Financial Management

 Overview

These materials support a discussion on the topic of costing and preparing budgets for open and distance learning programmes. The terms, concepts, and processes are presented as much as possible in a generic open and distance learning context. You may wish to apply them as well to some real situation drawn from the participants’ context.

Source materials for this topic

Dhanarajan, G., P. Ip, K. Yuen, and C. Swales (eds.). Economics of distance education: recent experience. Hong Kong: Open Learning Institute, 1994.

Orivel, F. Analyzing costs in distance education: a methodological approach. Dijon: iredu, Université de Bourgogne, 1987.

Perraton, H. The cost of distance education. Cambridge: International Extension College, 1982.

Rumble, G. Costing distance education. London: Commonwealth Secretariat, London, 1986.

Rumble, G. The Costs and Economics of Open and Distance Learning. London: Kogan Page, 1997.

 Organising and implementing budgets 

Models of budgetary management

An organisation may follow two models in handling budgets and costs: the centralised model and the decentralised or participative model.

Centralised model

In the centralised model:

·   budgets are developed centrally and all analyses are carried out at a central location;

·   the finance department typically controls the entire process, with minimal involvement of the academic or other operating divisions; and

·   the finance department also produces all management information for the organisation.

Decentralised or participative model

In the decentralised or participative model:

·   all operating units participate fully in developing the budget;

·   those responsible for the operations of a particular area perform detailed analyses of variances; and

·   the finance department is considered a support service, co-ordinating the collection of budget information and producing the overall institutional budget.

The participative model offers the following advantages:

·   stronger motivation of operating managers to accept responsibility for their expenditures;

·   a feeling of ownership because of being involved in the process;

·   greater knowledge of needs because of direct involvement with learners; and

·   better accountability at the level of the cost centre.

This model may not apply, however, to small organisations or to small units within a larger organisation that are considered operating units of that organisation and thereby subject to central finance policies and procedures.

The role of a finance department

For organisations to which a participative model applies, the finance department has the following roles:

·   co-ordinates the collection of budget information;

·   produces the overall institutional budget;

·   prepares reports;

·   supplies detail used by operating and academic personnel to measure their performance;

·   provides assistance to managers in analysing the information;

·   maintains the historical accounting records;

·   arranges for receipt and disbursement of cash;

·   makes short-term investments;

·   develops and maintains financial information systems;

·   prepares cost–benefit analyses; and

·   arranges short- or long-term financing.

Roles of operating divisions

Academic personnel

Since academic personnel have first-hand knowledge of the educational requirements of their learners, they are in the best position to know how available resources should be distributed. They take hard financial data and use it to construct an operating plan that comes closest to fulfilling their vision.

Negotiating

Available financial resources are seldom adequate to meet everyone’s needs. Therefore all managers must be skilled negotiators in order to obtain their fair share.

Variances

Once the hard decisions have been made, operating divisions must measure their financial performance by analysing their actual expenses compared to their original plan determining why there is a difference, or variance, between planned and actual expenditures and take corrective action.

Accountability

A definition of accountability might be that operating personnel are instrumental in developing operating budgets and therefore are responsible for the actual costs that they have estimated in their budgets. This involves:

·     taking great care in preparing budgets; and

·     monitoring their expenditures.

Delegation of authority must go hand in hand with accountability.

Note that in many open and distance learning programmes there is only limited decentralisation, since control over salaries, usually the largest budget item, remains centralised. Many managers control only non-salary expenditure.

 Revenue sources

Various revenue sources may provide the financial resources for an open and distance learning institution, and therefore a variety of agencies to whom institutions may be accountable.

Government funding

Many governments fund education on an enrolment-driven formula. Given its unique cost structure, with few if any classrooms and higher course development costs, and typically part-time learners, open and distance learning may not fit easily into formulae designed for conventional institutions.

Tuition fees

Determining a reasonable tuition fee can be a difficult task and may involve several, sometimes incompatible, factors, including:

·        government policy;

·        revenue needs (for example, need to recover full costs);

·        market elasticity (how much enrolments are affected by the price of the course);

·        mission of the institution or programme; and

·        comparison with other programmes.

Ancillary operations

Open and distance learning programmes can generate substantial revenue from activities outside normal course delivery. Examples include:

·        textbook sales;

·        course material sales;

·        consulting fees; and

·        charging out facilities, for example, printing.

Other revenue

Likely the other most important type of revenue is interest earned on investments. Donations and endowment funds also fit here.

Capital funding

For an educational programme to maintain and improve its services, capital funding is required. Unless the hosting organisation has the power to finance its own capital programme, it usually depends on either government or fund raising, neither of which is an assured funding source.

 Budgeting 

The budgeting process

The budgeting process consists of a series of steps by which estimates of revenue and expenses and related statistical data are used to compile a plan for expenditure for the next financial period.

Probably the most important in differentiating budgets for open and distance learning programmes from budgets for conventional programmes is the higher proportion of fixed expenses for course development and revision:

·   course development costs are not dependent on enrolments; and

·   if a full curriculum is to be offered, courses must be developed and kept current, regardless of the numbers of learners in the courses.

Steps in preparing a budget

The preparation of an open and distance learning programme budget involves the following steps, some of which may occur simultaneously, and some of which, in a small operation, may look somewhat different:

·   Review the strategic plan and adjust if the expected funding levels cannot accommodate it.

·   Obtain data on forecast enrolments, inflation rates, salary increases, required course development and revision, unit-tuition fees, historical unit costs per enrolment, and so on.

·   Prepare preliminary forecasts of revenues from all sources and assess the reliability of the estimates. It may be necessary to prepare budgets for the various funding levels.

·   Determine preliminary allocations of forecast revenues to operating divisions, in order to develop initial funding parameters.

·   Have the finance department prepare working papers and any other data that will assist operations personnel in estimating their expenditures.

·   Develop expenditure estimates by cost centre and expense type, within the divisional parameters.

·   Prepare estimates of monthly expenditures and revenues, an important step in order to reduce variances due to simple timing differences, and to serve as a basis for forecasting cash requirements.

·   Compile the cost centre budgets into divisional and then institutional expenditures.

·   Conduct final review and incorporate any necessary re-allocations.

·    Obtain final approval from the governing body.

·    Load the approved budget into the financial information system for subsequent comparison with actual revenues and expenses.

·    Develop the management reports to be used for cost control and decision making.

·    Set up procedures for monthly comparison of the actual expenditures and revenues with the plan (variance analysis) and the reporting of differences.

Budgets for decision making

Budgets can be used for at least two purposes:

·     as control mechanisms for the operation of open and distance learning units; and

·     to assess different courses of action and serve as a basis for decision making.

Different courses of action are assessed in an exercise called a cost–benefit analysis before the unit budget is developed. A cost–benefit analysis is carried out as follows:

·   if a service can be delivered in two or more possible ways, then the costs of each are estimated and the relative benefits are identified;

·   referring to the available revenues, informed decisions are made and the best value for a given expenditure determined; and

·   decisions are made so that they attain the objectives of the open and distance learning institution or unit.

Some examples of budgeting decisions that can be made using cost–benefit analysis include whether or not to:

·     provide face-to-face instruction as well as correspondence;

·     use television or other electronic assistance;

·     provide various types of media in a given course;

·     introduce new technology;

·     purchase capital equipment;

·     develop computer systems;

·     limit tutor course loads;

·     invite off-shore enrolments;

·     develop a course in circumstances of limited funding;

·     develop new programmes;

·     develop new ancillary activities; and

·     increase personnel to enhance service or management information.

Performance measurement

Close adherence to a budget can show careful initial planning and prudent use of resources.

If expenses are greater than budget, however, this does not automatically indicate poor management. Overspending in one or more areas may be necessary to maintain service.

Nevertheless, because of its impact on overall finances, significant overspending must be carefully weighed and approved beforehand.

The budget and actual variances are indications of a manager’s ability to plan his or her expenditures and adhere to the operating plan.

Good managers use budgets as financial guidelines.

 Costing open and distance learning programmes 

Terminology

·   The cost of something is the amount of actual or notional expenditure of money incurred on, or attributed to, a specific object or activity.

·   The total cost is the sum of all the costs attributed to something. Most open and distance learning institutions produce a product (learning materials, graduates) or a service (tutorial, counselling sessions) against which costs can be assigned.

·   A cost unit is a measured amount of a product or service used for the expression of the costs of that product or service.

·   Cost centres are locations, functions, items of equipment, or departments to which costs are attributed. For example, a particular degree programme may be identified as a cost centre within an institution.

·   The period of account is the period of time over which costs are measured.

·   Normally, costs are measured over a year — the financial year — which may or may not coincide with the academic or calendar year.

·   Recurrent costs are costs that occur year after year (or period of account after period of account).

·   Costs that do not occur year after year are called one-time or non-recurrent costs. The distinction is important because it is easier to withdraw from spending on non-recurrent items (e.g., an equipment purchase) than from recurrent items (e.g., staff salaries).

·    Revenue cost is expenditure that is expected to benefit only the current period of account. Since it is related to the current operations of the enterprise, it is also referred to as an operating cost.

·   Capital cost is expenditure on the acquisition of fixed assets (land, buildings, machinery, equipment) where the expenditure is intended to benefit more than one accounting period.

·   A capital ex revenue budget is money set aside on a recurring basis to meet capital expenditure.

Concepts of cost analysis

·   Costs are the units that measure the efficiency of any organisation.

·   Direct costs are costs that can be identified with a particular product or service and not with others. These normally comprise the cost of materials, labour, and of expenses directly incurred on the product or service.

·   An indirect cost is a cost which cannot be identified with any particular product or service, but has to be shared over a number of products or services because it is common to or jointly incurred by them.

·   The overhead cost is the sum of all the indirect costs of a cost centre or cost unit. Examples could include the cost of a shared telephone exchange, central computer, and utilities.

·   Fractions of the cost of a shared facility can be apportioned to cost centres.

·   Fixed costs are operating costs which are unaffected by variations in volumes of output. This does not mean that they do not vary over time in response to other cost factors (for example, price rises).

·   Variable costs are costs that vary with volume of output.

·   The marginal cost is the additional cost of an increase of one unit of output (for example, one additional open and distance learning centre). This term is often — but wrongly — used to describe the additional cost arising from an increase in more than one unit of output. The additional cost of more than one unit of cost (for example, ten open and distance learning centres) is more correctly called the incremental cost for that increase in activity.

·   Some fixed costs are only fixed within a certain range of activities, called the relevant range.

·   A stepped fixed cost is a cost that varies with the level of activity, but only has a number of possible values, each of which applies over a relevant range.

Activity costing and overheads

What we do with overhead costs depends largely on why we are costing. In particular, what we do will depend on whether:

·    we need to know the full cost of an activity. If so we will need to consider the direct costs but also the overhead costs and the extent to which overheads should be attributed to the product or activity; and

·    we are concerned only with marginal or incremental costing, that is, whether we are trying to assess the impact on total costs of changes in the volume of output. This involves identifying the direct costs of the variable we are interested in plus any stepped fixed costs that are affected by that variable.

Full absorption costing is used for some purposes — for example, to support pricing decisions and to derive performance measures — but is not required for others, as when we are looking at the effect of changes in the volume of output. Ask yourself, ‘Am I looking at costs as they are now (full absorption costing) or am I seeking to examine the effect on costs of profitability of a change in volume costs (marginal costing)?’

In an activity costing exercise,

·    the first thing to establish is the segment or cost object which is the subject of the exercise;

·    the second point is to establish the focus of the inquiry: direct cost only or full cost?

Exactly how overheads are apportioned depends on judgements about the nature of the overheads and what factors drive them. Quite often there are two stages in the process:

·    general overheads are apportioned between production and service delivery departments; and

·    overheads are then absorbed into or allocated between the cost objects.

Absorption and apportionment rest, more than most things, on judgement (sometimes called juggling).

 Process and project costing

Costing can be determined in different ways for differing purposes. Two examples follow.

Process costing

Process costing as applied to manufacturing is a system by which expenditures are accumulated into costs of production and allocated to units of the product, hence unit costs.

 

Process costing is not strictly applicable to open and distance learning delivery, which is a service rather than a product. However, the same principles can be used. You can determine unit costs for delivery on a similar basis and use them for similar purposes:

·     measuring against standards;

·     determining revenue needs;

·     developing budgets; and

·     deciding on various courses of action.

Project costing

Project costing is used when the manufacturing process is not continuous, but is a series of large, special-order contracts.

An example in open and distance learning is the development of a course. This activity has

·   a definite start date;

·   a unique identity;

·   a scheduled completion date;

·   a budget;

·   costs accumulated so they can be compared to the budget and maintained as a historical record;

·   direct costs charged to the project; and

·   overhead applied as a proportionate share of indirect expenses.

Course development costs are not normally written off over the life of the course but are charged to the period they are incurred. Nonetheless it is important to measure performance against budgets and keep records of development costs for specific courses. Historical costs of course development are indicators of the courses that will provide the most benefit for the available resources, if no other course priorities apply.

 Some examples of using costs in decision making

 

Cost-effectiveness

Some of the benefits of a project may be tangible and real, including

·     increased efficiency;

·     error reduction;

·     increased learner contact time; and

·     reduced recruitment costs.

Others may be intangible, such as

·     higher morale;

·     greater loyalty; and

·     heightened staff commitment.

In addition, it is not always easy to decide who reaps the benefit of carrying out a project such as this. Is it the institution, the staff, the distance learners, the community, or even the nation? If senior management agrees on these objectives, then all these aspects might be considered valid.

Opportunity costs

Opportunity costs are the notional costs, difficult to quantify, of undertaking one activity rather than another. For example, the project team and other staff involved, as well as materials and equipment, could all have been used in different ways to benefit the institution during the project period:

·     the space and buildings could be used instead for direct classroom purposes;

·     the team members and managers supporting administration could be used in tutoring;

·     the equipment and materials could be transferred to study areas or learning centres.

The opportunity costs of all these resources is the return that could have been achieved by using them for teaching output.

However, opportunity costs are generally omitted from costing exercises because of the subjective judgement involved in quantifying them. They are useful when you are comparing two alternative projects.

Cost–benefit analysis

Cost–benefit analysis is a systematic comparison between the cost of carrying out the project, and the value of the resulting service, resource, information, or product to any of a possible range of beneficiaries.

Cost–benefit analysis involves trying to determine whether the return expected from the project investment is high enough to match the criteria laid down by management.

Cost–benefit analysis also allows a stricter basis for the definitions of the project objectives and gives senior management a clearer view of the effectiveness of the project.

Some criteria for determining whether an investment is worthwhile or not include:

·   pay-back period of return: how long will it take to pay back the original investment of staff salaries and other costs?

·   rate of return: what percentage return are we getting on the investment?

·   discounted cash flow: what return would we want at some time in the future for a payment we make now?

Financial considerations can help to improve decision making about projects but these decisions are not the only ones since other values include social benefits or human relations values. A typical dilemma in open and distance learning programmes exemplifies this.

Example: The larger the number of open and distance learners the programme enrols, the greater the fee revenue generated for the programme. One way for a programme to generate a high rate of return on this revenue is by spending more on marketing and recruiting than on producing learning materials for these open and distance learners or providing them with support services, since high-quality materials and support services cost money to produce and supply. Over the long term, however, a programme operating in this way may not continue to attract learners or justify its existence to outside funders and donors, and hence be ill-served by such a strategy.

 Cost control techniques

A number of strategies other than variance analysis can be invaluable in controlling costs. Here are a number of suggestions.

·   Cash handling: Ensure that all remittances are deposited in your bank account as soon as they are received so they can earn interest.

·   Accounts receivable: Ensure that your accounts receivable are as current as possible, again so receipts can earn interest in your account.

·   Inventory: Keep inventory levels as low as possible, consistent with maintaining stock on hand to service learners. Cash tied up in surplus inventory is not earning interest.

·   Accounts payable: Ensure that you take full advantage of commercial credit terms. You will also gain considerably by not paying until the due date.

·   Short-term investments: Develop a cash-management system that will identify cash temporarily surplus to requirements and invest it in short-term funds.

·   Contract work: Try to negotiate as much of the payment as possible in advance; on big contracts, arrange for periodic progress payments.

·   Tendering: To benefit from competition, all major purchases should be by way of tender.

Review and control programmes: Keep a close eye on costs such as photocopying and telephone, both of which are significant and controllable

 Practice exercises 

The cost of open and distance learning

Instructions: Divide the group into a number of small working groups, three if possible.

Assign to each group one of the following scenarios. Ask each group to discuss and document their answers so they can present their finding to the larger group for discussion:

·   Scenario 1: glad (Global Learning at a Distance) is a commercial distance teaching company. It has just expanded its operations by launching a Diploma in International Law. It has hired permanent academic and administrative staff to support the programme, and has bought a building in the suburbs of the capital city. Furniture and equipment have also been purchased, and subscriptions for various law journals have been taken out. (Back issues of journals and important textbooks have also been bought.) The first task for the academic staff has been the development of a series of first year courses, which will have an expected life of several years. The main medium of teaching is print, and expenditure has been incurred on copyright clearances, design, editing, and print production, as well as hiring academic consultants to write certain units. Editing, design, and printing are all undertaken by an external publishing house under contract.

What kind of expenditure are the following?

·     salary and associated costs of the permanent academic staff;

·     cost of the building;

·     cost of the furniture and equipment;

·     journal subscriptions; and

·     cost of producing the first year courses.

·   Scenario 2: glad has decided to offer a new course. For this course, the cost of materials, postage, and script marking per learner is $56. In addition to correspondence tuition, glad insists that learners attend a day school. The learners are divided into classes of about 25, each with a tutor. The cost of the tutor for the day is $80. The cost of classroom hire works out at $24 per room per day. In addition to these costs, the learners come together and are shown a film. The cost of putting on the film in an auditorium with a capacity of 440 seats is $70 (auditorium hire plus technician). Each week over the 10-week course, two radio programmes are broadcast at a cost of $32 per programme. There are at present 284 learners on the course. Demand is likely to fluctuate, but in practice is unlikely ever to exceed 350 learners.

·     What kind of cost is the cost of postage?

·     What kind of cost is the cost of the face-to-face tutor and classroom?

·     What kind of cost is the cost of the film show?

·     What kind of cost is the cost of transmitting the radio programmes?

·     Where appropriate, what is the relevant range of these costs?

·     What is the marginal cost per learner?

·     What is the incremental cost of increasing the number of learners by 27?

·   Scenario 3: At glad, three courses in financial management are offered: Cost Accounting, Budgeting, and Activity Costing. The way these courses are taught varies, so that the direct costs per learner are quite different. Also, the number of learners on each course is different. Management has received a report on the direct costs of these courses, as follows.

The report goes on to say that the department of Accounting and Financial Management has overhead costs of $25,000. The Chairman of glad’s Finance Committee then asks what the full cost per learner is, so that fees can be set. At the next meeting, the Director of Finance presents a paper which apportions the overheads in proportion to the number of learners on each course. The Chairman looks surprised. He did the calculations another way. He divided the overhead cost of $25,000 equally across all three courses. This makes a real difference to the cost per learner on each course, and hence to the fee, if fees have to cover full costs.

·      Work out for yourself the cost per learner in the Budgeting course. (Hint: in each case, take the full cost per course, and divide by the number of learners; for example, the Director’s full cost per learner on the Cost accounting course is $16,905/100 learners.)

·      What is the Director’s answer?

·      What is the Chairman’s answer?

·      Which is right?

Timeframe: Approximately one-and-a-half hours, one half hour for small group discussions, ten minutes for each group report, and twenty minutes for general group discussion.

Materials: None. Formal reporting back from small groups is not required; facilitator can guide discussion by asking groups to supply answers from their discussions.