Public
Budgeting, PLS 503 (Dluhy)
Quantitative
Techniques for budget analysis, capital budgets, and forecasting
1.
Convert to “Constant Dollars” Adjusting for Inflation
When Comparing Revenues or Expenditures over time.
Inflation diminishes the value of money over time. Use either the CPI Index or the Implicit Price Deflator (IPD)—which is a better choice for local governments because index is based on government purchases of goods and services. Constant dollars will be the buying power of current dollars in base year dollars. Need to get inflation out of figures so that comparative analysis can be done.
Formula for calculation: p. 195.
Current $ rev. or exp. x base year IPD = Current rev. or exp. in base yr.$(constant$)
----------------
current IPD
Use: Doing analysis over time and you want to see efficiency savings or actual growth in services not just inflationary growth. Example, manpower may not actually increase over time but salaries go up. Other uses?
2.
Capital Investments.
The Payback Period method.
The time required to recover the capital investment through net annual cash flow savings. There are monies the city expects to save by making the capital investment minus expected expenditures.
Formula: p.292.
I (annual investment)
-------------------------- = PP (payback period) The shorter the better.
AS (net annual cash flow savings )
Actual Savings from investment:
EL (expected life)—PP x AS (net annual cash flow savings) = aS (actual savings)
Use: payback method does not address the time value of money. Shortest payback period is usually the best. Where future predicting is desirable and interest rates are unpredictable, good method. Best for periods less than 5 years or where assets have short term life.
3.
Capital Investment.
Rate of return on average capital investment.
This technique assumes the city depreciates its assets each year. This is calculated by dividing the net annual savings by the average investment in the capital asset.
Formula: p.293.
I (initial investment)
_________________ = Annual depreciation
EL (expected asset life, ie., 5 years)
FI (first year investment) + LI (book value the last year)
_____________________________________________ = AI (avj. Investment)
2
AS (net annual savings)
______________________ = RI (rate of return on avj. Investment)
AI (average investment)
Use: Calculation is the rate of return on average investment. This can be compared to other city investments. If rate of return on avj. Invested capital is good and the net annual savings are good, investment opportunity should be considered seriously.
4.
Capital Investment.
Positive Net Present Value.
Discounted Cash Flow.
Basic question is whether citizens or government would be better off allocating resources to this project (investment) or investing the money elsewhere? What a dollar is worth today and what a dollar will be worth in a few years. I could invest a dollar and earn interest or I could spend it and have the benefit of whatever I buy. You can figure the “present value” of a dollar spent sometime in the future by discounting it for the effect of inflation between now and then. Technique focuses on a higher value on money in hand today over future promises. How much will the principal be worth in year “n”. Discounting is compounding interest in the reverse. A future sum of money can be discounted at an appropriate interest rate to determine its equivalent present sum. It looks from the future back to the present. What is the present value (PV) of future sum invested for years n, at interest rate I, compounded annually.
Discount factor = 1
____________
(1 + i)t
I= interest rate. T= number of years.
PV (present value) = Future dollar amount X discount factor
Total present value (add figures)
Amount to be invested invested (add figures)
Use: Good to use when interest rates can be predicted. Positive net present value is a good summary investment figure to use. Assuming same initial investment and risk, the one having the highest possible net present value is preferable.
Notes on Capital Budgeting:
Current revenue
Property tax
Special Assessments
Fees if proprietary accounts (w&s, marinas, etc.)
General obligation bonds (secured by government’s taxing power)
Revenue bonds (proceeds of an enterprise are earmarked for debt payment
Lease purchase agreements (acquires use but not title, after city pays off becomes property of city) good for cars, trucks, etc.
Surpluses
Impact or facility fees (paid at time of new development and held in reserve fund until projects are built)
Name
For the following indicate whether the measure is an input, output, outcome, efficiency measure, productivity measure.