Financial Insight: Key for Tough Times

Knowledge is power: State and local officials are handicapped by their lack of good financial data.
by | July 2, 2008

It's another sequel, and you know the reviews will be bad. After years of relative prosperity, tough times have revisited state and local budgets. As in the early '80s, the early '90s and the first few years of this decade, many state and local governments find themselves struggling to stay above water in the face of falling revenues caused by a slowing economy. The Center on Budget and Policy Priorities estimates that states will take in nearly $50 billion less than originally forecast for the fiscal year just beginning.

How can states, cities and counties weather this storm without reverting to the usual budgeting gimmicks -- from raiding the rainy day fund to "sin tax" hikes -- that are trotted out each time budgets go south? Why do short-term fixes so often win out over true structural reforms when public officials are facing budget shortfalls? To be sure, political expediency and the desire to avoid making painful choices are two big culprits. But, there is another, more fundamental reason: The officials are handicapped by the lack of good financial data. If governments are to avoid the perennial cycle of short-term fiscal fixes that inevitably lead to bigger, long-term structural problems, they will first need to strengthen their finance functions.

This reality seems intuitive for corporations, but governments need a robust finance organization to anticipate and manage fiscal challenges and opportunities. A sophisticated finance operation is critical for addressing looming challenges, such as rising entitlement, health care, pension and infrastructure costs, and for meeting new operational demands, such as the heightened focuses on outcomes and transparency. But, therein lies the rub. Only one-third of government leaders believe they have the financial management capabilities needed to fully address these and other critical challenges.

This image, of a function mired in the past, is one of the main findings of a global survey of senior officials from more than 200 government organizations conducted by our team at Deloitte Research. Despite real progress over the past decade in streamlining transactional efficiency, in too many cases the finance function fails to serve governments' larger need for sophisticated financial insight. This is particularly true when it comes to the financial information needed to make informed tradeoffs during budgetary downturns. Fully 65 percent of respondents, for example, said that program managers do not understand the total cost of their services. Only one quarter of the government officials surveyed indicated that their agencies regularly prepare cost-of-service reports. Without fully understanding the cost of operations, programs, and service delivery, public officials cannot identify opportunities to reduce costs. Nor can they establish meaningful benchmarks for measuring financial performance.

The survey uncovered another endemic problem -- an incomplete understanding of the relationship between investments and outcomes. If performance-based budgeting is to be more than an academic exercise, and actually be employed to help pare costs during tight budgetary times, there must be rewards for good performance and real consequences for poor performance. This, however, requires legislators and budget directors to distinguish between programs that work and those that do not, and then to shift the right resources to the right places. More than half of those surveyed indicate that their organizations do not thoroughly understand the relationship between the investments they make in programs and the outcomes those programs produce.

That's the bad news.

On a more encouraging note, the survey results suggest early indications of a marked shift. A growing number of governments have recognized that, as with their private-sector counterparts, world-class finance functions create value by providing strategic insight and decision-making support to the enterprise as a whole. They do so in a variety of ways: They shine a spotlight on underperforming programs, comparing what is spent to the outcomes achieved; they help wring out inefficiencies by providing a picture of fully allocated costs; they quantify the tradeoffs between different policy options on the table; and they provide detailed information on true lifetime costs attached to particular decisions, so that future liabilities are properly understood.

These finance masters provide real-time financial information, accurate and activity-level cost information, and they ensure accountability. The U.S. Air Force Materiel Command, for example, revolutionized the management of its finances by making information on costs and outputs available to managers, who could then identify expenses and reduce them where appropriate. This helped the Air Force reduce its subsequent budget request by $2.7 billion.

The path to finance mastery involves two stages. The first is achieving basic finance stewardship and operations capabilities. The second is developing a more strategic set of capabilities that help government agencies determine what they should do -- i.e., mission, strategy, planning, and performance setting -- and then how they should operate.

In this challenging economic environment, equipping agencies with good financial information to help them figure out what they should do and how they should do it is a great opportunity to raise the profile of finance organizations at all levels of government.

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