Off the shelf ... and into business practices: developing financial policies that work.

Financial policies are guidelines for operational and strategic decision making related to financial matters. Financial policies identify acceptable and unacceptable courses of action, establish parameters within which a government may operate, (1) and provide a standard against which a government's financial performance can be judged. (2) As such, financial policies are a critical component of the management of a government organization.

However, public managers often find themselves disappointed with the extent to which financial policies are embraced by the governing body and staff. After their adoption, financial policies sometimes become nothing more than "shelf paper;" that is, they do not become an integral part of the organization's business processes. In other cases, governments may avoid adopting policies altogether for fear of the commitment those policies entail.

This article is intended to help public managers develop and implement effective financial policies. (3) Specifically, the article will provide an overview of the various dimensions of financial policies, the process used to develop policies, and the characteristics of effective policies.

THE DIMENSIONS OF FINANCIAL POLICIES

Financial policies are most commonly considered in terms of functional areas; for example, most finance officers are familiar with investment policies, debt policies, and operating budget policies. While this is certainly one useful approach to conceptualizing financial policies, this article considers financial policies along four alternative dimensions:

* Formal versus informal

* Policy versus procedure

* Accountability versus flexibility

* Actionable versus philosophical

As we will see, each of these dimensions has specific ramifications for the implementation of financial policies.

Formal Versus Informal. Governments can establish both formal and informal financial policies. Formal financial policies are those that are written down in an authoritative document and are typically approved by the upper echelons of the organization, usually by the governing body. Conversely, informal policies are de facto policies that have either evolved over time as the result of past practice or are simply unwritten rules promoted and practiced by an individual with influence, such as the finance director for matters of debt issuance. GFOA strongly recommends that governments develop and adopt formal financial policies. Consider the following advantages of formal policies:

* Formal policies usually outlive their creators, thus promoting stability and continuity. Formal policies also secure the buy-in of important stakeholders, since these same stakeholders are typically involved in their creation. In addition, stakeholder participation increases the likelihood that the actors in financial decision making will abide by a common set of rules.

* Formal policies can increase efficiency by standardizing operations. This eliminates the need to continually reinvent responses to recurring situations.

* Credit rating agencies look favorably on formal policies such as capital improvement policies, which can bolster bond ratings and thus reduce borrowing costs.

* Formal policies educate decision makers who may not have a background in government financial management. Many public officials, especially elected leaders, do not have expertise in the field of government finance. Financial polices can help inform officials of sound financial practices, increasing the likelihood that these practices will be followed.

* Formal policies promote long-term and strategic thinking by framing policy options and setting forth goals. For instance, if a revenue policy were to stipulate that no more than 25 percent of total revenues could be derived from a single source, then long-term strategic planning could focus on ways to maintain revenue diversity against this benchmark.

* Formal policies can be subjected to regular reviews in order to incorporate the latest thinking and best practices in the profession.

Informal policies can play a useful role in acclimating governments to the idea of financial policies in general, and they permit governments to determine which types of polices work and which do not before the policies are formalized. Governments that are hesitant to formalize financial policies might try to reach an internal consensus to use informal policies for a defined length of time before either formalizing or discarding those policies.

Policies Versus Procedures. Whereas financial policies are guidelines for financial management decisions, administrative procedures cover the detailed steps needed to accomplish business processes. Administrative procedures are an important complement to financial policies because they ensure that day-to-day activities are in line with financial policies. While administrative workers often find financial policies to be esoteric, they can usually relate to administrative procedures that provide detailed guidance. For example, a capital budget policy might stipulate that the first year of the capital improvement plan is to be adopted as the capital budget for the current year. Detailed administrative procedures might then be developed to outline the steps needed to make this happen, such as verifying CIP estimates before transitioning them to budget appropriations.

While procedures are a valuable complement to financial policies and can facilitate implementation of those policies at the ground level, it is sometimes difficult to identify where financial policies end and administrative procedures begin. Generally, if a "policy" item involves a management decision, it is likely not a policy at all, but rather a procedure. Personnel policies offer perhaps the best example of procedures masquerading as policies. Personnel policy handbooks are often very lengthy and contain detailed regulations governing day-to-day employment matters. Including what are really procedures as part of a policy to be considered by a governing board can impede implementation, as the sheer length of most procedural documents inhibits board understanding and buy-in.

Accountability Versus Flexibility. According to Peter Self of the London School of Economics, "the tensions between the requirements of responsibility or 'accountability' and those of effective executive action can reasonably be described as the classic dilemma of public administration." (4) Empowering public managers with the flexibility to achieve performance goals as they see fit is one of the paradigms of the new model of public administration. (5) However, empowerment and flexibility can conflict with the desire to maintain fairness in the provision of public services and to ensure the integrity of the processes used to achieve results. (6) Given that financial policies are meant to codify a government's ideals with respect to the functional areas of financial management, they can be designed to emphasize either accountability to the public or managerial flexibility. Exhibit 1 illustrates this concept.

Public managers must carefully consider the balance between accountability and flexibility as they develop policies. A policy that is too flexible may not provide meaningful guidance, while a policy that overemphasizes accountability may constrain a government's ability to operate effectively. Either extreme can discredit financial policies and ultimately lead to stakeholders disregarding them.

Actionable Versus Philosophical. Financial policies can generally be described as actionable or philosophical. Actionable policies are linked to specific performance indicators and dictate actions based on the status of those indicators. Actionable policies are valuable because they demand that governments take proactive steps toward financial management goals. In contrast, philosophical policies state general policy goals. The actionable or philosophical character of a policy has important implications for flexibility and accountability, as shown in Exhibit 2.

A third category of policies, which we will call "use of performance measures," lies between actionable policies and philosophical policies. This type of policy uses performance measures to gauge compliance, but, unlike actionable policies, does not prescribe a course of action in the event of underperformance. Instead, managers are left to decide how they will adjust operations to improve performance and thus comply with the policy. The following three hypothetical policy statements illustrate the distinctions among the types of policies illustrated in Exhibit 2.

1. Unreserved fund balance will be kept at an adequate level to maintain service continuity.

While this statement is useful as a basic philosophical statement, it begs the question: What is "adequate?" Since this is an open question, there is no way to accurately judge compliance with this policy.

2. Unreserved fund balance will be maintained at 15 percent of annual general revenues in order to maintain service continuity.

This statement uses performance measurement to judge compliance with the policy. However, it does not specify what should be done if reserves fall below 15 percent.

3. Unreserved fund balance will be maintained at 15 percent of annual general revenues in order to maintain service continuity If unreserved fund balance is less than 15 percent, the city will set aside a sufficient portion of the upcoming fiscal year's budget to meet the required reserve amount.

This statement is actionable because it specifies a clear course of action if the performance measure is not satisfied. This is the basic premise behind actionable policies. The advantage of actionable policies is that they establish a clear imperative for managing finances in accordance with performance standards and provide a mechanism to ensure that these standards are consistently met. In reality, such policies must be supported by extensive procedures that specify how fund balance might be increased and identify any exceptions to the rule.

Print Get the Mag Weekly Updates