Identification of capital works and formulation of capital budget ................................................. 44Figure 5: Summary of budget preparation process ................................................................................... 45Figure 6: Capital investment decision making process ............................................................................... 54Figure 7: Procedure followed by PMC for preparing CIP ............................................................................ 68Figure 8: Linkages of cash budget .............................................................................................................. 86Figure 9: Relationship between AMP and Budget .................................................................................... 114Table 10: Function and functionary codes for Cost Object - Water Supply .............................................. 124Figure 11: Internal control system ............................................................................................................. 133Figure 12: Format for collecting information on ULB assets ..................................................................... 179Figure 13: Format for monthly financial position ....................................................................................... 180Figure 14: Format for statement showing actual receipts against budgeted receipts .............................. 181Figure 15: Format for statement showing actual expenditure against budgeted expenditure .................. 182Figure 16: Format for statement showing investments in bank fixed deposits ......................................... 183Figure 17: Format for statement on returned/ dishonoured cheques ....................................................... 184Figure 18: Format for summarised status report on returned/ dishonoured cheques .............................. 185Figure 19: Format for unadjusted advances status report ........................................................................ 186Figure 20: Format for outstanding loans/ liability statement ..................................................................... 187Figure 21: Format for projected monthly cash flow statement .................................................................. 188Figure 22: Format for status report on examination of accounts .............................................................. 189 -9-
  • 10. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh1 INTRODUCTION1.1 Purpose of this manualThe primary purpose of this manual is to explain the concepts and define the policies and proceduresabout good practices of financial management for ULBs of M.P. A secondary purpose of the manual is todevelop the capacity of Urban Administration Development Department (UADD) and the ULBs to adoptand implement these policies and procedures.1.2 Target group of usersThis manual is intended for all municipal employees involved in financial management of a ULB.Particularly, these may include:1. Senior decision makers including senior administrative officers such as the Commissioners/ Chief Officers, department heads, elected representatives, as well as the Mayor-in-Council (MIC).2. Accounts officers, municipal engineers and administrative officers who are the key people involved in many of the processes related to financial management of a ULB.3. UADD of GoMP who would be involved primarily in monitoring, supervision and facilitating financial management process in ULBs.1.3 How to use this manualThis manual does not give detailed instructions on the course of action to be taken in every situationarising due to financial management. Instead, it outlines the basic policies, principles, procedures andgood practices observed in Indian or non-indian ULBs based on which decisions should be made.The manual is intended to act as a guide which will facilitate the municipal employees to successfullyunderstand and implement the best practices on financial management.1.4 Structure of this manualThe manual is structured into two parts.• Managing financial framework – Budget (formulation, implementation & evaluation) is the most important tool for managing financial framework and all other systems are aligned to it. It is most effectively managed by having a system of short-term and long-term financial management. Short- term financial management mainly includes cash management, receivables and payables management and short-term debt management, whereas, long-term financial management consists of formation of capital investment plan and long-term debt management. -10-
  • 11. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Performance enablers - Apart from this there are certain systems that act as performance enablers for managing the finance framework. These include Asset Management, Costing, Procurement, Internal Control and Financial Management Information Systems.The chapters of this manual have been framed keeping in the mind the above mentioned structure. Thefollowing table provides the sequence of chapters in the manual.Table 1: Structure of the Financial Management Manual Number Name Category Chapter 3 Budgeting Chapter 4 Capital Improvement Plan/Capital Budgeting Chapter 5 Cash Management Managing Financial Framework Chapter 6 Receivables and Payables Management Chapter 7 Debt Management Chapter 8 Asset Management Chapter 9 Expenditure Management Chapter 10 Costing Chapter 11 Internal Control Performance Enablers Chapter 12 Financial Management Information Systems Chapter 13 Financial Analysis Chapter 14 ProcurementApart from the above, a set of Annexures are appended to this manual, which provide formats for some ofthe areas of financial management. These include:• Annexure 1: Formats for budgeting• Annexure 2: Formats for asset management• Annexure 3: Formats for FMIS -11-
  • 12. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh2 INTRODUCTION TO FINANCIAL MANAGEMENTFinance has a unique and important place in personal, public, institutional and social walks of life. In orderto be successful in these walks of life, all of us need to augment and utilise financial resources efficientlyand in a sustainable way to ensure future flow of resources. Therefore, all decision-makers need to knowhow to manage finances of their institutions/ organisations.Financial management attempts at optimising output from the given input of funds. In a country like Indiawhere resources are scarce and there is enormous demand for funds, proper financial management is ofutmost importance.2.1 Defining financial managementFinancial management in simple terms means the entire gamut of managerial efforts devoted to themanagement of finance (both its sources and uses) of an enterprise (organisation/ institution/ public bodyetc.). It is the management of the finances of a business/ organisation in order to achieve its financialobjectives. Taking a business as the most common structure, the key objectives of financial managementwould be to:• Create wealth for the business,• Generate cash, and• Provide a return on investment keeping in mind the risks that the business is taking and the resources invested.It can be observed that traditionally, the basic objectives of Financial Management were the maintenanceof liquid assets and maximisation of the profitability of the organisation. But now it has undergone achange. Today, the ultimate objective of financial management is maximisation of wealth.The objective of wealth maximisation holds good for public bodies’ financial management also. Publicbodies or any governmental form of organisation exists not for ‘profit maximisation’ but for ’wealthmaximisation. In order to improve the overall standard of living of people or society, the governmentneeds to maximise wealth and then to ensure equal distribution of the wealth generated. Thus, publicbodies are expected to attain the objective of wealth maximisation through judicious allocation andutilisation of resources. In order to achieve this objective, public bodies must run their finance function asper modern financial management methods, as the discipline of financial management strives for ’wealthmaximisation.2.2 Need for financial management in ULBsIn the past two decades, India has witnessed a phase of rapid urbanization. This has resulted in mosturban settlements facing shortfalls in provision of urban services such as, housing, water supply, -12-
  • 13. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshsewerage and urban transportation systems. In addition to the growth in demand for urban services, poorfunctioning of municipal bodies has made the problem even more acute.In order to meet these and other growing challenges, the Government of India (GoI) introduced specialpurpose schemes such as the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) that intendto enable municipal bodies to meet these challenges by providing a fresh impetus to urban reforms. Asthe infusion of funds from these schemes is expected to increase municipal budgets, it is important thatULBs have sound financial management systems and procedures in place to ensure that these publicfunds are used efficiently and transparently.Hence ULBs require sound financial management systems to ensure that funds are effectively managedand efficiently utilised.2.3 Financial management processThe whole financial management process can be viewed from three angles:• Creating financial framework• Managing financial framework• Performance enablersThe creation of financial framework basically deals with three aspects namely financial policies, financialanalysis and financial planning. These three aspects form the core of financial framework for any ULB.After the creation of financial framework, the second most important aspect is managing this framework.Budget (formulation, implementation and evaluation) is the most important tool for managing financialframework and all other systems are aligned to it. Short-term financial management mainly includes cashmanagement, receivables and payables management and short term debt management. Long-termfinancial management consists of formation of capital investment plan and long-term debt management.Apart from this there are certain systems which act as performance enablers for managing the financeframework. These include Asset Management, Costing, Procurement, Internal Control and FinancialManagement Information Systems.The following figure depicts the financial management process. -13-
  • 14. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 1: Financial management process Enabling Performance Creating Financial Managing Financial Framework Framework Short term financial management BUDGETING Financial Management Financial Management Information System Financial Policies •Cash Management Internal Control •Receivables and payables management Operating Budget Financial Analysis •Short term debt management Long term financial + management Financial Planning •Capital Improvement Plan Capital Budget •Long term debt management Asset Management Costing Procurement -14-
  • 15. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3 BUDGETING PRACTICESThis section of the manual discusses various concepts, principles, techniques associated with budgeting,and provides the policies related to budgeting, the budget preparation process followed by the budgetreview mechanism.3.1 ConceptsBudgeting is a statutory activity for all urban local bodies (ULBs) in India. It acts as a powerful tool toallocate limited resources among competing priorities. It is a local government’s plan to allocate itsfinancial resources for a specified period including all planned revenues and expenses.A ULB budget typically includes:• Planned activities, projects, and services;• Estimates of the resources or revenues available; and• Estimates of public expenditure necessary to finance planned activities.3.1.1 DefinitionsOperating/ revenue budget: It is a plan for the on-going day-to-day operational expenditures of the ULBand the proposed means of financing for a specific period (usually one year).Capital budget: It is a plan of proposed capital improvements and the means of financing them, usuallybased on the first year of a multi-year capital improvement programme and typically enacted as partof the complete annual budget, which includes both operating and capital outlays.Extraordinary budget: It is a part of the capital budget, but contains receipts and payments which do notamount to income and expenditure for the ULBs. For example, deposit receipts and payments, advancesgiven and adjusted, etc.Poor budget: It is a budget which is sensitive to the needs of poor people or which tries to correct its biasin resource allocation for the alleviation of poverty by stipulating a certain percentage of resources for thepoor. For example, in normal practice, a budget fails to show sensitivity towards the needs of the urbanpoor in resource allocation and special needs of the poor get neglected.Gender-based budget: It is a budget which is sensitive towards gender or which tries to correct genderbias in resource allocation by stipulating a certain percentage of resources for one gender. For example,in normal practice, a budget fails to show sensitivity towards the needs of women in resource allocationand special needs of women get neglected. -15-
  • 16. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshParticipatory Budgeting: It refers to the adoption of alternative practices for local budget managementaimed at encouraging people’s participation in the allocation of municipal public resources. Suchpractices are believed to promote greater efficiency in the allocation of resources by forcing planning andtransparency into decisions on expenditure. Increasingly, municipal bodies all over the world haveintroduced such practices and there is increasing global recognition for the significance of such anapproach.3.1.2 Objectives of a budgetA budget is prepared with the objectives of controlling, managing and planning the financial resources ofan organisation. Each of these objectives are discussed in detail below.1. ControlAs a control document, a budget defines the legal and policy constraints within which the managers of aULB can operate. These constraints include determing:• Permissible expenditure by each ULB;• Purposes for which expenditure can legally be made (such as salaries, maintenance, and loan charges); and• Collection of tax resources and non-tax resources (i.e., revenue functions).Control is a significant objective governing the preparation of budgets in ULBs, although its achievementis drastically impaired by a number of systemic weaknesses. To achieve the objectives of control, thebudget needs to be supported by effective accounting and auditing systems.2. ManagementAs a management document, a budget sets targets that ensure the achievement of an efficient andeffective delivery of urban services. To enable the budget to be a fully effective management tool, theremust be a clear relationship between budgetary inputs (such as personnel and equipment) and expectedoutputs, defined in ULB performance measures (such as the number of square metres of road to berepaired, etc.). Such a relationship enables departmental heads to use the budget as a device to managetheir staff.3. PlanningThe preparation of a budget provides a major planning opportunity for a ULB, which wants to address itsgrowth and development needs through judicious use of its limited financial and personnel resources.Each year, the budget defines the anticipated revenues of a ULB and outlines the blueprint for itsexpenditure.3.1.3 Constituents of an ideal budgetA ULBs budget should cater to the interests of various users such as politicians, administrators, ULBmanagers, employees, representative groups such as NGOs/ CBOs, analysts and the public at large. A -16-
  • 17. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshbudget should meet the requirements of these varied user groups and yet should not become unyielding,bulky or ambiguous.An ideal budget document should be:• A policy document: As an operating plan for a local government, the budget document should propose, identify and clarify policies. These are generally adopted by the governing body during the year and are referred to or summarised in the budget message.• A financial plan: The budget process is the primary mechanism for promoting solvency, efficiency and rational collective choices regarding the distribution and use of the assets and resources of a ULB.• An operations guide: The budget provides a framework for operations of a ULB. It must go beyond purely financial dimensions to deal with the functions of different parts of the organisation and the number and levels of employees.• A communication device: A budget is a focal point for residents, taxpayers and constituents, and, therefore, should be made plain and simple. Therefore, sufficient efforts should be made to use simplistic narratives, charts or graphs to convey the meaning and impact of the budget to people who are not familiar with government finances.• Scrupulous: A budget should be able to stand up to scrutiny by competing interest groups.• Holistic: A budget should be holistic in approach and should not neglect some areas or over or under-emphasise others.3.1.4 Budgeting techniquesA number of budgeting techniques have evolved overtime in order to achieve diverse objectives. Thesetechniques have met varying degrees of success in different countries. Whereas, some of thesebudgeting techniques are more advanced, each budgeting technique offers distinct advantages and has,at the same time, certain limitations. It is for an organisation to select one or more budgeting techniquesthat are appropriate to its activities and budget classification.3.1.4.1 Line-item budgetingThis method of budgeting is also referred to as incremental budgeting. Under this approach, budgets arejustified on the basis of proposed expenditures by line-item, or object class. The base budget is usuallynot justified, but only the additions (or increments) are questioned. It is noteworthy that ULBs in MPcurrently develop their budgets on a line-item basis.A simplified example of line-item budget is presented in the table below.Table 2: Example of line-item budget for a ULB -17-
  • 18. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Budget Request Line-item Base Budget (INR) Increments (INR) (INR) Salaries 50,000 + 6,000 56,000 Travel 25,000 + 14,000 39,000 Equipment 40,000 - 10,000 30,000 TOTAL 1,15,000 + 10,000 1,25,000The base budget is equivalent to either:• The current year’s budget, including adjustments; or• The current year’s actual expenditures, usually estimated to the end of the fiscal year; or• The last year’s actual expenditures.The base budget is different from the current service budget, which is the anticipated cost of continuing aprogramme at the present levels, without policy changes or enactment of new laws. Mathematically, thecurrent services budget (CSB) can be expressed as follows:CSB = Base Budget + Unavoidable Cost IncreasesIncreases in unavoidable or fixed costs such as employee costs or dearness allowances may mean that itwill cost more to deliver the same level of services currently being provided. It is important for the budgetoffice to provide directions to the line departments to enable them to estimate fixed cost increases.No matter which budget development approach a government uses, its budget is usually translated into aline-item budget for the purpose of budget execution and control, with allocations to object classes.Advantages and disadvantagesThe primary advantage of the line-item approach is that it is easy. Whereas, the primary disadvantage ofusing the line-item approach is that it does not provide essential information.Table 3: Advantages and disadvantages of line-item budgeting Advantages Disadvantages 1. It is an efficient way of enhancing the 1. It is only concerned with inputs and not allocation and control of funds since it mirrors outputs. Thus, it is difficult for decision-makers the accounting system. to find out the results of their allocation decisions and what the public gets for its money in terms of services and outputs. 2. There is no need for extensive Management 2. It is difficult to develop a current services -18-
  • 19. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Advantages Disadvantages Information System (MIS) since information budget, as the present level of services is not pertaining to service levels, unit costs and known. Decision-makers do not know what programme output is not required to develop they get for their additional resources the budget. allocated to a programme: same level of service; higher level of service; or, less service. 3. Incremental budgeting is consistent with the 3. It does not provide any information to fact that many programmes are stable and do decision-makers about alternative ways of not change dramatically from year to year. accomplishing an objective and reveals little about a ULB’s priorities. 4. It is developed by using the estimates of direct costs only and, therefore, indirect costs are completely ignored. 5. It is characterised by budget control techniques, which do not provide sufficient flexibility to programme managers to achieve results. 6. Line-item budgeting is usually accompanied by ‘across-the-board’ approach to allocation decisions. Budget additions or deductions are distributed among all departments on a percentage basis, thus, failing to take into account the changing needs and priorities of the departments.3.1.4.2 Programme budgetingProgramme budgeting focuses on the decision-making process; particularly on problems of data andanalysis. Its first effort is to introduce a rational ordering of inputs and outputs, in which the initialemphasis is laid on the identifiable outputs, that is, major objectives of the governmental process. It thenattempts to order the inputs, that is, governmental activities created by manpower, material, real estate,etc., so that comparisons among wide ranges of alternatives are feasible and meaningful.Programme budgeting attempts to measure programme effectiveness and programme results in aquantifiable manner. It starts with clear, quantifiable and measurable programme objectives for allactivities. Programme budgeting can be defined at two levels:1. The way in which the budget is organised (by programme); and2. The way it is justified (on the basis of programme results).This method of budgeting provides a method for organizing activities into programmes (activities orservices with a common goal), identifying alternatives for achieving each goal, determining the costs andbenefits for each alternative, and selecting the right alternative to maximize benefits. Since total cost and -19-
  • 20. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshperformance levels are what matter — not the cost of each line item — budgetary allocations can beprovided “lump sum” by programme rather than in traditional department line items. Programmebudgeting is often accompanied by various kinds of performance measures.On the basis of the above explanation, the following characteristics of programme budgets emerge:• It discloses the full cost of a programme regardless of the number of organisational units involved in performing the function.• It attempts to measure the actual outcomes or programme results of a service or programme.• It uses ‘programme elements’ as the basic budgetary classification scheme instead of departments.• It provides for consideration of alternate service delivery options.Programme budgeting is feasible only if measures are quantifiable and specific. Measures utilising termssuch as ‘improve,’ ‘strengthen’, and ‘coordinate’ are impossible to quantify and are too general. Becauseof these deficiencies, they do not provide a means of holding agencies or managers accountable forresults. Consider these three possible programme measures for a maternal and child health programme:3. Measure A: Improves health of infants4. Measure B: Improves health of infants by 20 percent5. Measure C: Decreases infant mortality by 10 percent in 3 yearsMeasure A is not useful because it is not quantifiable, and is, therefore, not measurable. Measure B isquantifiable but it is not specific as to what is meant by the phrase ‘improves health of infants.’ How wouldan improvement in the health of infants be measured; Measure C is the best because it is bothquantifiable and specific. Therefore, in Measure C, it is possible to conclude whether the programmeachieves the desired outcome or fails to achieve it.Sample programme measuresThe following programme measurements may be used:1. Public Works a. Increase in the useful life of the infrastructure; and b. Decrease in the average downtime of the government’s equipment.2. Health Services a. Decrease in infant mortality rates; b. Decrease in the percentage of children classified as malnourished; c. Decrease in dental diseases; and d. Increase in the average lifespan of population.3. Public Safety -20-
  • 21. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh a. Number of structures saved from fire; b. Decrease in crime rates; and c. Decrease in traffic-related fatalities.4. Audit a. Rupees saved as a result of audits; and b. Number of audit findings successfully addressed.5. Tax and Revenue a. Number of tax returns accurately processed; and b. Additional revenue from tax compliance programmes.Advantages and disadvantagesTable 4: Advantages and disadvantages of programme budgeting Advantages Disadvantages 2. It leads to a rational allocation of resources 1. It is inherently difficult to quantify programme and is particularly useful in making decisions results or programme effectiveness. Even if about alternative ways of accomplishing an output and/or programme results can be objective. measured, it may not be possible to know whether a result was achieved due to the programme or because of another factor. 3. It provides information on the total resources 2. Programme budgeting may ignore the need to allocated to programmes (information not control expenditures by assigning available in other budgetary techniques). responsibilities to departments. 3. The costs of trying to measure programme effectiveness may outweigh the advantages and usefulness of the information. 4. Information about resources allocated to the programmes could only be obtained by reorganising government departments in line with the programme areas, which is time- consuming and not always feasible. 5. In order to effectively implement programme budgeting, budgetary personnel must be specially trained and must have the time to conduct programme audits, which is a costly affair and municipal bodies may not be able to afford it. -21-
  • 22. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.1.4.3 Zero-based budget (ZBB)Peter A. Pyhrr at Texas Instruments pioneered the concept of Zero-Base Budgeting (ZBB) in 1969 as atool for planning budgeting and controls. In this system of budgeting, organisations do not take budgetallocation in past years for an activity as granted while preparing their budgets and start from zeroallocation. Budget-making under this technique starts from zero instead of treating the current budget asthe base or the starting point. In this system, existing programmes and activities are reviewed andexamined in as much detail as in the case of newly proposed ones.DefinitionIn the words of Peter Pyhrr, ZBB is “an operating, planning and budgeting process, which requires eachmanager to justify his entire budget requisites in detail from scratch (hence zero basis). Each managerstates why he should spend any money at all. This approach requires that all activities be identified asdecision packages, which would be evaluated by systematic analysis ranked in order of importance.”ZBB is a formalised system for deciding whether a programme should be operated at a minimum,reduced, current or increased level. Priority rankings are assigned to all decision packages from thehighest to the lowest; packages are ranked either in or out of the budget. Decision packages must bediscrete, that is, they must be stand-alone and not rely on the other parts of the budget.Illustrative exampleAssuming that the base budget for the Public Works (Roads Maintenance Division) is INR 24 lakhs, anexample of a budget request prepared using the ZBB format is shown below.Table 5: Example of zero-base budgeting S.N. Decision Package Cost (INR) Total Budget (INR) 1. Only Maintenance 24,00,000 2. Resurface 5 kilometres of road + 3,00,000 27,00,000 3. Resurface 5 more kilometres + 2,50,000 29,50,000 4. Reconstruct bridge on Beach Road + 1,75,000 31,25,000Decision-makers can choose any, all, or none of the decision packages. If only decision package two ischosen, then a total of five kilometres of road will be resurfaced. If decision packages two and three arechosen, a total of 10 kilometres of road will be resurfaced. If all the decision packages are chosen, 10kilometres of road will be resurfaced and the bridge will be reconstructed.Advantages and Disadvantages -22-
  • 23. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 6: Advantages and disadvantages of zero-base budgeting Advantages Disadvantages 1. It enables decision-makers to make rational 1. ZBB requires agencies to justify every element allocation decisions across programme and of their budget every year. A good idea in organisational lines (for example, is it more theory, but in practice, this proves to be too important to resurface five more kilometres of cumbersome, time-consuming and involves road or build three more classrooms?). huge paperwork and is easy for managers to manipulate. In most places, ZBB has died of its own weight. 2. It has the advantage of being more realistic 2. It is unrealistic and a waste of resources to than either performance budgeting or justify the existence of programmes every year; programme budgeting on its own. few programmes are eventually terminated as a result of the ZBB process. 3. ZBB provides a systematic way to consider 3. The process is susceptible to games: various alternatives to accomplish an departments may put essential services in objective. lower-ranked decision packages, knowing that decision-makers will put them into the budget. 4. ZBB offers a systematic mechanism for 4. Decision units may not coincide with the deciding on the proper level of a programme. classification system used by the accounting For example, the Public Works budget might system, making it necessary to carry out have three decision packages for resurfacing complex crosswalks between ZBB and the a road. accounting/ appropriation structure.3.1.4.4 Target-based budgetingIn this type of budget, each department is given a maximum amount or target for budget request foraccomplishing minimum levels of service. Targets are based on revenue estimates for the coming fiscalyear and adjusted for any changes in priorities communicated by governing body members. The morecomplex part of target-based budgeting involves estimating each department’s current services budget.Generally, the current services budget is the department’s current year appropriation plus or minus someadjustments (i.e., one-time purchases, etc.). Once established, the target is typically set at somepercentage of the current services budget — for example, 95 per cent for lower priorities in the currentyear or 105 per cent for higher priorities. Although target-based budgeting includes some elements ofZBB, it greatly reduces conflict and the use of subjective judgment since departments know up front theirprobable level of funding for the next year.3.1.4.5 Performance budgetingIn India, the first step towards the introduction of performance budgeting was taken by the EstimatesCommittee of the first Lok Sabha, as early as in the year 1954. The Administrative Reforms Commissionalso recommended a phased introduction of performance budgeting in government bodies. Since then,the Government has been making efforts to introduce performance budgeting in more and more of itsoperations. -23-
  • 24. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshPerformance budgets relate the input of resources to the output of goods or services in a quantifiableformat. Under this approach, budgets are based on measures of work and cost necessary to carry out acertain level of activity. Budgets are based on unit costs and service expectations. At the end of the year,a performance analysis is conducted to compare actual work performed with budget estimates.Performance budgets provide information with regard to the efficiency and productivity of public services.Efficiency is a measure of the cost to provide a unit of service, while productivity is the measure of theinputs required to produce a unit of service against a cost standard.In order to make performance budgeting work, the following three conditions are necessary:• It must be possible to develop and measure the units of service for governmental activities;• The accounting system must provide information about costs; and• Management Information Systems (MIS) must provide information about the level of service provided by each activity.Performance measuresAt the heart of performance budgets are performance measures. Performance measures reflect output,i.e., how much service is provided. It is important to understand the distinction between performancemeasures and performance standards. While considering performance measures, the key question is:what is being counted. While considering performance standards, the key question is: how much or howmany should be produced or served per rupee or per employee.IllustrationExamples of performance measures and corresponding performance standards for various functions ofULBs are shown in the table below.Table 7: Sample performance measures Performance Measures Performance Standards Public Works Kilometres of road resurfaced INR 1,00,000 per kilometre MW of electricity delivered INR 0.09 per kW Health Services Number of outpatients treated INR 20.0 per patient per day Number of Inpatients treated INR 100.0 per patient per day Public Safety -24-
  • 25. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Performance Measures Performance Standards Number of food samples taken 10 samples per food inspector per day Number of fires fought 10 fires per fireman Environmental Protection Agency Number of water quality inspections INR 65.0 per inspection Number of land use permits reviewed INR 500 per permit reviewed Tax Revenue Number of tax returns processed INR 175 per return processed Number of tax audits conducted INR 2, 500 per tax audit Finance and Accounting Number of cheques drawn INR 4.5 per cheque Number of vouchers processed 500 documents per vouchers staff per yearAdvantages and DisadvantagesTable 8: Advantages and disadvantages of performance budgeting Advantages Disadvantages 1. Facilitates rational allocation decisions in 1. It is difficult to develop performance measures accordance with the desired level of service. for all government services, especially for For example, if it costs INR 25 lakhs to re- government functions which do not provide surface one km of road, and decision-makers services directly to the public such as financial, want 5 km of road to be re-surfaced, INR 125 legislative and general administrative functions. lakhs must be budgeted in the public works function for road re-surfacing. 2. Makes it possible to hold government officials 2. Developing and maintaining a system of and organisations accountable for their collecting performance data may be costly and performance. time-consuming; in some cases, it is not worth the expense. 3. Fosters a cost consciousness among 3. Performance budgets are generally programme managers, especially if incompatible with existing accounting systems, organisations are organised into cost centres which do not measure cost of service ex ante. and as many services as possible are treated Cost information is usually available only ex as direct costs. post (after the costs are incurred), and is not always reliable. -25-
  • 26. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Advantages Disadvantages 4. Programme output does not equal programme effectiveness. Measurement of service levels and work output do not always reveal information about programme effectiveness or programme results.3.1.4.6 Outcome BudgetingOutcome budget is a pre-expenditure instrument, which helps in realizing the performance through clearlydefined outputs/ outcomes, as compared to the current system built around post–expenditure scrutiny.Outcome budgeting is about clearly articulating outcomes of each and every capital work and linking suchexpected outcomes of development works or expenditure to the financial outlays in budget beforeundertaking it for implementation. It is a logical extension of performance budgeting and gets facilitated ifthere exists performance budgeting in a ULB. Performance budgeting links physical targets to financialoutlay but may or may not provide information about outcomes planned or expected on completion of thework or expenditure. Typical examples of outcomes are given below:• Construction of Elevated Storage Reservoir (2ML) for water supply, will serve a population of 12,000 @ 170 LPCD with a daily supply 4 hours. The numbers of new connections can be quantifiable depending on the pipe network size.• Laying of sewerage pipe of diameter 150mm of length covering a particular area, will provide proper sanitation facilities for sewer connection for households in that particular area. The number of new sewer connections is quantifiable.• Construction/ completion of a school building is the output, whereas increase in the literacy rate is the final outcome where an increase in enrolment would be an intermediate outcome.• Provision of public tap – it can quantifiable with the number of households that could use the service3.1.4.7 Gender BudgetingA gender-responsive budget is a budget that acknowledges the gender patterns in society and allocatesmoney to implement policies and programmes that will change these patterns in a way that movestowards a more gender equal society. Gender budget initiatives are exercises that aim to move thecountry in the direction of a gender-responsive budget.Gender budget initiatives are known by a range of different names. They have, for example, also beenreferred to as ‘women’s budgets’, ‘gender-sensitive budgets’, and ‘applied gender budget analysis’.Gender Budgeting is based on the modern idea that budgeting is not simply an accounting orbookkeeping exercise. Instead, budgeting is a key part of the planning and implementation process. -26-
  • 27. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshGender budgeting is not the only tool that can and must be used if equality and empowerment are to berealised. Gender Budgeting is, however, an essential tool because, unless sufficient money is allocated toimplement all the other tools and strategies, they will not be effective. The Five Step Framework for Gender Budgeting Step 1: An analysis of the situation for women and men and girls and boys (and the different sub- groups) in a given sector. Step 2: An assessment of the extent to which the sectors policy addresses the gender issues and gaps described in the first step. This step should include an assessment of the relevant legislation, policies, programmes and schemes. It includes an analysis of both the written policy as well as the implicit policy reflected in government activities. It should examine the extent to which the above meet the socio-economic and other rights of women. Step 3: An assessment of the adequacy of budget allocations to implement the gender sensitive policies and programmes identified in step 2 above. Step 4: Monitoring whether the money was spent as planned, what was delivered and to whom. This involves checking both financial performance and the physical deliverables (disaggregated by sex) Step 5: An assessment of the impact of the policy / programme / scheme and the extent to which the situation described in step 1 has been changed, in the direction of greater gender equality Source: UNIFEM-UNFPA Gender Responsive Budgeting and Womens Reproductive Rights: Resource PackExample of Gender Budgeting -Gender Budgeting is not about simply dividing government money 50-50 between men and boys on theone hand and women and girls on the other. A simple 50-50 division may look equal, but it is often notequitable, or fair, because the needs of women and men and girls and boys may be different. Instead,Gender Budgeting looks at every part of the government budget to assess how it will address the differentneeds of women and men, girls and boys and different groups of women and men, girls and boys. Forexample, in the area of health, male and female people will have similar needs in respect to influenza andmalaria. But women will have greater needs than men in terms of reproductive health.A municipal body to begin with can adopt a policy of reserving 10 to 15 % of its development budget forwelfare of women and illustrative items under this budget could be • Construction of adequate and appropriate toilet block for Girls in all municipal schools; • Construction of adequate and appropriate toilet block for women throughout the city; -27-
  • 28. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh • Construction and running Health care centres for women in each area; • Construction and operations of hostels for working women; • Construction and operations of shelter homes for destitute wormen, etc3.1.4.8 Multi-year planning budgetsMulti-year planning budgeting refers to a process designed to ensure that the long-range consequencesof budget decisions are identified and reflected in budget totals. In practice, this usually means that multi-year planning estimates for revenue and expenditures are shown for each programme beyond the budgetyear.For some governments, the annual budget is the vehicle for the implementation of multi-year (usually five-year) strategic plans. In this sense, long-range budgeting means integration of planning and budgetingprocesses. Decisions about public investments and programme expansion are made as a part of themulti-year planning process, and not as a part of the annual budgetary process.3.1.4.9 Participative budgetingIn India, there is growing awareness about the need to introduce such processes, particularly among civilsociety organizations. JNNURM scheme has mandated for State Governments to put in place ‘CitizensParticipation Law’ to facilitate citizens’ participation in urban governance. In light of this, adoption ofparticipative budgeting by the ULBs has become important.From a socio-political viewpoint, the process of participatory budgeting is an embodiment of the ideals ofdecentralized urban governance, namely transparency, accountability and the participation of the publicat large in identifying their needs and determining how these can be fulfilled. From a managerial ortechnical point of view, ‘participatory budgeting’ provides the link between financial planning and theplanning for infrastructure and services in the cities.3.2 Good practices of budgeting3.2.1 Preparing a budget1. Budgeting should be a continuous process: Budgeting is a 365-day activity. As soon as a budget st comes into force on 1 April of a particular year and actual figures become available in the month of May, a ULB should start the process of budget preparation for the next year. As part of this process, a ULB should forecast major revenue and expenditure items for next year’s budget.2. Budget forecast should be based on stated assumptions and methodology: The forecast along with its underlying assumptions and methodology should be clearly stated and made available to participants in the budget process. These assumptions and methodologies should also be provided as references in the final budget document. -28-
  • 29. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3. ULB should analyse the variances between previous forecast and actual amounts: The variance analysis should identify the factors that influence revenue collections, expenditure levels, and forecast assumptions. This will help improve future forecasting.4. Use of Budget Information Data Sheets (BIDS) for budget preparation: A ULB should use BIDS to collect information for preparing its budget. Using BIDS facilitates efficiency and cost audit as actual figures can be compared in a disaggregated manner to find out precisely the cost of overrun or cost inefficiency. Formats for collecting data in the form of BIDS are provided in Annexure 1. These are sample formats and ULBs are encouraged to develop BIDS for each important receipt and payment item on these lines.5. Use of Assets Management Plan (AMP) for budget preparation : Like BIDS a ULB should use AMP to assess funds needed for maintenance of the assets on scientific and preventive basis and then use financial figures coming out of AMP to formulate it annual maintenance budget. AMP is in a generic way one type of Budget Information Data Sheet.6. The budget document should clearly define the basis of accounting used for budgetary purposes.3.2.2 Capital budgeting1. Capital budget should be prepared as part of annual bugeting process: A ULB should prepare and adopt a formal capital budget as part of its annual budgeting process.2. Capital budget should be drawn from the multi-year capital improvement plan: The capital budget should flow from the multi-year capital improvement plan. Presentation of capital budget should include a summary of the multi-year capital improvement plan.3.2.3 Budgeting techniques1. Line-item budgeting should be used for preparation of revenue budget with the conservative incremental approach.2. Performance, participatory and outcome budgeting techniques are recommended for the formulation and administration of the capital budget.3. Budgeting for poor, gender budgeting, functional budgeting, budgeting on geographical basis (zone/area-wise budgeting) etc budget techniques should be used for segregation and presentation of budget in multi-dimentional manner.3.2.4 Implementing/ administering/ controlling the budgetHaving prepared and adopted the budget the next important aspect of budgeting is administering thebudget. Administering the budget is linked with several short term and long-term financial managementaspects. It is linked with cash and working capital management, bills receivables and payablesmanagement, inventory management for short-term financial management and long-term debtmanagement, assets management and implementation and revision of Capital Investment Plan, etc., forlong-term financial management. Following good practices have been observed for improving budgetimplementation. -29-
  • 30. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh1. Budget should be contingent on resource mobilization: In government parlance, budget is a legal authorization. As a result, once budget allocations are approved, the departments are free to utilise their allocations fully, even if the receipts are not realised as per targets. The expenditure mechanism assumes independent existence. Thus, by not making its expenditure contingent to actual receipts, ULBs enhance their budgetary deficit. In fact, a local body can control negative aspects of deficit financing by judiciously linking and making its expenditure contingent to resource mobilization. Instead, ULBs should make their budget expenditure contingent on their actual receipts and accounts or the finance officer should issue every month (in the light of actual receipts) a benchmark for undertaking expenditure by the departments. For instance, a year opening circular may allow departments to spend 10% of the budget in the month of April and cumulatively 20% in the April to June quarter. After that, the Finance Officer of ULBs could issue monthly and quarterly expenditure benchmarks at the beginning of every month on the basis of actual receipts in the past months. In summary, departments should not get automatic clearance to spend budget allocations once they are passed and they should be required to seek permission to use full or part of it in the light of actual receipts.2. Departments to obtain prior financial approval before spending budget approved: It would not be sufficient to make budget contingent on revenue realised. Its implementation requires a system of financial approval before starting procurement process (before administrative approval to the expenditure) by a competent authority, and then, after completion of procurement process, but, before issuing work order or purchase order. This system is a logical extension of making budget contingent on revenue realised. Under this budgetary control system Head of the Department must obtain financial approval to expenditure from Accounts/ Finance department of the ULB before starting procurement process and then before issuing work or purchase order for all the capital expenditure and certain operation and maintenance expenditure (as specified by the Commissioner of the ULB). Accounts/ Finance Department should maintain budget control register and uni-number system for giving number to approved expenditure files.3. Budget should be bifurcated into monthly cash and working capital budgets: In order to make expenditure contingent upon revenue realised and to implement system of prior financial approval to expenditure, annual budget of the ULB should be broken down into monthly cash and working capital budgets. At present, budget preparation is viewed as an annual activity. Financial managers need to change this mindset. A budget can be for one week or even for a day. For a detailed discussion on adopting cash and working capital budget see Chapter 5 of this manual.4. Budget administration to include management of inventory, assets, receivables and payables: The budget administration should include management of inventory, assets, receivables and payables. These sub-systems, except receivable management, constitute expenditure system. Like expenditure provided in the budget should be contingent on the revenue realised, the operation of these expenditure sub-systems should also be contingent on the revenue realised and should not work on a stand-alone basis. The Accounts Department of the ULB should decide through a system of prior financial approval to expenditure on when and how much inventory should be purchased or how much operation and maintenance expenditure should be undertaken or the extent of project works expenditure that should be undertaken in the light of revenue realised and availability of funds. -30-
  • 31. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.2.5 Monitoring and evaluating the budgetIf the above-mentioned good practices are followed rigorously, the need for a formal review mechanism isreduced. However, the following good practices should be followed for monitoring and evaluating abudget.1. Budget should be prepared using a budget coding structure: A ULB budget should be prepared using a budget coding structure as prescribed by the government. Adherence to budget coding structure would ensure that all the items are properly recorded and classified. This in turn captures all types of financial information within a ULB. If the discipline of classifying receipts and payments is not adhered to, then the entire database can get distorted and the quality of decision-making, based on the data, becomes poor.2. Budget Variance Report (BVR) to be used as a crucial budgetary control tool: ULBs should also prepare a Budget Variance Report that could be used as an important budgetary control tool. BVR analyses the positive and negative variances of actual vis-à-vis budgeted receipts and expenditure items. In other words, a BVR provides information on fast-moving and slow-moving receipts and expenditure items. Positive variance should be analysed for reasons. For instance, a ULB has collected more property tax than the budgeted amount in a particular ward. The reasons for the same should be analysed and replicated. Negative variance should be analysed for reasons and cost control measures should be identified. For instance, the increase in maintenance expenses or finance charges would indicate lack of planning or implementation follow-up.3. Performance benchmarks (standards), indicators and measurement system: For monitoring and evaluating budget the ULB should have pre-defined set of performance benchmarks (standards) to compare actual performance against budgeted performance, performance indicators to measure performance and institutional structure to run performance measurement system. Revised budget and next year’s budget should get improved in the light of learning from budgetary monitoring and evaluation exercise. Budget performance analysis report should be submitted quarterly to Mayor or Chairman in Council for information and discussion and should be released as a public document.3.3 Policies recommended for adoption3.3.1 Frequency and timingEach Municipal Corporation in MP shall prepare and adopt an annual budget of income and expenditureof the ULB before the last day of February in the preceding accounting year for the next accounting yearin the manner and form as prescribed in Madhya Pradesh Municipal Accounts Manual, July 2007. In thisregard, the Commissioner shall prepare estimates of income and expenditure and present before the thMayor-in-Council, on or before the 30 day of November in the preceding accounting year forconsideration, modification, and approval, as appropriate.3.3.2 Basis of preparation1. Each Municipal Corporation in MP shall integrate performance measures and productivity indicators with its annual budget. In this regard, Municipal Corporations shall adopt the systems of performance -31-
  • 32. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh budgeting and outcome budgeting for preparing, and approving estimates of all types of capital expenditure except loan repayment in the manner and form as prescribed in MPMAM.2. Each Municipal Corporation in MP shall adopt system of participating budgeting for preparing, estimates of operating and capital expenditure except salary, debt charges, loan repayment and any other statutory expenses in the manner and form as prescribed in MPMAM.3. Each Municipal Corporation in MP shall adopt the systems of Gender Sensitive and Pro-Poor Budgeting. For this purpose, a Municipal Corporation shall segregate relevant budget items and allocations into two separate main budget heads, viz., (1) ‘Providing Services to Women, Children, and Senior Citizens’ (for gender sensitive budget) and (2) ‘Providing Basic Service to Urban Poor’ (for pro-poor budget).3.3.3 Conservatism in revenue estimationIn order to maintain a stable level of services, each Municipal Corporation in MP shall use a conservative,objective, and analytical approach when preparing revenue estimates. The process shall include analysisof probable economic changes and their impacts on revenues, historical collection rates, and trends inrevenues. This approach should reduce the likelihood of actual revenues falling short of budget estimatesduring the year and should avoid mid-year service reductions.3.3.4 Fiscal control1. Each Municipal Corporation in MP shall ensure fiscal stability and the effective and efficient delivery of services, through the identification of necessary services, establishment of appropriate service levels, and careful administration of the expenditure of available resources.2. Each Municipal Corporation in MP shall adopt and maintain a balanced budget. For this purpose, expenditure deferrals into the following fiscal year, short-term loans, or use of one-time revenue sources shall be avoided to balance the budget.3. Each Municipal Corporation in MP shall operate on a current funding basis. Expenditures shall be budgeted and controlled so as not to exceed current revenues plus the planned use of fund balance accumulated through prior year savings.4. Each Municipal Corporation in MP shall project future operating costs associated with new capital investments and will include them in the operating budget forecasts.5. Debt or bond financing shall not be permitted to be used by any Municipal Corporation in MP to finance current operating expenditures.3.3.5 Presentation and formats3.3.5.1 Budget coding structureEach Municipal Corporation in MP shall prepare its annual budget using the six-digit coding structure asprescribed in the Madhya Pradesh Municipal Accounting Manual (MPMAM). The prescribed codingstructure shall have three levels of codification – first level representing function group, second level -32-
  • 33. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshrepresenting function description and the third level representing cost centre. Each level shall have a two-digit code. The codification structure is described below.1. First level represents the obligatory and discretionary functions of the ULBs under the Madhya Pradesh Municipal Corporation Act, 1956 and the Madhya Pradesh Municipalities Act, 1961. This is known as the “Function Group". Functions shall represent the various functions or services carried out by the local body. Account Heads shall represent the nature of the income or expenditure.2. Second level represents the particular type of service under a function, known as "Function Description".3. Third level represents a particular ”Cost Centre” code, which provides the service.Refer to Annexure 4 of the MPMAM for detailed formats as prescribed in MPMAM on coding structure.3.3.5.2 Budget categoriesThe budget of a Municipal Corporation in MP shall be divided in three distinct categories – Revenue(operating) budget comprising operating income and expenditure; Capital budget comprising capitalincome and expenditure including loan repayment and Extra-ordinary budget comprising receipts andpayments on account of deposits from people and advance given and recovered. These three broadbudget types shall then be sub-classified under functions performed by the ULB followed by the sub-functions or different departments of the ULB.3.3.5.3 Budget layoutBudget layout refers to the budget forms that will be used for final preparation and presentation of thebudget. Each Municipal Corporation in MP shall follow the method of bottom-up budgeting as prescribedin the MPMAM. Also, Municipal Corporations shall use the forms prescribed in the MPMAM for presentingbudget information. The table below provides the names and references of these forms as prescribed inthe MPMAM. It is noteworthy that the forms prescribed here relate to the final presentation of the budgetand not initial data collection by various departments.Table 9: Forms prescribed in MPMAM for budget layout Name of the form Description BUD 1 Summary Budget Estimates BUD 2 Abridged Major Account Head Wise Budget BUD 3 Revenue Income Budget Estimates BUD 4 Revenue Expenditure Budget Estimates BUD 5 Capital Receipts Budget Estimates BUD 6 Capital Expenditure Budget Estimates -33-
  • 34. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Name of the form Description BUD 7 Detailed Revenue Expenditure (Department-Wise) Budget Estimates BUD 8 Detailed Capital Expenditure (Department-Wise) Budget Estimates3.3.5.4 Ease of presentation and transparencyWhile presenting the budget, each Municipal Corporation in MP shall ensure that budget information ispresented in a way that facilitates policy analysis and promotes transparency and accountability.3.3.6 Closing balance of budgetThe budget shall be so prepared as to provide for a closing balance, which each Municipal Corporation inMP shall maintain at its credit at the end of the year and the amount of which shall be not less than thelimit prescribed in the [MP Municipal Finance and Accounts Rules].3.3.7 Review and revision1. The Commissioner of each Municipal Corporation in MP shall perform a mid-year budget review and analysis based on actual information for the [first six months] of the accounting year (April to September) and prepare revised estimates of income and expenditure of the Municipal Corporation for the current year. The analysis of the mid-year budget review shall be submitted to the Council for approval.2. Each Municipal Corporation in MP shall be permitted to revise its budgets only [once] during a particular accounting year.3. Each Municipal Corporation in MP shall prepare a Budget Variance Report (BVR), as prescribed in the MPMAM. The BVR shall be prepared by each Municipal Corporation on a [quarterly] basis. A copy of the BVR shall be submitted to the Urban Administration and Development Department.3.3.8 Other policiesEach Municipal Corporation in MP shall project revenues and expenditures for the next [three] years andshall update the projections annually.3.4 ProceduresThis section provides a detailed step-by-step discussion related to the budget process.3.4.1 Step 1- Development of budget policies and toolsThe Commissioner of the ULB is responsible for developing various budget tools, the set of rules andprinciples as well as the forms and guidelines to regulate the budget preparation and implementation -34-
  • 35. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshprocess. These documents must be circulated within each department of the ULB before starting thebudget preparation process. These documents must include:• Policies — Principles or financial policies are needed to guide budget preparation. Department managers should be encouraged to use this information to reassess the benefits of current service activities as well as justify requirements for any new and/ or expanded services. These policies may be formed keeping in mind the expected financial situation in the upcoming financial year.• Budget Calendar — A calendar or detailed time/ event schedule that identifies due dates for budget- related activities; steps to be taken during budget preparation; the person or group responsible for each step; and the date on which each step must be completed. The following figure shows a sample budget calendar.Figure 2: Sample budget calendar Identification of works for next year budget in consultative manner Identification of works for next year budget in consultative manner Preparation of draft budget by various department heads Preparation of draft budget by various department heads April to April to September September Finalization and Submission of budget by Commissioner to Mayor-in-council Finalization and Submission of budget by Commissioner to Mayor-in-council October to October to November November Final adoption of budget estimates and approval by mayor-in-council Final adoption of budget estimates and approval by mayor-in-council December-March December-March Implementation of Budget by getting administrative approval to each work, tendering, Implementation of Budget by getting administrative approval to each work, tendering, contracting and implementing them contracting and implementing them Implementation Implementation year around year aroundWhereas, the Madhya Pradesh Municipal Corporation Act, 1956 and the Madhya Pradesh andChattisgarh Municipalities Act, 1961 provide the dates for submission, approval and adoption of budget ofa ULB, a Budget Calendar should not be confined to these end result dates. Budgeting is a 365-day stactivity. As soon as a budget comes into force on 1 April and actual figures become available in themonth of May, the repective ULB should start the process of budget preparation for the next year.The period between May and September should be used for the identification of major O&M works andcapital works for the next year through consultative process and then preparing design and estimates ofthe probable projects. Therefore, by the time primary budget preparation process starts in November, theULB would be ready with the list of projects for the next year’s budget.Similarly, during the period October to December, the ULB should take stock of projects undertaken in thecurrent year to identify the projects that can be completed before end of current year in March and theprojects that can spill over to next year’s budget. Also, during this period, a revised budget should beformulated and presented separately. Therefore, when the budget is put together in January, the ULBclearly knows its revised revenue and expenditure, the expenditure that would spill over to next year and -35-
  • 36. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshthe works that need to be taken up in the next year’s budget. A similar analysis and implementationactivity should be carried out for the revenue side of the budget.3.4.2 Step 2 - Application of budgetary techniquesSection 3.1.4 of this manual explains different techniques that could be used by a ULB to prepare abudget. Each budgeting technique has its distinct advantages and constraints, but no budgetingtechnique should be viewed as superior to other budgeting techniques. Each technique has its ownapplication, depending upon the objectives of preparing a budget as pursued by the ULB. Given below isan illustrative application of different budgetary techniques.• Revenue Budget: The “Line-item Budgeting” technique should be used for the preparation of the revenue budget, with the conservative incremental approach. “Line-item Budgeting” is preferred over other budgeting technique for the preparation of revenue budget because it contains numerous routine and statutory expenditure items, which can be calculated precisely and objectively. Also, in case of these items, control is more important than performance measurement. Moreover, this technique is simple and user-friendly. In order to overcome the limitations of Line-item Budgeting and excessive use of incremental approach, the system of subsidiary budgeting has been designed, which involves the preparation of Budget Information Data Sheets (BIDS). Whereas, participatory budgeting technique is not applicable for preparation of the revenue budget, but gender budgeting or budgeting for poor concepts can be applied to segregate budget items of revenue budget on the lines of gender and poor budgets.• Capital Budget: Performance measurement is one of the most important aspects regarding development or capital works. Therefore, performance and outcome budgeting techniques are suggested for the formulation and administration of the capital budget. Performance budgeting requires linking of physical targets to budgetary (financial) allocations made in the capital budget. Accordingly, municipal bodies will have to prepare a schedule of capital works linked to each budget item (allocation) of capital budget. Outcome budgeting requires determining outcome/ results expected out of each capital works undertaken by a ULB. Therefore, besides linking physical targets to financial allocations, ULB should detail out the outcomes expected out of each of such works and financial allocation. The format for preparing schedule regarding capital works detailing physical aspect and outcomes is provided below.Table 10: Sample format for listing and linking proposed capital investment works tobudget allocations Budget code D55201 Budgete d Amount Particulars Expected Budget Item - Erection of Streetlight on Central Divider Outcome -36-
  • 37. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Budget code D55201 Budgete d AmountSr. Name Of Work Estimated Tender Work Expense Expense Cumulati AmountNo. Cost Value Status At up to last During ve to be the end year the Expense spilled Of Year current by the over to / budget end of to be year current spent in budget draft year budget year1 2 3 4 5 6 7 8 91 On ABC Road Creating 0.59 0.59 Done Nil 0.59 0.59 0 from point X to streetlight Point Z (Sodium facility on the 150 watts) road2 On XYZ Road Creating 6.26 6.3 Partly 4.25 1.00 5.25 0.95 from point A to streetlight Done Point B (Sodium facility on the 250 watts) road3 On PQR Road Creating 6.00 Not called New N.A. 6.00 from point T to streetlight work point U (Sodium facility on the 250 watts) road st The capital budget should be non-lapsable at the end of the year (31 March of each accounting year), i.e., the unspent amount and the unfinished works should be carried over to the next budget year. Thus while preparing capital budget for the next year municipal bodies will have to take stock of the works, which are going to spill over to next budget year. Such works and amounts required to complete works will be earmarked first in the next year’s capital budget. The new capital works for the next year budget will have to be selected only for the amount, which will be available after making due provision for the spill over capital works for the past years. There is a possibility that certain capital works selected earlier may become unnecessary or non- feasible. Such works should be identified by adopting ‘Zero-base Budgeting’ and should be dropped by consensus, if required. Application of Participatory Budgeting technique is most relevant for capital budgeting. Similarly, Gender and Budgeting for Poor (internal earmarking for basic service for urban poor) concepts have crucial application in preparation of capital budget.• Extra-ordinary Budget: There are two parts of an extra-ordinary budget, viz., (1) Deposits and (2) Fund and Advances. Both of these parts of an extra-ordinary budget should be prepared by following the “Line item Budgeting” technique as they do not involve any performance aspect. As these budgets are also non-lapsable, payments can be released so long as there is balance. The remaining budget preparation techniques have little role in preparing an extra-ordinary budget for a ULB. -37-
  • 38. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.4.2.1 Applying performance and outcome budgeting techniquesMost ULB budgets are expressed in financial terms only. This essentially implies that the works related tothe amount budgeted and the outcomes expected from the works are not included in budget document.This leads to subjectivity, non-transparency and non-measurability of performance as, at the time ofbudget implementation, unplanned works get implemented. As the expected outcomes are not mentionedbeforehand, it is not possible to measure them and guage performance improvement. As a result, thesanctioning process become prolonged as each and every work is required to be sent to the Council for stadministrative approval after budget implementation starts from 1 of April each year. It is, therefore,crucial to introduce the concepts of performance and outcome budgeting in ULB budgeting.3.4.2.2 Applying participative budgeting techniqueAt present, the municipal budget formulation process is non-participatory. This is particularly becausethere is no legal provision making it mandatory for the ULB to make its budget participative. However, in arecent development, the Citzens’ Participation Law suggested by GoI for adoption by States underJNNURM provides for giving powers to Area Sabhas and Ward Committees to formulate their ownbudgets.ULBs in MP can adopt the following measures to make their budgets participative.1. Creating communication material including, web pages, power point presentations, printed booklets, etc., through which a citizen can understand the budget of a ULB and the highlights of the previous and current year’s budget. These communication materials should be made available to the citizen free cost.2. Wide dissemination of the existing and previous years’ budgets to the citizens through various communication channels.3. Developing a system by which a citizen can give his views and recommendations on budget, works included or to be included, revenue sources, expenditure heads, etc., throughout the year through any of the following mediums – a. by visiting website of the ULB, b. by sending emails, c. by writing a letter sent through post or handed over personally, or d. by attending consultative sessions organised by the ULB.4. The ULB should adopt a system of organising formal consultative sessions with citizens at different levels and across different stakeholders to discuss and to take their views on the revised budget and on the next year’s budget in the month of November before the budget is sent to Mayor–in-Council or Chairman-in-Council by the Municipal Commissioner/ Chief Officer of the Municipality and also during the budget adoption process. In addition, a budget should carry a separate note stating suggestions, views received from the citizens on the budget and the suggestions adopted in the budget.5. After budget is finally adopted by the Council, the ULB should organise some sessions to explain highlights of the budget to the citizens. -38-
  • 39. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.4.3 Step 3 – Preparation/ formulation of revenue budget estimatesAn important component of the revenue budget is the O&M expenditure. At present, the decision-makingprocess with respect to major and minor O&M works suffers from two limitations – first, lack of an assetmanagement policy and, second, a comprehensive multi-year asset maintenance plan. In other words,the present approach towards O&M is curative (reactive) rather than preventive (pro-active).In order to overcome the above limitations, it is necessary to re-engineer the present decision-makingprocess. It is necessary to segregate the total O&M expenditure into three parts, viz., (1) fixed or givenO&M expenditure such as electricity, fuel, communication and consumables (chlorine for water supply,insecticides, chemicals, sanitary tools for solid waste etc); (2) exigency or emergency works as and whenthey arise, and (3) planned maintenance works on the basis of assets management policy, technicalnorms and a plan prepared in advance. The following figure presents the decision-making process forO&M expenditure, which ULBs of MP should adopt. -39-
  • 40. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 3: Decision making process for O& M expenditure Need or Demand for O Tecno/Eco/environ Prioritization Budgetary & M Works mental Validation classification Allocation Past year’s trend of Preparation of Exigency In Current exigency O&M works design, estimate, or very Year budget tender as and when emergency by proposal Past year’s trend of exigency occurs works to council Fixed O&M Expend. Works identified Validation of under Assets suggested Urgent but In Current Management Plan on O&M works not Year revised priority and time basis coming from exigency budget in the all channels O&M month of with Assets works January New O & M works for consideration Management • Department’s field Policy, technical Preventive In the New experience norms and O&M Year’s • Suggested by the Plan. If work is works’ budget in the - citizens not in AM Plan primary month of - councilors then getting list, with January in individually or jointly technical estimated the light of - MP, MLA and opinion about cost for availability others its relevance & allocation of funds -other government time schedule in budget officers, departments Minimal Consultation Technical Consultation with Political Consultation consultants, engineers in allocating budgetIt can be observed from the figure that the O&M expenditure should be classified as per nature ofexpenditure and the budget process associated with it should be undertaken round the year in fourstages. First stage refers to identification of O&M works through various channels. Second stage involvestech-eco-environmental verification of the works identified in the first stage. Third stage refers toclassification and prioritisation of O&M works in different budgets as per their urgency and the final stagerefers to resource allocation and approval by Council of the O&M Budget.These operative budgetary requirements should be calculated in a detailed manner so that the budgetallocation is more realistic in nature. But as mentioned earlier, currently ULBs mostly follow theincremental approach to make their budgets which makes many a times budget unrealistic. For instance, -40-
  • 41. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshif last year’s budget allocation for the streetlight energy bill was INR 10 lakhs, then this year it can beincreased by 5% or 10%. The problem of unrealistic budgeting by municipal bodies in India is well known.The critical issue is how to make Municipal Budget realistic and amenable to performance monitoring andauditing? To achieve this, ULBs of MP should adopt a system of preparing Asset Management Plan(AMP) and Budget Information Data Sheets (BIDS) for doing detailed calculations of operating budgetaryrequirements. Preparation and application of AMP for preparing municipal budget has been discussed indetail in a separate chapter while system of preparing and using BIDS is explained in following para. It isrecommended that system of preparing Asset Management Plan (AMP) and Budget Information DataSheets (BIDS) for arriving at operating expenditure requirements or revenue potential should be mademandatory for municipal bodies through proposed MP Accounting & Financial rules. The appropriate wayto calculate the streetlight energy bill for the budget year using BIDS could be –• Existing streetlights (category-wise) points + new streetlight points likely to get added = Total streetlight points less average non-operational streetlight points = streetlights for budget calculations• Number of streetlight points (tube lights) X average usage hours per day X electricity units consumed per hour = average total number of electricity units consumed per day X price per electricity unit consumed = per day cost of electricity consumption X 365 days = annual streetlight electricity cost for particular category at current prices.• Annual electricity cost X likely price rise in percentage terms as estimated by electricity board.The above mentioned example is a simplistic example to calculate the cost of a particular O&Mcomponent. When such detailed working is done in a systematic manner for each and every major O&Mbudget item in a standardized format, it is called a system of subsidiary budgeting. Such a systemfacilitates efficiency and cost audit as actual figures can be compared in a disaggregated manner to findout precisely the cost of cost overruns or cost inefficiency.A similar calculation should be undertaken for each type of streetlight – sodium, mercury, simple lamps,etc. and a grand total should be arrived at. Annexure 1 of this manual contains some detailed formats thatwould guide the reader in doing such calculations. These formats are illustrative formats (BIDS) forundertaking estimation of budget requirements for streetlight electricity charges, streetlight O&Mexpenditure or expenditure on fuel or tyres required for vehicles. It is not feasible to provide BIDS for eachand every expenditure item, each ULB should develop and use such formats for each and everyimportant, sizeable expenditure and revenue item of its operating (revenue) budget. Following paraprovides methodology to develop a BIDS that is a generic BIDS which a municipal body should use fordeveloping as many BIDS it wish to have.BIDS are essentially standard cost sheets so their preparation is based on cost accounting principles andmethodology (activity based costing). The object of BIDS is to arrive at a realistic projected cost of anactivity on the basis of standards in the budget year. A municipal body should use following step by stepapproach • Select activity, receipt or expenditure item for which BIDS is to be prepared. Select such item which is important or significant and is measurable in standard and actual terms. -41-
  • 42. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh • Determine existing physical parameter – for example if transportation cost of solid waste is selected for preparing BIDS then physical parameters will be – o Existing Population of particular city, its zones, wards, locality o Per capita per day solid waste generation (standard value) o Solid waste generated per day in the city, or in the zones or in the wards or in locality o Solid waste collection efficiency in % terms o Solid waste required to be transported per day in MT • Determine likely addition or change during the year in physical parameters o Increase in population, or increase in service area or increase in solid waste producing activities (new industries, businesses, markets, hotels etc) in the city, zones/area/locality • Add future changes in physical parameters to value of existing parameters • Determine standard cost or observed cost or actual cost aasociated for doing an activity or component or single unit of an activity. Continuing with same example an activity – transportation of solid waste from collection to disposal point the cost per unit can be as follows o Transportation cost per MT (if this activity is outsourced this figure will be available from the contract, if undertaken by a municipal body then a separate cost sheet to be prepared to work out per MT transportation cost. It would again involve finding out physical parameters of this activity) • Multiply unit/s of a physical parameter by existing standard, actual or observed unit cost to find out projected cost of doing an activity in the budget year • Determine likely increase in cost associated with doing an activity or a component or a unit of an activity due to inflation, during the year and likely increase in cost to the projected cost calculated above. • Add contingency expenditure to the total cost worked out for the activity.3.4.4 Step 4 - Preparation/ formulation of capital budget estimatesThe Capital Budget is of immense importance as it deals with growth related issues and has long rangeimpact on all the aspects of any organisation’s financial management. Most of the ULBs in India includingMP suffer from very weak capital budgeting. The existing practice lacks long term perspective and oftencapital budgets are conceived and prepared with an annual perspective, which is not beneficial for theULBs. -42-
  • 43. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe culture and discipline of preparing City Development Plan/ Strategy (CDP or CDS) resulting into amulti-year Capital Investment Plan (CIP) and then preparing annual capital budget within the context andframework of CDP and CIP, is generally lacking in most of the ULBs of India. It is only in recent years(since the year 2006) through the JnNURM programme that GoI made preparation of CDP and CIPmandatory for 63 cities. In other words, for rest of more than 4,000 ULBs preparation of CDP and CIP isstill not compulsory. But GoI through JnNURM has certainly succeeded in introducing the concept of CDPand CIP, which must spread across India and should be developed and sustained over a period.Therefore, whether mandatory or not, a ULB should prepare and revise regularly a city development plan(CDP) for its city. A CDP necessarily contains a capital investment plan (CIP), which is nothing but a longterm capital budget. The CIP must be prepared for a period ranging between five and seven year timeframe for each and every ULB. The multiyear CIP should set framework for annual capital budget andboth should be linked with each other organically.GoMP, rightly understanding the importance of CDP and CIP (long term capital budgeting), hasundertaken the project of preparing CDPs for 85 ULBs. This is a pragmatic initiative and should beextended to the remaining ULBs in MP at the earliest. Preparation of CDP and CIP will go a long way inimproving annual capital budget and financial management of ULBs.To develop an understanding on the preparation of CIP, the reader is suggested to refer to the Chapter3.5 of this manual and GoI’s revised guideline on preparation of CDP and CIP for cities. The followingfigure illustrates the process of capital budgeting that ULBs of MP could adopt. -43-
  • 44. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 4: Identification of capital works and formulation of capital budget Need or Demand for Tecno/Eco/environ Prioritization Budgetary Capital Investment mental Validation classification Allocation Department’s field Validation of experience each and every Exigency In Current suggested or very Year budget work coming emergency by proposal Works identified works to council under Master Plan on from all priority and time basis channels with Service-wise Master Plan, Urgent but In Current Suggestions by the CDP, Multi- not Year revised citizens year CIP. If exigency budget in the work is not in works month of Suggestions by the Master Plan January elected representatives then getting individually or jointly technical opinion about Capital In the New its relevance investment Year’s Suggestion by the MP, with Master MLA and others works budget in the Plan. Updation primary month of of Master Plan, list, with January in Suggestion by other CDP, multi estimated the light of government officers, year CIP at cost availability departments etc. regular interval of funds Consultation with Technical Consultation with Political Consultation proposer of the work, consultants, engineers in allocating budget other stakeholders including urban poorAdopting a system of mandatory preparation and periodical revision of CDP and multi-year CIP andlinking them with the annual capital budget will not be sufficient. As depicted in the above figure, eachULB in Madhya Pradesh should be required to back up each of its capital budget allocations by the list ofworks planned under each resource allocation or budget item. Each work of the list against each capitalbudget item should provide a complete description – name, length, width, technical specifications,estimated amount and expected outcomes. For example, laying a particular water line will increasequantity of water by 50 MLD to the area or will provide connections to 1,000 new consumers, and so on.Aadoption of performance and outcome budgeting will facilitate performance measurement and reducethe work sanctioning process as administrative approvals will not be required. This will result in -44-
  • 45. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshsubstantial time savings. Planning and clarity about the works to be done during the year for theadministration gets improved under this system as all the works to be undertaken in the budget year getdiscussed in terms of priority, feasibility, output and outcome/ impact (service improvement from) of thework, exact funds required, etc. when the budget is prepared and passed in the Council. The worksidentified will be known to everybody in all respects and will be available with administrative approval for stimplementation. Thus, as soon as the budget opens w.e.f. 1 April of the year, the administration can goahead with the invitation of tender and the approval process.At the end of this section we summarise the key considerations while preparing a revenue and capitalbudget in the following figure.Figure 5: Summary of budget preparation process 1. Prepare Asset Management Plan (AMP), Budget Information Data Sheets (BIDS) (Annexure 1) for selected revenue and expenditure items, list of works and amount likely to spillover to the next year and annual capital investment plan in the context of multi-year capital investment plan by the end November of the year taking in to account first six months actual data/performance.. 2. Estimate Revenue Income and Revenue Expenditure for the budget year. Income should be estimated conservatively while expenditure should be measured liberally. 3. Deduct Revenue Expenditure from Revenue Income to get Revenue Surplus 4. Add to Revenue Surplus following incomes to get Gross Amount Available for Undertaking Capital/ Development Works a. Capital Receipt from own sources – sale of assets, one time revenue, development charge, etc. b. Capital Grants from government c. New loans planned and feasible 5. Deduct Loan Repayment amount and any other liability repayment from Gross Amount Available for undertaking capital/ development works 6. Provide for emergency or exigency work requirements at the rate of minimum 5% to maximum 10% of the amount available for development after deducting loan and other liability repayment amount as mentioned in Step 4 above. The amount available is known as Net Amount Available for Undertaking Capital Works 7. From Net Amount Available for Undertaking Capital Works deduct a. Spill Over Works’ Liability: For working out Spill Over Works’ Liability utilise format as provided in (table 30) of this manual b. ULB’s contribution towards Grant or Loan or Fund project whose receipts taken into account under capital receipts under step 3 (b) and (c) above 8. After deduction of Spill Over Works’ liability and contribution towards other grant/ loan projects amount if there remains a balance then that amount will be known as Net Amount Available for Undertaking New Capital/ Development Works 9. From the Net Amount Available for Undertaking New Capital/ Development Works provide budget for undertaking New Capital/ Development Works worked out using Performance Budget and Outcome Budget. Finance department of ULB should work out this figure well in advance and allocate function-wise to different departments as per the guidance of the Commissioner. Each and every budget item of capital budget should be of a generic nature backed by list of works to be carried under that budget item. 10. A capital work may be spanning over more than one year period, in such case, based on estimated engineering work schedule amount likely to be spent in budget year and budget + one or more years should be calculated and to present this information one more column should be added to standard budget page layout after the final budget column. For example if current year is 2008-09 then budget year is 2009-10. So after this a column showing budget booked amount for the year 2010-11 should be added to budget. This will bring in clarity about how much budget of future years has already been consumed. -45-
  • 46. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.4.5 Step 5 - Budget review by Commissioner/ Chief OfficerIn the next stage, the Municipal Commissioner/ Chief Officer of a ULB should hold discussions with theheads of various departments, revenue officers, deputy commissioners, and city engineer and accountsofficer to assess the budgetary estimates. The following tasks should be undertaken:• Technical review: Each department’s request should be reviewed by the assigned budget analyst for numerical accuracy and completeness. It should also be checked that all the formats and procedures are followed.• Programme review: Regardless of the budgeting technique adopted, each programme request should be reviewed to ensure that the current levels of service are still provided within the base budget. Service goals, objectives, and performance measures should also be available to ensure that the current level of service is maintained.3.4.6 Step 6 - Recommendation and adoptionAfter several rounds of discussions with various departmental heads of the ULB, the MunicipalCommissioner/ Chief Officer shall place the revised budget of the current year and the budget proposalfor the next year before the Mayor-in-Council/ Municipal Council.The Mayor-in-Council/ Municipal Council have the power to directly adopt the budget placed before ormake modifications and submit it to the ULB. The stage of budget adoption is highly critical. It is at thisstage that the administrative and deliberative wings of a ULB come into close interaction with each otherand engage in policy-making activities, which have multiple implications for the city. Further, it is thisstage that provides for a wider participation in determining the budget. It is the responsibility of Mayor-in-Council/ Municipal Council to review the contents of the budget and consider them in the light of the viewsof citizen groups and others.The ideal budget should provide a picture of both the work to be performed in the coming year and thefinancial programme that will enable this work to be carried out. The budget should be easy to read,simple enough for ordinary citizens to understand, yet complete enough to satisfy the needs of financialexperts.Good budgets have a number of characteristics in common. They: (1) meet basic legal requirements; (2)include all the necessary components; (3) focus on information essential to decision-making; and (4)present information in a clear and accessible way.3.5 Case study: Budgetary reforms at Vadodara Municipal CorporationIn course of the last decade various Indian municipal bodies have undertaken various types of structural,financial, accounting and budgetary reforms. Vadodara Municipal Corporation (VMC) had also carried outvarious reforms to improve efficiency and accountability of its governance. This case study documentsthe success story of the budgetary reforms conducted by VMC. -46-
  • 47. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.5.1 Budgeting system prior to reformsPrior to reforms, the VMC was preparing and presenting its budget, under three heads:• Revenue Income and Expenditure Budget (Revenue Budget)• Loan Receipts and Expenditure Budget (Loan Budget)• Budget for Deposits, Capital Grants etc (Suspense Budget)3.5.1.1 Revenue budgetVadodara Municipal Corporation followed the Classical Line-item Budgeting technique for its revenuebudget. Revenue budget included tax income from octroi, property tax, and other taxes, various non-taxincomes and government grants. It also included capital income from sale of land, incrementalcontribution, development charges, etc. Thus there was no distinction between revenue and capitalincome. Also there was no distinction between capital and revenue grants’ receipts, and as a resultcapital grants were also included in the revenue budget. On the expenditure side, the revenue budgetincluded expenditure heads like establishment, contingency, repairs and maintenance, loan interest andrepayment. It also included expenditure on new works, i.e., capital expenditure.3.5.1.2 Loan budgetThis budget accounted for the new loans taken and expenditure carried out from it. It was essentially acapital budget but wrongly termed as Loan Budget Loan It was neither a Line-Item budget nor any othertype of budget (performance or planning and programming budgeting system (PPBS) or zero basebudgeting (ZBB)) in a true sense. It was merely a list of developmental items accompanied by adhocallocations, classified under different loan sources.3.5.1.3 Suspense budgetThis was the budget for the extraordinary receipts and payments. The Budget for Deposits and Advanceswas quite underdeveloped or unaugmented. It included few budget items and as a result it was notpossible to know deposits received or refunded under different heads or categories or purposes.Similarly, it was not also possible to know advances given or recovered, both, department-wise orpurpose-wise. The estimates pertaining to deposits or advances were mostly block estimates i.e. howmuch new deposits would be received or refunded during the year or how much new advances will begranted or will be adjusted during the year. Another drawback associated with this budget was that ofclubbing two diametrically opposite items, deposits and advances, under one head or format. Sincedeposit receipts represent liability while advances represent assets, totalling them less than one headwas not correct.Vadodara Municipal Corporation followed an incremental approach for the preparation of these budgets,that is, the figures of the previous year were taken as the base and incremental amount was added at afixed rate or percentage (for e.g., 10% p.a.) to formulate the budgetary allocations for the budget year. Attimes base for increment was taken as the composite average of past three year’s annual growth rate. In -47-
  • 48. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshmost cases, the budget estimates were decided not on the incremental approach but on the basis of pullsand pressures exerted by elected representative and by executives.3.5.2 Major drawbacks with budgeting system of VMCThe major drawbacks of the budgeting system of the Vadodara Municipal Corporation, most of which arecommon to all ULBs in India, were as follows.3.5.2.1 Defective structure and improper classification of budgetVMC budget lacked logical budget structure and classification and as a result, the budget document ofVMC tended to grow by leaps and bounds every year, in size and complexity.3.5.2.2 Improper distinction between various natures of expenditureThere was no unanimity about which receipt or expenditure was to be treated as capital or revenue.Consequently, there was also no unanimity about classification of budget into capital and revenue items.3.5.2.3 Budgeting of ‘how much’ rather than ‘how best’The budget of VMC, like most of the municipal bodies of India, was characterized by the ‘how much’(quantitative) budgeting process instead of ‘how best’ (qualitative). Everyone was oriented towarddiscovering ‘how much’ money/ allocation is provided or available next year, ‘how much’ variousdepartments of the organisation want to spend and ‘how much’ can be cut in order to make the numberscome out even.3.5.2.4 Excessive reliance on incremental approachSince the budget estimates were prepared on the basis of incremental approach, the Corporationallocated budget to various items/ activities without verifying whether a particular item/ activity wasrelevant/ useful or whether a particular expenditure was necessary. Also, as the Corporation followedfixed rate incremental approach it failed to reflect/ absorb the changing national financial environment,inflationary forces and changing developmental priorities of the city.3.5.2.5 Absence of overall targets/ ceilingsFinancial estimates and figures were budgeted without having any overall targets/ ceilings beforehand,causing heavy demand on sources of funds. Also, no detailed base work or calculations or analysis weremade while estimating fund requirements or forecasting receipts of the Corporation.3.5.2.6 Unrealistic past figuresCorporation based its budget estimates and allocations on historical figures but the historical figures werethemselves unrealistic. As on April 1, 1989, the accounts were pending for past six to seven years ateach level and stage. -48-
  • 49. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.5.2.7 Absence of proper resource allocation mechanismVMC’s budget did not have an inbuilt system of resource allocation to correct the developmentalimbalances of various areas of the Vadodara City. In the absence of well-designed resource allocationmechanism/ policy, VMC’s developmental efforts were lop-sided and without focus.3.5.2.8 Excessive reliance on deficit financingWhile compiling and finalising its budget the Corporation had excessive reliance on Public Finance, i.e.,deficit financing. As per deficit financing system, the Corporation first estimated/ finalised the fundrequirements, and in order to balance its budget it just inflated its revenue projections without anyjustification/ tax raising steps/ resource augmentation efforts. The result was obvious and disastrous. Atthe end of year, receipts fell short of projections and expenditure exceeded the allocation resulting intoheavy deficit.3.5.2.9 Non-linking of financial and physical outlaysOne of the greatest drawbacks of the municipal budgeting system in India is the absence of linkagebetween financial outlay with physical targets/ achievements. Budget allocations are made in ad-hocfinancial terms only.3.5.3 Budgetary reforms at VMCBudgetary reform is not a one-time solution, but it is a continuous process. Various budgetary reformscarried out by the VMC that are enlisted below belong to the last whole decade (1992 – 2002). All thebudgetary reforms were not undertaken at one go; they have been undertaken on a piece-meal basis.3.5.3.1 Reorganized and restructured budgetThis was the first and foremost budgetary reform. VMC, as a first step, segregated its income andexpenditure items by their nature (revenue/ capital/ extra-ordinary) and by their sources of finance(revenue, capital, loans, deposits, etc). Accordingly the Corporation apportioned its budget initially intofour parts in place of the earlier three-parts.Similar provision in the manual (Section 3.3.5.2) presecribes that budget of a Municipal Corporation in MPshall be divided in three distinct categories – Revenue (operating) budget comprising operating incomeand expenditure; Capital budget comprising capital income and expenditure including loan repayment andExtra-ordinary budget comprising receipts and payments on account of deposits from people andadvance given and recovered. These three broad budget types shall then be sub-classified underfunctions performed by the ULB followed by the sub-functions or different departments of the ULB.3.5.3.2 Judicious application of budgeting techniquesVMC employed different techniques/ approaches for different parts of its budget in the following way. -49-
  • 50. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh1. Revenue Budget: VMC continued with “Incremental Approach” for making projections and allocations regarding items of its Revenue Budget. Along with it, VMC continued to use “Line-Item Budgeting” technique for its Revenue Budget, because of the following reasons - a. Revenue Budget accounted for more than 80 percent of its total receipts and payments. b. More than 90 percent expenditure was such that could be expressed in financial terms only. Further, it warranted financial accountability, legality, and regularity and centralized financial control rather than performance evaluation.2. Capital (From Own Sources) Budget, Capital (Loan) Budget and Capital (Grants): The Corporation adopted “Performance Budgeting” technique coupled with “Zero-base Budgeting” for the formulation, implementation and control of these Capital Budgets.Similar provison in the manual (Section 3.3.2) discusses about application of budgetary techniques asfollowed by VMC3.5.3.3 Streamlined and pruned down budgetVMC streamlined and pruned down all parts and items of its budget by applying zero-base budgetingconcept. It removed all overlap, dormancy, duplication and repetition of budget items from various budgetparts. Using zero-base budgeting concept, the Corporation deleted all budget items pertaining to theprograms/ activities, which had lost their purpose/ relevance, e.g., subsidised flushing latrines scheme,free of cost water connection scheme, etc.3.5.3.4 Devised model for budget / resource allocationThe Corporation devised an in-built model of budget/ resource allocation for its Capital Budget to ensurea balanced development of the entire city. The restructuring and reclassification of the budget under thenew system made it very easy to know how many funds will be available for capital works. The surplus ofrevenue budget and the revenue capital receipts formed the total funds available for development. TheCorporation also adopted a policy of setting aside funds for spillover capital works and to the committedprojects expenditure or counter funding responsibility of the Corporation as a first.3.5.3.5 Increased participation of elected representativesThe Corporation evolved a unique and real participative system of budget formulation. Under the newlyintroduced participative budget system, the Capital Budget was allocated to various areas, as perdeveloped, underdeveloped and semi-developed status. Thus each and every area (Election Ward) wassure of a certain amount of development. Also all the works to be undertaken were finalized in the orderof priority as per the suggestion of the concerned elected councilors of the particular election wards. Infact Councilors were asked to decide the list of development works within the framework of rules adoptedby them and within the budgetary allocations made.The concept of participative budgeting has been discussed in section 3.1.4.8. -50-
  • 51. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3.5.3.6 Expenditure made contingent to resource realisationAnother milestone in Corporation’s reform process came into effect from April 1, 1993 (for the budget1993-94). The Corporation, for the first time made its expenditure contingent to actual resourcerealisation, that is, capital/ development works to be undertaken as per actual receipts.3.5.4 Results/ achievements1. The reforms made VMC’s budget participative and empowered elected representatives with real power. The reforms retrieved it from the excessive bureaucratic dominance, which is still observed in other municipal bodies.2. The reforms resulted into all round, balanced development of the Vadodara City. This was a direct result of the resource allocation mechanism, that is, each and every area/ elected representative received equitable distribution of funds available for development.3. The reforms improved VMC’s resource mobilisation performance but again it was not based on tax rate improvement. VMC has increased its tax and rates only four times in past eleven years (between 1990 and 2002) and still it has managed to undertake development works of INR 35,000 lakhs. Today, citizens of Vadodara are paying less tax in real terms compare to the taxes, which they were paying 1990s.4. The reforms stabilized financial position of VMC. It brought in strict financial discipline. Consequently, as of today, VMC has no overdue payment to any external party. VMC has not defaulted in payment and it has not taken overdraft in the last decade. It makes timely payment to all lending agencies, suppliers, contractors, service providers and workers. -51-
  • 52. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4 CAPITAL IMPROVEMENT PROGRAM AND CAPITAL BUDGETING4.1 Concepts4.1.1 Capital improvement/ investment planThis is a multi-year (usually 5-6 years) plan of capital investment projects, listed in priority order by yearwith anticipated beginning and completion dates, annual estimated costs and proposed methods offinancing. Annually, the plan is reviewed and revised in light of result of year completed.4.1.2 Capital budgetsThe capital budget covers projects included in the first year of the capital investment plan. It should beadopted as a separate budget. In the capital budget, the ULB appropriates funds for projects to beundertaken during the current budget year. Each year, the succeeding year of the capital investment planbecomes the annual capital budget after necessary changes.4.1.3 Separation of capital investment projects from the operating budgetThe capital investment project should be kept separate from the operating budget due to the followingreasons:• Capital investment projects require multi-year expenditures because they are expensive and may take more than one year to design and construct.• Capital investment projects often involve multiple sources of financing such as current funds, debt, reserves, and grants that must be accounted for separately.• Capital investment projects have future operating budget impact, which requires careful planning.• Financial resources for capital investment projects are limited and, therefore, must be considered and allocated in a systematic manner.4.1.4 Classification of expenditure as revenue and capitalCapital Expenditure intended to benefit future period in contrast to a revenue expenditure, which benefitsa current period. The term is generally restricted to expenditure that adds fixed asset units or that has theeffect of improving the capacity, efficiency, life span, or economy of operations of an existing asset.Revenue Expenditure on the other hand is incurred in the course of regular ULB operations and thebenefit is generally availed in the same accounting year. -52-
  • 53. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshMunicipal Corporations across M.P should follow the rules prescribed under Madhya Pradeh MunicipalAccounting Manual for classification of expenditure as revenue and capital4.2 Good practices of CIP1. A ULB should mandatorily prepare and adopt comprehensive multi-year capital investment plan to ensure effective management and development of capital assets.2. City Development Plan comprising capital investment planning should be prepared for a period of 5-6 years in the light of past and current year results and should then be revised every year in the light of year completed. At the end of plan period (five or six years) a multi-year capital investment plan should be prepared for another plan period (five or six years).3. CIP to form foundation for annual capital budget and certain % of annual capital budget mandatorily must get spent to implement multi-year CIP.4. City Development Plan and Capital Investment Plan should be prepared in a consultative manner.4.3 Policies recommended for adoption4.3.1 Preparation of CIP1. The Commissioner of each Municipal Corporation in MP shall prepare a capital investment plan for a period of five years, which shall be approved and adopted by the Council of the Corporation at least [six months] prior to the commencement of such period. The Corporation shall update the CIP each year along with the preparation of its annual budget.2. Preparation of CIP for multi year period and its annual revision must be consultative, transparent3. The Accounts Department of a Municipal Corporation shall be responsible for coordinating the preparation of a Capital Investment Plan process.4.3.2 Fiscal prudence1. Capital investment of a project financed through borrowing by any Municipal Corporation in MP shall be financed for a period not exceeding the useful life of such project.2. Each Municipal Corporation in MP shall determine the future operating costs of all capital investment projects included in the CIP and at appropriate time such projected operating costs should get place in annual operating budget when capital budget gets incuded in annual capital budget.3. Each Municipal Corporation in MP shall ensure that one time revenues, revenue from the sale of property and a percentage of operating surplus (as per limit prescribed in the MP Finance and Accounts Rules) shall be earmarked for capital investment projects.4.3.3 Proportion of capital budget from CIPEach Municipal Corporation in MP shall ensure that at least 50% of the Corporation’s annual capitalbudget shall comprise projects proposed under the CIP. -53-
  • 54. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4.4 Procedures4.4.1 Prerequisites or enabling systems for developing CIPThe main drawbacks in the current system of working of ULBs in Madhya Pradesh are (1) lack of long-term and comprehensive views (2) technical foundation and (3) absence of a consultative process. Only afew cities have prepared service-wise master plans or City Development Plans (CDPs) or multi-yearcapital investment plans in Madhya Pradesh. As a result, capital investment works get selected in an ad-hoc and arbitrary manner, and sometimes, without appropriate technical soundness and preparedness.Therefore, it is necessary to establish certain enabling systems and also it is necessary to re-engineer thecapital investment decision making process to enable ULBs to prepare CIPs.CIP is a constituent and result of a CDP. Therefore, for the preparation of the CIP, it is necessary that aULB prepares a CDP. A CDP gets immensely benefited if there exists, (i) a Perspective Plan consisting ofvision, mission statement, goal, objective, strategies, programs, activities for developing the city; (ii) aPhysical Plan detailing land use and development control plan; and (iii) service-wise (water, sewerage,roads, storm water drainage, solid waste management, etc.) Technical Master Plans. A CDP should beprepared, drawing inputs from these three plans.Multi-year capital investment plan also forms an integral of a CDP. Thereafter, Financial and OperatingPlans and Detailed Project Reports should be prepared. A CIP should have forward linkages with theannual budgets of a ULB – revenue and capital. All these plans should get calibrated every year in thelight of the actual results achieved through the annual budget.Figure 6: Capital investment decision making process Progress Feedback Actual Data, achievements Perspective Plan, Vision Plan Mission, Goals, Objectives, City Development Strategy Planning exercise Annual Plan through for 15 to 25 years through Budget consultative consultative process process Comprising Revenue Multi-year Capital (Operating) Investment Plan Budget Physical Plan – land use planning and development and Financial and Operating Plan for Capital control planning – 10 to 15 the period of 5 to Budget years 7 years. CDP should be revised at least after three Service-wise Technical years and fully Preparation Master Plans providing list of after five or seven of Detailed works to be undertaken over years. Project short, medium and long term time frame. Reports Progress Feedback Actual Data, achievements -54-
  • 55. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshDifferent plans and the interrelated system presented in the above figure should be adopted by all theULBs of MP over a period of time. Though a CIP immensely benefits from these different plans, theirabsence should not stop a ULB from preparing a CIP. It may prepare a preliminary CIP to guide itsannual budget in the short run, but it should ensure that different plans and enabling systems are createdat the earliest.The following section describes the process and procedure for developing a CIP.4.4.2 Step 1: Define Vision, Mission, Goals, Objectives & StrategiesThe first step involved in the preparation of a CIP is to define the development objectives. If a ULB hasalready prepared a Vision Plan/ CDP, the objectives of its CIP should align to that.An illustrative list of development objectives could include:• Revenue enhancement Share of property tax income in the total revenue income should double in the next five years Coverage ratio for property tax assessments should go up to 85% for current assessments. Collection ratio for all the taxes collected by a municipal body should be 90 % for the current demand and minimum 50% of arrears demand. Share of non-tax revenue to total revenue income should increase by at least 20% on a year-on- year basis User charges on identified services such as water supply, sewerage, and solid waste collection have to be levied to achieve full cost recovery of all recurring operating cost over a five-year period• Expenditure management Explore different avenues to manage and reduce expenditure; in other words, improving productivity or outcome of expenditure.• Asset management Streamline building approval processes through revision of building bye laws Simplify legal and regulatory procedures for conversion of agricultural land for non-agricultural use Public-Private Partnerships with real estate developers for construction of shopping complexes on land owned by the ULB Assess existing assets, prepare their short and long-term maintenance and upgradation schedule and decide which assets to hold or dispose till when and the manner in which it should be disposed off -55-
  • 56. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Assess need for additional assets, short and long-term plan for acquisition, construction of additional assets required, prepare short and long-term maintenance and upgradation schedule of new assets planned Identify assets that can be used commercially and can be leased on rental income to enhance revenue of the ULB Example – vision, mission, strategy statement of Pune Municipal CorporationPMC conducted extensive consultation with different types of stakeholders. At the time of individualdiscussions and the workshops, the stakeholders discussed and articulated several factors that should betaken into consideration while formulating the vision. These are listed below. An environment friendly city with excellent Slum free and pollution free city infrastructure and sustainable development The Development Plan for Pune should factor Multi-sector economic approach to ensure the economic vision sustainability in case of adverse economic environment An IT Destination Promote it as a tourist hub Plan the city for younger generation Best public transport and better connectivity Promote aqua sportsThe Vision Statement of PMCBased on the above vision, perspectives, citizen’s desires and potential of Pune, the following draft visionstatements were articulated by various stakeholders. Based on these, the final VISION statement shall bearticulated with a larger group of stakeholders to reflect the futuristic desires of all “Punekars.”“An economically vibrant city of diverse opportunities with a rich culture in which all thecitizens enjoy safe and livable environment with good connectivity”“A city of its citizens with economic equity, diverse opportunities, rich culture and accessto services for Urban Poor”“A dynamic, vibrant, self-reliant and sustainable city with all basic amenities, to providea better quality of life for all”“City with mobility, safe, affordable, eco-friendly and efficient”“A role model in good governance, adequate, equitable, sustainable access to servicesfor all citizens”“Safe and livable city that promotes growth for its citizens” -56-
  • 57. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe Mission Statement of PMC –“Commitment to being the principal facilitator and provider of services throughdedication to achieve excellence in civic amenities’ provision and a Responsive,Modern, Simple, Accountable and Transparent Administration”.4.4.3 Step 2: Establish policiesA discussion of capital policies should precede the initiation of the CIP process. Clearly defined andwritten policies 1) guide the process, 2) facilitate planning and objective setting, 3) establish parametersfor identifying and prioritizing projects and financing options, and 4) provide staff direction. Thecommissioner, council members and staff need to be involved in the formulation of capital policies andshould consider adopting policies that:1. Define capital investment project, in effect, the minimum criteria for an investment to be considered for inclusion in the CIP. Possible criteria could include: a. Minimum cost of investment b. Minimum useful life of investment c. Exclude routine replacement of equipment2. Determine the period covered by the capital program (usually it should cover four, five, or six years)3. Designate responsibility for managing CIP preparation, which could involve an existing city office or department (usually the Finance, or Public Works, or Planning Department) or a special CIP Coordinating Committee with representatives from several departments4. Determine forms and timing of involvement of citizens and business leaders5. Adopt CIP Calendar6. Provide guidelines on methods of financing capital projects7. Determine the process for preparing capital project requests; overall method for reviewing requests and for selecting and prioritizing projects8. Determine the process for official submission of CIP from commissioner to the Council and the form (legal status) of approval from the Council9. Provide maintenance and replacement guidelines for major types of equipment10. Provide multi-year capital investment objectives and priorities, for example, to restore 24-hour water service by a certain date, to renovate all schools over a ten-year period, etc.11. Determine the method and timing of citizen participation12. Assess the future operating costs of capital projects -57-
  • 58. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4.4.4 Step 3: Assess existing assetsAfter defining the objectives to be achieved, the ULB should assess and review its existing assets in linewith those objectives. For assessing the existing assets, important parameters to be kept in mind aredescription of the asset, location, age, physical dimensions, construction method and type of materials,condition, repair history and costs, proposed date for replacement, replacement costs, operating cost andtype and extent of use. Information on these parameters can be obtained from engineering, architectural,insurance and property records.The following methods should be used to assess the condition of capital assets. However, the ULBshould involve an external agency for conducting these methods as they are time-consuming and entail acontinuous process.• Visual Inspection: This method involves inspecting the facilities using industry standards and other criteria. Inspection should be aided by common definitions, checklists, forms, and rating scales. This method is subjective and requires guidelines, training, and careful monitoring.• Engineering Analysis: In this method, engineering technology is used for condition assessment. This technology is costly but offers a valuable tool. For example, core samples, infrared and ultra- sound equipment could be employed to assess the condition of a bridge. It is an expensive method and can be avoided depending upon the need and capacity of the ULB.• Repair Analysis: This type of analysis involves information on the nature, frequency, and cost of repairs. Repair information also aids in the evaluation of different maintenance and repair strategies.• Complaint and Service Interruption Analysis: Tracking and analyzing complaints and service interruptions is an effective and low-cost method of obtaining condition information. Data on downtime, breaks, leaks, sewer back-ups, potholes, low water pressure, building problems, street congestion, broken playground equipment and inoperable street lights help to document capital needs and problems.• Service Standard Information: Central government, industry, professional association, and other standards are another useful source of information for determining capital needs. Examples of such standards are hectares or acres of park land per 100 residents, building space standards, and street lighting, water, and wastewater treatment standards.• Citizen Surveys: Citizen Surveys are effective in measuring citizen expectations relating to capital needs and methods of paying for them. Surveys are a means of identifying the level of support and opposition to different projects.Note: The condition assessment methods to be used by a particular ULB will depend upon the size,budget, and availability of information and staff. A ULB should make every effort to improve the quality ofcondition of information, since it is critical to identify capital needs. -58-
  • 59. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4.4.5 Step 4: Identification of areas of improvementAfter conducting an assessment of the existing assets, the ULB should prepare a detailed list of projectsthat need to be taken up to achieve the defined objectives. Post identification, the following two studiesshould be immediately conducted to assess the preliminary feasibility of identified projects:1. Environmental Impact Study: All legal requirements for environmental impact studies must be fulfilled concurrently with the development of project details. In addition to identifying important environmental conditions that need to be resolved, all associated costs must be calculated and included in the project budget.2. Preplanning Study: This study has three important components: a. Statement of Need: It should cover the specific need or function for which the capital asset/ improvement is required. This statement should help the master planning decision progress from general to specific and derive the actual functional requirements for the project. b. Statement of Quality: It is essential to define the desired quality of the project, right at the outset. This is important because there are many different perceptions of quality, and when undefined, expectations can vary substantially. The level of quality achievable will obviously be closely related to the funds available for a project. So at this stage, it may only be possible to make a general statement of expected quality, which would be consistent with the anticipated funds available. c. Statement of Time: It is important at this stage to recognize, and budget for the realistic period of time between planning and realization of the project.The planning schedule must include allowances for the following activities: Site acquisition Planning approvals Design and tendering for construction Obtaining building permits Construction Obtaining occupancy permits4.4.6 Step 5: Analyze financial capacityThis analysis should be made to assess the financial condition of the ULB and its capacity to financeidentified capital investment projects. This will involve significant amount of data collection and analysis.The process will involve the following measures.4.4.6.1 Identify sources of informationThe sources of information that will have to be used are: -59-
  • 60. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Annual accounts of the last five years• Annual administrative reports of the last five years• Budget estimates of the last five years• Demand and collection statements of tax revenues• Other registers as maintained under the respective acts, rules, etc.4.4.6.2 Data compilationData of two types has to be collected and compiled; the first, financial data and the second, service leveldata. Financial data analysis will give the trend ratios and provide an insight into the composition ofvarious sources of income and expenditure. Service level data will indicate the quality of service deliveryand provide an insight into various service level indicators.4.4.6.3 Financial analysisFinancial analysis would involve the following measures:• A three-to-five year analysis of own source revenues by major source, expenditures, operating and capital reserves and surplus or deficits• A three-to-five year projection of future own source recurring revenues, expenditures, reserves and surplus• Analysis of current and future debt capacity, debt service and overlapping of debt of other ULBs supported by the same tax base• An analysis of per capita debt, debt as a percentage of revenues, and debt service as a percentage of the budget• An analysis of lease obligations• An analysis of potential future changes in central government funding• An analysis of potential capital investment funding sources -60-
  • 61. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshExample of Financial Analysis from Pune City Development Plan Revenue Income (a combination of Trends in Revenue Income & Expenditure General and Water Account) of PMC has 90000 grown to a level of INR 77205 lakhs in FY 80000 70000 2004-05 from INR 47664 lakhs during FY 60000 2000-01, registering a compounded annual 50000 growth rate (CAGR) of 13 percent, while 40000 revenue expenditure increased at a CAGR 30000 20000 of 14 per cent. Though this doesn’t present 10000 a very sound financial condition for the 0 future, PMC consistently maintained a 2000-01 2001-02 2002-03 2003-04 2004-05 revenue surplus of about 35 percent of its Revenue Income Revenue Expenditure revenue income. However, everything doesn’t appear to be in place with theoverall municipal account showing an increasing deficit from a surplus position, warranting expenditurecontrol measures and planned capital investments the part of PMC.Table - Financial Status at a Glance 2000-01 2001-02 2002-03 2003-04 2004-05 CAGRItems Actuals in Rs. Lakhs %Revenue Account Income 47664 50174 60471 60959 77205 13 Expenditure 28645 33414 40381 42378 48657 14 Surplus/ Deficit 19019 16760 20089 18580 28549Capital Account Receipts 92 99 129 23 1575 103 Payments 14862 19524 23267 26791 27318 16 Surplus/ Deficit (14770) (19425) (23138) (26768) (25743)Overall Status incl. O.B. 4250 1585 (1463) (9651) (6845)Source: PMC Annual Accounts -61-
  • 62. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Capital income of PMC comprises loans and Trends in Capital Income & Expenditure internal transfers from revenue to capital account 35000 or utilisation of funds for asset creation from the 30000 25000 sinking funds; during the past few years, PMC 20000 has not availed of any loans for its capital 15000 expenditure. 10000 5000 It is observed that capital income from external 0 sources is negligible when compared to the 2000-01 2001-02 2002-03 2003-04 2004-05 expenditure; this indicates most of the capital Capital Expenditure Capital Income expenditure is met from the internal surplus alone. It is also observed that capital expenditurehas been inconsistent during the review period; this trend can be attributed to availability of revenuesurplus.4.4.7 Step 6: Preliminary Capital Investment PlanThis phase involves using the results of the initial phases to prepare a preliminary plan to be presented tothe senior officials of the ULB.1. Prepare project requestsThe departmental staff is responsible for preparing project requests in accordance with the forms,instructions and guidelines issued by the capital investment plan committee. In this stage, focus shouldbe given to justification, cost, and financing parts of the project request.• Project Justification: In justifying a project request, it is important to furnish accurate, objective and supportable information. There should be comments on the technical, financial, political, economic, environmental, and administrative feasibility of the project. The project request should be supported with citizen survey, service standard, regulatory compliance, demographic, and other relevant data.• Project Costs: All project cost should be estimated including: Feasibility and planning studies Engineering and architectural Land acquisition Construction and construction management Contingency Site improvements Equipment and furnishings Debt service -62-
  • 63. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Project Financing: This should include recommendations on capital financing alternatives and viable options. The strength and weakness of each option should be discussed in detail along with the available alternatives.2. Review capital investment project requestsAfter the project requests are prepared, they should be reviewed by the capital investment plancommittee in cooperation with planning, finance, engineering, and architectural staff specialists. EachULB needs to develop a review process consistent with its size and resources.There are four important types of review process:• Administrative Review -- This will mainly involve a check on the accuracy of information and forms submitted.• Planning Review -- This review mainly involves assessing the projects with respect to development and other plans and the impact of project on economic development.• Financial Review -- This involves the following checks: Are the financing recommendations accurate and feasible? Are the direct and indirect operating and maintenance cost projections accurate and realistic? Have all capital costs been identified? Is cash flow sufficient to finance the project? What fiscal impact does the project have on other projects?• Engineering and Architectural Review --- This review involves the following checks: Is the project design adequate? Have design alternatives been considered? Are the specifications adequate?3. Prioritize project requestsGenerally, funds are not available to finance all the necessary capital investment projects. Consequently,ULB officials have to make hard choices among competing projects. Therefore, the most demanding anddifficult aspect of a project review is the prioritization and selection of projects.The project evaluation and prioritization process can be made more objective and rational by thedevelopment of pre-determined and clearly defined criteria. Evaluation criteria should be establishedbefore the preparation of project requests in order to provide guidance to those drafting the requests.The various approaches for setting up defined criteria and prioritizing project requests are explainedbelow. However, each ULB needs to identify its own criteria.• Single standard criteria -63-
  • 64. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThis approach uses a single standard such as return on investment or availability of finance to evaluateprojects. Projects that have short investment payback periods or can be financed by other than ULBfunds receive high priorities.• Prioritization by category, based on valuesEach project is placed into one of a small number of rating categories based on urgency and communityvalues. Examples of categories include mandatory, urgent, essential, necessary, desirable, acceptable,and deferrable. This type of system generally does not prioritize projects within each category but pointscan be assigned and projects ranked.• Multiple criteria approachThis approach uses multiple criteria for evaluating projects in order to balance diverse and competingvalues and needs. Examples of criteria include fiscal, health, safety, economic, environmental, operatingbudget and political impact. Numeric weights of 1 to 10 may be assigned to each criterion according totheir importance and ULB values. For each criterion, the score is multiplied by the criterion weight toreach a total score. An overall score is then calculated for each project by totalling all the criteria scores.4.4.8 Step 7: Prpeare Financial and Operating PlanThe Financial Operating Plan (FOP) is a multi-year forecast of finances of the urban local body for amedium term. It is generated for the period similar to CIP and takes in to account year-wise phasingprovided in CIP, A salient feature of the FOP is that all outstanding dues, including debt and non-debtliabilities, should also be taken into account while forecasting finances of the urban local body. The FOPis generated to assess the investment-sustaining capacity of an organisation (the Urban Local Body inour case), if it adopts a project funding structure comprising grants under the JNURM framework(accounting for 70 per cent of the funding) and internal resources and loans accounting for the rest.Example – Pune Municipal Corporation’s FOP – following para provide basis taken for forecastingfinances and for preparing FOP of the PMC.The major criterion for ascertaining the investment-sustaining capacity of PMC are: PMC should have ayear-to year positive opening balance, year-to-year operating surplus and the debt-servicing ratio duringeach year shall not exceed 25%. The accounts data for the fiscal years 2000-01 to 2004-05 has beenused as the base to ascertain assumptions and to prepare the FOP. A spreadsheet FOP model wascustomised as to work out the investment sustaining capacity of PMC, based on the FOP assumptions.Finally the phased investment identified under CIP was loaded onto the FOP model to get combinedpicture,Table - Important assumptions made in the projectionsProperty taxGrowth in Property Tax Follows the current growth rate with a ceiling of a minimum of 1% and aAssessments maximum of 2% in accordance with the assumed growth scenario. -64-
  • 65. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshOther Income items and Capital grants (EFC/ TFC grants)Growth rate Base Case scenario :- Current CAGR with a ceiling of minimum 8% and maximum of 10% and Improvement Case scenario :- Current CAGR with a ceiling of minimum 8% and maximum of 15%ExpenditureGrowth rate Current CAGR with a ceiling of maximum 8%Salaries/ Wages th thPay commission Revision 6 pay commission revision during 2007-08 and 7 pay commission revision during 2012-13 (Maximum of 15% in Base Case scenario and Maximum of 25% in Improved Case scenario)Project Financing TermsRatio of Grant: Loan: ULB • JNNURM Frameworkcontribution • 50% GoI Grant, 20% GoM Grant, 15% Loan, 15% PMC contribution • Water Supply, Sewerage & Sanitation, Transportation and Traffic Management, Solid Waste Management/ Conservancy, Street Lighting, Drainage, Urban poor/ Slums – All capital works except land acquisition costs • Non-JNNURM Proposals • Land Acquisition Costs • 50% loan, 0% grant, 50% ULB contribution • Other Sectors/ Capital Works • 85% loan, 0% grant, 15% ULB contributionSectoral Deployment of Refer to Section on Capital Investment Plan (CIP) and PhasingInvestmentLoan terms Loan period: 20 years (5+15) Moratorium period: 5 years on principal repayment Repayment method: Equal annual instalments Interest rate: 7.5% -65-
  • 66. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshDebt Service Coverage 1Ratio & Debt Servicing DSCR of at least 1.25 and DSR of maximum 25% 2RatioO & M expenditure (arising from new assets)O & M expenditure (from Average of 5% (rate as % of investment) for all Sectors together.2007-08) (Water supply 4%, Sewerage 6%, Solid waste management 15%, Roads & Drains 6%, Street lighting 8%, Urban poor/ Slums 3%)Outstanding Debt & Non-debt LiabilitiesNon-debt Liabilities Equal instalments over a 5-year period from 2006-07 to 2010-11Debt Liabilities Equal instalments over a 1 to 10-year period starting 2006-07Projection ScenariosThe scenarios are differentiated according to the level of internal revenue improvement that is attemptedby the ULB and level of SFC grant support.Base Case Scenario: The scenario assumes that the ULB’s revenue generation efforts would continue attheir present levels.Improved Case Scenario: Under this scenario, the ULB undertakes nominal internal revenueimprovements by increasing tax rates and improving collection efficiencies.Important revenue augmentation assumptions that differentiate each scenario are presented in detail inthe ensuing table.Table - Projection ScenariosScenario Normal SustainedScenario No. 1 2Property Tax1 DSCR= (current year revenue – non-debt service expenses, but including additional O&M expenses)/ Debt Service obligation. 2 DSR=(Debt Service obligation/ Revenue income) -66-
  • 67. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshGrowth in PT Current CAGR with ceiling of a Current CAGR with ceiling of aAssessments (Buildings minimum of 1% and maximum of minimum of 1.25% and maximum of& Lands) 1.5% 2.0% Incremental increase over a periodCollection efficiency for Maximum of each of last 5 years of 5 years to 90% if current averageboth current as well as and average of last 5 years above 90%, to 85% if currentarrears demand (minimal improvement) average above 65%, or to 70% if current average below 65%, To be revised every 3 years, by To be revised every 3 years, byGrowth in tax rate 5% 15%Water Charges Continues at present coverage Incremental increase over a periodGrowth in HSCs and (% of PT Assessments) – Minimal of 5 years to 80% of PTdemand Growth Assessments – High Growth Incremental increase over a Incremental increase over a period period of 5 years to 65% if current of 5 years to 90% if current averageCollection efficiency average above 65% or to 50% if above 90% or to 75% if current current average below 50%, average below 50%,Water rate & New Maintain current level of no To be revised every 5 years by 25%Connection Deposit revisionSewerage Charges Incremental increase over a Incremental increase over a periodGrowth in HSCs and period of 5 years to 50% of PT of 5 years to 70% of PTdemand Assessments – Nominal Growth Assessments – High Growth Maintain current level of no Maintain current level of no chargesCollection efficiency charges and no revision and no revision Maintain current level of no Maintain current level of no monthlySewerage Charge & monthly charges and no revision. charges and no revision. CurrentNew Connection Current New connection Deposit New connection Deposit to continue -67-
  • 68. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshDeposit to continue without revision without revision4.4.9 Step 8: Evaluative financing optionsSelection of the most appropriate sources of financing is complicated by the number and variety ofavailable options, changes in central government laws, volatile debt markets and the constantdevelopment of new, complex and creative financing sources. For these reasons, the finance staff of aULB should prepare an analysis of the key features and advantages and disadvantages of each type ofcapital financing. Every effort needs to be made to identify and evaluate all available sources.Each ULB will need to identify and evaluate the capital financing options available to it. Information onoptions can be obtained from the statutes, ministries of finance, financial consultants, and professionalassociations. Department heads are also often aware of sources of financing for projects related to theiroperations.4.4.10 Step 9: Final capital investment planHaving undertaken the above-mentioned steps, a ULB should put together its final CIP that providessector and sub-wise, year-wise classification of all the capital works planned in the order of priority.4.5 Case study: CIP of Pune Municipal Corporation (PMC)PMC followed a similar procedure as laid down in the manual for preparing its CIP (Section 4.3).Thefollowing figure depicts the procedure followed by PMC.Figure 7: Procedure followed by PMC for preparing CIP Defining Vision Assess Existing Identification of Analyse Financials Mission, Goals Assets areas of & Preparation of Objectives etc. improvement FOP4.5.1 Defining vision, mission, goals, objectives etc.For preparing CDP for Pune, secondary data was sourced from PMC and other agencies. Various studyreports and Detailed Project Report documents prepared for and by PMC were extensively used foranalysis, correlation of primary data and discussions. -68-
  • 69. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe strategies adopted for the CDP primarily had three dimensions: (i) improving the service delivery byhigher efficiency, (ii) improving service delivery by creating infrastructure assets, and (iii) improving thegovernance aspects of the Corporation.These strategies developed by PMC act as a broad framework for defining the objectives as discussedunder Section 4.4.2.4.5.2 Assessing Existing AssetsPMC carried out detailed survey of its existing assets, their present condition, their sufficiency to meetdemands of people etc.4.5.3 Identification of areas of improvementThe CIP involved the identification of public capital facilities to cater to the demands of the city populaceby the year 2011 and 2031 according to its short, medium and long-term infrastructure needs. Projectswere identified on the basis of demand-gap analysis and strategies listed under each of the servicesectors following various detailed engineering studies and stakeholder consultations. The projects derivedaim at ensuring the optimal and efficient utilisation of existing infrastructure systems and enhancing thecapacity of the systems for future needs.In order to implement these strategies and to meet the infrastructure requirements of the city, PMCprepared a CIP. This included investment in core services of the ULB and also in non-core sectors likeinner city revitalisation, restoration of heritage structures, relocation of markets and economicinfrastructure.4.5.4 Analyse Financial Capacity and Preparation of FOPIn line with the phasing of identified capital investment plan from financial year 2006-07 to financial year2011-12, the FOP was generated for the same period. The accounts data between the years 2000-01and 2004-05 were used as the basis to determine past trends in revenue and expenditure and arrive atappropriate growth assumptions for each income and expense item. After forecasting the revenueaccount, the capital investments proposed under the CIP were added to the forecast. The FOP assessedthe investment sustaining capacity of the Corporation under a scenario where it adopts a project fundingstructure comprising grants under the JNNURM framework (accounting for 70 percent of the funding) andinternal resources and loans accounting for the rest. The level of investment that PMC could sustain wasthen determined by studying the overall surpluses, year-to-year opening balance and DSCR. If the DSCRfell below 1.25 (i.e., less than 25% cushion), then the investments were reduced gradually till the DSCRexceeded 1.25 in all the years in the forecast period. In determining a long-term financial strategy, PMCplaned to raise resources and fund the CIP. (The investment capacity of PMC was assessed asdiscussed under section 4.3.5 of the manual and for details of workings kindly refer examples given undersection no. 4.4.6 & 4.4.8). The resultant FOPs (base case and improved case scenario) of PMC were asfollows -69-
  • 70. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshBase Case ScenarioUnder the assumptions made and the identified investment loaded, in the Base Case scenario, PMCwould be able to sustain the entire identified investment. The actual sustenance is 115 percent ofthe identified investment of Rs. 6349 crores. Hence, the investment capacity of PMC is Rs. 7301.66Crores at constant prices which implies that the per-capita investment capacity of Rs. 24777.In this scenario, investment capacity of PMC is highly dependent on the availability of JNNURM grants totake up the proposed capital investments. It is observed that in the absence of JNNURM grants, thesustainability of PMC drops to 34% of the identified investment that is the investment capacity of Rs.2158.75 crores at a per-capita investment capacity of Rs. 7325.Fund RequirementUnder the Base Case scenario with minimal growth assumptions, PMC would be able to sustain theentire identified investment phased over a period from 2006-07 to 2012-13. For the identified investmentof PMC under this scenario of Rs. 6349 crores at constant prices and Rs. 8036.60 crores at currentprices, the funding pattern as worked out in the FOP model would be as follows:Table: Base Case Projection – Funding Pattern Amount (Rs. Crores) – % of TotalS. No Mode of Funding Source Current Prices InvestmentIdentified Investment 8036.60 1001 Grants JNNURM 4475.81* 56* GoI Grants JNNURM 3197.01 40 GoM Grants JNNURM 1278.80 162 Loan Open Market/ FIs 1356.51 173 Own sources PMC 2204.28 27* Of the total investment of Rs. 8036.60 crores (current prices), only Rs. 6671.91 crores are beingproposed under JNNURM; thus the figure of Rs. 4475.81 Crores reflects 56% of total identifiedinvestment.In this scenario, PMC would be able to maintain an average municipal account surplus of Rs. 622 croresper annum during the period 2006-07 to 2015-16. The operating surplus for the same period would be anaverage Rs. 338 crores per annum. Debt servicing burden on the revenue account would be an averageRs. 91 crores per annum during the same period with a peak load of Rs. 144 crores from 2013-14. -70-
  • 71. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshImproved Case ScenarioUnder the assumptions made and the fully identified investment loaded, in the Improved Case scenario,PMC would be able to sustain the entire identified investment. The actual sustenance is 160percent of the identified investment of Rs. 6349 crores that is investment capacity of PMC is Rs.10158.83 Crores at constant prices that is a per-capita investment capacity of Rs. 34472.In this scenario, the investment capacity of PMC is highly dependent on the availability of JNNURMgrants to take up the proposed capital investments. It is observed that in the absence of JNNURM grants,the sustainability of PMC drops to 55% of the identified investment that is the investment capacity of Rs.3492.10 crores at a per-capita investment capacity of Rs. 11850.Fund RequirementUnder the Improved Case scenario with marginally higher growth assumptions, PMC would be able tosustain the entire identified investment phased over a period from 2006-07 to 2012-13. For the identifiedinvestment of PMC, under this scenario of Rs. 6349 crores at constant prices and Rs. 8036.60 crores atcurrent prices, the funding pattern as worked out in the FOP model would be:Table: Improved Case Projection – Funding Pattern Amount (Rs. Crores) – % of TotalS. No Mode of Funding Source Current Prices InvestmentIdentified Investment 8036.60 1001 Grants JNNURM 4475.81* 56* GoI Grants JNNURM 3197.01 40 GoM Grants JNNURM 1278.80 162 Loan Open Market/ FIs 1356.51 173 Own sources PMC 2204.28 27Note: The figures in 0 and 0 do not differ as PMC indicates 100% sustainability in both the projectionscenarios.* Of the total investment of Rs. 8036.60 crores (current prices), only Rs. 6671.91 crores is beingproposed under JNNURM and hence the figure of Rs. 4475.81 crores reflects 56% of total identifiedinvestment. -71-
  • 72. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshIn this scenario, PMC would be able to maintain an average municipal account surplus of Rs. 2029 croresper annum during the period 2006-07 to 2015-16. The operating surplus for the same period would be anaverage Rs. 635 crores per annum. Debt servicing burden on the revenue account is the same as in theBase Case scenario at an average of Rs. 91 crores per annum during the same period with a peak loadof Rs. 144 crores from 2013-14.4.5.5 CIP format as adopted by PMCThe following table depicts the format of CIP as prepared by the PMC:• Institutionalising the CIP Process• Capital facilities, investment phasing and implementationTable 11: Format of CIP prepared by PMC• Water supplyThis manual shows format for only one sector. Similar formats were used for other sectors as well. Long term needs (2031) -72-
  • 73. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshPriority Needs (2011-12) -73-
  • 74. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5 CASH MANAGEMENT5.1 Concepts 3Cash , the most liquid asset is of vital importance to the daily operations of all organisations. While theproportion of corporate assets held in the form of cash is very small, the same in case of ULBs is quitesubstantial. This is because most of the services require resources which are cash based. The cashinflows in the form of tax receipts and other non tax receipts continuously pour in large amounts and thesame are used for daily operational purposes. Hence efficient management of cash is very crucial forULBs and is an increasingly important part of financial management in the municipal sector as ULBscontinue to struggle with tight operating and capital budgets. More and more, ULBs are looking foropportunities to improve cash management and mitigate risk even in a relatively low interest rateenvironment. A well managed cash management system and its associate investment portfolio cangenerate substantial incremental earnings to offset escalating costs.A successful cash management system should include:1. DocumentationSuccessful cash management requires a ULB to fully document cash management and investmentpolicies and procedures to ensure informed decision-making. This provides a clear understanding ofthe approved policies governing cash management. This may include investment strategies, accountsreceivable and payable policies, tendering policies, etc. Policies ensure that the ULB has a set of clearguidelines for facilitating the execution of the day-to-day activities of the cash management program.Within the context of the adopted policies, the ULB should set out specific objectives which can be usedperiodically to assess performance.2. CommunicationEffective cash management involves all departments and is typically co-ordinated through finance andaccounts department. This includes the need to communicate policies and procedures internally(departments) and externally (banks) to promote a clear understanding of what is expected and what theULB wants to achieve.3. ControlThere is a need to establish sound cash management controls to safeguard the ULB’s assets.These controls as well as the roles and responsibilities associated with cash management control mustbe clearly articulated and communicated to the departments.3 The word ‘Cash’ is used here in generic sense and includes receipts and payments in the form of cheques also, provided they getrealised or paid during the time period (month) in consideration. -74-
  • 75. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4. AuditSuccessful cash management requires a regular review of cash management systems and investmentdecisions to respond to a changing environment.5.1.1 Cash flow forecastingCash flow forecasting is defined as an estimate of receipts and payments during a given period. It isdistinct from municipal accounting and budgeting as the forecast is done with the intent to measure theorganizations ability to meet needs in light of resources with the ultimate goal of negotiating the need forany short term borrowing and to avoid the liquidation of any long term securities (investments).Tostructure an investment portfolio or make investment decisions, it is necessary to undertake a cash flowforecasting.• Need for cash flow forecasting: Forecasting the dates when receipts exceed payments and conversely when payments exceed receipts leads to investment potential maximization. Through efficient forecasting, ULBs can often generate additional income by maximizing the term of the investment. With limited ability to raise revenues the investment function has become an increasingly important activity for ULBs. Determines when funds are required to cover anticipated and unanticipated liabilities. Minimises banking fees and charges, with the potential to avoid overall cost Provides an opportunity for spending patterns to be coordinated to mitigate any potential shortfalls and balance the flow of funds Defines liquidity requirements Helps estimate the future cash position enabling the ULB to manage its funds more efficiently Assists in making the most appropriate investment decisions, thereby maximizing annual investment returns. Provides the ability to effectively time investment maturities with anticipated future cash outlays5.2 Good practices of cash management5.2.1 Cash book1. Tallying cash book daily: A ULB should carry out physical verification of the cash in hand at the end of each day and check with the closing balance recorded in the Cash Book.2. Obtaining bank statement: The bank statement should be obtained from the banks on a daily baisis in Municipal Corporations.3. Reconciliation of Cash Book (Bank portion) with the Bank statements on a periodic basis.:Main Fund account should be reconciled on a daily basis in Municipal Corporations. -75-
  • 76. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5.2.2 Managing investments1. ULB should maintain investments in liquid instruments: A ULB should invest cash reserves in liquid instruments to ensure the absolute safety of principal and interest, meet the liquidity needs of the Municipal Corporation and achieve the highest possible yield.2. ULB should negotiate better terms with financial institutions: A ULB should periodically initiate competitive-bidding and negotiation processes, in accordance with the state and local laws and regulations, for major banking services. The processes should include requests for proposals and should cover services, fees, earnings credit rates, and availability schedules for deposited funds.3. Appoint a relationship manager: ULB should appoint a relationship manager who will best understand the needs of the entity and be able to provide service improvement recommendations as well as cohesive communications.5.2.3 Cash flow projections1. ULB should prepare cash flow projections: ULB should develop reasonable expectations of planned expenditures and revenues including investment maturities. This basically involves cash flow forecasting for long-term and short-term.2. Successful cash management requires a ULB to fully document cash management and investment policies and procedures to ensure informed decision-making.5.2.4 Collection of dues1. ULB should use most efficient method of collection: Governments of all sizes have taken advantage of technological advancements that allow for more efficient handling of traditional forms of payment (e.g., cash and cheques) and entirely new forms of payment (e.g., electronic funds transfer). 4 Improving payment processing can yield gains in a) staffing efficiency and b) reductions in float .5.3 Policies5.3.1 Cash balance1. Each Municipal Corporation in MP shall maintain a sum of cash balance at the end of each day as a proportion of its budgeted aggregate annual recurring income, which shall not be less than the limit prescribed in the MP Municipal Finance and Accounts Rules.2. Reconciliation of Cash Book with the Bank statements on a periodic basis: Main Fund account should be reconciled on a daily basis in Municipal Corporations.4 Float is the lag time involved in accepting a payment and processing it before it is invested. This concept is discussed in thechapter on Receivables and Payables Management. -76-
  • 77. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5.3.2 Investment of excess cash1. Each Municipal Corporation in MP shall invest cash reserves in liquid instruments to: ensure the absolute safety of principal and interest; meet the liquidity needs of the Municipal Corporation; and, achieve the highest possible yield.2. Each Municipal Corporation in MP shall establish guidelines that emphasize the safety and liquidity in the investment of its funds.5.3.3 Report on investment activity1. Accounts Officer of each Municipal Corporation in MP shall file [monthly] reports of investment activity with the Commissioner. The report shall includes information on type of investment, purchase date, maturity date, face value or purchase cost, market value, rate of interest and amount of interest received.5.3.4 ComplianceCash management activities shall be conducted by each Municipal Corporation in MP in full compliancewith prevailing local, state and national regulations. All cash transactions shall be recorded in accordancewith the procedures, manner and form prescribed in Madhya Pradesh Municipal Accounts Manual, July2007.5.3.5 Safety of financial assets1. All aspects of cash management operations shall be designed to ensure the absolute safety and integrity of the local governments financial assets.2. The Head of Accounts of each Municipal Corporation shall ensure that physical cash is kept in a safe and secured place and adequately locked within the premises of the Corporation.5.3.6 Tally of physical cash with books of accounts1. The Head of Accounts of each Municipal Corporation in MP shall physically verify the cash in hand at the end of each day, check with the closing balance recorded in the Cash Book and countersign in the space provided in the Cash Book for authorization by the Cashier or any other responsible officer maintaining the cash book.2. If any discrepancy or difference is found between the physical cash balance and balance as per the Cash Book, the matter shall be forthwith remedied or rectified. In case of the difference remains unreconciled, it shall be immediately reported by the Head of Accounts to the Commissioner of the Corporation for appropriate and necessary action. -77-
  • 78. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5.4 Procedures5.4.1 Managing working capitalManaging of working capital refers to the management of current assets as well as current liabilities. Themajor thrust, of course, is on the management of current assets. This is understandable because currentliabilities arise in the context of current assets.Current assets are those assets that are either held in cash or can be easily converted into cash withinone accounting period. Examples of current assets are cash, short term investments, sundry debtors,accounts receivables, advances, etc. Similarly, current liabilities are those liabilities that have to be paidwithin the accounting period like sundry creditors, accounts payable, outstanding expenses, short termloans, etc.Working capital management is significant aspect of financial management. Its importance stems fromtwo reasons:1. Investment in current assets represents a substantial portion of total investment; and2. Investment in current assets and the level of current liabilities have to be geared quickly to provision of services.The importance of working capital management is reflected in the fact that municipal bodies spend agreat deal of time in managing current assets and current liabilities. Arranging short term financing(overdraft, etc.), negotiating favourable credit terms, controlling the movement of cash, administeringaccounts receivable and monitoring investment in inventories consume a great of time of ULBsWe have divided working capital management into five sections. These include:1. Characteristics of current assets2. Factors influencing working capital requirements3. Working capital policy4. Profit criterion for current assets5. Working capital control5.4.1.1 Characteristics of current assetsIn the management of working capital, two characteristics of current assets must be borne in mind:• Short life span• Swift transformation into other asset formsCurrent assets have a short life span of 30-60 days and inventories may be held from 30 days to 100days. The life span of currents assets depend on the time required in various municipal activities,projects, maintenance, revenue collection and the degree of synchronization among them. -78-
  • 79. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshEach current asset is swiftly transformed into other asset forms; cash is used for acquiring material andlabour, which in turn are used for providing services and maintenance and also for capital projects (whichhave to pass through various stages of work-in-progress). These services are provided at apredetermined rate on credit that is transformed into accounts receivable and finally accounts receivableon realization generates cash.5.4.1.2 Factors influencing working capital requirementsThe working capital needs of a ULB are influenced by numerous factors. The important ones are:• Nature of operationsThe working capital requirement of an organisation is closely related to the nature of its operations. ULB,being a service organisation, has a short operating cycle that operates predominantly on cash basis. Inother words, ULBs have modest working capital requirement compared to a large manufacturing concern,which has a long operating cycle and sells largely on credit. The proportion of fixed assets is more in caseof ULBs like land, buildings, infrastructure, entertainment parks, etc. The nature of assets in a ULB is verydifferent from that of business organizations and hence the working capital requirements are also affectedaccordingly. The current assets of ULBs are mostly in the form of tax revenues, which largely depend onvarious legal provisions and efficiency of tax recovery departments.• Seasonality of operationsULBs have marked seasonality in their operations. This is due to various festivals, adjustments related toweather and climatic conditions, etc. Due to this reason they have highly fluctuating working capitalrequirements. For example, decorations and celebrations during various festivals, repair of roads andpipelines before the onset of monsoon, additional provision of storm water drainage during rains, etc.require large amount of resources.• Government policiesMacro and micro economic changes in government policies may affect the loans and grants given toULBs and as a result may temporarily effect the functioning of a ULB.• Conditions of supplyThe inventories of various materials, spares and stores depend on the conditions of supply. If the supplyis prompt and adequate, a ULB can manage with small inventory. However, if the supply is unpredictableand scant then the ULB would have to acquire the stocks as and when they are available and carry largerinventory on an average to ensure continuity of operations. A similar policy will have to be followed whenthe same material is available only seasonally and the operations are carried out throughout the year.5.4.1.3 Working capital policyThe important issues in formulation of a working capital policy are:• What should be the ratio of current assets to revenues? -79-
  • 80. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshUnlike a business firm, the revenues and receipts of ULBs can be estimated in advance. This is veryhelpful in determining the level of cash balances needed as working capital for carrying out day to dayoperations. It is in this context that the investment in current assets also can be identified uniquely.• Current Ratio – Ratio of current assets to current liabilities.This ratio is an indicator of level of coverage; current assets have over current liabilities. In ULBs a ratio of1.80 would be reasonable. Higher the ratio the better it is.• Ratio of short-term financing to long-term financingThe two broad policy alternatives in this respect are i) a conservative current asset financing policy and ii)an aggressive current asset financing policy.A conservative current asset financing policy relies less on short-term bank financing and more on long-term sources like debentures. An aggressive current asset financing policy on the other hand reliesheavily on short-term bank finance and seeks to reduce dependence on long-term financing.A conservative policy reduces the risk that the ULB will be unable to repay or replace its short-term debtperiodically. It nevertheless, enhances the cost of financing because the long-term sources of finance,debt and equity have a higher cost associated with them. An aggressive current asset financing policyrelying more on short-term bank financing, tends to have the opposite effects. It exposes the ULB to ahigher degree of risk, but reduces the average cost of financing.5.4.1.4 Working capital controlIn ULBs, the control of working capital requires an analysis of operating cycle as in the case of privatefirms. The operating cycle of a ULB begins with the delivery of municipal services and ends with thecollection of tax. The duration of operating cycle depends on the time required at each stage. The controlof working capital is possible by efficient planning and adhering to budget as far as possible. For short-term debt requirements also, planning is essential in terms of cash budget, which will ensure control overthe movement of cash.The main point to emphasize is that working capital estimation needs to be carried out in advance andaccordingly a control system should ensure a smooth operating cycle.5.4.2 Procedure for cash flow forecastingCash management requires the coordination of two essential activities mainly cash flow forecasting andcollections and disbursements. The latter has been discussed in the chapter on receivables and payablesmanagement. Steps for undertaking cash flow forecasting are discussed in the following text.5.4.2.1 Step 1: Identify information resourcesThe first step involves identifying information sources which will help to identify major revenue andexpenditure items and provide the flow of fund information to assist in the development of a cash flow -80-
  • 81. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshforecast. The following table provides some of the suggestive sources of information available to assist inthe development of a cash flow forecast.Table 12: Sources of information for Cash Flow forecast Source of information Comments Budget • No detail on timing of cash flows but will provide the key sources of revenues and expenditures • Further detail can be provided through consultation with departments Daily/ monthly bank statements Of assistance in developing timing for cash flow analysis Investment statements Of assistance in developing estimations of amount and timing of transactions for cash flow analysis Accounts receivable, ledgers and trial Providing billing cycles and terms of payments balance Accounts payable records Provides indication of future payment schedules Government records Provides estimated amounts, timing of subsidies - subsidy/funding agreements Property/ utility records Provides billing cycles, terms of payments5.4.2.2 Step 2: Analysis of material sources of revenue and expenditureThe next step should be to identify material sources of revenue and expenditure that ULBs typicallyinclude in the cash flow forecast. Fine tuning of the list of revenues and expenditures will be needed tomeet a ULB’s unique circumstances.• Typical revenues a. Property tax revenues: This account for 50% to 60% of total revenues for most of the ULBs. It is a major source of revenues and should be included in the cash flow forecast. b. Provincial grants c. User fees for utility services d. Other user fees associated with recreation centres, transit usage, etc. can also be quite significant e. Cash, maturities and short-term investments i. Cash includes currency on hand and demand deposits -81-
  • 82. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh ii. Short-term investments have low transactions costs, but should be viewed as emergency cash bridges iii. Maturities include all items held in investments, which may become mature during the forecast time frame• Typical expenditures a. Payroll and payroll deduction payments - these are easily estimated and are due on regularly scheduled dates. This should be included in the model for cash flow forecasting b. Payments for income tax deductions c. Employee benefits d. Daily accounts payable transactions e. Major contract for services f. Debt repayments g. Operations and maintenance5.4.2.3 Step 3: Establish appropriate level of detail for forecasts in the short-term and long-term budgetingA decision would be required in terms of level of detail required for the cash flow forecast. As a generalrule of thumb, the following parameters are being used by ULBs:• Cash flow forecast for a year cash budgeting (typically on a monthly basis)• Broad forecast is needed for 5-10 years long-term cash forecasting (includes long-term capital budget)5.4.2.4 Step 4: Undertake historical and future trend analysisA general funding level for anticipated and unanticipated expenditure should be determined by looking atpast trends and changes that have occurred that will impact future forecasts. This will involve looking atpast years cash flow patterns and making assumptions about the current year.A year wise analysis of past years would be required for long-term forecasting, whereas, a month-wiseanalysis would be required for short-term budgeting. There are a number of driving factors that impactcash flow analysis including but not limited to (illustrative factors):• Property instalment deadlines• Water/ sewer billing cycles• State grants/ subsidy instalment schedules -82-
  • 83. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshHistorical trends are important as it is generally accepted that analysis of 3-5 years is appropriate to avoidanomalies associated with specific one-time events, e.g., large retroactive state payments, specific capitalprojects, etc.It is recommended to use historical data to measure activity of a cyclical nature for both receipts anddisbursements. A well established base of financial activity predicated on historical data better enablesthe forecaster to anticipate disbursements and receipts. This activity should be verified by the operatingdepartment for its likely recurrence. Historical data will give insight into what can be expected in thefuture.But it is also important to focus on the future. A review of changes in policies impacting cash flows andinvestments is required. Policies that may impact future cash flows include:• User fee policies and rates• Contribution to reserves• Debt policies• Tax policies, rates and payment dates• Development charge policiesIn addition, capital financing plans will impact the availability of cash for investment purposes as well asthe need and source of cash to support financing plan.5.4.2.5 Step 5: Considerations in undertaking trend analysisThe following text provides some general payment trends experienced in ULBs that should be consideredby each ULB in preparing its cash flow forecast.1. Consider historical timing of property tax payments and the method by which payments are made. Historically, trends indicate that the vast majority of tax payments are made on or immediately prior to the due dates.2. Identify property tax instalment/ non instalment months. Instalment months are much more revenue rich than non payment months and the bulk of those remittances are made near the end of those months.3. Adjust for changing trends and input parameters to ensure reliable future estimates. Consideration should also be given to how tax payments are made using various options as each may have a different payment pattern that will impact the cash flow analysis. Types of payments include: a. Over the counter payments b. Payments at banks c. Pre-authorized payments d. User fees: Understand trends in payments for user fees. For example, typically payments are higher on Mondays than any other day of the week, which will impact the short term forecasting. -83-
  • 84. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh e. Capital projects: While capital projects may include payment schedules and milestone payments, the project may not always reflect the anticipated schedule. Project managers know the project progress and can offer the investor required information with respect to changes in the project payment schedule. f. Identity changes in pricing: For current and mid/ long-term forecasting, overall expenditure and revenue patterns may be the same but the amounts may vary based on increases in costs such as salary negotiations, utility price increases, property tax increases, etc.5.4.2.6 Step 6: Consult with departmentsAccurate cash flow forecasting must be done with input from departments to fully understand revenueand expenditure cash flows. This will require input from all operating departments to develop reasonableexpectations of planned expenditures and revenues.5.4.2.7 Step 7: Develop a financial model to track cash flowsA computer spreadsheet is needed to track cash flows over time and predict future cash flows. Theappropriate level of complexity in the spreadsheet should adequately project the municipal cash positionwith limited daily effort. As this is a forecast tool, municipalities should consider this a combination of art/science. Assumptions should be tracked and updated on a regular basis to reflect the ULB’s bestestimate of what the cash flows will be on an ongoing basis.Developing a cash flow spreadsheet initially will take a substantial investment of time. Updating andrefining the cash flow forecasts thereafter becomes routine and will consume a limited amount of time.Cash flows must constantly be modified as new information is gathered. Tracking of planned versusactual revenues and expenditures is needed to provide useful information to investigate major variances.5.4.3 Application of cash flow budget forecasting techniques5.4.3.1 Step 1: Past trend analysisThis involves analyzing the trends for past five years for key cash receipts and expenditure items. Thefollowing format should be used to gather data for past years and to calculate a month-wise average. Itshould be noted that the below table only shows format for one month. Similar formats should be used forall years.Table 13: Format for gathering data for trend analysis (Rs. In lacs) Items Jan Jan Jan Jan Jan Average (5 Years) Year 1 Year 2 Year 3 Year 4 Year 5 Opening Balance 28 25 11 12 14 18 Cash Receipts -84-
  • 85. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Items Jan Jan Jan Jan Jan Average (5 Years) Year 1 Year 2 Year 3 Year 4 Year 5 Property Tax 96.0 101.0 110.0 106.0 118.0 106.2 User fees for utility 58.0 63.0 69.0 64.0 72.0 65.2 services Grants from various 180.0 196.0 208.0 214.0 230.0 205.6 sources Other receipts 23.0 29.0 33.0 31.0 38.0 31.8 Cash Receipt Total 357 389 420 415 463 408.8 Cash Expenditure (Fixed ) Salary Related 161 172 186 200 215 186.8 O&M Related 123 135 163 166 171 151.6 Interest & 27 31 35 37 38 33.6 Repayment Sub-total fixed exp 311 338 384 403 424 372 O & M Variable 20 23 16 17 26 20.4 Capital Expenditure 22 27 15 12 13 17.8 Total Cash Exp 353 388 415 432 463 410.2 Closing Balance 32 26 16 -5 14 16.6 Investment in FD 15 10 Encashment of FD 10As shown in the above table, the ULB must do this activity for each month for the past five years data.Such data will help the ULB to identify the months that are cash deficit or cash rich. There would bemonths with extraordinarily high or low cash due to abnormal items and should be excluded from thecalculation. Also it can be observed from the table 13 that monthly cash budget was balanced bycontrolling variable expenditure to the extent possible. -85-
  • 86. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5.4.3.2 Step 2: Formulation of cash budget and linkage with receivables, payables and investmentsAfter the past trend analysis, the next step is to formulate the cash budget for the current year basedupon the past trends; clearly identifying the months with excess and deficit cash. The formulation of cashbudget should then be linked to receivables and payables for the year. Based upon that, the investmentsshould also be planned in a manner such that the working capital requirements are met efficiently.The following figure illustrates the linkage of cash budget with receivables and payables and investments.Figure 8: Linkages of cash budget Receivables Short term investments The ULB can plan The ULB can decide the tenure discounts/penalties of the investments/fixed on user charges deposits Cash Budget The ULB can The ULB can alter decide about the its discretionary short term payments borrowing Payables Short term borrowingReceivables and PayablesOnce the ULB has prepared its cash budget, it identifies the months with excess or deficit cash. Basedupon this analysis, the ULB should plan the timing of its receivables by offering more discounts in deficitmonths to generate more cash. Similarly, the discretionary payables should be planned and incurred asper the availability of cash in future months.InvestmentsA ULB could use investments as an effective medium to bridge the gap between the cash-rich period andthe cash-deficit period. This has been explained with the help of the following illustration.Illustration: A ULB has to make a payment of INR 100 lacs in June. As per the cash budget of the ULB,it is expected that the ULB will not have sufficient cash to make the payment in June but projected cashbudget of the January month shows that it is likely to have INR 100 lacs surplus in the January. To avoiddeficit in the month of June, the ULB could invest surplus of January in a six-month fixed deposit inJanuary, which is planned to mature in June. The following table explains this illustration and shows theformat for a typical cash budget. -86-
  • 87. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 14: Illustration on judicious use of investments (Rs. In lacs) Items Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Income A 20 X X X X 20 X X X X X X B 40 X X X X 10 X X X X X X C 50 X X X X 15 X X X X X X D 60 X X X X 25 X X X X X X Total 170 X X X X 70 X X X X X X Expenditure A 20 X X X X 20 X X X X X X B 10 X X X X 40 X X X X X X C 15 X X X X 50 X X X X X X D 25 X X X X 60 X X X X X X Total 70 X X X X 170 X X X X X X Net 100 X X x x -100 X X x X X X Action Investment in fixed deposit (INR 100) for six months in the month of January maturing in June.Key points to be observed based upon above table:• ULB prepared its proposed cash budget based upon the trend analysis and then looked into major receivables and payables• After formulation, it assessed that there will be excess cash in the month of January and deficit in the month of June• Based upon this calculation, it decides to go for a fixed deposit of six months maturing in June to avoid cash deficitSimilarly, the ULB could go for a short-term borrowing if it cannot make investments and needs to borrowmoney. It is notable that knowing the need for short-term borrowing in advance can help a ULB to get alower rate of interest. This way any ULB can perform this activity for key revenue and expenditure itemsand manage its working capital efficiently. -87-
  • 88. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5.4.3.3 Step 3: Continuous revision of cash budgetThe important point to note here is that preparation of cash budget is not a one-time activity – but is acontinuous process. This means that every month, the actual figures should be compared with figuresproposed in the cash budget, and in the light of that, remaining month estimates should be revised. -88-
  • 89. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh6 RECEIVABLE AND PAYABLE MANAGEMENTThe first part of this chapter deals with the policies for receivables and payables management, thenexploring tools for better receivables and payables management. Then the monitoring mechanism forreceivables and payables is discussed for efficient cash management followed by a note on investment ofsurplus funds by ULB.6.1 Concepts6.1.1 Accounts ReceivablesThe amounts owing to a ULB from citizens for invoices issued by it are known as accounts receivables.Accounts receivable are classified as current assets on the balance sheet, but are distinguished fromprepayments and other non-trade debtors. A provision for bad debts should be shown against theaccounts receivable balance in line with the prudence concept. This provision should be based on theULBs past history of bad debts and its current expectations. A general provision is often based on apercentage of the total bills issued, for example 2% of bills issued during the accounting period.In case of a ULB, receivables are mainly in the form of taxes, which are to be paid yearly by the citizens.In the case of Municipal Corporations, receivables are very large due to large population covered by itand it is in this context, that receivables management assumes great significance.6.1.2 Accounts PayablesThe amount of money a ULB owes to suppliers is basically known as accounts payable. Thus it is in theform of a credit that suppliers offer to the ULB by allowing them to pay for a product or service after it hasalready been received.Accounts payables also include the amount that a ULB is required to pay to contractors for the worksdone. The amount of accounts payables are sometimes very high in a ULB due to non-availability offunds. Therefore, it is increasingly becoming important to manage payables by proper control andcoordination.6.2 Good practices of receivables and payable management1. Detailed information on debtors should be maintained: It is a good practice to maintain complete information about receivables including amount of receivables corresponding to each consumer, the aging profile of receivables, the amount of cash collected and the amount of receivables written off.2. ULB should have a debt management policy: There should be a clear debt management policy and all accounts and finance staff should be fully aware of and understand. -89-
  • 90. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3. Incentives/ disincentives should be used for early payment: Effective discount on property taxes should be provided to increase collection efifficiency and similary penal interest should be charged for overdue payments.4. Innovative techniques to be used for increasing collections: A ULB could implement latest tools/ techniques to expedite cash collection and manage disbursements. For instance, a ULB could install collection kiosks at various locations across the city to facilitate quick collection of property taxes and other user charges.5. ULB should conduct periodical review of aged receivables: The review of a summarised aged receivables report enables a ULB to easily judge the effectiveness of credit control procedures, to identify specific debtors’ issues and ensure that appropriate action is being taken to recover amounts owed. There should be appropriate escalation procedures to involve senior management where receivables are not being recovered as agreed.6. ULBs should send payment reminders to debtors: Another good practice for a ULB to ensure timely collection of dues is to send a statement or reminder to debtors, within the credit period. Following this, the Accounts Department should coordinate, focus and ensure vigorous follow-up on receipts overdue.7. Irrecoverable debts should be written off as per relevant provisions: Senior management should periodically review all outstanding debt and consider and recommend write-off where appropriate.6.3 Policies6.3.1 Maintenance of high collection ratesEach Municipal Corporation in MP shall maintain high collection rates for all revenues by keeping therevenue system as simple as possible in order to facilitate payment. Since revenue should exceed thecost of producing it, Municipal Corporations in MP shall strive to control and reduce administrative costs.6.3.2 Pursuing overdue paymentsEach Municipal Corporation in MP shall pursue to the full extent allowed by law all delinquent taxpayersand others overdue in payments to the Municipal Corporation.6.3.3 Discount on taxes/ chargesMunicipal Corporations in MP may offer discount on taxes and charges to any consumer who pays thetaxes/ charges due before such date as the Corporation shall fix. As per Section 137 of the MadhyaPradesh Municipal Corporation Act, 1956, not more than six and a quarter percent of discount on propertytax shall be allowed on the amount due from every person who pays the tax due before such date as theCorporation shall fix. -90-
  • 91. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh6.3.4 Notice of demandEach Municipal Corporation in MP shall serve a Notice of Demand upon a consumer for a bill presentedby the Municipal Corporation if the sum, for which bill is presented, is not paid within [15 days] from thepresentation of such bill. Such Notice of Demand shall specifically mention that penal interest shall comeinto force and he will be liable to pay that. This is in accordance with Section 174 of the Madhya PradeshMunicipal Corporation Act, 1956.6.3.5 Penal interestA Municipal Corporation shall levy penal interest on receivables regarding property tax, water charge and thall other municipal taxes and charges at the rate of [18 per cent] from the [16 day] of presentation ofproperty tax or water charge or any other municipal tax or charge bill.6.3.6 Issue of warrantIf the person on whom a Notice of Demand is served by a Municipal Corporation, does not pay the sumdemanded within [30 days] of the service of such notice, such sum with all costs of recovery, may berecovered under a Warrant signed by Commissioner. This is in accordance with Section 175 of theMadhya Pradesh Municipal Corporation Act, 1956.6.3.7 Write off of bad debts relating to property taxThe Commissioner of a Municipal Corporation in MP may, with the previous approval of the Council,write-off the books of the Corporation any sum due on account of any tax or of the costs of recovering anytax, which may appear to him to be irrecoverable. This provision is in accordance with Section 187 of theMadhya Pradesh Municipal Corporation Act, 1956.6.4 Procedures6.4.1 Step 1: Develop strong internal controlA detailed overview of internal control measures is provided in a Chapter 11 of this manual.6.4.2 Step 2: Explore, analyze and implement tools to expedite cash collectionEffective cash management involves speeding up the billing and collection process for fast movement ofcash. If cash collection can be improved, there is an opportunity to increase the cash inflow and enhancethe potential for greater earnings on the investments. There can be a number of tools and strategies toensure an efficient and effective accounts receivable/ collection practice by meeting one or a combinationof the following goals:• increased levels of customer service• reductions in costs -91-
  • 92. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• increased investment opportunitiesThese tools and strategies are discussed in the following text.6.4.2.1 Direct DebitDirect Debit is a facility that allows a consumer to pay user charges to a ULB directly through its bankaccount, without involving any cash transaction. To use this facility, a consumer needs to provideauthorization to a ULB to enable transfer of funds from the consumer’s bank account to the ULB’s bankaccount. This approach has the advantage of reduced processing costs.Direct debit has been successfully implemented in numerous ULBs in India.6.4.2.2 Integrated Voice ResponseThis system combines use of human operators and a computer-based system to allow customers tomake payments over the phone, generally using a credit card. This system has been proven highlysuccessful where a large number of payments are processed regularly.6.4.2.3 Drop boxesDrop box service provider (either banks or other vendors) deploy equipments that convert manual tasks— mail opening, reading of checks, reading of remittances into automated functions. In these cases, thebank typically collects the cheques and deposits them directly into the ULBs account, making the moneyavailable more quickly than through traditional mail-in practices.Before adopting this approach, a cost-benefit analysis must be conducted. Using a drop box for thecollection of property taxes and water bills is one of the best remedies to eliminate untimely payment ofULB charges by consumers.6.4.2.4 Electronic Funds Transfers (EFT)EFT provides quicker, less costly, and more secure means of moving funds from one account to anothercompared to cheques or other instruments that have to move through the traditional postal system.Receiving major revenues via EFT could cut down on the collection and deposit time for a ULB.Cost-benefit of electronic payments should consider:1. Experience with fraudulent or returned cheques2. Administrative and processing costs3. Information technology resources and capabilities of the jurisdictionULBs should implement the following safeguards in EFT:• Strong internal and data processing controls on all programs and data files associated with banking information of vendors and employees to ensure privacy and prevent unauthorized use -92-
  • 93. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Network security to protect data files from internal and external threats• Written agreements establishing procedures and risk exposure• Establishment and use of passwords for authorized personnel to initiate transactions• Call-back procedures to verify transactions• Confirmations of transactions from financial institutions• Establishment and use of adequate controls against unauthorized automatic clearing house debits, such as blocks and filters6.4.2.5 Changing Billing CyclesBy changing billing cycles for various user charges such as property taxes or water/ sewer bills, a ULBcould improve the flow of funds. Also, internal processes should be evaluated in terms of the time it takesfrom the time a meter reading is done to the billing of users. By shortening the time period betweenreading water meters and mailing the bills, receipt of funds can be expedited. This would require a reviewof internal procedures and practices. The analysis should address whether the period between readingand billing is reasonable. If not, there may be opportunities to improve the timing of the flow of funds tothe municipality.It is recommended that a cost analysis from the city’s perspective be undertaken to determine the mostappropriate reading/ billing cycle. In doing so, customer preferences should also be considered. Changesto the billing/ reading cycle may not only increase customer satisfaction but also increase interestearnings for the city (net of additional expenses). A Council approved policy should be put in place toestablish the reading/ billing cycle.There are further opportunities to review the actual cycle of billing for water/ sewer as well as propertytaxes as the shorter the cycle the quicker the municipality receives the funds. Municipalities shouldundertake the following analysis:• Review the billing cycles to determine reasonable time period between meter readings and billings• Review the frequency of billings (e.g., bill customers quarterly or bi-monthly instead of semi-annually)• Review the above-mentioned point carefully to determine if increasing the billing frequencies is cost effective. This will require a cost-benefit analysis to compare the cost of additional readings and billings to increased interest earnings by receiving funds earlier• Review current office staffing level/ duties6.4.2.6 Using penalties or offering cash discountsIn order to encourage payment, interest charges can be used on overdue accounts. Currently, ULBs inMP provide for discounts and penalties on property taxes only. -93-
  • 94. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh6.4.2.7 Credit cardsCredit card acceptance as a payment method has become virtually universal within the private sector,and it is gradually being accepted by ULBs for payment of user charges. There are advantages anddisadvantages of accepting credit cards, which ULBs need to weigh when deciding whether to accept thisform of payment.A ULB needs to assess the following before using credit cards as a method of payment:• Evaluate whether acceptance of credit cards as a payment option is reasonable and appropriate for the type of charge or fee being paid and the customer service level desired• Merchant discount fees: Costs charged by the credit card issuer per transaction typically vary between one and three percent of the value of the transaction. ULBs should negotiate the lowest possible fee to minimize the financial impact to the ULB• Type of payment: Acceptance of credit cards as a method of payment for mandatory charges may not significantly increase the amount of revenues as a result of paying the merchant discount fee• Acceptance of credit cards as a method of payment for discretionary charges and absorption or payment of related merchant discount fees may facilitate collection of such charges• Administrative costs: The costs of equipment and the associated personnel necessary to process credit card transactions6.4.3 Step 3: Developing tools for disbursementsDisbursements represent the outflow of funds in the form of cheques issued and payments made.Delaying cash outflows enables an organization to optimize earnings on available funds. Ideally, cashshould be disbursed only when absolutely required and at the last possible moment. While this practiceshould be carried out in a manner that avoids fines for late payment and minimizes poor vendor relations,efforts should be made to hold or delay payments.Effective disbursements require that accounts payable be well-managed. The timing of disbursements isan important decision that has implications on the liquidity position of the ULB.6.4.3.1 Electronics Funds Transfer (EFT)EFT could be used to delay disbursements on the same manner that it can be used to speed-upcollections. This can maximize the time for which money can be used by the ULB by reducing the floattime. This provides the ability to set a definite timeframe upon which funds can be maintained ininvestments, rather than having to rely on estimates on when payments would clear through cheques.For example, by transferring debt service funds on the day of payment, the ULB can hold the funds for aslong as the due date. This provides for immediate transfer of funds, which allows cash managers to retainfunds longer and still make major payments, like debt service, on the due date. This ability requiresadditional necessary safeguards. -94-
  • 95. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshEFT could be ‘repetitive’ (debt service, tax payments, etc.) or, non-repetitive for unique payments(purchase of an investment for example).ULBs should evaluate opportunities to make and receive EFT in the following areas:• Payroll• Expense reimbursements• Vendor payments• Inter-governmental payments6.4.3.2 Purchasing card programmesThe purpose of a purchasing card programme is to provide an efficient, cost-effective method ofpurchasing and paying for small value as well as high volume, repetitive purchases. This programme isdesigned as an alternative to the traditional purchasing process and can result in a significant reduction inthe volume of purchase orders, invoices and cheques processed.Advantages of purchasing card programmes• Convenience of purchasing without purchase orders• Reduced paperwork• Can result in a significant reduction in volume of purchase orders, invoices and cheques processed• Provides increased management information on purchasing histories6.4.4 Step 4: Monitoring collections and disbursementsTo enhance the efficiency of cash management, collections and disbursements must be properlymonitored. In this respect, the following measures are useful.6.4.4.1 Prompt billingOften there is a time lag between dispatch of goods or provision of service and the sending of bills. Incase of ULBs there is always a time lag between the provision of service and the sending of bills. Bypreparing and sending the bills promptly, a ULB can ensure earlier collection of receivables. It should berealised that there is sizeable opportunity to free up cash in the area of billing if the ULB observes greatercontrol on it. To tap this opportunity, the finance and accounts department must accelerate invoice data,mail bills properly and identify payment locations clearly.6.4.4.2 Expeditious collection of chequesAn important aspect of efficient cash management is to process the cheques very promptly. Yet manyULBs deposit cheques received by them with some delay. This causes locking of cash for a certain -95-
  • 96. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshperiod. It is imperative for the ULB to ensure quick handling of cheques and making arrangements withthe banks to cut down the delay in conversion of cheques into cash.6.4.4.3 Control of payablesBy controling its payables, a ULB can conserve its cash resources.This involves following two key steps:• Payment should be made only as and when it falls due• Arrangement may be made with suppliers to set due dates of their bills to match with ULBs period of peak receipts. Synchronization of cash out flows and inflows would help a ULB to get greater mileage from its cash resources6.4.4.4 Paying the floatWhen an ULB issues a cheque, it reduces the balance in its books. The balance in the bank books,however, is not reduced till the payment is made by the bank. The amount of cheques issued by the ULBbut not paid for by bank is referred to as the ‘payment float’.Now, consider what happens when a ULB receives a cheque and deposit it with its bank. The ULBincreases the balance in its books but the balance is banks books are not increased until the cheque iscleared. The amount of cheques deposited by the ULB in the bank but not cleared is referred to as thecollection float.The difference between the payment float and collection float is referred to as the net float .When the netfloat is positive, the balance in the books of the bank is higher then the balance in the books of the ULB.When the net float is negative the balance in the books of the bank is less than balance in the books ofthe ULB.As long as the books of the bank show a positive balance, a negative cash balance in the books of ULBmay not be viewed with alarm. So, if a ULB enjoys a positive net float, it may issue cheques even if itmeans having an overdrawn bank account in books. Such an action is referred to as ‘playing the float’and is considered risky. However, within limits, a ULB could play the float reasonably safely and gethigher mileage from its cash resources.6.4.5 Step 5: Investment of surplus fundsULBs often have surplus funds for short period of time, before they are required for capital expenditures,loan repayment or some other purpose. These funds may be deployed in variety of ways. One mostcommon way to make a short-term investment is the term deposit in a bank, which is virtually a risk-freeinvestment.It may be possible; however, to view the investment scenario so that avenues can be looked up. Thelegal aspects have to be considered before a municipal body can invest its funds in any kind of securities. -96-
  • 97. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh7 DEBT MANAGEMENTThis chapter of the manual examines how debt management is developed and implemented. We willprovide definitions of debt management and other related terms. We will also review the benefits ofinstituting a debt management program, identify policies that should be developed, and discuss the legalenvironment surrounding the use of debt. The chapter will address types of financing, methods forselecting credit instruments and the mechanics for obtaining financing. It will also discuss the legal issuesgoverning retirement of debt and assessment of borrowing capacity of a ULB.7.1 ConceptsOne major responsibility of the ULB is making decisions about borrowing money. It may borrow for shortperiods of time when there is not enough cash to meet current expenses, or for long periods of time,typically to finance capital investments such as a land purchase, engineering design, utility relocation,construction, or purchase of equipment that has a long useful life. Long-term debt places a claim againstfuture governmental revenues or assets that may reach far into the future.Debt management is the process of directing and controlling the acquisition and retirement of debt. Debtservice is the cost of principal and interest on borrowed money for a given year or series of years,according to a predetermined payment schedule. For ease of reading, we will use the term “debt service”to refer generically to all types of payments, whether for a bank loan, central government loan, and localgovernment bond or lease agreement. Debt service payments are the sum of interest and principal ofbonds scheduled to mature in a given year.7.1.1 BenefitsAn effective debt management programme helps preserve the local ULBs long-term fiscal viability. Hereare specific ways debt management can benefit a ULB• Establishes parameters that limit the power to borrow money and avoid potential abuses.• Provides a way to finance capital investments within the city’s capacity to repay the loans.• Establishes sound debt management practices that support creditworthiness.• Saves money on interest charges by selecting appropriate debt instruments and structures.• Improves the image of local government in the eyes of the business community and taxpayers for being fiscally responsible. -97-
  • 98. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh7.2 Good practices of debt management1. ULB should set-up debt management policies: Debt management policies should be comprehensively documented and reviewed at least annually and revised as necessary.2. ULB should set policies that prescribe the threshold limit for borrowing new debt: In funding capital projects through debt, the debt service expense (interst cost of debt) becomes a fixed cost in the revenue budget of a ULB. This debt service expense, if excessive, can limit future financial sustainability. The amount of debt that is viewed as affordable should be the cornerstone of a ULB’s debt policy. For instance, a ULB could set a guideline that the ULB must have a benchmark Debt 5 Service Coverage Ratio of 2 or above for the entire loan repayment period to ensure that the operating surplus is enough to cover the debt payments (interest+ principal).3. Capital planning should be linked to debt planning: Good debt management of a ULB is dependent on a well-formulated capital planning process. Therefore, a ULB should link capital planning with debt decisions and operating budget.4. Assessment of borrowing capacity before new debt: As a policy, a ULB should assess its borrowing capacity using specific parameters before borrowing additional debt. Debt Service Coverage Ratio is a good indicator to assess the borrowing capacity of a ULB.5. Review of parameters that limit the borrowing power: Parameters that limit the borrowing power of a ULB should be regularly reviewed.6. ULB considering the issuance of taxable debt should develop a thorough understanding of the differences between the tax exempt and taxable markets before proceeding with a planned sale.7.3 Policies7.3.1 Short-term borrowingShort-term borrowing shall be repaid before the end of a year from the date of such borrowing. In effect, aMunicipal Corporation shall retire short-term debt within a maximum period of 12 months.7.3.2 Fiscal prudence1. A Municipal Corporation shall not use long-term debt for payment of current expenses.2. Total debt charges (interest payment) of a Municipal Corporation shall not exceed [15%] of the Corporation’s total operating revenues.3. Total debt service (interest and loan repayment) of a Municipal Corporation shall not exceed [30%] of the Corporation’s total operating revenues.5 Debt Service Coverage Ratio implies the amount of cash available to meet annual interest and principal payments on debt. It iscalculated as Operating Surplus/ Total Debt Service. -98-
  • 99. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh4. For taking any new debt, each Municipal Corporation shall ensure that the Debt Service Coverage Ratio of the Corporation is equal to or above [2] for the entire loan repayment period to ensure that the operating surplus is enough to cover the debt payments (interest + principal).7.3.3 Procurement of loansA Municipal Corporation shall only go for loan that is most economical in overall terms, after conductingthorough analysis of different options available. Also, such analysis of various options preceding theborrowing decision shall be recorded by the Municipal Corporation for future review.7.3.4 Legal provisionsFormulation of debt policy must comply with all legal requirements. Discussed below are the relevantsections of the acts governing ULBs in MP, which should be taken into account.7.3.4.1 Madhya Pradesh Municipal Corporation Act, 19561. As per Section 102, the corporation has power to borrow money for works specified under this act by issue of debentures or security of immovable property vested in the corporation or security of any taxes, duties, tolls, cesses, fees authorized by this act.2. As per section 103, the corporation has power to open credit or cash accounts with banks.3. Section 104 provides that sums payable under this act shall not at any time exceed together with the balances of all the outstanding loans and debts due by the corporation ,double the annual value of lands and buildings in the city4. Section 113 provides that every loan raise by the corporation shall be repaid within the time approved by payment from a sinking fund, equal payments of principal and interest or by equal payments of principal5. Section 123 provides that the Commissioner shall prepare an annual statement at the end of each year showing the amount and due of borrowing of loans, annual loan charges, details regarding loan repaid during the year ,particulars of securities in which the sinking fund have been established.7.3.4.2 Madhya Pradesh Municipalities Borrowing of Money Rules, 19741. Section 3 allows the corporation to borrow money from the state government or with the sanction of state government from other sources for any of the purposes enumerated in the act2. Section 10 provides for conductions such as a. The term of the loan should not exceed 20 years unless the state government fixes a longer period b. The rate of interest payable on the loan is such as the state government may determine c. Interest shall be charged yearly or half yearly as the state government may determine. d. State government may lay a penal interest not exceeding 2.5% above the normal rate. It shall be paid on all overdue instalments of the principal and interest. -99-
  • 100. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh3. Section 11 provides that in case of non-government loans, following conditions should be fulfilled a. The term of loan doesn’t exceed fifteen years unless the state government agrees for a longer period b. The rate of interest is note more than that approved by the state government c. The municipal council submits it annual estimates of income and expenditure during the period of its indebtedness for confirmation by the state government4. Section 15 requires the Municipal Council to take consent of the state government to repay the whole or any part of a loan in advance of the period fixed by the conditions of the loan.7.4 ProceduresDebt management process starts with the assessment of borrowing capacity of the ULB and then definingthe length/ need of a debt followed by identifying the sources for procuring the debt. The governingfactors for this would be the legal provisions discussed above (section 7.3.4). Post this, are the rulesgoverning the retirement of debt.7.4.1 Step 1: Borrowing capacity of ULBPrior to taking a new debt on its books, a ULB should assess its borrowing capacity. The DSCR ratio,which basically assesses the amount of cash available to meet annual interest and principal payments ondebt, is a good indicator to evaluate the borrowing capacity of an entity.It should be noted that while calculating the future operating surplus for working out future years’ DSCR,the operation and maintenance cost of increased infrastructure should be taken into account.7.4.2 Step 2: Deciding length of debt (Short-term/ long-term)Length of a debt can be identified based upon the maturity date. Short-term debt consists of a maturity ofone year or less after the date of issue of such debt. It includes direct bank loans and debt issued throughcredit markets. Long-term debt is for a specific project with a specific duration greater than one year fromthe date of issue.7.4.2.1 Short-term debtShort-term debt can be used as a cash management tool to meet daily, weekly or monthly expenditurerequirements. It enables a ULB to pay bills, employee expenses, etc., when revenue flows lag. Short-termobligations for current expenses should not be allowed to become long-term debt through annual “rollingover” into the next fiscal year. ULBs in MP should resort to short-term debt in case of any revenue lag formeeting their current expenses.Sources of short-term financingA direct bank loan is usually the simplest and easiest way to meet short-term debt needs. Bank loansprovide flexibility in choosing the time at which money is to be drawn and repaid. Commitments can be -100-
  • 101. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshsecured to advance monies on a schedule. If circumstances change, the terms ordinarily can be re-negotiated. Additionally, bank loans usually do not involve “cost of issuance” as is the case with bonds ornotes sold in the credit market.When and how much to borrowA ULB looking to borrow a short-term debt should consider two questions: when and how much? Thesedecisions rest on an assessment of current circumstances, projected needs, and the opportunity forarbitrage. The following steps could be followed by ULBs to answer these questions.• Step 1: Prepare a cash flow budget: A cash flow budget determines the cash needs for the budget year. It shows all anticipated revenues and disbursements for a period of time—usually one year. A ULB should carefully examine each major revenue source and disbursement category on a monthly or weekly basis using at least three years of actual historical experience to construct the cash budget. It identifies when a deficit cash flow occurs and the estimated amounts of cash necessary to correct the situation.• Step 2: Analyze and modify: Analyze the cash budget and modify it. The original projection produces a one-year forecast of revenues and disbursements; but, it is based on historical averages, which smooth out year-to-year variations. However, significant variations can be expected in anyone year. A ULB should anticipate yearly variations and build in some flexibility by using conservative revenue estimates and liberal disbursement patterns. Also, it should provide a reserve element to avoid returning to the bank or credit market for additional funds. Going back is likely to produce an adverse impact on the ULB’s credibility• Step 3: Develop a plan: Take the modified cash budget and develop a plan to create flexibility in disbursements. The crudest form of flexibility is to simply delay payment to vendors. However, this is usually short sighted and costly. It costs the city its reputation to pay suppliers/ contractors late, reduces the number of vendors willing to do business with the city, and those that do, raise prices to take delays into account. Look at each type of disbursement and identify any that can be delayed without incurring penalties.• Step 4: Determine how much to borrow and the potential for arbitrage: Arbitrage is the profit derived from the more or less simultaneous purchase of a security in one credit market and the sale of a security in a different market. In this case, arbitrage means the borrowing money from the bank at one rate and investing the proceeds temporarily at a higher rate. A ULB should consider the following two approaches. Borrow money based on the cash flow budget schedule. The bank advances loans and are repaid as promptly as cash flow permits. This minimizes the amount of short-term debt outstanding and pays the smallest amount of interest. Borrow the total amount needed to cover the projected deficits and reserve for the entire year. A portion of the money can be invested for longer periods and, therefore, is able to earn interest. The earned interest can be used to reduce the total cost of the transaction. If the re-investment interest rate is higher than the loan rate, a profit can be earned. -101-
  • 102. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh7.4.2.2 Long-term financingLong-term debt consists of a maturity of more than one year after the date of issuance. It is one of thebest ways of financing capital improvements. It helps in the following:1. Creates a possibly self supporting enterprise – a capital improvement built with the proceeds from long-term debt can produce revenues by selling its services. It may provide sufficient revenues to pay for operation and maintenance expenses, debt service and additional capital facilities.2. Speeds up construction of facilities - funds are immediately available, capital investments can be completed faster than if they were dependent upon operating budget surpluses.3. Shares the cost of the capital investment between current and future users – by repaying over the useful life of a capital facility, the cost is shared by all the users or beneficiaries during its useful life.Sources of long term debt financingLong-term debt financing can be obtained from a variety of sources. These include commercial banks andsavings institutions, government and international development organizations, local government bondsand lease financing.1. Commercial banks and saving institutions are a common source of financing for capital improvements. These institutions serve as a readily available source of funds because they are located in the community. Usually, they have an established relationship with the ULB by providing traditional banking services. Although the specific terms of a bank loan would vary depending upon a ULB’s financial circumstances, certain generalizations can be made. a. Term: Commercial banks offer loans that are usually shorter than other loans, having a maturity of 2-5 years. It should be noted that foreign banks and other loan institutions may provide longer term maturity. The term of loan would be determined by the bank based on the purpose of the loan and bank policy. As a general rule, loans that finance capital facilities or equipment should never exceed the life of the asset financed. b. Interest Rate: The bank sets the interest rate on loans based on current market rates, length of debt, collateral or security for the loan, and creditworthiness of the borrower. Interest rates on bank loans can be fixed or floating. A fixed interest rate is set at the time the loan is approved and reflects financial market conditions at that time. It remains in effect during the entire term of the loan. A floating interest rate moves with market interest rates and represents a specific percentage above the general level of interest rate. In choosing between fixed or floating rates, the ULB must make a judgment on the future direction of interest rates. A fixed interest rate is considered advantageous if interest rates are rising since it locks in a specific rate and protects from continuing rising rates. A floating rate is more advantageous in a declining interest rate environment where the periodic resetting of the interest rate produces lower interest costs with each adjustment and hopefully a lower rate. c. Structure: The bank establishes the loan structure and determines how quickly the principal is repaid. Generally, they require monthly or quarterly repayments of principal and interest in equal instalments for the term of the loan, which is normally referred to as the annuity method. In this method, the principal amount paid increases in each instalment while the interest amount paid -102-
  • 103. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh decreases in each instalment. The result is a level or even payment throughout the loan period. There are other variations of structure, but these are used more typically with municipal bonds. d. Guarantees or collateral: Bank loans normally are secured by ULB property or by a pledge of future revenues. There are four standard types of guarantees or collateral: i. A guarantee of ULB property, e.g., real estate ii. A pledge of proportionate taxes or subsidy from the state budget. The ULB pledges these taxes or subsidy for the loan payment and establishes a dedicated amortization fund for the sole purpose of receiving the revenues and repaying the principal and interest iii. A guarantee by future ULB revenues. This method allows the bank or creditor to have local taxes or other ULB revenues credited to its account at the time of their collection iv. Cash deposit or securities2. Government and International Development Programme Loans offer financing to support specific programs such as environmental protection or local government housing development. As a result, their appeal will be limited to communities that have specific need and can meet the loan requirements. These organizations require a completed loan application to be considered. There is no guarantee that the loan would be approved since the loan process is often very competitive and only the most deserving are approved. The terms, conditions and application process of loans from international development programs tend to be quite complex and lengthy. These are usually issued as sub-loans, with the state government as the main borrower. The funds are then on-lent to ULBs or their enterprises, usually through an intermediary. a. Term: Governments and international development organisations offer loans for longer terms than bank loans. Given that international development agency loans are based on long-term funds, the length of the primary loan (20-30 years) and the sub-loans (often 10-15 years) are more adapted to ULB needs. The length of the loan is often tied to the useful life of the asset. b. Interest Rate: Rates are typically based on the government’s ability to borrow money. Other elements of interest rates are the cost of the source of funds, the on-lending policy (for loan fees and mark-ups) of the international institution. Usually, this means that rates are below commercial bank rates. Fixed interest rates are common and are set based on a relationship to government interest rates. c. Structure: There is considerable latitude to create attractive loans that range from traditional loans at market rates called “hard loans” to more flexible loans called “soft loans.” Soft loans may be offered at lower interest rates, deferred repayment, exceptional length or a combination of these terms. Soft loans are usually designed for specific purposes or to make the loan affordable to the borrower. Other elements of interest rates are the cost of the source of funds, the on- lending policy (for loan fees and mark-ups) of the international institution. d. Guarantees or Collateral: Both types of loans require that the local government provide a guarantee or provide collateral to repay the loan or equipment being financed. Often such loans will take a second position behind bank loans or local government bonds.3. Local government bonds are another source of financing that can be tapped for capital improvement projects. -103-
  • 104. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh a. Interest Rate: ULB bond interest rates reflect current financial market conditions, the term and structure of the bond being issued and the creditworthiness of the local government. For these reasons, interest rates tend to be lower than rates for private bank loans. ULBs also can choose to issue fixed or floating rate bonds with the same dilemma discussed in a commercial bank loan determining the future direction of interest rates. b. Structure: In preparing to issue bonds, the accounts officer should take a lead role in structuring the issue to meet the ULBs financing needs. Working with the city’s financial advisor or bank and ULB officials, the accounts officer, should consider the following in developing the local government bond structure: i. capacity of the city to assume new debt; ii. current laws and debt policies; iii. useful life of the investments being financed; and iv. demand for local government bonds.4. Lease Financing a. True Lease: An arrangement in which the lessee (i.e., a ULB) acquires use, but not ownership, of leased property, and the lease term is shorter than the asset’s useful life. Depending upon tax laws, there may be benefits, such as depreciation, to the lessor of retaining ownership. Offsetting these potential benefits, the lessor usually must pay income taxes on the full amount of the lease rental payments. b. Lease Purchase Agreement: These agreements are called leases but are, in substance, purchases for which payments are made over time. The lessee typically acquires use of the leased property from the start of the lease term and the lease typically specifies a date on which title to the property changes hands. The payments established in the lease agreement are divided into principal and interest. If the lessee is a local government, the interest portion may receive favourable tax treatment depending upon income tax law. Lessors, on the other hand, charge a higher interest rate than for a guaranteed contract term and include a non-substitution clause that states the lessee cannot lease or purchase replacement equipment within a specified time. c. Finance Lease: A financing device in which the lessor is a bank, another financial institution or an investor. The ULB requires use of the leased asset over a major portion but not the entire useful life. The lessee is responsible for the costs of operation and maintenance, taxes and insurance. The lease term and payments generally are structured to recoup the lessor’s investment to purchase the leased property and provide a satisfactory return on investment. Broadly conceived, a finance lease may be a true lease or a lease-purchase agreement. As the term “finance lease” is commonly used, it refers to a type of true lease. d. Sale-lease Back: An arrangement in which the owner of property (e.g., ULB) sells a property to a financial institution or an investor and simultaneously executes an agreement to lease the property back from the buyer. If a sale-lease back is structured as a true lease, the seller/ lessee may be able to transfer the tax benefits of ownership to the buyer/ lessor in return for favourable or low lease payments. If a sale-lease back is structured as a lease purchase, the arrangement may qualify as a ULB lease enabling the buyer-lessor to obtain ULB interest and to pay tax at -104-
  • 105. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh reduced rates. Of course, these transactions need to be reviewed by legal counsel to determine the tax benefits that accrue, if any.Table 15: Decision matrix for choosing among long-term financing alternatives -105-
  • 106. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh7.4.3 Step 3: Retirement of debtAs per Section 113 of the Madhya Pradesh Municipal Corporation Act, 1956, every loan raised by aMunicipal Corporation shall be repaid within the time approved and by any of the following methods:• By payment from sinking fund established under Section 114 of the Madhya Pradesh Municipal Corporation Act, 1956, in respect of the loan• By equal payments of principal and interest• By equal payments of principal• From any sum borrowed under Section 102 of the Madhya Pradesh Municipal Corporation Act, 1956• Partly from the sinking fund established under Section 114 of the Madhya Pradesh Municipal Corporation Act, 1956 in respect of the loan and partly from the money borrowed for the purpose under provisio (iii) to subsection (1) of Section 102 of the Madhya Pradesh Municipal Corporation Act, 1956Municipal Corporations should follow any of these methods for retirement of their debt. Other sections asprescribed in Chapter IX of the Madhya Pradesh Municiapl Corporation Act, 1956 should be adhered tofor retirement of debt.7.5 Case Study: Debt management strategy of Vadodara Municiapal CorporationVadodara Municiapl Corporation in the past has carried out an exercise and restructured or repaid someof its high cost debt by raising low cost debt to bring down its overall cost of debt stock. VadodaraMunicipal Corporation has, along with Surat Municipal Corporation exhibited to the other Municipal bodiesof India, how to raise loans at minimum possible cost by weighting each source against each other and bytaking judicious decisions about right kind of loan source.Building on this experience, Vadodara Municipal Corporation repaid its high cost term loans of HUDCOand Government of Gujarat to bring down total cost of its debt stock. This innovation is not limited toraising low cost loans from market and to repay existing high cost loans. Along with this innovation,Vadodara Municipal Corporation achieved another path breaking innovation of using its internal sourcesof funds to finance or to restructure high cost loans. Enthused with the successful refinancing of high-costdebt by low cost debt from internal funds VMC went for restructuring/ refinancing of its moderately pricedcommercial bank loans through market-based operation. -106-
  • 107. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh8 ASSET MANAGEMENTAsset management is defined as the systematic process of long term maintainence of assets, with theobjective of bringing out the the best results from the assets. This chapter details out the need for anasset management plan, activities involved in the asset management process, pre-requisites of assetmanagement and levels of asset management. Further it also discusses the procedure for assetclassification.8.1 Concepts8.1.1 Need for an asset management planAn Asset Management Plan (AMP) is necessary for efficient utilisation of scare resources. Resources arelimited and more so in case of ULBs. Inefficient assets or infrastructure management means inefficientuse of scarce resources, which places great burden on municipal finances. It results into diversion ofresources that could have gone for more urgent services like education, health, sanitation, etc. Thusstrategic Asset Management is must for three reasons discussed below.1. To bring better clarity, efficiency and purpose in resource utilisation, which leads to resource saving that is resource generation. A rupee saved is a rupee generated.2. To sustain assets/ infrastructure in right condition till the end of its life to achieve their full potential utilisation. This in turn reduces investment needs as existing assets can serve more a longer period of time.3. To avoid unnecessary expenditure taking place under the name of maintenance of assets.8.1.2 Activities for formulation of AMPThe following activities are to be undertaken for effective formulation of an AMP.• Consultation with different stakeholders to define service delivery and performance goals and objectives• Review of existing level of service and performance standards• Plan for future assets/ infrastructure requirements after reviewing the adequacy of current assets portfolio in the light of growth projections and service delivery goals and objectives decided earlier through consultation• Prepare and maintain asset registers and performance information• Continuous assessment and evaluation of asset management options to ensure that optimal operations, maintenance, renewal, acquisition and disposal decisions are made, taking into account both economic and social objectives -107-
  • 108. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Accounting for the assets in such a way that the true cost of the service provided can be calculated and future asset maintenance vis-a-vis investment needs required to maintain desired service potential of the asset can be determined• Auditing asset performance (the practice, procedures and systems used to make asset management decisions) and continuously monitoring and improving these asset management processes to ensure improvement8.1.3 Pre-requisites of asset managementFollowing are the prerequisites of comprehensive and efficient asset management:1. Knowledge of the service levels required by the customers including knowledge about customers’ willingness to pay2. Ability to predict future demands for services to predict its impact on the asset and the need for future investment3. Knowledge of ownership of existing assets – a situation at city level is complex, asset in public use may be belonging to central or state government or to a trust or even to a private party4. Knowledge of existing physical condition of assets to know renewal liabilities, risks and management requirements5. Knowledge of existing level of asset performance and reliability – knowledge about the types of failure, number of customers affected and the degree to which the failures affect the target level of service6. Knowledge of assets utilisation and capacity – to avoid over or under investment in infrastructure assets and inefficient use of scarce resources7. Ability to predict failure mode and estimated time of failure of assets – information about assets failure modes in the past and its frequency. The asset failure modes include: a. Structural/ condition failure b. Capacity failure c. Obsolescence d. Economic failure e. Performance failure f. Operator error8. Ability to estimate willingness to pay and satisfaction of customers – to know pay back period of investment and to know availability of financial resources9. Ability to analyse alternative technological options – available to mitigate various types of the asset failure -108-
  • 109. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh10. Ability to rank works/ options on basis of economic analysis – involves decisions as to how and when assets should be maintained and renewed at different stages during their life. While assessing any option following aspects must be considered: a. The capital investment and timings b. The recurrent operating and maintenance expenditure c. The tangible and intangible benefits of each option d. The effectiveness of different technology options e. The impact on the levels of services delivered by the asset11. Ability to prioritize work in the context of availability of budget – framework to assign financial resources to asset management activities12. Ability to revise and develop alternative service delivery and performance objectives for assets – all assets must have clearly identified objectives and performance measures13. Ability to optimise operations and maintenance of assets – optimal blend of planned and unplanned maintenance activities to minimise O&M costs without compromising effectiveness and objectives8.2 Good practices of asset management1. ULB should record and review past experience of capital assets: The best source of relevant information on the estimated useful lives of ULBs capital assets normally is its own past experience with similar assets. In situations where the documentation of ULB’s own past experience for a given type of capital asset is not adequate for this purpose, a government should profit as much as possible from the experience of other ULBs.2. Inventorise capital assets: Every ULB should periodically inventorise its tangible capital assets so that all such assets are accounted for, at least on a test basis, no less often than once every five years.3. Prepase an Asset Management Plan: An Asset Management Plan is necessary for efficient utilisation of scarce resources.4. Review of capital assets: A ULB should conduct regular review of existing assets for future planning of assets/ infrastructure requirements.5. ULBs contemplating the sale or securitization of properties undertake a careful analysis of benefits and risks both in the current fiscal year and over the long-term.6. Asset Management Plan forms foundation for preparation annual operating budget.8.3 Policies8.3.1 Asset management planEach Municipal Corporation shall prepare an annual Asset Management Plan after conducting an annualinventory of all assets. Both the operating and capital budgets of the Municipal Corporation shall be -109-
  • 110. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshclosely linked to the Asset Management Plan. For this purpose, the Asset Management Plan of theCorporation shall clearly state detailed workings of the funds required for the operations and maintenanceof the existing and future assets of the Corporation, the funds required to replace existing assets and thereceipts (operating & capital) that can be generated from the assets of the Corporation.Disclosure of an Asset Management Plan – Each ULB shall disclose an Asset Management Planprepared as a part of Annual Budget. Such document should clearly state Asset Management Plan andstrategies proposed for the Budget Year and also should state Asset Management Actions undertaken,results achieved or failures in the year completed and in the months completed of the current year.Audit of an Asset Management Plan - An Asset Management Plan prepared by the ULB shall be subjectto audit by the agency appointed for the audit of accounts of the ULB ,8.3.2 Sale of assetsEach Municipal Corporation shall solicit competitive bids for all sales of property valued in excess of amonetary value prescribed in the MP Municipal Finance and Accounts Rules.8.4 ProceduresFor effective asset management, the most important task is to prepare an asset management plan. Postthe preparation of an AMP, it is equally important to understand its output vis-à-vis other financialmanagement systems and then using AMP output for financial decision making. The important point tonote here is that both the tasks are not independent of each other.8.4.1 Task 1: Preparation of Asset Management PlanThe first task involves preparation of an AMP. It is a long-term strategic plan for managing ULBs goalsand objectives. It has to be prepared for specific services provided by a ULB, e.g., water supply, roads,sewerage, etc. An AMP must be prepared with linkage to the strategic goals of the ULB. Following stepsare involved in the preparation of an AMP.8.4.1.1 Step 1: Recording the assetsThe first step involved in the preparation of an AMP deals with recording all the information related toassets. All fixed assets (immovable or movable) owned by the ULB or otherwise vested in it or held by itin trust shall be recorded in the registers in the format and in a manner as prescribed in Madhya PradeshMunicipal Accounts Manual for double entry accrual based accounting system. A list of registers forrecording of fixed assets is given below.1. Land Register2. Building Register3. Statues and Heritage Register4. Roads and Street Register -110-
  • 111. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5. Bridges, Flyover, Subway and Causeway Register6. Drains (including underground drains) Register7. Public Lighting System Register8. Ponds and Lakes Register9. Plant and Machinery Register10. Vehicle Register11. Office Equipment Register12. Furniture and Fixtures Register13. Computer and Peripherals Register14. Software RegisterFixed Assets held in trust by the ULB should be clearly identified and separately recorded in therespective fixed asset registers. Each of these registers should be updated on a regular basis by theappointed officer.Although the formats given in the Madhya Pradesh State Accoutning Manual should be used forrecording information on ULB assets, each ULB could also design its own formats as per its assetclassification for the purpose of recording asset related information. An illustrative format for recording aland parcel is shown in Annexure 2.8.4.1.2 Step 2: Inspection of assetsAfter recording all the information related to assets, it is important to conduct inspecton to assess theirexisting situation. For inspection of the existing assets, some of the important parameters to be kept inmind are – description of the asset, location, age, physical dimensions, construction method and type ofmaterials, condition, repair history and costs, proposed date for replacement, replacement costs,operating cost and type and extent of use. Information on these parameters can be obtained fromengineering, architectural, insurance and property records.A committee called ‘Assets Condition Assessment Team’, should be constituted by each ULB and shouldcomprise following members – • Municipal Engineer or City Engineer (engineering head) • Municipal Architect if not available then any municipal engineering staff with architecture background • Elected representative who is member of Public Works Committee or assets committee or ways and means committee or who has engineering background • Engineering expert member/s from local engineering college, other government department or private sector – one with civil, one from architecture and one with structural background. -111-
  • 112. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe following methods should be used to assess the condition of capital assets. It is suggested, however,that a ULB should involve an external agency for conducting these assessments as they are timeconsuming and a continuous process.• Visual Inspection: This method involves inspecting the facilities using industry standards and other criteria. Inspection should be aided by common definitions, checklists, forms, and rating scales. This method is subjective and requires guidelines, training, and careful monitoring.• Engineering Analysis: In this method engineering technology is used for condition assessment. This technology is costly but offers a valuable tool. For example, core samples, infrared and ultra sound equipment are employed to assess bridge conditions. It is an expensive method and can be avoided depending upon the need and capacity of the ULB.• Repair Analysis: This type of analysis involves information on the nature, frequency, and cost of repairs. Repair information also aids in the evaluation of different maintenance and repair strategies.• Complaint and Service Interruption Analysis: Tracking and analyzing complaints and service interruptions is an effective and low-cost method of obtaining condition information. Data on downtime, breaks, leaks, sewer backups, potholes, low water pressure, building problems, street congestion, broken playground equipment and inoperable street lights help to document capital needs and problems.• Service Standard Information: Central government, industry, professional association, and other standards are another useful source of information for determining capital needs. Examples of such standards are hectares or acres of park land per 100 residents, building space standards, and street lighting, water, and wastewater treatment standards.• Citizen Surveys: Citizen surveys are effective in measuring citizen expectations relating to capital needs and methods of paying for them. Surveys are a means of identifying the level of support and opposition to different projects.This inspection will help in identifying the existing status of assets, which will help in identifying the currentsituation of assets.8.4.1.3 Step 3: Level of services and performance standardsThe ULB must define the level of service required to be achieved. It must be in consonance with strategicgoals of the ULB, expectation of the consumers and legal and statutory requirements. Along with level ofservice it is necessary that AMP should identify and provide measurable performance standardsregarding following aspects:• Quantity• Quality• Availability and Reliability• Safety• Economic efficiency -112-
  • 113. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Environmental sustainabilityAfter defining the level of services, it is important to do a comparison of the existing situation (assessed inprevious step) with the defined level of services. This will help in identifying the nature of expenditure(revenue/ capital) required on the asset to match it with current requirement.This will eventually form asan output of AMP and wil be linked to budget.8.4.1.4 Step 4: Growth and Demand ProjectionsIt is a very important stage in development of an AMP because need and utilisation of assets dependupon demand for services and infrastructure assets. Hence demand projections should be made keepingin mind future changes in technology, legal requirements, environmental standards and customerexpectations. These growth and demand projections will result in estimation of asset related expenses fornext 4-5 years.Comparison of existing assets with defined level of services is not enough from the point of view of assetmanagement plan. It is equally important to make demand and growth projections and assess the assetrelated expenses. This will help in identifying the assets that can be completely sold off, requires majorrepairs and requirement of new assets. Finaly, this will form as an output of AMP and direclty linked tobudget.The various ouputs derived from the AMP should be linked to the budget as explained in task 2 below.8.4.2 Task 2: Output from AMP and BudgetMost important aspect of the asset management process is the output derived out of the process and itscorresponding linkage with the budget. These are illustrated in the figure 9 .As shown figure 9, the asset management plan, annual budget and long term capital budget (CIP) aredirectly linked with each other. AMP will provide details about the assets that a ULB should use for ownpurpose and the assets it should rent or lease out or sell out.This aspect of AMP provides following fundamental information for annual and long term budgetformulation:• Projections about income from assets that can be rented or put on lease provide base for the revenue receipts projections of a ULB• Estimated sale amount for assets that are no longer in use or required and can be sold off, forms base for the capital receipts projections• O&M expenditure required to maintain existing assets and is estimated scientifically under AMP, will provide realistic base for the revenue expenditure projections of a ULB• AMP will identify the need for O&M expenditure of any new asset which will result because of the capital expenditure undertaken by a ULB and will provide that information for revenue expenditure projects by a ULB -113-
  • 114. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 9: Relationship between AMP and Budget OUTPUT AMP BUDGET Assets on rent/lease Revenue Receipts Sale of assets Revenue Expenditure 0&M for existing assets Capital Receipts O&M for increased assets Capital Expenditure for existing Capital Expenditure assets Additions to existing stock of City Development Plan/City assets Investment Plan• Lastly, AMP will provide information about capital expenditure required for existing assets. This information is must for preparation of the city development plan and also estimating annual capital expenditure -114-
  • 115. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh9 EXPENDITURE MANAGEMENTExpenditure is very critical for sustaining any operating entity and ULBs are no different. It is veryimportant for any ULB to balance the services they provide with the resources they spend.Expenditure management in Indian ULBs has tended to be a zero sum game. That is because decisionsrelated to expenditure become perpetual and tend to be nonreversible in nature. Consequently, anextravagant hike in a financially good year constrains key expenditure in a tough year.The ULBs’ revenue expenditure can be categorised under three main heads: wages and salaries, O&M,and interest payments. ULBs also need to fund capital expenditure from revenue surpluses, grants andother funding sources. Unfortunately, O&M and capital expenditure have become a residual function ofinternal surpluses and other funding sources and are usually compromised due to financial constraints.At the same time, decisions impacting administrative expenditure too are characterised by a mere primafacie analysis of their long-term impact and are based instead on historical trends and negotiations.ULBs, however, need to take proactive steps to ensure that adequate capital and O&M expenditure isundertaken. This implies taking key expenditure actions only after an in-depth analysis of their impact onthe ULB’s financial and operational health. Therefore, expenditure management is an on-going activity for any ULB, which cannot be taken up as aseparate activity. It forms part of all major financial management systems.The most important aspect of expenditure management is adopting proper budgetary techniques andcontrol mechanism. Budget is the prime tool for expenditure management. (Please refer to Chapter 3 ofthis manual on Budgeting for more details.)However, ULBs can take several pro-active steps to rationalise and optimise their expenditure. These arediscussed below:• Expenditure to be contingent on revenue realization – expenditure and its management can not be independent of revenue and revenue management. Expenditure must be contingent on revenue realization. The Principal Executive Officer and the Head of Accounts of the ULB shall before sanctioning any expenditure ascertain that the ULB has or will have sufficient revenue. For this purpose at the start of new budget (1st April) the Principal Executive Officer will issue order restricting maximum expenditure up to 50% of the each and every budget provision till the further order. Further orders during the year to increase budget spending limit shall be issued by the Principal Executive Officer of the ULB only after sufficient revenue has actually been realised by the ULB so that at the end of year the ULB will not end up in operating deficit in actual terms.• No Expenditure to be incurred with out prior financial approval - Expenditure management inherently involves system of financial control. For attaining the objective of making expenditure contingent on revenue realization and expenditure management the ULB shall adopt a system of financial approval -115-
  • 116. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh before starting procurement process (before administrative approval to the expenditure by competent authority) and then after completion of procurement process but before issuing work order or purchase order. The financial approval at both stages will be given by the Principal Executive Officer on the basis of information input and advice from the Head of the Accounts and no Head of the Department (budget drawing officer) will be authorised to undertake expenditure without prior financial approval.• Avoiding wasteful expenditure in all areas of operation by better financial control and competitive bidding. This basically means that the ULB should plan its expenditure in a way that there is minimum wasteful expenditure. This can be ensured by preparing a cash budget (discussed in Chapter 5 of this manual on Cash Management) and adopting sound procurement policies for competitive bidding.• Redeployment of staff with adequate training thus reducing contractual staff. This is one of the best ways to manage expenditure by redeploying the staff with adequate training and skill sets to reduce dependency on contractual staff.• Competitive bidding of all works and empanelment of contractors. This will result in better pricing of the tender and ensure responsibility of quality of materials supplied. Bidding of all works and tenders should be very competitive in nature and based upon sound procurement policies.• Implementing a costing system (based on various aspects discussed in the Chapter 10 on Costing) that is based on unit rates. Expenditure is well-managed when there is a proper costing system in place.• Classification of expenditure heads so as to reflect the nature of services (whether essential or discretionary), timing of expenses (whether deferrable or non-deferrable) and nature of expenses (salaries, fuel, electricity, contingency, etc.). Deferrable and discretionary type of expenses should only be undertaken in the case of a surplus cash position, except for matters relating to basic health, elementary education and social well being particularly of the poor citizens. Proper classification of expenditure is important to demarcate the nature of services and take decisions accordingly. Also, surplus cash position can be assessed by preparing a cash budget and deferrable expenses can be planned accordingly.• Regular and timely bill payments, which are important for planning and managing expenditure. Tools regarding receivables and payables management are discussed in detail in the chapter 6 on Receivables and Payables Management.• Introducing proper cash and working capital management through preparation of monthly cash budgets would help in estimating the fund requirement, which would then guide the expenditure. For details refer to the chapter 5 on Cash Management.• Encouraging public private partnership, which can be used as a vehicle for expenditure management. Cost sharing schemes could be considered for services such as sanitation and garbage collection.• Undertaking and using energy audit for an expenditure management – a municipal body uses one or another forms of energy (electricity, petrol, diesel, gas etc) to perform its functions. Sources of energy being costly and becoming costly its use involves lot of money. If all types of energy uses put together then 30 to 35 % of its operating budget get spent on energy related expenditure. It is a second -116-
  • 117. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh highest expenditure item after salary of operating expenditure. A decade or more so concept of energy audit made entry in municipal sector essential from environmental conservation aspect but Energy audit should be viewed as tool of expenditure management and should be adopted by each ULB of MP on regular basis to avoid wasteful expenditure resulting from inefficient and wasteful energy usage. Energy audit though requires technical expertise but the underlying concept behind it is simple and should be explained to all working and associated with a ULB. Municipal operations involve various types of machinery which becomes inefficient in energy usage with the passage of time or some times due to selection wrong kind of machinery or contracting wrong kind of energy supply etc. Energy audit essentially helps in identifying inefficient and wasteful energy use and recommending action plan to avoid it. Efficient use of energy brings down need for enery and thus results in savings. The experience over last decade have shown that energy audit has helped municipal bodies to bring down their energy cost. Energy audit may have helped in conservation of energy in environmental terms but it has definitely helped in expenditure management. Implementing energy audit recommendations many a times involve sizeable capital investment. The issue if a ULB is not having adequate funds for operations or capital development how can go for implementation of energy audit recommendation involving capaitla investment. A ULB can solve this issue if there is a real/concrete cost saving by energy audit recommendation in following two ways – • Using potential financial cost saving resulting from energy conservation actions (replacement or refurbishing of pumps) as a loan repayment and interest payment to borrow funds required capital investment to implement energy audit recommendations • Using potential financial cost savings resulting from energy conservation actions (replacement of pumps etc) as an annuity payment to private player who does capital investment and attains energy efficiency, till he recovers his investment with agreed reasonable rate of return. Such kind of efficiency linked saving based contracts have started taking place. It is highly recommended MP ULBs should adot energy audit as a tool of expenditure management.• Undertaking and using water audit for an expenditure management – as explained above regarding an energy audit system, a water audit system to find inefficiency in water usage can help municipal body to improve its efficiency and expenditure management. -117-
  • 118. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh10 COSTING PRACTICESFirst recognition of cost accounting practice came when industries were required to put a value to theinventory in their financial statements. The concept of cost or market value, whichever is lower, wasevolved and is even practiced today. Cost accounting that evolved for manufacturing sector initially, hasgained lot of importance in other sectors including the services sector. Today, cost accounting is beingused, amongst many other things, for management decisions like whether to carry out work in house orcontract out, planning and control of expenditure and fixing selling prices of products or services. It hasbecome an excellent tool for carrying our cost benefit analysis of any activity or project.Presently costing of various services provided by ULBs in India is not done in a scientific manner. Thereis no formal costing system in place in any of the ULBs in India. More often than not, costing of ULBservices is based on the ‘willingness to pay’ of users of the service. This ultimately leads to the situationwhere user charges collected by ULBs for providing services generally do not cover the cost of providingsuch services. The situation of ULBs in MP is not much different from ULBs elsewhere in India.In view of this, it is believed that institutionalising costing system across ULBs in MP would help addressthese issues. As costing is an advanced subject that requires detailed inputs, reforms in accountingsystems, as undertaken under the MPUSP programme, would provide a foundation for institutionalisingcosting systems in ULBs of MP.10.1 Concepts10.1.1 DefinitionsCost is the amount of expenditure incurred (Actual or notional) on or attributable to a specified article,product or activity.Cost Object is anything for which separate measurement of cost is desired. Examples are a product, aservice, a project, a customer, an activity, a department, a programme.Direct Costs are costs that are related to the cost object and can be traced in an economically feasibleway.Indirect Costs are costs that are related to a cost object but cannot be traced to it in an economicallyfeasible way.Standard Cost is a predetermined cost which is calculated from managements expected standard ofefficient operation and the relevant necessary expenditure. IT may be used as a basis for price fixing andfor cost control through variance analysis. -118-
  • 119. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshMarginal Cost is the amount at any given volume of output by which the aggregate costs are changed ifthe volume of output is increased or decreased by one unit.Cost Centre is a location, person or an item of equipment (or group of these), department, service forwhich cost may be ascertained and used for the purpose of cost control.Cost Unit is a unit of product, service or time or combination of these in relation to which costs can bedetermined. Examples are per MLD of water distributed, per square km of road repaired, per lamp postinstalled, per student educated in school, per patient Xrayed in Radiology department, per tap for waterinstalled in slums etc.10.1.2 Costing, cost accounting and cost accountancy definedCosting is defined as the technique and process of ascertaining costs.Cost Accounting is defined as the process of accounting for costs, which begins with the recording ofincome and expenditure or the bases on which they are calculated, and, ends with the preparation ofperiodical statements and reports for ascertaining and controlling costs.Cost Accountancy is defined as the application of costing and cost accounting principles, methods andtechniques to the science, art, and practice of cost control and the ascertainment of profitability. Itincludes the presentation of information derived for the process of managerial decision making.10.1.3 Types of costs10.1.3.1 Direct CostsCosts pertaining to material and labour that can be economically identified with the unit of cost object(finished product) are called as the Direct Material or Direct Labour costs.10.1.3.2 Overheads or the indirect costsDirect costs like direct material cost, direct labour costs and direct expenses can be convenientlyallocated to the cost object. However, the real difficulty lies in allocation of indirect costs over the costobject. For example salaries paid to the security guards of the administrative office or the electricityexpenses of the administrative office are the kinds of costs that are not incurred for any particular activitybut for all activities of organization in general.These indirect costs can be categorised as (i) indirect material costs, (ii) indirect labour costs and (iii)indirect expenses. These costs can not, economically, be identified with a cost object (or finishedproduct).These indirect costs need to be identified and allocated to the cost object (function or department) onsome scientific basis. For example salaries of the staff in the office of the Commissioner or the office ofthe Mayor are incurred for all activities of a Corporation including water distribution, solid waste -119-
  • 120. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshmanagement, electrification of streets, maintenance of sewer lines, etc. It is therefore necessary toapportion or distribute the common costs over these functions.There are various methods by which the overheads can be apportioned over various functions or costobjects (like Water Department, Education Department, etc). These are:1. On the basis of benefit received by them;2. On the basis of ability to pay or contribution made to total revenues; and3. Analysis of existing conditions, for example, number of hours spent on matters of various departments.Of the above, both (1) and (2) are suitable for ULBs as these are easy to calculate.10.1.4 Purpose of costingThe purpose of costing is not simply to collect cost data, but to provide municipal managers and officialswith information they can use to make better management decisions in several areas like:• Analyzing the efficiency of municipal services;• Making budget decisions;• Fixing prices for services and determining intergovernmental charges; and• Choosing among alternative methods of providing services, such as contracting or in house works etc.10.1.5 Objectives of cost accountingThe main objectives of cost accounting are as follows:• Ascertainment of costs of each activity• Determination of selling price• Cost control and cost reduction• Assisting management in decision making.10.1.6 Costing methodsThere are various methods of costing that are widely being used by various organizations. Some of theseare discussed below.• Job Costing – is suitable for organizations that carry out job works, where each job is a separate work process, for e.g., construction of roads. -120-
  • 121. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Contract Costing/ Batch Costing/ Process Costing/ Operation Costing – are costing methods that are suitable for organizations that are engaged in continuous process works or mass manufacture of a single product, for e.g., costing for procurement of water its purification and distribution.• Activity Based Costing (ABC) - is an accounting technique that allows an organization to determine the actual cost associated with each product and service produced by the organization without regard to the organizational structure. It is developed to provide more accurate ways of assigning the costs of indirect and support resources to activities, business processes, products, services, and customers. ABC systems recognize that many organizational resources are required not for physical production of units of product but to provide a broad array of support activities that enable a variety of products and services to be produced for a diverse group of customers. The goal of ABC is not to allocate common costs to products. The goal is to measure and then price out all the resources used for activities that support the production and delivery of products and services to customers. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.10.1.7 Costing as a tool for decision makingA good costing system can be used as an effective tool for decision making by the management of anyorganisation. With the help of a well-designed costing system, crucial decisions of the organisation couldbe taken judiciously. Some of these decisions may include:• Pricing of services or fixing user charges (for e.g., water charges, etc.);• In-sourcing vis-à-vis outsourcing of work (for e.g., collection of property taxes, etc.); and• Run an in-house workshop for vehicles or to send vehicles outside for repairs.10.1.7.1 IllustrationA ULB generates 10,000 property tax bills in a year. A decision has to be taken whether to discontinuethe tax collection department and give the work to an outside agency for INR 12.0/- per demand. Presentcost to the ULB, per demand, is INR 9.5/-. The existing salaries of the ULB include salaries for temporarystaff employed by the tax collection department.Table 16: Illustration on cost savings through outsourcing Cost component Cost in INR Existing cost for maintaining property tax department Expenditure on salaries (including 25% for temporary staff) 75,000.00 Expenditure on Administrative Costs 20,000.00 -121-
  • 122. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Cost component Cost in INR Total cost 95,000.00 Savings if the department is closed down Salary (25% on account of removal of temporary staff) 18,750.00 Administrative costs (100% savings) 20,000.00 Total savings 38,750.00 If property tax collection outsourced to third party Payment to third party @ INR 12/- per demand 120,000.00 Costs Saved 38,750.00 Net Cost for Work 81,250.00 Cost per demand (INR 81,250 divided by 10,000) 8.13Based on the above table, it can be derived that the proposal for outsourcing the work to an outsideragency would prove profitable for the ULB as per demand cost reduces from INR 9.50 to INR 8.13.10.2 Policies10.2.1 Cost policy1. Municipal Corporations in MP shall formulate a cost policy under the authority of the Council, which shall clearly spell out the Cost Objects2. Cost policy shall identify the accounting heads, from the list of Chart of Accounts (COA), which can be considered as direct costs for the Cost Object3. In order to use Marginal Costing Tool for decision making in respect of a particular Cost Object, the cost policy shall identify the accounting heads, from the list of Chart of Accounts (COA), which can be considered as Variable Costs, Semi Variable Costs and Fixed Costs. Also, method of allocating variable and fixed portion in a semi variable cost shall be clearly mentioned4. Cost policy shall indicate how the indirect costs shall be allocated over the Cost Objects and basis of such allocation5. Cost policy shall state the method of costing to be used for determining cost of projects. For e.g., Job Costing, Contract Costing, etc.6. Cost policy shall ensure that there are enough internal controls so that a cost is not allocated twice7. Pricing of services shall be a part of the cost policy and shall indicate the method of costing that shall be used -122-
  • 123. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh8. Cost policy shall be reviewed every year10.2.2 User charges1. Municipal Corporations in MP shall place increased emphasis on user charges to finance the cost of local government services. For services that benefit specific users, each Municipal Corporation in MP shall establish and collect fees to recover the costs of those services.2. All Municipal Corporations in MP shall adopt a consumption-based user charges model for providing st water and wastewater services on or before [31 December, 2011]. As per this model, Municipal Corporations shall charge user charges for water and wastewater services based on the amount of water consumed by consumers.10.2.3 Economic cost recoveryMunicipal Corporations shall seek to recover [full] direct and indirect costs for providing municipalservices. Utility rates and user fees shall be fixed by Municipal Corporations in MP at levels sufficient tocover [operating expenditures, meet debt obligations, provide additional funding for capitalinvestments, and provide adequate levels of working capital].10.2.4 Review of user charges1. User fees shall be reviewed on a regular basis to calculate their full cost recovery levels, to compare them to the current fee structure, and to recommend adjustments where necessary. a. Each Municipal Corporation in MP shall conduct an [annual] review of fees and charges related to [water and wastewater services] to determine the extent to which the full cost of these services is being recovered by revenues. b. Each Municipal Corporation shall review all fees and charges, [including property taxes], at least once every [three] years.10.3 Procedures10.3.1 Step 1: Determination of Cost Object and Cost Center creation in a ULBThere are several services provided by a ULB that require determination of cost. These include watersupply, sanitation, education and services to poor. A ULB needs to indentify the service for which costingsystem is required.It is advised that ULBs in MP should refer to the MP State Accounting Manual where a detailed codingsystem is discussed. The manual has a chapter on Chart of Accounts under which functions of ULB hasbeen listed. The list has details like name of function, nature of function and department or sectioncarrying out the function. Also, these have been appropriately codified. For example, a part of the chartthat pertains to Water Supply is mentioned in table given below. -123-
  • 124. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 10: Function and functionary codes for Cost Object - Water Supply Function Nature of Functionary- Combined Department / Section Code Function 40 Civic Amenities 00 Consolidated 00 Civic Amenities – Water 40 00 00 – Water Supply Supply Department 41 Water Supply 01 Water Treatment Plant 40 41 01 Section 02 Water Pumping Station 40 41 02 Section 03 Water Distribution Section 40 41 03 04 Water Distribution (Supply 40 41 04 by Tankers) SectionSince water supply involves various important activities and significant expenditure is involved at eachstage, it would be useful to employ Activity Based Costing system. This system shall throw up costs ateach stage.For employing Activity Based Costing system, above table can be made as detailed as required. This is tomean that the Departments or Sections carrying out specific and important activity (involving significantexpenditure) in the whole system of water distribution should be mentioned. For example if we look at thewater supply system, it can be broken in following activities. These activities are also called as the costobjects or cost centers.1. Water intake, including raw water purchase2. Water treatment plant3. Water pumping section4. Water distributionIt is important to note that unnecessary detailing must be avoided. This is because in the later stagesallocation of indirect expenses, over these cost centers, becomes difficult. Once cost objects areidentified we move on to the next step. -124-
  • 125. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh10.3.2 Step 2: Classification and allocation of costsIn this step, the ULB should conduct classification of heads of Income and Expenditure as direct andindirect expenses. As per the Chart of Accounts as given in the MPMAM, the heads of expenditure havebeen classified as:1. Revenue Income2. Revenue Expenditure3. Capital Receipts and Liabilities4. Capital Expenses and AssetsUnder each of the heads there are detailed heads and detailed sub-heads. Any expenditure that a ULBmakes gets classified under one of the above heads. Most of the accounting systems have a provision ofallocating a transaction to a particular cost center. This provision should be used and each of the incomeand expenditure transaction be allocated to the cost centers.The basic allocation of transactions to cost centers would be done based on the Department or theFunction for which the expenditure was incurred. Therefore, the income or expenditure pertaining to aparticular cost center or cost object can be accumulated and ascertained. Thus all expenditures directlyincurred for an activity can be identified as a direct expenditure.Indirect expenditure could be in the nature of Administrative Expenditure incurred by MunicipalAuthorities. For instance, all expenditure related to the Mayor’s office or the Commissioner’s office couldbe classified as Administrative Expenditure. As per the chart of Functions these are classified underAdministrative Expenditure, Municipal Authorities, Mayor’s office (Code 00 01 01). So all expendituresincurred for administrative purpose by the Mayor shall get classified under the abovementioned head.However, the Mayor works for the entire organization and water supply department is one of the activities.Thus all the expenses of Mayor’s office must again be classified under various cost objects alreadyidentified under Step 1, discussed above. These cost objects could be water supply, sanitation, streetlights, roads, etc. Distribution of common expenditure over various cost objects is called as allocation ofindirect expenses.For each indirect expenditure, there should be a basis of apportionment over the cost objects. Forexample, expenditure of Mayor’s office can be apportioned over departments like water supply,sanitation, street lights, roads, etc. on the basis of time spent. If time allocation becomes difficult, it can beon the basis of total expenditure incurred by each department.Ideally previous year’s information can be used to arrive at a ratio of expenditure of each department tototal expenditure incurred by all departments. Apportionment of indirect expenses can be made in thisratio. This may not be the best way of apportioning indirect expenditure, but any method by which we canget closest to a correct allocation, should be used. It must be remembered that one single formula ofallocation shall not hold good for all indirect expenses.This concept has been explained in the illustration below. -125-
  • 126. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshIllustration:A ULB has incurred INR 2,00,000 as expenditure on the Mayor’s office. This expenditure has to beapportioned to various cost centres based on a ratio of apportionment, which has been determined on thebasis of the time allocated to each of the cost centres by the Mayor’s office.Table 17: Illustration showing apportionment of indirect expenses Nature of Expenditure Amount in Ratio of Calculations Expenses after INR apportionmen Apportionment t Expenditure by Water 50,00,000 50.0% (2,00,000 x 50%) 51,00,000 Supply Department = 1,00,000 Expenditure by Street 40,00,000 40.0% (2,00,000 x 40%) 40,80,000 Lights Department = 80,000 Expenditure by Property 1,75,000 5.0% (2,00,000 x 5%) 1,85,000 Tax Department = 10,000 Expenditure by 5,00,000 5.0% (2,00,000 x 5%) 5,10,000 Accounts and Finance = 10,000 Department Total Expenses 96,75,000 98,75,000For Activity Based Costing, the activity of a department is broken into various smaller activities. Allocatingcommon cost of the department to the smaller activities can be done as mentioned above. For example,the salary of the Head of Department of the Water Department should be apportioned over all identifiedcost centres of the department like water intake, treatment, pumping and distribution activities.10.3.3 Step 3: Determining physical parametersAfter determining the cost centres, it is necessary that the cost determined above is put in reference to acertain measurable activity. For example, cost per 100 liters of water, cost of educating 100 children, costof delivering and recovering 1 demand note for property tax, etc. This measurable activity must bedetermined from the records maintained for the purpose. For instance, the amount of water pumped canbe obtained from pumping station; amount of potable water supplied can be obtained from the billingsection of water department. In order to arrive at the cost at an activity level in Activity Based Costing,physical parameters for that activity must be available. The table below presents a format for collectinginformation on physical parameters.Table 18: Physical parameters for costing -126-
  • 127. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Parameters Water Intake Water Pumping Distribution Treatment Machine hours Xxx hrs Xxx hrs Xxx hrs Xxx hrs Water pumped (MLD) xxx xxx xxx xxx Losses (litres) xxx xxx xxx xxxA ULB could arrive at the per unit cost of delivering a particular service by dividing the total cost of suchservice with the physical parameters.10.3.4 Step 4: Building an Activity Based Cost sheetTable 19: A typical cost sheet of Water Works Department Costs Accounting Water Water Pumping Distribution Total Codes Intake Treatment Direct Costs Purchase of 2302001 xxx xxx raw water Purchase of 2303001 xxx xxx Chemicals Electricity 2301001 xxx xxx xxx xxx Xxx Expenses O& M 2305041 xxx xxx xxx xxx xxx expenses Salaries 2101001-21 xxx xxx xxx xxx xxx Administrative 2201100 xxx xxx xxx xxx xxx Expenses Depreciation of 2724000 xxx xxx xxx xxx xxx Assets Total Direct xxx xxx xxx xxx xxx Costs (A) Indirect Costs Mayors’ office xxx xxx xxx xxx xxx -127-
  • 128. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Costs Accounting Water Water Pumping Distribution Total Codes Intake Treatment Commissioners xxx xxx xxx xxx xxx office Accounts and xxx xxx xxx xxx xxx Finance Dept Total Indirect xxx xxx xxx xxx xxx Costs (B) Total Cost xxx xxx xxx xxx xxx (A+B)10.3.5 Step 5: Marginal costingMarginal costing may be defined as the technique of presenting cost data wherein variable costs andfixed costs are shown separately for managerial decision-making. It should be clearly understood thatmarginal costing is not a method of costing like process costing or job costing. Rather, it is simply amethod or technique of the analysis of cost information for the guidance of management to find out theimpact of changes in the volume of output on cost.Marginal costing techniques could be used by ULBs for pricing decisions as well as decisions related tocarrying out in-house activity vis-a-vis contracting out.10.3.5.1 Variable and Fixed CostsIn order to implement Marginal Costing it is essential to classify each ledger head appearing in the costsheet into one of the following:1. Variable costs2. Fixed costs3. Semi variable costs (percentage of variable nature, as far as possible)Variable cost is the direct cost. This means that for every unit of service delivered the cost shall beproportionately incurred. For example, in case of water distribution, every MLD of raw water purchasedhas a cost. This cost is directly proportional to the water drawn and varies directly with the volume ofwater drawn. Thus cost varies with volume. Electricity expenses of pump house are directly proportionalto volume of water pumped. Such costs are variable costs or direct costs.Fixed costs are those costs that are not directly proportional to the cost of delivery. For example, salaryexpenses of the pumping station employees. The salary has to be paid even if the pumping efficiency islow. Similarly, electricity expenses of the Water Department (not pumping house) are more or less fixedand not dependent on volume of water pumped. These are fixed costs or indirect costs. -128-
  • 129. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshSemi variable Costs is another class of expenditure that remains constant for a certain level of activity.However, after that threshold is crossed, the expenses go up. For example, fixed costs pertaining todepartment carrying repairs for roads are based on a normal activity. But if in a year, it is decided to carryout repairs of thrice the quantum of work carried out in earlier year, additional personnel may have to beemployed in that department, new equipments may have to be purchased. Therefore, fixed costs change.But, this shall remain constant until the activity increases or decreases sizably. It becomes necessary todetermine the threshold level after which the costs vary and segregate the costs into variable and fixednature.Variable costs usually have direct impact on decision making process. If the demand of water goes up insummer, cost of raw water shall proportionately go up. Therefore, as the volumes go up, total cost ofdelivery (including variable and fixed costs) comes down. This is because as volume goes up fixed costper unit of water distributed comes down. Therefore, in order to take any decision regarding distributinghigher/ lower volumes of water, the break-up of variable and fixed cost shall play an important role indecision-making.In the above cost sheet this classification can be made as: Costs Accounting Water Water Pumping Distribution Total Codes Intake Treatment Variable Costs Purchase of 2302001 V V raw water Purchase of 2303001 V V V Chemicals Electricity 2301001 V V V V V Expenses O&M expenses 2305041 V V V V V Variable 30% 30% 30% 30% 30% Portion 30% Total Variable xxx xxx xxx xxx xxx Costs (P) Physical Xxx MLD Xxx MLD Xxx MLD Xxx MLD Xxx MLD Parameters (Q) Variable Cost xxx xxx xxx xxx xxx per unit, (P) divided by (Q) Fixed Costs -129-
  • 130. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Costs Accounting Water Water Pumping Distribution Total Codes Intake Treatment O&M expenses 2305041 F F F F F Fixed Portion 70% 70% 70% 70% 70% 70% Salaries 2101001-21 F F F F F Administrative 2201100 F F F F F Expenses Depreciation of 2724000 F F F F F Assets Indirect Costs Mayors’ office F F F F F Commissioners F F F F F office Accounts and F F F F F Finance Dept Total Fixed xxx xxx xxx xxx xxx Costs B(“V” - Variable cost and “F” - Fixed Cost.)In order to use the Marginal Costing Tool for decision making we now know variable cost per unit andfixed cost for providing water. Whereas, variable cost is directly proportional to the quantity or physicalparameters, fixed cost does not change with the physical parameters unless there is a substantial changein the physical parameters.10.3.5.2 Break Even Point (BEP)Break Even Point for a product or service is the point where total revenue received equals the total costsassociated with the sale of the product. A break-even point is typically calculated in order for businessesto determine if it would be profitable to sell a proposed product, as opposed to attempting to modify anexisting product instead so it can be made lucrative.In case of ULBs, BEP can be used to determine the price its services such that the ULB at least recoversthe costs involved in delivering the services. Parameters required for calculating BEP can be obtainedfrom above mentioned cost sheet.If total demand raised for X MLD of water distributed is D, and variable cost per MLD is V and Fixed Costof providing water is F then: -130-
  • 131. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshContribution ”Q” is (Demand raised – Variable Cost)Therefore, Q = (D-V) and Contribution per MLD “C” is Q divided by XTherefore, C = Q divided by X, where C is contribution per MLD.If Fixed Cost is F, BEP in terms of MLD distributed isFixed Cost “F” divided by Contribution per MLD “C”Therefore BEP = F divided by CAny demand raised in addition to the BEP quantity shall generate additional revenue to the ULB providedContribution is positive. Consider the following example for more clarity:Sr No Particulars Qty in MLD Rate per MLD Amount Billed (Rs in Lacs) (Rs. In Lacs)1 Bill Raised 200 10 20002 Variable Cost 200 8 16003 Contribution (1-2) 4004. Contribution per MLD ( contribution / Qty ) = (400 / 200) 25. Fixed Cost 2506. Break Even Point (BEP) in Qty = Fixed Cost / Contribution per MLD = 125 MLD 250 / 2 =7. BEP in terms of Billing amount = (BEP (Qty) x Rate per MLD)= 125 x 10 1250 -131-
  • 132. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11 INTERNAL CONTROLSAccounting and financial reporting is incomplete without appropriate auditing and internal control systems.In response to developments in accounting and financial reporting theory and practices, the auditing andinternal control practices are also required to be updated. ULBs need to adopt modern auditing andinternal control systems, to supplement reforms in accounting and financial reporting system. Auditingpresupposes the existence of an adequate internal control system and an auditor has to evaluate theadequacy and efficacy of such a system before conducting the audit. Therefore, internal control is anintegral part of any organisation. This section of the manual explains the concept and system of internalcontrol.11.1 ConceptsA system of internal control can be defined as all methods and procedures adopted by the ULB to assistin achieving its objective of ensuring an orderly and efficient conduct of business as far as practicable.This includes:• Adherence to acts and policies• Safeguarding of assets• Prevention and detection of fraud and error• Accuracy and completeness of accounting records• Timely preparation of reliable financial informationThe system of internal control extends beyond those matters that relate directly to the functioning of theaccounting system. The internal audit function constitutes a separate component of internal control withthe objective of determining whether other internal controls are well designed and properly operated. Theenvironment in which internal control operates has an impact on the effectiveness of the specific controlprocedures. A strong control environment, for example, one with tight budgetary controls and an effectiveinternal audit function, can significantly complement specific control procedures. The system of internalcontrol must be under continuous supervision by the management of the ULB to determine that it isfunctioning as prescribed and is modified, as appropriate for changes in operating conditions.11.1.1 Factors affecting internal control systemThe factors affecting internal control environment are outlined below.11.1.1.1 Organisational structureThe organisational structure of any ULB serves as a framework for the direction and control of itsactivities. It should be designed, in so far as practicable, to preclude an individual from overriding the -132-
  • 133. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshcontrol system and should provide for the segregation of the incompatible functions. Functions areincompatible if their combination may permit the commitment or concealment of fraud or error. Functionsthat typically are segregated are access to assets, authorisation of transactions, execution thereof, andrecord keeping.11.1.1.2 Management supervisionThe management is responsible for devising and maintaining the system of internal control. In carryingout its supervisory responsibility, the management should review the adequacy of internal control on aregular basis to ensure that all significant controls are operating effectively. Since all the ULBs haveinternal audit system, the management may entrust to it some of its supervisory functions, especially, withrespect to the review of internal control.An internal control system primarily includes systems of internal check, internal audit, operational auditand other control systems. The relationship between these inter-related systems is discussed in thefollowing section. The following figure illustrates this relationship.Figure 11: Internal control system Internal Check Internal Control Operational Internal Audit Audit11.1.1.3 Internal checkInstitute of Chartered Accountants of England and Wales has defined internal check as ‘the checks onday-to-day transactions which operate continuously as part of the routine system whereby the work ofone person is proved independently or is complementary to the work of another, the object being theprevention or early detection of errors and fraud’.Internal check is a part of the internal control system and operates as an in-built device as far as the stafforganisation and job allocation aspects of the control system are concerned. A system of internal checkaccounting implies organisation of a system of bookkeeping and arrangement of staff duties in such amanner that no person can independently carry through a transaction and record every aspect thereof. -133-
  • 134. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.1.1.4 Internal auditInternal auditing should not be confined to the tallying of accounting and allied records. The modernconcept extends the role of internal auditing to the task of reviewing whether the resource utilisation of anorganisation is efficient and economical. The new role necessitates a review of effectiveness of alloperations and the management.Internal audit is a technique of managerial control. It functions through a continuous process ofmeasurement and evaluation of the effectiveness of other controls. It is an aid to verification of credibilityof accounts and review of systems within the organisation itself. It helps in early detection of errors andfrauds, their prompt rectification and a planned arrangement to reduce possibilities of repetition of sucherrors or frauds in future. Internal audit is a form of continuous audit conducted by the staff of theorganisation. Depending upon the nature and size of the organisation, there may be even a separatedepartment of internal audit to carry out this job of responsibility. Efficiency and effectiveness of internalaudit is governed by the following elements:• Totality - the concept of totality in internal control demands the system to include all aspects of the organisation under its purview of control and verification of affairs• Expertise - expertise represents the professional aspects of the job. Internal auditors generally should professionals conversant with the principles and procedures of internal control• Independence - the element of independence is applicable to all categories of audit. This means the opportunity granted to the auditors to report directly to the top authority• Objectivity - the objectivity aspect of internal control is to judge the effectiveness of the system in operation. The system should be able to promote safety of assets as well as accuracy and reliability of recordsThus effectiveness and efficiency of internal audit requires a complete coverage of the organisation,management of internal audit by professionally competent people, right of independence to report to thetop, purpose of approach to combine safety, accuracy and reliability and an effort to contribute itsusefulness to the process of management.11.1.1.5 Operational auditAccording to Cadrnus, “Operational auditing is not different from internal auditing; it is merely anextension of internal auditing into operational areas and it is characterised in both financial andoperational areas by the auditor’s approach and state of mind.” The difference between internal andoperational audit can be clarified with an example. To a traditional internal auditor, a loss of INR 20, 000caused by a wrong totalling of invoice is important and this is what he looks for. But an operational auditorwill be interested to know whether a right kind of operational arrangement exists to avoid incidences ofwrong totalling or whether cash balance remains excessive to the need.There exist two opposing views about the nature and role of operation audit. One view holds thatoperational auditing is only a gathering tool that will help the management appraise performance andidentify areas in which additional investigations may yield improvement. The other view advocates -134-
  • 135. Manual on Good Practices of Financial Management for ULBs of Madhya Pradeshextension of the scope of operational audit to making recommendations of specific changes intended tocorrect the shortcomings observed by the auditor.Need for operation auditOperational Audit is considered a specialised management information tool to fill the void thatconventional information sources fail to fill. Conventional sources of management information aredepartment managers, routine performance report, internal audit reports and periodic specialinvestigation and surveys. When these conventional sources fail to provide information for the bestdirection of the departments all of whose activities do not come under direct observation of managers,operational audit comes to the help of the organisation. Generally, Operational audit objectives include:• Appraisal of controls;• Evaluation of performance;• Appraisal of objectives and plans; and• Appraisal of organisational structure.11.2 Good practices of internal controls1. Training on internal control: ULB should ensure that the financial manager gets the training needed to meaningfully take responsibility for internal control. In particular, they should obtain a sound understanding of the essential components of internal control.2. Periodical review of internal control: Financial managers with the assistance of internal auditors or equivalent personnel as needed should periodically evaluate relevant internal control procedures.3. Qualification of head of internal audit: The head of Internal Audit function should possess a college degree and appropriate relevant experience. It also is highly desirable that the head of the internal audit function also holds some appropriate form of professional certification.4. All reports of internal auditors, as well as the annual internal audit work plan, should be made available to the government’s audit committee or its equivalent.11.3 Policies11.3.1 Establishing internal controlsEach Municipal Corporation in MP shall establish and maintain an internal control structure with adequateseparation of functions designed to provide reasonable assurance that local government assets aresafeguarded and the potential of significant errors in the Municipal Corporation’s financial records areminimized. From time to time these procedures should be re-evaluated. -135-
  • 136. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.3.2 Recording financial transactionsMunicipal Corporations in MP shall develop and maintain procedures that will ensure financialtransactions and events are properly recorded so that all financial reports may be relied upon asaccurate, complete and up-to-date.11.3.3 Safety of financial assets and recordsMunicipal Corporations in MP shall design and maintain procedures to ensure that adequate safeguardsexist over the access to and use of financial assets and records.11.4 ProceduresInternal control assists in achieving the management’s objective of ensuring as far as practicable:• Orderly and efficient conduct of its business, including adherence to management policies;• Safeguarding of assets;• Prevention and detection of fraud and error;• Accuracy and completeness of accounting records; and• Timely preparation of reliable financial information.In contrast to audit system reforms, which are largely dependent on the state government’s initiative, theinternal control system reforms fall under the domain of a ULB. Neither any law prevents a ULB frompursuing internal control system reforms, nor does any municipal act provide for formats or proceduresregarding internal control systems. Internal control systems are managerial control devices so ULBs canindependently, in their own right, go ahead with suitable internal control system reforms.The following steps detail out the procedure on effectively introducing internal control systems in a ULB.11.4.1 Step 1: Formulate statement of objectives of the internal control reformsBefore the commencement of the internal control system reforms exercise a ULB should decide about theobjectives of the proposed reforms, i.e., why a ULB wants to undertake this exercise and what it wants toachieve from such an exercise. The formulation of objectives is an essential exercise as establishment ofinternal control systems involves sizeable cost.A ULB should carry out a primary cost-benefit analysis about the proposed internal control systemsreform. Of course, there cannot be a situation of no or zero internal control system because it involvescost. On the other hand, there cannot be a situation of absolute internal control system because it fetchesbenefits. Up to a certain extent an improvement or investment in internal control systems leads toincreasing returns (benefits), but, after that limit the incremental cost outweighs incremental returns. -136-
  • 137. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshAfter formulating the objective of Internal Control reforms, it is important to decide about the need for aprofessional support or if the reforms can be carried out within the ULB.11.4.2 Step 2: Decide about professional supportA ULB aiming to introduce or to improve its internal control system should at first instance take a policydecision about hiring of professional support. If it decides to hire, then the following should be considered:• To what extent it wishes to hire? and• What would be the terms of reference of such proferssional support?Smaller ULBs, as far as possible, will not be required to go for external professional support, as they donot need very complex and detailed internal control systems. Larger ULBs may require externalprofessional support. External professional support can be taken for a partial purpose or for developing afull-fledged internal control system. A ULB should take this policy decision at the start of theimplementation process.11.4.3 Step 3: Evaluation of existing internal control systemsULBs are not newly created organisations. In fact, some ULBs boast of existence of more than 100 years.Therefore, each ULB has some sort of an internal control system evolved over the years consciously orunconsciously. As a first step, in implementing internal control system reforms, a ULB should carry out anevaluation of its internal control systems. Such an evaluation should cover the following aspects:• Whether there exists any internal control system?• Whether the internal system is formalised?• What the are the control systems and how they work?• Whether the controls have been understood by the operative personnel in the same way as the management intended?• Whether the controls are in fact operating?It is important that the internal control system, said to be in operation, should be checked in terms of itsactual operation. Otherwise, there is a positive danger of one being misled into complacence. In thisconnection it will be useful to have a critical study of the following aspects as a part of the evaluation ofthe existing internal control system:• Characteristics of a ULB, in a sense, the various activities carried out by that ULB;• System of bookkeeping and accounting;• Duties of various executives and other officers and the division of responsibilities;• Systems of budgeting, financial planning and management of information; -137-
  • 138. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• System of internal check; and• System of internal audit and other control systems.11.4.4 Step 4: Document the existing internal control systemsAlongwith the evaluation process as suggested above, a ULB should document its existing internalcontrol systems. In most of the cases such documentation is presently absent. The documentation ofexisting internal control system should include evaluation of the reforms carried out as above, markingclearly area-wise; sub-system-wise weaknesses of the existing internal control system. Suchdocumentation is essential for formulating system reforms or an improvement plan.For the purpose of evaluation and documentation a ULB should make use of modern techniques likequestionnaires, checklists, flowcharts, etc. Among these techniques a flowchart is the most appropriatemethod for reporting any system. It provides a neat visual picture of the entire activities of the section ordepartment involving flow of documents and activities. The flowchart technique helps the management toclarify following:• At what point a document is raised internally or received from an external source;• Number of copies of the document is raised or received;• Intermediate stages set sequentially through which the document and the activity pass;• Distribution of the documents to various sections, department or operations;• Checking authorisation and matching at the relevant stages;• Filing of the document; and• Final disposal by sending out or distribution.11.4.5 Step 5: Take a stock of other reforms envisaged by a ULBBefore proceeding for formulation of the internal control system reforms, a ULB should take stock ofbudgetary, accounting or any other administrative or management reforms it has undertaken. It shouldenlist the requirements of ensuing reforms about the internal control system. This will help a ULB toformulate a minimum reforms programme of the internal control system to ensure effectiveness andsustainability of the accounting and budgetary reforms, which it has undertaken. Once this is done, theULB, as mentioned above, should think beyond the requirements of other reforms about the internalcontrol system to formulate an ideal or the maximum reforms programme about the internal controlsystem.11.4.6 Step 6: Revise and refine the Statement of ObjectivesA ULB should revise and refine its preliminary statement of objectives formulated before commencing theprocess of the internal control system reform in the light of evaluation of the existing system, otherreforms, need for reforms, etc. -138-
  • 139. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.4.7 Step 7: Internal control system - design guidelines for various operationsDesigning or formulating the internal control system guidelines regarding various operations could besummarised as follows. These guidelines are illustrative and not exhaustive.11.4.7.1 General Financial ArrangementsThe General Financial Arrangements include:1. Devising an appropriate and properly integrated system of accounts and records;2. Determining the form of general financial supervision and control by the management, using such means as budgetary control, regular interim accounts of suitable frequency, and special reports;3. Ensuring that adequate precautions are taken to safeguard (and if necessary to duplicate and store separately) important records; and4. Engaging, training and allocating specific duties to the management and the staff competent to fulfil their responsibility, arranging for rotation of duties as necessary; and delegating responsibilities during staff absences.11.4.7.2 Cash and cheques receivedThe risk of misappropriation of cash and cheques needs no emphasis. Safeguards may be summarisedas follows:1. number of persons handling cash and cheques should be restricted;2. responsibility should be clearly defined;3. principles of division of duties particularly as between the recording and custodianship functions, should be observed as far as possible;4. adequate supervision and independent checks should be imposed; and5. moneys received should be paid into the bank at the earliest opportunity.11.4.7.3 RecordingIncoming cash and cheques should be recorded as soon as possible. Matters for consideration shouldinclude the following:1. Who is responsible for maintaining records of money received?2. What practicable limitations may be put on the duties and responsibilities of the receiving cashier, particularly as regards dealing with such matters as other books of account, other funds, securities and negotiable instruments, sales invoices, credit notes and cash payments?11.4.7.4 Cash and bank balancesThe issue to be decided in connection with the control of cash balances include: -139-
  • 140. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh1. Amount to be retained as cash floats at cash desks and registers, and whether payment out of cash received are to be permitted;2. Restrictions to be imposed as to access to cash registers and offices; and3. Special insurance arrangements (such as fidelity guarantee and cash insurance) are judged desirable having regard to the nature of the business, the sums handled, and the length of time when they are kept on the premises.Regular reconciliation of bank accounts by a responsible official is an essential element of control overbank balances.11.4.7.5 Cash and Cheques Payment1. Cheque payments a. Procedure to be adopted for controlling the supply and issue of cheques for use, and who is to be responsible for their safe-keeping; and b. Safeguard to be adopted if cheques are signed mechanically or carry printed signatures.2. Cash payment a. Nomination of a responsible person to authorise expenditure, the means of indicating such authorisation and the documentation to be preserved as evidence; and b. Arrangement to ensure that the vouchers supporting the payment cannot be presented for payment twice.3. Cheque and cash payment (general) a. Arrangement should be such that as far as practicable the cashier is not concerned with keeping or writing up books of account other than those recording disbursements, nor should he have access to or be responsible for the custody of securities, the seal of the ULB; b. Similarly, as far as possible, the person responsible for preparing cheques lists should not himself be a cheque signatory: cheque signatories in turn should not be responsible for recording payments; and c. On the other hand, it must be recognised that in the case of smaller ULBs staff limitations often will make it impossible to divide duties in this manner and in such situation considerable attention is to be given to the adequacy of managerial supervision.4. Wages and salaries a. Who may authorise the engagement and discharge of employees? b. Who may authorise general and individual changes in rates of pay? c. How notifications of changes in personal and rates of pay are to be recorded and controlled to prevent irregularities and errors in preparation and payment of wages and salaries; and d. How deductions from employees’ pay other than for income tax and insurances are to be authorised? -140-
  • 141. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh5. Preparation of payroll a. What records are to be used as bases for compilation of the payroll and how they are to be authorised? b. Who is to be responsible (i) for preparing pay sheets, (ii) for checking them and (iii) for approving them (preferably separate persons), and by what means individual responsibility at each stage is to be indicated? c. What procedures are to be laid down for notifying and dealing with non-routine circumstances such as an employee’s absence from work, or an employee leaving at a short notice in the middle of a pay period?6. Payment of wages and salaries a. What arrangements are to be made to provide the requisite cash for paying out (e.g., encashment of the cheque for the total amount of net wages) and what steps are to be taken to safeguard such moneys during collection and transit and until distributed? b. What safeguards against irregularities are to be adopted (e.g. by arranging for any packets to be filled by persons other than those responsible for preparing pay sheets; providing them with the exact amount of cash required, and forbidding their access to other cash), and what particulars are to be given to payees? c. Who is to pay cash wages over to employees (preferably a person independent of those engaged in the preparation of pay sheets and pay packets)? d. How payee’s identities are to be verified? e. What officials are to be in attendance? f. How distribution is to be recorded (e.g. by recipient’s signature or by checking off names on the pay list)? g. What arrangements are to be made for dealing with unclaimed wages?Where wages and salaries are paid cheque or bank transfer, the, matters to be decided include: h. What persons are (i) to prepare and (ii) to sign cheques and bank transfer lists (preferably these persons should be independent of each other and of those responsible for preparing pay sheets)? i. Whether a separate wages and salaries bank account is to be maintained, what amounts are to be transferred to it from time to time (preferably on due dates the net amount required to meet pay cheques and transfers) and who is to be responsible for its regular reconciliation (preferably someone independent of those responsible for maintaining pay records)?7. Deductions from payAppropriate arrangements should be made for dealing with statutory and other authorised deductionsfrom pay, such as insurance premium, pension fund contributions, etc., and savings held in trust. Aprimary consideration is the establishment of adequate controls over the records authorising deductions.8. Purchase and trade creditors -141-
  • 142. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe internal control system should cover following: a. The procedure to be followed when issuing requisitions for additions to and replacements of stocks, and the persons to be responsible for such requisitions; and b. The preparation and authorisation of purchase orders for general items and for capital items. Acceptance of tenders submitted or prices quoted.9. Goods inwardThe factors to be considered include: a. Arrangements for examining goods inwards as to quantity quality and conditions and for evidencing such examinations; and b. Appointments of persons responsible for accepting goods and the procedure for recording, examining and evidencing goods.10. Accounting (recording)The factors to be considered for a designing internal control system are: a. Appointment of persons as far as possible separately responsible for: i. Checking suppliers’ invoices; ii. Recording purchases and purchase returns; iii. Maintaining suppliers’ ledger accounts or similar records; and iv. Authorising payments. b. Arrangements to ensure that before accounts are paid: i. The goods concerned have been received in accordance with the purchase order, are properly priced and correctly invoiced; ii. The expenditure has been properly allocated; and iii. Payment has been duly authorised by the official responsible.11. The establishment of an appropriate procedure in connection with purchase returns special credits and other adjustments12. Arrangement to deal with purchases made for employees under special terms13. Regular independent checking of suppliers’ accounts against current statements or direct verification with suppliers11.4.7.6 Sales and trade debtorsThese groups of operations are not much applicable to a ULB, but if there are certain areas of operationsin any ULB then the separation of authorisation, custodianship and recording functions described abovein respect of purchases and trade creditors apply similarly to sale and trade debtors. -142-
  • 143. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.4.7.7 Stock (including Work-in-Progress)The stock can be as susceptible to irregularities as in the case of cash. In some circumstances the risk ofloss may be materially higher. The stock control procedures should ensure that stocks held areadequately protected against loss or misuse, are properly applied in the operations of the organisationand duly accounted for. According to the nature of the business, separate arrangements should beworked out for different categories of stocks such as raw materials, components, work-in-progress,finished goods and consumable stores.Accordingly, the internal control system of stock and work-in-progress should be framed keeping in viewthe following aspects:1. What arrangements are to be made for receiving, checking and recording goods in works?2. Who is to be responsible for the safeguarding of stocks and what precautions are to be taken against theft, misuse and deterioration?3. What arrangements are to be made for controlling and recording stock, what procedures to be followed as to the periodic reconciliation of stock records with the financial accounts?4. How movements of stock out of store are to be authorised, evidenced and recorded and what steps are to be take to guard against irregularities?5. What persons are to be responsible for physically checking stocks, at what intervals and what procedures are to be followed?6. What bases are to be adopted for computing the amount at which stocks are to be stated in the accounts and which persons are to perform and check the calculations?7. What arrangements are to be made for periodic review of the condition of stocks, how write-offs are to be authorised?8. What steps are to be taken to control and account for scrap and waste and receipts for the disposal of such items?11.4.7.8 Fixed assetsSome of the principal matters to be decided in connection with designing internal controls relating to fixedassets are as follows:1. Who is to authorise capital expenditure and how such authorisation is to be evidenced?2. Who is to authorise the sale, scrapping or transfer of fixed assets, how such authorisation is to be evidenced, and what arrangements are to be made for controlling and dealing with receipts from disposals?3. Who is to maintain accounting records in respect to fixed assets and how it is to be ensured that a proper accounting distinction is observed between capital and revenue expenditure?4. What arrangements are to be made for keeping plant and property registers and how frequently they are to be agreed with the relevant accounts and physically verified? -143-
  • 144. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh11.4.7.9 InvestmentsFraming an internal control system for dealing with investments will involve inter-alia determining:1. Who is to be responsible for authorising purchases and sales of investments, and how such authorisations are to be evidenced?2. What arrangements are to be made for maintaining a detailed investment register, and who should be responsible for agreeing it periodically with the investment control account and physically verifying the document of title?11.4.8 Way forwardULBs across India suffer from an inadequate system of auditing and internal control systems alongwithinadequate systems of accounting and budgeting. ULBs of MP are not exception to this fact. Onlyaccounting and budgeting system reforms will not be sufficient, though they may pave the way for theauditing and internal control system reforms. The accounting and budgeting system needs to be backedby a set of well-drawn auditing and internal control system reforms to realise their full benefits.These reforms have to be systemic and holistic, rather than reactive and piece-meal. For that, one needsto understand the modern concepts and practices of auditing and internal control as discussed in thischapter. ULBs of MP need to adopt these auditing and internal control systems to ensure sustainability ofreforms carried out in other areas, such as financial planning, budgeting, accounting, etc. -144-
  • 145. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh12 FINANCIAL MANAGEMENT INFORMATION SYSTEMSFinancial Management Information Systems (FMIS) do not exist in most of the ULBs across India. Whatexists in most of the ULBs is an unregulated flow of raw information. This information is usually notanalysed and documented for posterity and, more importantly, it is not used for decision-making in aformal manner. The decision-making in the ULBs is based on experience or is a reflex reaction to asituation on the basis of the information gathered by the decision-maker.This section tries to discuss various aspects, which are important from the point of view of introduction ofan FMIS in a ULB. It also includes detailed formats that can be used by ULBs for effective implementationof FMIS.12.1 Concepts12.1.1 Need for FMISGiven below are the two major reasons for the growing importance of FMIS to ULBs.1. Growing complexity in ULBsThe internal and external structure of ULBs is becoming more and more complex. In today’s day and age,any municipal management has to deal with large quantities of information. Whether a municipal bodytakes the right decision, strongly depends on the organisation and management of all this information.Consequently, information and information exchange play a vital role in coordinating various departmentsand activities in a ULB.2. Computer technologyThe increasing use of computers in ULBs has a direct influence on the growing importance of MIS. On amicro-level, appropriate MIS within a municipal body make it possible for everyone to have access to anykind of information.12.1.2 Prerequisites of an Effective FMISThe following are the prerequisites for an effective FMIS.12.1.2.1 DatabaseA database should be maintained in such a way that it satisfies the needs of all the users and at the sametime has a restricted access and is controlled by a separate authority established for this purpose. -145-
  • 146. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh12.1.2.2 Support of top managementContinuous support of top management is an essential requirement for effective implementation of FMIS.Unless the top management gives support to its subordinates, the lower-level managers become lethargicabout their activities and usually do not perform up to their capacity.12.1.2.3 Control and maintenanceThe database and the system should be regularly updated and checked keeping in view the changingneeds of the entity and changes in the external environment, to ensure that the system is working as itwas designed and is generating the desired reports.12.1.3 Information economicsInformation is a valuable resource for any organisation. However, developing information in the mannerthat is useful for any kind of decision making comes at a cost. So, the question arises: how much shouldan organisation spend for information?It is important to understand here that the information must be selective and hence some type of a cost-benefit analysis should be undertaken for this purpose. This is more easy said than done. Difficultiesoccur in measuring the cost of providing information and measuring the value of information. Informationis conceptual in nature and hardly has any tangible characteristics, except symbolic representations.However, let us attempt to understand some aspects of information economics.12.1.3.1 Cost of informationThe cost of operating the information system could be categorised as follows:Hardware costsThese are fixed costs that typically involve setting up of computer based information system. With aquantum jump in the field of electronics, the hardware costs are gradually coming down.System analysis, design and implementation costsThis function includes formulating a methodology for the overall electronic data processing procedure.This should include the cost for preparation of programmers and software costs. These software costs areincreasing day-by-day owing to their growing need and value.Conversion costsThis includes the cost involved in any kind of change from one method of data processing to another.Costs for space and environmental control factorsThese costs are semi-variable. Examples of these costs include floor space, air-conditioners anddehumidifier systems, power control units, stand-by generators, security, etc. -146-
  • 147. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshOperational costsThese are in the nature of variable cost and include costs pertaining to systems maintenance, suppliesand support facilities.12.1.3.2 Value of informationInformation must primarily possess attributes of relevance, availability and timeliness, to have a value andto qualify as real information. No doubt quantification of information is desired to the maximum extentpossible. The quality attributes refer to the presence or absence of ambiguities in information. No doubtall information should preferably possess ‘quality’. Measures of quality are validity, accuracy andprecision. These measures of quality are especially important and applicable to quantified information.Even if information is presented in such a way so as to be transmitted efficiently and interpreted correctly,it may not be used effectively. The quality of information is determined by how it motivates human actionand contributes to an effective decision-making. Information may be evaluated in terms of ‘utility’, whichmay facilitate or retard its use. These ‘utilities’ are explained below.Form utilityAs the form of information more closely matches the requirements of the decision-maker, its valueincreases. If an official is looking for a graph depicting the expenditure history, he appreciates receivingthe data in a graphical form rather than in a tabular form.Time utilityInformation has a greater value to the decision-maker if it is available when needed. If you make itavailable well ahead of time, he might forget about it. Obviously, any availability after the due time willhave no relevance.Place utility (accessibility)Information has a greater value if it can be accessed or delivered easily. On-line systems maximise bothtime and place utility. It is very important to have the information available at the place desired.12.2 Policies12.2.1 FMIS reports1. Results achieved relative to the goals and objectives of major budget programmes shall be presented by each Municipal Corporation in MP [annually] to the Council.2. Municipal Corporations in MP shall prepare [monthly] FMIS reports for review by the Commissioner that analyze, evaluate and forecast the local governments financial performance and economic condition. These reports shall include: comparisons of expenditures and revenues to current budget; expenditures and revenues projections through the end of the year; the status of fund balances; and remedial actions necessary to maintain the Municipal Corporations financial position. -147-
  • 148. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh12.2.2 Extra-budgetary activities1. Municipal Corporations in MP shall identify clear mechanisms for the coordination, management and reporting to their respective Councils and public of any extra-budgetary activities.12.3 ProceduresHaving understood the various dynamics that are involved in FMIS, it is important to understand theimplementation of the same. A ULB can introduce or improve FMIS in its organisation by taking thefollowing simple steps.12.3.1 Step 1: Survey for information requirementFirst of all, a ULB should carry out a survey regarding information requirements by interviewing itsofficers. Such an informal internal survey should find out what kind of information is required by officers ofa ULB to improve their decision-making. If found necessary, the officers of the ULB should be providedtraining about importance and application of information to improve their decision-making.Such an in-house training workshop should be conducted with by a ULB the help of information andmanagement experts, prior to the above survey. Such an exposure will create a need for informationamong the ULB officers and they will be able to respond in a constructive manner to the survey about theinformation needs.12.3.2 Step 2: Assessing current FMISA ULB should carry out another survey about the nature and type of information that presently getsgenerated within the ULB. Linking this with the above survey will provide an understanding about theinformation available but not required and the information that is required but currently not gettingcollected in the ULB. As information management involves costs, information should be managedselectively.12.3.3 Step 3: Designing FMIS to meet the needs of decision makersThe design of the information system should clearly spell out the following:• From the total information that gets generated every day, which information should be stored, analysed and sent to the concerned officer;• The system of flow of information, the starting and ending points, the formats, its frequency, the officers/ employees responsible for maintaining the flow of information;• The system of documentation and retrieval of information;• The system regarding collection of information from the secondary sources (outside of ULB) and the persons responsible for the same; and -148-
  • 149. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• The system regarding application of computers for information management. A ULB should ask itself questions like whether application of computer technology is a must. Can the ULB afford computers? And, these questions should be answered clearly.The entire exercise should be made as participative as possible and all the participants should berequested to finalise an information system for themselves, which will be simple, cost effective,economical, focused and drafted in such a way that most of its work is shared by the existing machinery.A ULB should ensure that implementation of an MIS should not lead to the creation of an additional set-up or a monolith department.If designing of information system is made really participative and participants are motivated to create asystem for themselves on their own, then such an information system will not become top-heavy. In orderto coordinate the above process and to undertake activities regarding implementing or improving an MISin a ULB, the ULB could procure help of outside individual professional.12.3.4 Formats for FMIS12.3.4.1 Monthly financial positionFigure 13 shows the format for preparing the monthly financial position of the ULB. This statement shouldbe prepared by the accounts department. It contains the opening and closing balances along with majorrevenue and expenditure items. This is very useful for assessing the monthly performance of the ULB.12.3.4.2 Statement showing actual receipts against budgeted receiptsFigure 14 provides a format for preparing a statement showing actual receipts against budgeted receipts.This statement is prepared by the accounts department and helps in assessing the actual receipts as perthe budgeted revenue and then calculating what percentage has been received so far. Such a statementhelps in comparison of budgeted and actual.12.3.4.3 Statement showing actual expenditure against budgeted expenditureFigure 15 provides a format for statement showing actual expenditure against budgeted expenditure. It issimilar to the statement showing receipts, as in this case expenditure is shown in place of receipts.12.3.4.4 Statement of investments in bank fixed depositsFigure 16 provides a format for preparing a statement of investments in bank fixed deposits. Thisstatement reflects the details regarding investments in bank fixed deposits with specifics such as type offixed deposits and banks.12.3.4.5 Statement report on dishonoured chequesFigure 17 provides a format for statement on dishonoured cheques. This statement basically reflects thestatus of dishonoured/ returned cheques and their recovery. This should be prepared by each departmenthead and submitted to the accounts officer. -149-
  • 150. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh12.3.4.6 Summarised status report on returned/dishonoured chequesFigure 18 provides a format for statement on summarised status on returned/ dishonoured cheques. Thisstatement summarises the status of cheques returned/ dishonoured zone wise. It is prepared by theaccounts officer and submitted to the Municipal Commissioner. -150-
  • 151. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh13 FINANCIAL ANALYSISA ULB experiences a lot of inflows and outflows of funds. The inflows are on account of collections oftaxes and user charges, receipt of grants from inter governmental sources, outside borrowings etc. andoutflow with budgetary expenditure towards making services available to the citizens, repayment of loans,Investments of funds etc. In the entire process of managing funds inflow and outflow, it is necessary tomonitor the financial health of ULB, so that funds can be made available whenever requiredThis part describes the tools and techniques of financial analysis and forecasting. The main utility of thesetools is to diagnose the financial condition of the ULB and to suggest definite solutions to the financialproblems. These tools and techniques can be suitability adopted to various municipal situations withrelevant modifications.13.1 Concepts13.1.1 Break-even analysisIt is a very important tool of financial analysis which deals with cost-volume relationship. This analysis canbe very useful for allocation of resources to various activities and determining the financing needs toaccommodate the changes in volume.Further, the knowledge of cost behaviour helps to minimise costs and maximise returns. These returnsmay not necessarily be only of financial nature, they can be of developmental or social nature making thistool even more valuable for municipal corporations.In this we will first discuss the concepts related to break even analysis and then applicability through anillustration.13.1.1.1 ConceptsVariable costs and fixed costsVariable costs are uniform per unit but their total fluctuates in direct proportion to the related activity orvolume. For example if a ULB pays its ten plumbers wages of INR 50 each, per day cost would be INR500.Fixed costs are costs which remain cost irrespective of the output but progressively becomes smaller on aper unit basis as volume increasesMarginal costsIt is defined as the amount at any given volume of output by which the aggregate costs are changed if thevolume of output is increased or decreased by one unit -151-
  • 152. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshContributionIt is the amount of difference between the selling price and marginal cost. Contribution minus the fixedcost is profit. The municipal services may be offered at a loss also for achieving social objectives.Therefore the contribution will be fixed costs less lossProfit/ Volume ratioThis is a very important ratio which is commonly known as P/V ratio. It is mainly used in the determinationof break even point. This ratio expresses the relationship between contribution and sales and whenmultiplied by 100, it indicates the amount of contribution being earned per 100 rupee of sales. This can becomputed asP/V Ratio = Contribution (Sales-Variable Costs)/SalesBreak even pointA business is said to be breakeven when its revenues (sales) exactly match all costs. In case of ULBs,individual operations like water supply system, sewerage system, gas supply services may have their ownbreak even points. It is a no profit no loss situation and it is at this point that all costs-fixed and variableare recovered through sales. It is calculated asBreak even point in units = Fixed cost/Contribution per unitBreak even point in sales = (Fixed cost/Contribution per unit) * Selling price per unitMargin of safetyMargin of safety is the difference between break even volume of sales and the actual sales beingachieved. Since all fixed costs are recovered at break-even point, only variable cost will be incurred forany output/sale after this point. In other words Margin of Safety * PV Ratio = Profit.13.1.1.2 Illustration: Gas supply project at Baroda Municipal CorporationIn the late sixties, Baroda Municipal Corporation undertook a project to supply natural gas to domesticand industrial users. In 1972, the infrastructure was installed and operations were commenced. At thattime 50,000 cubic meters (cu m) per day of gas was supplied per day. From 1982 onwards, 10,000 cu mper day of additional gas supply was made operational. Since then, the volume of gas supplied hasremained constant at 60,000 cu m per day but the costs have been steadily increasing. The project wasfinancially viable right from the beginning, but, gradually there was seen a decline in the profitability.The following figures show the situation in the year 1982• Volume of gas supplied per day - 60,000 cu m• Cost of establishment, administration and loans per day - INR 35,616 -152-
  • 153. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Average purchase price per day (including taxes) - INR 42,000• Total cost of gas supply per day- INR 77,616• Average revenue earned per day- INR 83,333In this situation, the break-even point lies below INR 77616 at which point the volume is also lower than60,000 cu m per day. Due to sufficient margin, the full cost was recovered and the gas operation wasprofitable in 1982. However, it is practically not possible to reduce the volume lower than 60.000 cu m perday. Hence, at this volume, the gas supply project breaks even at INR 77,616.The following figures shows the situation in for the year 1993• Volume of gas supplied per day - 60,000 cu m• Cost of establishment ,Administration and loans per day - INR 97,000• Average purchase price per day (including taxes) - INR 1,29,000• Total cost of gas supply per day- INR 2,26,000• Average revenue earned per day- INR 2,00,000In this situation, the break even point is INR 2,26,000, whereas, the revenue earned is less than cost.Hence the break even point is not reached and the gas supply service is making a loss of almost of INR26,000 per day.Four alternative solutions can be thought of a. increase the rates of gas supply, b. increase the volume of gas to be supplied, c. reduce the establishment, administration and similar costs, or d. optimum combination of above three solutions, i.e. partial increase of rates with partial increase of volume, etc.The rates of gas supply cannot be increased as and when required because of political pressures andother social reasons.• If BMC wishes to attain the break-even point by increasing the rates only, it will have to increase per unit (per cu. m of gas) sales price to the extent that daily average revenue comes to INR 2,26,000 or more. In other words, it will have to increase the per cu m sale price of gas from INR 3 for domestic users and INR 6 for non-domestic to INR 6 for domestic and INR 8 for non domestic users.13.1.2 Financial ratiosFinancial Ratios are calculated on the basis of information available from the accounting system of ULB.The process of determining the ratios and forming an opinion on the outcome of the ratio is called as -153-
  • 154. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFinancial Ratio Analysis. This is a very common method of determining Financial Health of a company inthe corporate world. Though ULBs do not have a profit making motive, the financial managementprinciples remain same and so does the methods of monitoring financial health.Concept and Determination of Financial RatiosConceptually Financial Ratios are calculated to arrive at an absolute factor or a ratio, which can becompared with the similar ratio in different periods. For example Operating Expenditure Ratio can becompared with a similar ratio for earlier years or half years or quarters etc. The ratio is also comparedwith the predetermined standard ratios for example Debt Service Coverage Ratio (DSCR) or the DebtEquity Ratio. The ratio can be presented as a number, percentage, rate per unit etc.The Ratios are classified as follows1. Ratios related to Revenue Income2. Ratios related to Revenue Expenditure3. Ratios related to Capital Receipts.4. Ratios related to Capital ExpenditureComposition of Revenue and Capital FundsThe Budget is usually divided into four major categories of accounting classificationThe structure of Budget is as follows: Income Expenditure Revenue Income Revenue Expenditure • Tax Revenues • Establishment related expenses • Non Tax Revenues • Operations and Maintenance • Interest on Borrowed funds Capital Receipts Capital Expenditure • Capital Grants • Fixed Assets • Borrowings • Works in progress • Security Deposits • Investments • Repayment of Debt • Advances -154-
  • 155. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshDetails about the nature of expenditure and classification have been elaborated in the chapter pertainingto Budgets. Financial Ratios pertaining to these categories are given in fore coming paragraphs.Illustrative Examples :In order to illustrate the calculation of various ratios, we have considered Financial Statements ofMunicipality of Dwarka (Gujarat State) for the years 2007 and 2008. Following Financial Ratios areworked out based on these Financial Statements. In order to facilitate linking of figures, relevant pagenumbers have been given in brackets wherever required. These page numbers refer to page numbers ofFinancial Statements of Municipality of Dwarka for the years 2007and 2008 as mentioned earlier.13.1.2.1 Ratios related to Revenue IncomeThese ratios basically indicate the composition of various revenues. Analysis of these ratios wouldindicate the strength of growth or otherwise, of various sources of revenue income.Net Surplus Ratio (%)Ratio is calculated as Net Surplus 100 -------------------- X ----- Total Revenue 1(Net surplus means excess of income over expenditure as per Income and Expenditure Account .)The ratio indicates how much of the income is ploughed back into the entity for non operational purpose.This is a general indicator of entity’s ability to meet its operational expenses and provide for meeting otherobligations. However, in an accrual based accounting environment, Receivables or outstanding duesalso need to be considered for the purpose of deciding what portion of accrued income is actuallyreceived.For example, in case of Municipality of Dwarka Ratio is Net Surplus 100 48.93 -------------------- X ----- = --------- x 100 = 14.64 % Total Revenue 1 334.13This ratio indicates that 14.64% of the Revenue Funds have been ploughed back for non operationslpurpose.Operating Revenue to Total revenue (%)Ratio is calculated as Operating Revenue 100 ---------------------------- X ------ = Total Revenue 1 -155-
  • 156. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh(Here Revenue Grants and subsidies are considered as ULBs own revenue, as the ULB qualifies toreceive the grants from state Govt.) Thus income from interest on investments, other interest and otherincome is very minimal.This is an indicator of ULBs strength in generating its own revenue as compared to the total revenue. TheULB delivers services all of which are not income generating. This ratio indicates as to out of the totalrevenue generated how much is contributed by the income generating activities.For example, in case of Municipality of Dwarka Ratio is Operating Revenue 100 327.92 ---------------------------- X ------ = -----------x 100 = 98.14 % Total Revenue 1 334.13(Here Assigned Revenues and Revenue Grants, contributions & subsidies are considered as operatingincomes)Ratio indicates that nearly all income of Municipality is operating income.Revenue Composition RatioRatio is calculated as Revenue Income from single source 100 ------------------------------------------------ X ----- Total Revenue 1This is an indicator of what percentage share of Total Revenue is the Revenue from individuallyidentifiable source. This ratio helps in monitoring the revenues from different sources and shortfall ascompared to earlier trends can be identified. This ratio also helps in comparing the trend of similar streamof revenue of different ULBs. Divergent trends can further be analysed to determine the reasons for suchdivergence.For example, in case of Municipality of Dwarka Ratio isTax revenue composition ratio (2008) : Tax Revenue 43.85 ----------------------- x 100 = ---------- x 100 = 13.12 % Total Revenue 334.13Tax revenue composition ratio (2007) : Tax Revenue 36.10 ----------------------- x 100 = ---------- x 100 = 10.95 % Total Revenue 329.62Assigned Revenues and Compensations composition ratio (2008) : Assigned Revenues 152.49 --------------------------- x 100 = ------------ x 100 = 46.05 % Total Revenues 334.13 -156-
  • 157. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshAssigned Revenues and Compensations composition ratio (2007) : Assigned Revenues 186.37 --------------------------- x 100 = ------------ x 100 = 56.54 % Total Revenues 329.62In the above example it can be seen that the Tax revenue contribution to total revenue has gone up byabout 2.17 % (13.12% -10.95% ) and also in case of assigned revenues and compensation thecontribution has gone up by about 10.50 %.Annual Growth Ratio (%)Ratio is calculated as Income for year y1 100 ----------------------- X ----- Income for year y0 1(Where y1 is the income of the current year and Y0 is the income of the earlier year .)This ratio can be calculated for Gross Revenues or individual Revenue Sources. Growth of income in oneperiod over earlier period can be calculated for revenues like user charges, Tax Revenues, TotalRevenue, Non Tax Revenue etc. Growth in revenues of a ULB over earlier period, in percentage terms,can be calculated by this ratio.For example, in case of Municipality of Dwarka Ratio is Income for year y1 100 334.13 ----------------------- X ----- = ----------- x 100 = 101.37 Income for year y0 1 329.62(Where y1 is the income of the current year ie 2008 and Y0 is the income of the earlier year i.e. 2007.)From the above ratio it can be seen that there is a marginal growth of 1.37 % in the total revenues from2007 to 200813.1.2.2 Ratios related to Revenue Expenditure (%)Operating Expenditure Ratio (%)The ratio is calculated as Operating Expenditure 100 ------------------------------ X ------ Operating Revenue 1Where Operating Expenditure relates to the expenditure to operate an activity in order to deliver serviceto the citizens and Operating Revenue relates to revenue generated out of providing the services to thecitizens. For instance, water distribution, running schools, running public health facilities, maintainingsewer systems, solid waste management, etc. -157-
  • 158. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshThe ratio is less than 1 it indicates that the there is surplus generated in the activity that such revenue andexpenditure relates to. This ratio should be used in conjugation with Debt Service Coverage Ratio(DSCR) in order to determine if there is a sufficient liquidity to cover the Debt repayment obligation inrespect of such activity. If the ratio is more than 1 it indicates that the user charges or the revenuegenerated from the activity are not sufficient to cover the operating expenses. Debt repayment in suchcases is definitely not supported by the activity revenues and has to be supported by surplus from otheractivities. Water user charges for example, are never sufficient to cover the operating expenses and loanrepayment obligations. This ratio is usually more than 1 in such cases. There may be a case where thisratio is less than 1 but DSCR is poor (less than 1) which indicates that the surplus is not sufficient to fulfilloan repayment obligation.For example, in case of Municipality of Dwarka Ratio isOperating Expenditure of Water supply and sewerage services (2008)(data source : page 55 of Financial Statements) Operating Expenditure 100 ------------------------------ X ------ Operating Revenue 1 41.96 -------- x 100 = 226.19 % 18.55 In above example ratio of 226.19% (2.26 times revenue) indicates that expenditure is higher by 226.19%or 2.26 times the revenue. Thus there can not be surplus from this activity and infact there are cashlosses by carrying out this service.Expenditure Composition Ratio (%)This is similar to the Revenue Composition Ratio. The ratio is calculated as Operating Expenditure on single activity 100 ----------------------------------------------------- X ----- Total Operating (Revenue) Expenditure 1For water supply and sewerage services operating ratio would be (data source : page 55 of FinancialStatements of Municipality of Dwarka ):For example, in case of Municipality of Dwarka Ratio is 41.96 ---------- x 100 = 14.71% 285.20This ratio indicates how much of the total revenue expenditure is being spent on operating a particularactivity. This ratio can also be calculated for all the independent activities and their correlation with thetotal revenue expenditure can be determined. For example• Establishment expenditure to total Revenue Expenditure -158-
  • 159. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh• Administrative Expenditure to total Revenue Expenditure• Operation and Maintenance expenditure to Revenue Expenditure• Interest on borrowed funds to Revenue Expenditure, etc.These ratios can be used to determine diverging trends in the expenditure pattern of the ULB.IN the above example the operating ratio of Water supply and sewerage services to total operatingexpenses is 14.71%. This means that 14.71% of the total operating expenses are incurred on watersupply and sewer services.Annual Operating Expenditure Growth Ratio (%)Ratio is calculated as Operating Expenditure for period 1 100 -------------------------------------------- X ----- Operating Expenditure for period 0 1Where period1 is the Revenue Expenditure of the current period i.e (2008) and period0 is the RevenueExpenditure of the earlier periods i.e. (2007).This ratio can be used for comparing similar expenditures (both capital and revenue) for different periods.The periods could be year or half year or quarter. Seasonal activities can be compared for the similaractivity in the earlier season.For example, in case of Municipality of Dwarka Ratio is :Operating Expenditure Ratio : 285.20 ---------- x 100 = 106.73 % 267.22Above example indicates that expenditure of 2008 has gone up by 6.73 % as compared to year 2007.Other ratios can beGrowth in Capital Expenditure (%) Capital Expenditure for period 1 100 ----------------------------------------- X ----- Capital Expenditure for period 0 1Growth in Establishment (%) Establishment Expenditure for period 1 100 129.55 ----------------------------------------- X ----- = ---------- x 100 = 110.84 %- Establishment Expenditure for period 0 1 116.88 -159-
  • 160. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshIndicates increase in Establishment Expenses in 2008, by 10.84% as compared to year 2007.Growth in Interest payment (%) Interest Expenditure for period 1 100 51540 ----------------------------------------- X ----- = ---------- x 100 = 1258.30 % Interest Expenditure for period 0 1 4096Here though the amounts are not large variance is very high. It would be necessary to look into suchincidence of high variance.Maintenance expenditure to Fixed AssetsRatio is calculated as Expenditure on Maintenance 100 ---------------------------------------- X ----- Total Fixed Asset 1This is an important ratio that indicates the condition of assets. The ratio can be calculated for individualclass of assets like buildings, Plant and Machinery, Vehicles etc. If the ratio is high for Plant andMachinery (more than say 25%) that indicates that the operating efficiency of machine has gone down.Further it may indicate a requirement for major overhaul or replacement. Advanced analysis shall help intaking Capital Investment decisions.For example, in case of Municipality of Dwarka (2008) Maintenance Expenditure is given in Sch L, page 7 of the Financial Statements for 07-08. Relevant figures are : Repairs and Maintenance (Infrastructure Assets) 33.44 Lacs Repairs and Maintenance (ICivic Amenities) 5.82 Lacs Repairs and Maintenance (IBuildings) 3.14 Lacs Repairs and Maintenance (IVehicle, Plant and Mach) 11.99 Lacs Total Repairs and Maintenance 54.39 Lacs Fixed assets (Page 19 ) (At Gorss value) 48.94 Lacs Expenditure on Maintenance 54.39 -------------------------------------- x 100 = --------- x 100 = 111.14 % Fixed Assets (Gross) 48.94In above example, the ratio indicates that maintenance expenditure is very high. It may be worthanalysing whether the assets need replacement. High expenses on maintenance may be incurredbecause of worned out Fixed Assets. Further Fixed Assetwise analysis can give better understanding if aparticular class of asset requires more maintenance.Cost of borrowings RatioRatio is calculated as: -160-
  • 161. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Interest and Finance charges paid 100 ---------------------------------------------- X ----- Total Loans and Borrowings 1The ratio indicates the cost in percentage, paid during the year on Total borrowings. This ratio iscompared with the trends of interest rates in the market and in case the divergence is on a higher side(Interest rate is more than he market rate) further analysis can be done in order to determine if a Debtrestructuring is required.For example, in case of Municipality of Dwarka (2008) Interest on Borrowings (p 7) 0.52 --------------------------------------- x 100 = ---------- = 0.88 % Unsecured Borrowings (p 19) 59.15In the above example the ratio of 0.88% does not depict a correct position of the interest and Loanstaken. There is a mismatch somewhere else the ratio can not be very low. This needs furtherinvestigation which will help correctly disclosing the figures in the schedule.13.1.2.3 Ratios related to Capital ReceiptsCapital Receipts to Total Receipts Ratio (%)The ratio is calculated as Capital Receipts 100 ----------------------- X ------- Total Receipts 1The ratio indicates percentage of Capital Receipts as compared to total receipts. The capital receiptscould be in the nature of Capital Grants, Loans taken, and other items like Investments Matured,Advances adjusted etc. Tough this ratio may not be comparable with the earlier years since the trend ofreceipt of Capital Receipts can not be same. The ratio indicates composition of Capital Receipts ascompared to Revenue Receipts out of Total Receipts for the period.For example, in case of Municipality of Dwarka (2008)Capital Contribution (p 19) 463.87 453.87----------------------------------------------------------------------------------- = ------------------------- = ---------- = 56.88%Total Receipts (Capital Contri (p 19) + Revenue Receipts (p 4) (334.13 + 463.87) 798Growth in Capital Receipts (%)Ratio is calculated as follows: Capital Receipt for period 1 100 ----------------------------------------- x ----- Capital Receipt for period 0 1 -161-
  • 162. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshWhere period 1 is the Capital Receipt of the current period and period 0 is the Capital Receipt for theearlier period.The ratio indicates Growth / Decline in the Capital Receipts as Compared to the previous period.Comparison of Growth related ratios of various receipts during the current period with the correspondingreceipts of earlier period would help in analyzing the reasons for growth or decline in growth.For example, in case of Municipality of Dwarka (2008)Capital Receipts (2008) 463.87--------------------------------- x100 = ---------- x 100 = 116.80%Capital Receipts (2007) 397.14In above example there is a growth in Capital Receipt during 2008 by 116.80% as compared to similarreceipts in 2007.Growth in Capital Grants (%)The Ratio is calculated as follows: Capital Grant for period 1 100 ----------------------------------------- x ----- Capital Grant for period 0 1Where period1 is the Capital Grant of the current period and period0 is the Capital Grant for the earlierperiod.Above example can be used to understand this ratio also.13.1.2.4 Financial Ratios related to Capital ExpenditureCapital Expenditure to Total Expenditure Ratio (%)The ratio is calculated as follows: Total Capital Expenditure 100 ---------------------------------- X ----- Total Expenditure 1The ratio indicates the percentage of Capital Expenditure to Total expenditure. The Composition of capitalexpenditure could be Developmental Expenditure, Acquisition of Fixed Assets, and Spending from CapitalGrant, Advances, and Capital Work in Progress, Investments, and Repayment of Loan etc. This ratio foreach of the component of Capital Expenditure shall indicate share of each component in CapitalExpenditure RatioFor example, in case of Municipality of Dwarka (2008) Capital Expenditure during the year is calculated as : (Rs. In Lacs) -162-
  • 163. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh Particulars 2008 2007 Addition during Yr. Fixed Assets 48.94 43.69 5.25 CWIP 30.42 11.99 18.43 Total 23.68 Total Expenditure is Capital Expenditure 23.68 Revenue Expenditure (p 4) 285.20 Total 308.88The Ratio is : 23.68 ----------- x 100 = 7.66 % 308.88In the above example, only 7.66% of total expenditure is of Capital Nature. Another ratio would beinteresting to analyse: Total Capital Expenditure 23.68 ---------------------------------- x 100 = ----------- x 100 = 4.77 % Total Capital Receipts 496.67 Capital Receipts = Capital Grants + Capital Contributions (both p 19) 463.87 + 32.80 = 496.67Thus, only 4.77% funds, out of funds available for capital expenditure have been spent.In order to arrive at meaningful ratios the components of Capital Expenditure need to be well definedwhile preparing the budget. For example if the Development Expenditure is classified further intoExpenditure for Poor and for Women, the ratio can be calculated to know what percentage ofdevelopmental Expenditure is made for pro poor and pro Women activities. These ratios become animportant Financial Management Tool to control the expenditure to achieve the objectives of the ULB.Capital Expenditure to Total Receipts Ratio (%)The ratio is calculated as follows: Total Capital Expenditure 100 -------------------------------------------- X ----- Total Receipts (Capital + Revenue) 1Ratio indicates the percentage of Capital Expenditure to total Receipts. As mentioned earlier, the ratiocan be calculated for each components of the Capital Expenditure.For example, in case of Municipality of Dwarka (2008) the Ratio is Total Capital Expenditure. 23.68 -------------------------------------- x 100 = --------------- x 100 = 2.85% Total Receipts (Cap + Rev) 830.80 Total Receipts = ( 496.67 + 334.13) = 830.80 -163-
  • 164. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh (Ref p 4 for Revenue Receipts and Capital Receipts are calculated above)This ratio indicates that only 2.85% of the total funds received are spent on Capital13.1.2.5 Budget Related Ratios (%)The Ratio can be calculated as follows: Actual Total Receipts / Expenditure 100 ----------------------------------------------- X ----- Budgeted Total Receipts / Expenditure 1This ratio can be used to determine actual performance as compared to the Budgeted targets inpercentage terms. This ratio can be calculated for various components of Receipts and Expenditure todetermine the percentage achievement of the Budgeted targets. If the ratio exceeds 1 (or exceeds100%), it means that the actual achievement is more than the Budgeted targets. In case of Expenditure,further analysis can be made to determine if the excess expenditure was authorized by appropriateauthority.This ratio can be calculated for other components of Income or Expenditure for example:• Actual Property Tax Collection to Budgeted Property Tax collection.• Actual Developmental Expenditure to Budgeted Developmental Expenditure• Actual Collection of Market Rent to Budgeted Collection of Rent• Actual collection of Water user charge to Budgeted collection of Water User charge.13.1.2.6 Liquidity Related RatiosCurrent RatioThis ratio is calculated as Current Assets ---------------------- Current Liabilities.In the Corporate world this ratio has a great significance to measure the liquidity position of a company.The ratio indicates if there are sufficient funds available in short term to cover the payment of liabilitiesarising in short term. Current assets or current liabilities here mean assets realizing within one year orliabilities payable within one year. The ratio above 1.2 is considered as a comfortable position. Ratiobelow this figure means the current assets are strained to meet the current liabilities and liquidity positionis tight. This ratio however, in case of a ULB should be at least 1.8 to be considered as a comfortableposition. This is because the Financial Management in ULBs has not reached to a professional level,therefore each liability -164-
  • 165. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFor example, in case of Municipality of Dwarka (2008) Current Assets 648.65 ------------------------ = ---------- = 3.98 Current Liabilities 162.94 (refer page 19 for figures)In the above example the Current Ratio is 3.98 which is very healthy. This indicates that current liabilitiesare covered 3.98 times by Current Assets, which is a good liquidity position.Debt Service Coverage RatioThe ratio is calculated as follows: Surplus before deducting Interest and Depreciation -------------------------------------------------------------- ------ Loan Repayment (Interest + Principal)The ratio indicates the capacity of the ULB to service the debt. The ratio is relevant for Term Debts andratio above 1.8 is considered as good for companies in private sector. However, in ULBs where there isno professional management the ratio should be 2 and above. Before accepting any long term debtliability, ULBs should calculate DSCR to determine its comfort in making timely repayments.In case of Municipality of Dwarka Loan repayment is Rs. 8.50 Lacs per annum and interest accrued onoutstanding balance is Rs. 3.75 Lacs approx. Therefore total liability for repayment is 12.25 Lacs(8.50+3.75)Surplus before interest and depreciation is calculated as: Excess of income over expenditure 48.93 Add: Depreciation 1.43 Add: Interest on Loans __ 0.51 __ Total: Surplus before interest and depreciation 50.87The ratio in above example is therefore : 50.87 -------- = 4.15 12.25This is a sound liquidity position in terms of borrowing capacity of the Municipality.Loan Liabilities to Own Funds RatioThis ratio is calculated as follows: Total Loans ----------------- Owned Funds -165-
  • 166. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshIn corporate sector this ratio is also known as Debt Equity Ratio Total Loans mean all the Loans taken bythe ULB outstanding as at the date of calculation. Owned Funds means the Municipal Fund and Reservesif any. This ratio is an indication of how much cover is available for Loans out of ULBs own Funds. Lowerthe Ratio better it is. In any case the ratio should not exceed 3. If the ratio is 3 it would mean that the ULBhas borrowed Funds up to 3 times Own Funds. It is observed that repayment of interest and principalbecomes difficult if the ratio exceeds 3.In case of Municipality of Dwarka the ratio is calculated as follows : Total Loans = Unsecured Loans as per Balance Sheet (p 19) = 59.15 Lacs Own Funds = Municipal Funds + Reserves. (p 19) = 0.53 LacsRatio is 59.15 -------- = 111.60 0.53 This ratio indicates Unsecured Loans are 111.60 times Municipality’s own funds. This,though is a very adverse financial position, it can be explained that since the Municipality shifted toaccrual based accounting, while preparing Balance Sheet Own Fund was taken as a balancing figure.This was a negative figure in 2007 and is marginally positive in 2008.13.1.2.7 Financial ratios as an expenditure management toolIt can be seen that financial ratios and its analysis is a good Financial Management tool to monitor theFinancial Health of a ULB. Standardisation or benchmarking of ratios can be carried out and actual ratioscan be compared with the standards. This would do away with the need to analyse ratios every time. Onlythe cases, where variance is more than the standard or acceptable level, need to be analysed further.The analysis would reveal the reasons for deviation. The reasons could be controllable or uncontrollable.The controllable reasons should be looked into and rectified so that the deviations are addressed to. Thiscan be applied for various expenditures like interest payment, operating expenses, project expenses,administrative expenses, repairs and maintenance expenses, etc.13.2 Good practices of financial analysis1. Every Municipal Corporation should use its web site as a primary means of communicating financial information to citizens and other interested parties.2. All ULBs should present mandated budgetary comparisons as part of their audited basic financial statements.13.3 Policies1. Each Municipal Corporation in MP shall prepare and present [monthly] financial reports that analyse comparisons of actual with budget amount evaluate and forecast the ULB’s financial performance and economic condition to the Commissioner.2. Each Municipal Corporation in MP shall establish benchmarks for key trends and monitor and issue reports on these trends on a [quarterly] basis. -166-
  • 167. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh13.4 ProceduresThe following section discusses the procedures for implementing the process of financial analysis in aULB.13.4.1 Step 1: Select and develop significant indicatorsThe usefulness of indicators increases considerably if a ULB approaches them in a comprehensive way.This means that after considering the purpose of analysis, a ULB should first outline the localgovernment’s problems and then define indicators that treat them. A maximum of two indicators shouldbe related to each key problem.For example, if the local government is undertaking a general financial evaluation, a ULB can categorizeits budget into sectors and identify one or two characteristic indicators for each sector.13.4.2 Step 2: Collect the data and calculate the indicatorsA ULB should use primary, reliable sources of data. The most important feature of any data is its source.For example, a ULB can calculate per capita revenues based on the actual population data of the localgovernment. In many cases, however, the necessary data are only available from unreliable sources, ifthey exist at all, and many times the ULB will need to accept an estimate. In certain cases a ULB willeven need to make its own estimates. This is better than not using any data at all. When a ULB usesuncertain data, it should indicate their source and reliability.It is important that adequate attention is paid to the unit of measurement. Are the data in percentages,thousands, or millions? Failure to report the unit will affect correct interpretation of the data. Failure toconsistently use the same unit of measurement each year will also restrict a ULB’s ability to compare dataand analyze trends in the future. If a ULB’s objective is to compare data with that of another localgovernment, it should be sure to collect the data in the same unit of measurement.It is also important to identify the fiscal period for which the data were collected. The budget data usuallyreflects the year-end position. However, if a ULB uses a different period, this should be so noted, and theULB should adjust any year-to-year comparisons, accordingly.A ULB must adjust indicators for inflation to reflect year-to-year comparisons in constant terms. Ingraphing indicators, a ULB should consider including two lines showing both current and constant termsto demonstrate the impact of inflation. Therefore, to compare budget data from different periods, a ULBneeds to compute the current data relative to constant data, or in the case of constant values, keep inmind that they include inflation.A ULB should use multiyear data for analysis. An evaluation of fiscal condition is most practical anduseful if it focuses on multiyear trends. Budgets usually show a comparison of last year, this year, andproposals for next year. However, it is best to use three to five years of actual data for trend analysis. Thiswill indicate in what direction each indicator is moving and how fast. -167-
  • 168. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh13.4.3 Step 3: Analyze and interpret the indicatorsA ULB should also analyze and interpret the fiscal indicators that are calculated. The primary tool foranalyzing indicators is trend analysis - examining each indicator over a period of three to five years. Thishas several advantages: (1) it allows officials to determine how fast an indicator is changing and in whatdirection; 2) it permits a ULB to compare one trend to another; 3) it allows comparison to othercommunities; and (4) it provides a database for effective budgeting and capital planning.Trend analysis involves the following steps:1. Identify both favorable and unfavorable trends.2. Determine when the unfavorable trend began. How fast is it changing? Is it getting better or worse? How serious is the problem?3. Consider mitigating circumstances, for these may neutralize an otherwise unfavourable trend. For example, if per capita expenditures increase — which a ULB may at first perceive as an unfavorable trend — it could be mitigated by a proportionate rise in per capita revenues.4. Identify the causes underlying unfavorable trends.5. Determine reasons for favorable trends. A ULB can use this information to explain positive trends to citizens and to justify borrowing needs to lending institutions.6. Analyze each indicator in relation to other indicators. No single trend implies a good or bad fiscal condition. It only points to a situation that should be examined more closely.7. Compare conditions to those of other local governments or to regional or national trends.8. Determine whether a ULB should perform further analysis.9. Apply professional judgment.13.4.4 Step 4: Present the resultsA ULB should present indicators in an understandable format. This means that the ULB should preparecharts, tables, or figures that summarize the indicators and illustrate unfavorable trends.In any report a ULB prepares, it is important to find a good balance between numbers and charts, andcontents and format. Bar diagrams are the most widely used figures, lines suggesting a continuouschange, and pie charts are appropriate for presenting the share of a certain value (income tax as a shareof total revenues, for example).13.4.5 In conclusionRatio analysis is not an end of Financial Management but a tool for it. The ratios help in focusing on theareas that indicate weakness. They can throw up early signs of trouble and if acted upon for correctiveaction, monitoring of funds is strengthened. Ratios also help in comparison of actual position with the pasttrends and to extrapolate these trends to map the Future trends. They help in taking strategic decisionslike borrowing funds, taking up newer projects with substantial capital outlay, Investments etc. -168-
  • 169. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshRatios mentioned above are generally used ratios and is not an exhaustive list. Ratios can be calculatedin respect of various other parameters depending upon need for monitoring. Ratios can also be calculatedbased on per capita information. Such ratios can indicate the per capita expenditure or income and howefficiently Municipal services are provided to citizens. -169-
  • 170. Manual on Good Practices of Financial Management for ULBs of Madhya Pradesh14PROCUREMENTThe Procurement Guidelines for Works, Equipment and Technical Assistance prepared under theMPUSP programme provide elaborate policies, guidelines and procedures for procuring works,equipment and technical assistance under the programme. Although, this document is applicable only onthe participating cities of the MPUSP programme, it is not restricted for use by other ULBs in MP.The document has received wide recognition and acceptance from institutions such as DFID and AsianDevelopment Bank. Therefore, all ULBs in MP are encouraged to use the policies, guidelines andprocedures laid down in the document to conduct procurement for any works, equipment and technicalassistance. -170-
  • 171. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshANNEXURE 1: FORMATS FOR BUDGETINGTable 20 : Format for calculating budget requirements for electricity charges for streetlight serviceParticulars Exist Likely Average Total Average Electricity Price Per day Annual Likely Total Exigency Total ing Additions Non- Operational Usage Units per Cost of Cost of % projected Budget budget operating 6 Consumed price Cost of required Num Points per day unit Electricity Electricity @ 5% for the bers points (2+3-4) Per day per (INR) For all For SLS Rise Electricity year (hours) point (11 points INR (9X365) (10X11) Rs. In hours) Rs. In (5X7X8) Rs. In lacs lacs lacs (12+13)1 2 3 4 5 6 7 8 9 10 11 12 13 14Tube lights 1000 100 100 1000 11 hr 0.61 5 3050 11.13 10% 12.243Mercury 80 W 2000 500 200 2300 11 hr 1.1 5 12650 46.17 10% 50.787Sodium 150 W 3000 300 100 3200 11 hr 1.9 5 30400 110.96 10% 122.056Sodium 250 W 1000 500 100 1400 11 hr 3.1 5 21700 79.21 10% 87.131Total 7000 1300 500 7800 11 hr 67800 247.47 10% 272.217 13.61 285.8276 This is yearly average. In summer streetlight is used for 8 hours while in winter for 13 hours so yearly average per day comes 11 years as rule of thumb. A municipal body can usesame format to calculate month wise electric consumption if required. -171-
  • 172. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 21: Format for calculating budget requirement for O&M of streetlight serviceParticulars of Exis Likely Total Replacement Replacem Replace Price Replacement Likely Projected Exigency Total RemarksStreet Lights ting Additions Operational units as per ent ment per Cost at % cost of Budget budget Num technical Units as units current price required SL Points estimate unit replacement @ 5% for the bers standards per prices 8 (2+3) d for (INR) Rise (9 X 10) year Historical budget (7 X8) (11+12) trend 7 year1 2 3 4 5 6 7 8 9 10 11 12 13 14Tube lights 1000 100 1100 9 1200 1100 40 44000 10% 48400 2420 50820 1100Mercury 80 W 2000 500 2500 800 900 800 300 240000 10% 264000 13200 277200Sodium 150 W 3000 300 3300 1100 900 1100 500 550000 10% 605000 30250 635250Sodium 250 W 1000 500 1500 500 300 500 800 400000 10% 440000 22000 462000Mercury 80 W 2000 500 2500 500 500 500 300 150000 10% 165000 8250 173250chalksTL Starter 1000 100 1100 220 400 220 5 1100 10% 1210 61 1270.5TL Chalks 1000 100 1100 220 300 220 120 26400 10% 29040 1452 30492SV 150 W 3000 300 3300 660 600 660 600 396000 10% 435600 21780 457380ChalkSodium 250 W 1000 500 1500 300 300 300 750 225000 10% 247500 12375 259875SL Poles 7000 1400 8400 140 100 140 10000 1400000 10% 1540000 77000 1617000Total 3432500 10% 3775750 188788 39645387 For simplicity it has been taken same as technical standards but in reality a judicious decision should be taken on basis of historical trend & technical standard value8 % price rise for each item may be different but for simplicity 10% increase is taken in to account. But in actual practice ULB should take actual price rise expected.9 A tube light average life is 5000 hours, while mercury and sodium lamps last for 15000 hours. Thus all tubelight will require replacement in a year while one third mercury and sodiumlamps will require replacement as their life is three years. Replacement ratio of 20% is assumed for Base Units of lamps, starters, chalks while replacement ratio of 12% for SL Poles -172-
  • 173. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 22 : Format for calculating budget requirements for electricity charges for pumping operations of Water Supply Service 10 Existing Likely Average Total Average Electricity Price Per day Annual Likely Total Exigency TotalParticulars Numbers Additions Non- Operational Pump Units per Cost of Cost of % projected Budget budget operating Usage Consumed price Cost of required Pumps unit Electricity Electricity @ 5% for the pumps (2+3-4) per day Per Day (INR) For Pumps For SLS Rise Electricity year (hours) (5X6X7X8) (9X365) (10X11)1 2 3 4 5 6 7 8 9 10 11 12Pumps at 5 1 1 5SourcePumps at 5 1 1 5WTPPumps at 2 1 3OHT NO 1Pumps at 2 1 1 2OHT NO 1Total10 Though here pumps have been classified as per category as an illustration, this format can be extended by enlisting each pump separately and the format given here can be usedas a summarised format. Here for simplicity each pump is taken of 1 mgd capacity -173-
  • 174. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 23 : Format for calculating budget requirements for electricity charges for Pumping operations of Sewerage Service 11 Existing Likely Average Total Average Electricity Price Per day Annual Likely Total Exigency TotalParticulars Numbers Additions Non- Operational Pump Units per Cost of Cost of % projected Budget budget operating Usage Consumed price Cost of required Pumps unit Electricity Electricity @ 5% for the pumps (2+3-4) per day Per day (INR) For Pumps For SLS Rise Electricity year (hours) (5X6X7X8) (9X365) (10X11)1 2 3 4 5 6 7 8 9 10 11 12Pumps at 5 2 1 6seweragepumpingstationsPumps at 5 3 1 7STPTotalTable 24: Format for calculating budget requirement for fuel expenses for vehicles & other machineryParticulars Existi Likely Average Total Average Petrol or Price Per day Annual Likely Total Exigency Totalof Vehicles / ng Additi Non- Operatio Usage Diesel per Cost of Cost of % price projected Budget budgetmachines Numb ons operating nal Consumed Cost of requiredowned and per day (litres) litter Fuel Fuel Rise @ 5% for the ers Vehicles / Units by all /petrol/ Electricityused by (INR) For vehicle yearULB Machinery (2+3-4) vehicles diesel (11X12) (10X365) (kms) (8X9)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Car 10 2 2 10 2100 150Jeeps 20 5 3 22 4500Mini Trucks 15 3 3 15 150011 Though here pumps have been classified as per category as an illustration, this format can be extended by enlisting each pump separately and the format given here can be usedas a summarised format. Here for simplicity each pump is taken of 1 mgd capacity -174-
  • 175. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshParticulars Existi Likely Average Total Average Petrol or Price Per day Annual Likely Total Exigency Totalof Vehicles / ng Additi Non- Operatio Usage Diesel per Cost of Cost of % price projected Budget budgetmachines Numb ons operating nal Consumed Cost of requiredowned and per day (litres) litter Fuel Fuel Rise @ 5% for the ers Vehicles / Units by all /petrol/ Electricityused by (INR) For vehicle yearULB Machinery (2+3-4) vehicles diesel (11X12) (10X365) (kms) (8X9)Trucks 20 2 1 21 2100DieselPumpsHot Mix PlantTotalTable 25: Format for calculating budget requirement for purchase of tyres for vehiclesParticulars Existi Likely Average Total Average Historical Standar Total Price Annual Likely Total Exige Totalof Vehicles ng Additi Non- Operatio Usage trend in d number of per Cost of % projected ncy budgetowned and Numb ons operating nal need for quantity tires price Cost of Budge requiredused by ULB per day tires per of tires estimated for unit tiers for the ers Vehicles Vehicles Rise tires t (kms) vehicle required the budget (INR) For vehicle year (2+3-4) year (11X12) @ 5% (9X10)1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Car 10 2 2 10Jeeps 20 5 3 22Mini Trucks 15 3 3 15Trucks 20 2 1 21TipperCompactorTotal -175-
  • 176. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 26 : Format for calculating budget requirements for online Clorinisation requirement for Water Supply ServiceParticulars Existing Likely Total Average Clorin Price Per day Annual Average Saving Annual Likely Total Exigency T Water Additions Water Water Units per Cost of Cost of No. of due to Cost of % projected Budget b Supply to WS Supply Supply Consumed non non price Cost of re unit of Clorin Clorin operating operating Clorin @ 5% fo Capacity capacity per day per day Per MGD Clorin Rise Clorin for per Day per day (MLD) For WS For WS days per days For WS ye (MGD) of Water (INR) year (8X10) WS c (MLD) (MLD) (2+3) Supply (5X6X7) (8X365) (8X11) (12X13)1 2 3 4 5 6 7 8 9 10 11 12 13 14OHT1OHT2OHT3TotalTable 27 : Format for calculating budget requirements for Solid Waste Transportation when operation is outsourcedParticulars Existing Per Solid % Solid Solid Solid Solid Likely Total Exigency Total Population Capita Waste Collection Waste Waste Waste Waste % price projected Budget Budget Solid gener efficiency Collected transport transpo Transpo Cost of required Waste Per Day Rise @ 5% for Ation tation rtation Rtation Solid Gene per Day (MT) cost per cost cost per Solid Waste ratIon (MT) (4X5) MT (Rs) per day annum Transpo Waste (grams) (Rs.) (Rs) Transpo (8X365) rtationj (6X7) rtationj (9X10) (11+12)1 2 3 4 5 6 7 8 9 10 11 12 13 14Area 1Area 2Area 3Total -176-
  • 177. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 28 : Format for calculating Solid Waste Transportation cost when operations are handled inhouse by a municipal bodyParticulars Solid Load No. of Total Salary Fuel cost O & M Total TransportTypes of Waste capacity trips transport cost of the of athe cost of cost of cost ofVehicle Collected of the feasible capacity of vehicle vehicle the running per MT and to be vehicle by the the vehicle per day per day vehicle the (INR) transported vehicle per day (average (average per day vehicle (9/5) Per Day (MT) annual annual (average per day (MT) (3X4) cost/365 cost/365 annual (INR) days) days) cost/365 (6+7+8) (INR) (INR) days) (INR)1 2 3 4 5 6 7 8 9 10 11 12 13 14TotalTable 29 : Format for calculating Storm Water Drains cleaning cost when operation is outsourcedParticulars Total Likely Total Cost of Cost of Likely Total Exigency TotalTypes of length of Additions length of cleaning cleaning % price projected Budget BudgetStorm Storm during Storm Storm Storm Cost of requiredWater Water the Water Water Water Rise @ 5% forDrains Drains budget Drains to Drains (per Drains SWD (INR) Cleaning SWD (meter) year be running (INR) Cleaning cleaned meter) (4X5) (6X17) (meters) (INR) (INR) (8+9)1 2 3 4 5 6 7 8 9 10 11 12 13 14NaturalOpen brickpitchedOpen BoxClosed BoxPipe BasedTotal -177-
  • 178. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTable 30: BIDS for listing spill over works and for estimating their budget liability Model Budget Formats For MP ULBs Budget Information Data Sheet Statement for Listing Spill Over Works and for estimating their Budget Liability Sr. Name of the work Sanctioned Expenditure Expenditure Expenditure Total No. Budget to be booked which will get which will get Amount Amount in the current booked in booked in of Work year before Budget Year Budget + one 31st March Year Category One - Works approved and started in earlier Budget Year and getting completed in the current year and to be paid in the current year 1 2 Subtotal Category Two - Works approved and started in current Budget Year and getting Part or Fully completed in the current year and to be paid in the current year 1 2 Subtotal Category Three - Works approved and started in earlier and current Budget Year but will get completed in the Budget Year and to be paid in the Budget Year 1 2 Subtotal Category Four - Works approved and started in earlier and current Budget Year but will get completed in the Budget + One year and to be paid in the Budget + One year 1 2 Subtotal Category Five - Works approved but not started till date 1 2 Subtotal Grant Total -178-
  • 179. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshANNEXURE 2: FORMAT FOR ASSET MANAGEMENTFigure 12: Format for collecting information on ULB assets Land Parcel Loca tion Ca da stra l ID# P osta l Addre ss Le ga l De scription P rope rty Ta x Account M a yora lty / Tow n Ne ighborhood Ge ocode s X Y S ite De scription S iz e M2 Hec tares Dim e nsions Front m 2 Depth m 2 Topogra phy type : Level S loping S oil bonita tion (cla ss) Floodpla in cla ssifica tion Y es No Environm e nta l ha z a rd Y es No P rope rty Rights Fully ow ne d a nd use d Y es No Date A c quired Date S old Building ow ne d by: Le a se d out: S tart Date Les s or Finis h Date Building rights gra nte d: S tart Date Holder B uilding c onditions Curre nt Use Building re fe re nce s: Y es No Oc c upied area - m 2 V ac ant area - m 2 B uilding bas e area - m 2 Num ber of B uildings Building IDs: 1. B uilding ID M ain us er: (Us e another page if 2. B uilding ID M ain us er: there are m ore than 3. B uilding ID M ain us er: 5 buildings on this 4. B uilding ID M ain us er: P roperty ID# 5. B uilding ID M ain us er: Building functions: M unicipa l P ublic M unicipa l P riva te B uilding ID B uilding ID B uilding ID B uilding ID B uilding ID B uilding ID S ta te P rope rty a pplie d for tra nsfe r to M unicipa lity Com m erc ial Indus trial A gric ultural Other S ite Im prove m e nts P aving Lands c aped S e rvicing / infra structure W ater E lec tric S ewer Gas V a ca nt La nd P ortion Y es No P artially V ac ant Land m 2 V a ca nt La nd Use A gric ultural P ark Fores t P ark ing V ac ant Other Tra nsport Acce ss Roa d & S tre e t Y es Km No Km Urba n Tra nsit Y es Km No Km Airport Y es Km No Km Ra il S ta tion Y es Km No Km W a te r Te rm ina l Y es Km No Km La nd Use P la nning La nd Use Zoning M a ste r P la n P e rm ite d Use s Res idential Com m erc ial Indus trial Ins titutional A gric ultural P ark P e rm ite d De nsity Res idential Com m erc ial Indus trial Ins titutional S e rvice Constra ints W ater E lec tric -179-
  • 180. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshANNEXURE 3: FORMATS FOR FMISFigure 13: Format for monthly financial position MIS Format No. - I/G/1 ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Monthly Financial Position Accounts Department Month : Actual Receipt Actual Exp. Receipts Amount (Rs.) Amount (Rs.) Amount (Rs.) Expenditures Amount (Rs.) Amount (Rs.) Amount (Rs.) till last month in this month total till date till last Month in current Month total till Date Opening Balance Budgeted Expenditure Bank Balance 1. Establishment Cash Balance 2. Contingency Fixed Deposits 3. Operation & Maintenance Total 4. Loan Instalment Add : 5. Loan Interest Budgeted Revenue 6. Expenditure from Grants 1. Tax Revenue 7. Expenditure from Loan A/c. Octroi 8. New Advances Property Tax 9. Deposits Refunds Water Charge Sub-Total Other Tax Non-Budgeted Expenditure 2. Non-Tax Revenue - Interfund transfer Rents - Cheques returned Interest - Excess Income returned Income other - Accounts payable than Tax Sub-total - Return of Advances Total Expenditure - Deposits received Closing Balance 3. Other Revenue Cash - Revenue Grants Bank - New Loans Fixed Deposits Sub-Total Total Non-Budgeted Receipt - Interfund Transfer - Amount received against Cheque returned - Accounts receivables Total Receipts Submitted by : Chief Accountant Submitted to : Municipal Commissioner, Dy. or Asst. Municipal Commissioner -180-
  • 181. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 14: Format for statement showing actual receipts against budgeted receipts ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Statement Showing Receipts against Budget Accounts Department Month : Last Sr. No. Particulars of Budgeted Actual Receipts % Receipts during Total % Receipt % Year Data Revenue Source Revenue up to previous against the last Month Receipt against Budget Growth over till Date Month Budget till Date last Year 3 1 2 4 5 6 7 8 9 10 Total Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. Muni. Commissioner (Finance) -181-
  • 182. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 15: Format for statement showing actual expenditure against budgetedexpenditure MIS Format No. - I/G/3 ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Statement showing Expenditure against Budget Accounts Department Month : Last Years Sr. No. Particulars of Budgeted Expenditure % Expenditure Total % against % Data till Expenditure Expenditure till last Month against during the Month till the Budget Growth over Date Amount Budget Date last Year 3 1 2 4 5 6 7 8 9 10 Total Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. or Asstt. Municipal Commissioner (Finance) -182-
  • 183. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 16: Format for statement showing investments in bank fixed deposits ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Statement on Investments in Bank Fixed Deposits Accounts Department Month : Sr. No. Name of Bank Op. Balance of New Encashment Closing fixed Deposit Investment of F.D. Balance of F.D. 1 2 3 4 5 6 General Fund Bank - A Bank - B Bank - C Sub-total Sinking Fund Bank - X Bank - Y Bank - Z Sub-total Other Fund Bank - P Bank - Q Bank - R Sub-total Grand Total Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. or Asstt. Municipal Commissioner -183-
  • 184. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 17: Format for statement on returned/ dishonoured cheques ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Status Report on Returned/Dishonoured Cheques & Recovery XYZ Department Month : Description Number Amount Remarks Returned Cheques pending for Recovery Add. : Cheques returned during the Month Subtotal Less : Recovery against Cheques returned Cheques pending for the Recovery at the End of the Month Submitted by : Office Head or Head of Department Submitted to : Chief Accounts Officer, Dy. or Asstt. Municipal Commissioner -184-
  • 185. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 18: Format for summarised status report on returned/ dishonoured cheques ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Summarised Status Report on Returned/Dishonoured Cheques (monthly Report) Accounts Department Month : Sr. Departments Returned Cheques Cheques returned Recovery against Returned Cheques Remarks No. or Zones pending for during the returned Cheques pending for Recovery Recovery Month at the End of the Month Nos. Amount Nos. Amount Nos. Amount Nos. Amount 1 2 3 4 5 6 7 8 9 10 11 Zone - A Zone - B Zone - C Zone - D Any other Dept. Total Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. or Asstt. Municipal Commissioner (Finance) -185-
  • 186. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 19: Format for unadjusted advances status report ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Unadjusted Advances Status Report Accounts Department Month : Sr. Name of Unadjusted New Advances Advances adjusted Unadjusted Remarks No. Department Advances given during during the Month Advances pending at the Month the Beginning of the Month Total Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. or Asstt. Municipal Commissioner -186-
  • 187. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 20: Format for outstanding loans/ liability statement ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Outstanding Loans/Liability Statement Accounts Department Quarterly : Sr. Name of the Amount of Amount of New Loans Total Amount Loans repaid Total Loans Remarks No. Institution Loans taken Loans taken in the of Loans taken during the outstanding at the Beginning outstanding Quarter at the End Quarter at the End of Quarter at the Beginning of Quarter of the Quarter of Quarter 1 2 3 4 5 6 7 8 9 Total Submitted by: Chief Accounts Officer Submitted to: Municipal Commissioner, Dy. or Asstt. Municipal Commissioner -187-
  • 188. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 21: Format for projected monthly cash flow statement ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Projected Monthly Cash-Flow Statement Accounts Department Month : Receipt Projected Actual Expenditure Projected Items Figures Expenditure Items Figures for for the up to last the Month Month Month Opening Balance Budgeted Expenditure Add : Budgeted Receipts Establishment Tax Income Contingency Operation & Maintenance Non-Tax Income Loan Interest Loan Repayment Grant Exp. Grants Sub-total Sub-total Non-Income Receipts Non-Budgeted Expenditure - Loan Receipts - Deposits Refund - Deposits Receipts - Inter-fund Transfer - Advances adjusted - Advances given - Interfund Transfers Sub-total Sub-total Grand Total Grand Total Closing Balance Submitted by : Chief Accounts Officer Submitted to : Municipal Commissioner, Dy. or Asstt. Municipal Commmissioner -188-
  • 189. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshFigure 22: Format for status report on examination of accounts ABC MUNICIPAL BODY MANAGEMENT INFORMATION SYSTEM Status Report on Examination of Accounts Audit Department Sr. Department or Section ACCOUNTS WEEKLY BALANCE REASONS PENDING AUDIT REMARKS NO. Name EXAMINATIO ACCOUNTS ACCOUNT FOR DELAY IN AUDIT PARAS N PERIOD EXAMINATION EXAMINATION ACCOUNTS PARAS OF CLEARED EXAMINATION EARLIER DURING PERIOD THE MONTH 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 2003 - 2004 Total -189-
  • 190. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshANNEXURE 4: TOR CHECK LISTTOR Relevant Sections of the ManualBudgeting“Consider appropriate measures for implementingflexible and multi-year budgeting in a scientificmannerin the ULBs.The manual shall be capable of Section 3.1.4.7, 3.2.4 and 3.2.5facilitating the implementation of a budgetarycontrol system for tracking performance against Implementation of multiyear budgeting will betargets and analysis of variances” discussed in the implementation note“The budgetary system shall have financial as wellas physical targets for performance and a method Section 3.4.2, 3.4.3 and 3.4.4of prioritization of expenditure based on availableresources”“The manual must discuss the participatory processof budgeting and financial planning and must relate Section 3.1.1 and 3.1.4.6to the good aspects of gender budgeting andoutcome budgeting”Capital Improvement Program (CIP) and Capital Budgeting“The manual would also discuss the methodologyof preparing a capital improvement program, whichwould be a multiyear (usually five to six-year) Section 4.4 details out the procedures forplanning instrument used by governments to implementing CIP Programmeidentify needed capital projects and to coordinatethe financing and timing of improvements in a waythat maximizes the benefits to the citizens”The consultants would consider the fact that duringthe CIP process, the elected representativescompare and evaluate the dissimilar projects. Section 4.1.4These elected representatives represent thecitizens in choosing among various facilities and -190-
  • 191. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the Manualservices. Hence, the manual must describe themethodology of classification of all localgovernment expenditures are either capitalimprovements or operating expenses“Classification of items between capital andoperating depends on two criteria – cost andfrequency. The cost of a capital improvementshould be high enough to require special attention.Thus, the manual must clearly describe how theULB would establish the CIP program in a mannerthat minimum costs for items are included in thecapital improvements program. The manual must Section 4.1.3differentiate between the CIP and capital budgets,where the later represents the first year of thecapital improvement plan. The primary differencebetween the capital budget and the CIP is that thecapital budget is a legal document (a part of theoverall budget document) that authorizes thefinancing for specific projects during the ensuingfiscal period”Costing“Consider an activity-based costing practiceprescribing an appropriate costing methodology to‘ring fence’ the cost of important urban services Section 10.1.6and functions. This will enable accurate allocationof costs to specific services and adoption of outputmeasures to achieve “value for money”“The manual shall help provide disaggregatedinformation by cost centre for determining the ‘fullcost’ of municipal services. The system shallenable identification of major services and activities Section 10.1.6 and 10.3and identification of costs for each such service onan activity-based approach. The manual shall alsoenable compiling of costs on an ongoing basis andprovide user guides to of staff and management in -191-
  • 192. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the Manualcost compilation and in using the cost data”“The manual shall help provide disaggregatedinformation by cost centre for determining the ‘fullcost’ of municipal services. The system shallenable identification of major services and activitiesand identification of costs for each such service on Section 10.3an activity-based approach. The manual shall alsoenable compiling of costs on an ongoing basis andprovide user guides to of staff and management incost compilation and in using the cost data”Expenditure Management – Allready mentioned in the chapterAsset Management“The manual would cover examination and detaileddiscussion how the ULB can use asset Section 8.1 and 8.2management as an effective management tool”“The consultant may consider that the term assetswould include and mean the asset managementsystems and plans and describe the benefits ofusing asset management to better plan capitalinvestments and achieve service delivery goals.Already various exercises is under progress underthe MPUSP project like listing of assets and Based upon the assessment conducted in stage 1,preparation of fixed assets register, study on non- procedures have been developed for AMP (Sectionperforming assets, study on heritage assets, etc. 8.4). Methods to develop staff skills will beThe manual would clearly link these efforts and discussed as part of the implementation notesuggest the methods of documenting assetoperation and maintenance processes, developingprimary asset information system, methods toprepare basic asset management plans, andmethods to develop staff skills and createawareness among the ULB management” -192-
  • 193. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the ManualDebt Management“Another objective of the manual would be todiscuss in length the methodology of implementing Section 7.2 details out the good practices in debtgood practices of financial management in a ULB management while section 7.4 detail out theconcerning how debt management is developed procedures for implementing themand implemented”Obtaining long or short-term financing is not aneveryday occurrence. Most accounts and financeofficers of a ULB are not as familiar withprocedures for efficient and prudent managementof debt as with other responsibilities. However, it isno less important, and if done poorly, can result inhigher interest costs than necessary; and in a worstcase, poor debt management can bankrupt agovernment. Simply stated, debt is an obligation topay or return something at a future date. The term“debt” refers to all local government debtregardless of length, type, instrument, or lender.Length of debt refers to the amount of time beforerepaying the debt. Short-term debt is to be paid offin one year or less and long-term debt in over one Section 7.4year. The manual would also cover the concept ofdebt service, which is the cost of principal andinterest on borrowed money for a given year orseries of years, according to a predeterminedpayment schedule. The term “debt service” refersgenerically to all types of payments, whether for abank loan, central government loan, and localgovernment bond or lease agreement. Debt servicepayments are the sum of interest and principal ofbonds scheduled to mature in a given year. Themanual would thus describe all facets of debtmanagement starting from the process of directingand controlling the acquisition until retirement ofdebtFinancial Analysis – This chapter covers all the aspects of the TOR in the form of Break evenanalysis, Financial Ratios and procedures for implementing financial analysis in detail. -193-
  • 194. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the ManualCash Management“The manual would discuss about cash assetsmanagement, which implies ensuring that allprocess-generated revenues are effectivelycontrolled and utilized in the best possible mannerto result in gains for the ULB. The manual musthighlight the fact that management of cashresources holds the central position in the area ofshort term financing decisions. Holding of cashcarries the opportunity cost of earning, which is Section 5.1 and Section 5.2determinable if the cash either is under use withinthe organization or is under investment elsewhere.The manual would discuss about the basicobjectives of cash assets management, which are -(a) To ensure availability of cash as per paymentschedule; and (b) To minimize the amount of idlecash; The manual would discuss about the need ofproper planning and forecast of cash flows”The manual would outline the methods todetermine the expected cash inflows and cash Section 5.1.1 and Section 5.4.2outflows. This will help the efficient management ofcash assetsReceivables and Payables ManagementThe manual would discuss in length about themethods to manage the receivables, andparticularly discuss how to achieve a growth in the Section 6.4.2 and Section 6.4.3collection.- The manual may discuss methods ofintroducing various types of rebate to ensure afaster collection.“The manual would also discuss how to calculatethe carrying costs of the receivables, i.e. the cost ofinterest on receivables, which the ULB could haveearned if all the receivables have come on anormal course. The manual would also consider -194-
  • 195. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the Manualthe costs associated with the risk of default, i.e. acertain percentage of receivables may not come atall and will become bad debts. Such “defaultingcosts” will include legal charges, costs of filing suitetc”Internal controlThe manual would cover the essential pre-requisitefor efficient and effective financial management of Section 11.1.1any organization including a ULB i.e. theunderstanding efficacies of internal control“The manual would discuss in length the primaryobjectives and responsibilities for the managementof the ULBs are to establish and maintain anadequate and appropriate system of internalcontrol. Theoretically, one defines the internalcontrol as the plan of organization and all themethods and procedures adopted by themanagement of an organization. That would assistin achieving management’s objective of ensuring, Section 11.4as far as practicable. The manual would cover (a)the orderly and efficient conduct of its obligations,including adherence to management policies; (b)the safeguarding of assets; (c) the prevention anddetection of frauds and error; (d) the accuracy andcompleteness of the accounting records; and (e)timely preparation of reliable financial informationby the management”Financial Management Information System“The manual would also discuss about themethodology to develop an improved FinancialManagement Information System (FMIS), which is Section 12.3appropriate for planning, decision-making,performance evaluation and control” -195-
  • 196. Manual on Good Practices of Financial Management for ULBs of Madhya PradeshTOR Relevant Sections of the Manual“The FMIS shall ensure that sufficient information isavailable in the desired format and in a reasonabletime to enable management to exercise appropriatecontrol. The manual must provide the designs of Annexure 3FMIS, including formats for operating the system,to provide an integrated picture of financialinformation”The FMIS shall define the roles and responsibilities Will be covered in the implementation noteof the implementersThe manual shall discuss how the FMIS woulddovetail and link with the accounting, budgeting Will be covered in the implementation noteand costing systems. -196-