1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
System Dynamics for Budget Planning and Management Control
Habib Sedehi Ugo Biader Ceipidor
HELP Auditing Informatico Dipartimento di Scienze Chimiche , Universita’
Via Antonio d'Achiardi, 31 di Camerino
00158 Rome Italy Via S.Agostino, 1
62032 Camerino, Macerata, Italy
Lidia D’ Alessio, Chiara Ronconi
Facolta’ di E ia & Ci io, Universita’ di Roma
Via del Castro Laurenziano 9
00161 Rome, Italy
Abstract
Top management, through strategic plan, designs the guide lines of actions that are necessary to
achieve company goals.
Methodologies and tools are essential for comparing the results reached through operative actions
with those programmed; so that the management can analyse the differences and decide operations to
better manage the future. In this area the principle aim is to support, who has the decision, with
instruments that increase management knowledge. As a whole, the control system, is "simply" an
overall feedback model, the results of which, if given in time to top management, allows him/her
corrective actions that can be "vital" for company conduction.
Above knowing how things are going compared to what has been planned, top management needs to
know which are the so called "master variables" that have particularly influenced the results.
What we will describe in this paper will be the following: how, through System Dynamics approach,
a simple "feedback control” model can be ii d with a "feed-forward system" so to
support top management in the process of budget planning and management control.
Two problems will be particularly discuss that could be of interest;
+ An application of dynamic problem definition as a prerequisite to a good System Dynamics
modelling. This theoretical approach will be integrated also with an approach that imposes to
define an aggregate model which contains, particularly, "master variables".
+ The model will be discussed and developed together with an academic expert in Italian public
accounting and this will be a way to spread out the k ledge in System D: i hin
Italian university environment.
The result model will support public managers in the process of budget plan and management control.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
SYSTEM DYNAMICS FOR BUDGET PLANNING AND
MANAGEMENT CONTROL
1. THE PUBLIC COMPANY IN THE MODERN.ECONOMIC SYSTEM
Public company is the name which distinguishes particular corporation or organisms dealing
with activities which are of particular social importance and that necessitate a complex system
of controls, and laws which regulate their constitutions and organisations, case by case.
Although there is no net division between public companies and “non profit organizations” and
private enterprises, a public company can be defined as organism whose sole object is not net
profit. Generally, its object is to furnish services in a condition of equilibrium in which introits
are equal to expenses and/or liquid sums are used to cover expenses.
In a public company the decisions made by the Board of Directors follow the objective of
obtaining the best possible service with the available resources and its success is measured on
the basis of the quantity and quality of the services rendered.
Since no criteria comparable to profit inspires the Board of Directérs and the management of
the enterprise, there is no careful verification of its grade of efficiency and its economic
viability and the study of the and the activities of all such
organisms pivot exclusively on the central point of safeguarding its legal nature. But,
undoubtedly, public companies are not wholly exempted from the natural pressures exercised
by their sur di
When private companies which, and this is generally the case, offer their services to the public
or to other enterprises are teken into consideration, the attitude of the buyers, their abstention
or their readiness to purchase the services offered, are, in themselves, proof of their quality or
of the goodly prices at which their services are marketed and, therefore, in the end, of the
productivity itself of such state enterprises. In a certain sense, therefore, they too are subject to
the laws of the market but their dependency upon them are somewhat limited. Many private
companies enjoy a monopoly of legal or unwritten rights which are, in fact, a direct result of
the same nature as those enjoyed by industries in general before they were nationalised.
The following are the ct istics of a public
P
* absence of a profit making goal;
* prevalence of distribution objectives;
* conditions and obligations i in the choice of objectives and strategies;
* it cannot be condi d fi ially by its cli
* the style of management is different from the style adopted by private enterprises;
* managerial control which is always practically non existent and/or inadequate.
Furthermore, the mission of a public pany is decided] iti by two el which
are not easily divisible:
e the necessity of living an efficiency - efficacy type of relationship within a frame of
regulations sufficiently defined by the economic public subject;
« the contextual necessity of the economic subjects of maximising their identity.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
In this situation, an innovative process which would bring. about a transition from a typically
bureaucratic type of enterprise to a d by an i function
correlated with all the other aims and objectives of the ise, within the perspective of
internal change linked to the i devel of the objectives of the enterprise: in
short, the development of the culture of public services, is to be hoped for. The introduction
and the ensuing affirmation of new corporation roles (especially in the fields of planning and
managerial verific ications), the introduction of new and specific skills, would create the
ions for a ion of public services in a managerial profile different
from the one to which we have been accustomed in the past.
2. THE ROLES OF PLANNING AND CONTROL
In order to take into consideration planning and verification in public enterprises, it is
necessary to verify the applicability of the rules concerning the “science of administration and
fundament rules of the economy of an enterprises” to the peculiar reality of such organisms.
The introduction of the concept of economy, and of efficacy and efficiency, is based on the
assumption that there will be a serious and all - encompassing revision of the very
istics in the of the enterprise accompanied ideally by more adequate
planning. To this end the planning activity should include the following characteristics:
. A fully detailed system of information which would make it possible to produce not only all
the “documents” pertaining to the budget (invoices, wage packets, etc.)but would also place
before the scrutiny of the Board of Directors “information” which would facilitate
the role of being acquainted with and interpreting all the variables which could possibly
influence or determine the future activities of the enterprise;
2. Amore complete and articulated range of possible alternative lines of action to be evaluated
by taking into i the
»
A more precise and accurate study and simulation of the proposed alternatives such as to
make it possible to choose the best solutions.
The Board of Directors should be able to verify in an integrated manner the complex
organizational system of the enterprise by taking into consideration the correlations and the
interdependence existing in all its parts. The informative system should not simply be
organized for the sole purpose of producing accounting documents but should consent a critical
analysis of objective reality as it is mirrored in the outside world and the definition of an
aggregated model of data, resulting in the identification of the so-called “key variable” or
“master variables”, which it is essential to control if a viable strategic planning is to ensue.
To data, public managers have put into a type of p ized by a
vision based on a brief vision and identifying financial choices on the basis of past experience
with limited or partial adjustments for the future.
The management instruments in use today are inadequate, for they are based on mathematical
models stemming from operational research valid only for rigidly quantitative volumes and
which are applicable only to limited areas of operational activities. In addition, such models are
often static or linear and represent the relationship among the variables in a manner which is
too superficial, so that their validity is limited to the period of time in which the conditions
“surrounding the issue” can be considered constant; such situations can, in fact come into
being only in brief periods of time.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
the above ioned difficulties, it is, nevertheless, evident that each
organizing organism needs to develop managerial verification and a system of control on the
part of the Board of Directors which finds its natural synthesis in the budget process.
The budget is a plan for future activity in which all the objectives that the enterprise intends to
reach in a period of time which is generally fixed in one year. The budget is different from all
the other instruments used to control management, because of its global nature, for it
encompasses each and every activity of the enterprise: all the functional areas, the
organizational levels, its products and, generally, all aspects of the business. In synthesis, the
budget express the very model of beaviour on the part of the enterprise.
The Board of Directors uses the budget to achieve the following:
to compare effective activities with the programmed results;
to influence the beaviour of its administrators.
¢ to programme the use of company resource to the end of achieving its objectives;
e to communicate Plans and quotas of objectives to the ibl
© to motivate the i to the achi of the established objectives;
.
.
The budget is expressed in a series of administrative documents; these must naturally be
approved by the Board of Directors making it binding among the different departments that
have worked together to draw up the plan, at a global level. The budget assumes the form of a
preliminary balance sheet; in effect it conveys the of the following
or future activities of the company duly formalised and having the typical structure for budgets
which are synthetic systems of economic, financial and patrimonial values.
The drawing up of budget is an important part of the process of planning and control in every
organization but it is an even more important in a “non profit” organization than in a company
oriented towards profit making.
In public companies and, particularly in industrial private enterprises, the grater part of
expenditures are of a technical nature linked to the productive process and to its equipment and
installations. The quantity of labour and of raw materials necessary to production vary within
rather narrow limits or limits which can easily be determined. It is, therefore, possible to
exercise only a limited influence on such items during the formulation of the budget. Once
what is to be produced and in what quantities is it to be produced has been decided, what sales
procedures are to be adopted and through what channels of distribution, largely coincides in
the budget with a declaration of design.
In the greater part of public ies the ination of costs of production and the
distribution of the services furnished are more difficult to ascertain as the exact
predetermination of the results of management. In such conditions the budget is necessarily a
valid instrument of support which helps to establish what has to be done or how to utilise
to the instituti finalities which they develop. But the very
peculiar characteristics and circumstances which have been described above, together with
demotivation, deresponsibility and disinformation have influenced the role effectively assigned
to the activities of planning and verification and, in the final analysis, also to all the budget
activities which is at its very echelons have matured a certain distrust in the possibility of using
quantitative instruments to support their individual decisions.
F ing the i i i it is possible to state the decisional instruments for a
company’s strategic choices must:
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
be capable of describing the exact level of the company;
© be ch ised by few variables with the obj of ing a rapid and intuitive
understanding of the results and, therefore, be capable of fortifying managers’ trust and
faith in the instrument;
consider the “time” variable as the natural driving force of the parameters that characterise
the process;
offer relative answers to quantitative variables to the suitable level of aggregation in order
to be able to integrate them with the intangibles that the manager elaborates on the basic of
his own individual experience;
¢ be manoeuvrable or manageable with non difficulties by the users who generally know little
or nothing of computers.
.
System Dynamics certainly have the characteristics which best respond to the above mentioned
necessities.
3. THE BUDGET AS A PLANNING AND CONTROL TOOL IN LOCAL AGENCIES
the most y i unities in which Italian national
enterprises are divided. Municipal enterprises represent state enterprises in as much as they are
constituted with an act of common law which recognises them as the legal public personality of
such territorial organisms.
The municipality can be defined as state enterprise and a distribution enterprise whose
principal aims are those of furnishing assets and services to satisfy a certain number of
categories of social needs such as, for example, education, public security, justice, etc.. To
prepare such services, the local agencies turn to a number of familiar “management” forms
such as for example, the following:
production in economy through the use of their own structures and employees;
using special institutions such as consortiums, or other types of co-operatives or other types
of special corporations;
e by ing state ions and to private parties.
To carry out their tasks, local agencies in Italy are essentially dependent on direct and indirect
taxation. Having their power to levy taxes been almost totally suppressed and, following the
coming into force of the laws conceming the tributary reform (aimed at unifying local and state
finances) and, successively, having their power of di been further h d by the
yearly regulations concerning local finance, as of 1979 local agencies have witnessed
limitations and deformations of their constitutional autonomous power and rights.
The planning and verification function of a local agency is carried out through a series of
estimated statements of accounts drawn up and presented on the basic of legislations
concerning public balance sheets. The fund | aspects of this discipline are part of a state
law which, among other things, provides for the following points.
1. The drawing up of a pluriennal balance sheet in direct co-ordination with the pluriannual
balance sheet of the region to which it belongs.
2. The drawing up of an estimated annual balance sheet containing the stages and limits of cash
and competence.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
3.The obligation of financial balance for estimates of competence in the annual balance sheet,
while for cash estimates it is specified that payments are not to exceed the total of introits plus
the initial deposits of the fund.
4. The classification of introits in titles, categories, and chapters and of expenses incurred for
titles, ledgers, divisions, categories and chapters.
5. The elaboration of a recapitulatory general frame of the estimated balance sheet with all
differentiated results set out.
6. The lay out of reverse funds and the i i ion of the ing and
procedures for their expenditure.
7. The regulation of all residual sums.
8. The preparation of an illustrated note with the administrative and economic results reached
at the end of the financial year.
However, such documents do not have a pragmatic role, nor do they present an easily
identifiable strategic content for they do not clarify the purposes and the objectives which the
volatile organ of the municipal structure intends to reach in the future.
In order to overcome the above mentioned limits, there is a new regulation which strives to
modify both the cultural and b i conduct of cabable of ishing the state
enterprise the possibility of obtaining the i which up to now belonged
exclusively to private enterprises.
Through a clearer and more incisive attribution of responsibility and discretionary power
among the administrative and political organs, it may be possible to develop an effective
process of planning which finds its synthesis in the drawing up of the annual and pluriannual
estimated balance sheet.
The estimated annual balance sheet is denominated “double and mixed”; double in as much as
it examines the introits and the exp and cash, mixed in as
much as it contains in the prospects regarding competency and cash, both the administrative
fund and the cash fund. The results of the ion (surplus/defici
balance) and of the cash flow are important insofar as they help to increase or diminish the
available financial sums of competence and cash in future exercises. A condition of financial
equilibrium is foreseen in the prescribed balance: the balance of the introits is confirmed and is
to be ined together with expendi which are esti d in the course for the exercise.
The cash balance which meet the conditions of liquidity, can accept both the balance and a
surplus while deficits are absolutely forbidden. The expendible sums, made up of former
i and of p into accounts, cannot exceed the introits resulting in the
initial cash fund.
The annual estimated balance sheet is very different from the concept of budget. It does not
place into evidence the objectives and the evaluations comparable to those included in a
budget; it contains, instead, an ensemble of allocations of funds to cover expenditures which
are to be met with estimated sums of introits. It is not always possible to discover in this
jectives which are to be realised, or the global institutional,
economic or “distribution purposes attributed to the public company or the responsibilities of
each executive in the different operational sectors. There is also no information or data in the
statement of accounts, suitable to illustrating and pointing out the objectives which have been
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
reached or the managerial skills used to reach such finalities and objectives. In such conditions
it is also difficult to carry out a quality control of the services being offered or to measure the
average managerial levels of efficiency and efficacy.
It is, therefore, opportune to revise the techniques used to draw up the estimated annual
balance sheet in order to conceive it from a very different view which must necessarily be
transformed into an efficient instrument of a complex planning and control process in the local
agencies.
4, THE MODEL FOR AN ECONOMIC FINANCIAL BUDGET
The economic financial system of any enterprise, both private and public, can be identified by
two “poles”, “liquidity” and “margin” which represent the dual reality of an organization
pertaining to the financial and to the economic factors. Liquidity concentrates all the cash flow
ion of ding debts and p ), the “balance” represents the financial
requirements or the financial surplus. The “margin” the i
values of the period and through the “balance” determines the economic result.
However, the peculiar ch istic of public ies and, therefore, also of local agencies,
is that their management is not oriented towards profit making but towards a balance between
introits and expendi which di ines the so called ic-financial equilibrium. The
economic maragement of these enterprises is completely overlooked,determining, in
consequence, a poor or totally non-existent control of economy, efficiency and efficacy. On the
other hand, an efficient economic control requires, inevitably, the determination of
relationships and agreements among the different flow of economic outlays manifest during the
administrative period, the flow of a financial nature and, finally, the variation which have taken
place in the initial asstes, justified by the dynamic el of as exp din the
financial and economic balance sheets.
Generally speaking, a distinction can be made among the various levels of management: those
determined by the lack of coincid among the ic flow and ponding financial
flow and levels of capital, moved in harmony with the economic-financial choices, from the
flow of invested capital whether it be on hand or borrowed.
It follows that the model of an economic-financial budget which can be described with the
methodology of the System Dynamics will contain the state variables which coincide with the
“levels” and correspond to the voices included in the assets, while the “flows” which will
coincide with th voices of the financial fund will determine the variations.
It is necessary to point out that in the economic-financial model, the indications of the levels
are of particular importance: the levels will have a positive or negative sign according to their
correspondance voices of the assets situated respectively in the active or in the passive zone. It
follows that the algebraic sum of all the levels of the economic-financial system is necessarily
null(zero). There is, therefore, a perfect balance.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
5. THE MODEL AND THE CONCLUSIONS
The model which is still being perfected is illustrated in the figure.
The state variables (levels) taken into i ion, as far as the activities of the assets of the
local agency are concerned, are as follows:
¢ cash fund;
© immobilizations;
© other activities;
while the passive voices were synthesized through:
© mortgages and long term financements;
© other passive voices;
e result of the annual exercise.
From the causal diagramme, all the correlations existing among the variables can be easily
deducted.
The model presently is implemented on a Personal Computer, using VENSIM (simulation
modelling tool), and is currently under test for the of the i duced, at
the faculty of Economics of the Rome University with the data having been furnished by a
local agency situated in Northen Italy.
The model is developed with two specific aims:
e the first and principal aim is to use a methodology which can help students to better
understand the process of budgeting in a public company; this subject is under discussion in
a course on public accounting at the faculty of economy and currently is the argument of a
disertation;
the second objective is to use the model in an operational manner as soon as the value of
parameters are viable in the local agency, where the data was collected with the intent of
furnishing an innovative tool of support to “management” for the purpose of verifying the
budget plan.
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
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1994 INTERNATIONAL SYSTEM DYNAMICS CONFERENCE
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Amaduzzi A. L’economia nelle aziende pubbliche di erogazione.
Anthony R.N. - Young 1984. Management Control in non-profit organizations.
Irwin, Homewood, Illinois.
Bartezzaghi E. Mariotti S. 1983. Modelli per le decisioni strategiche aziendali.
Franco Angeli.
Brusa L. 1983. Il budget e controllo di gestione. Giuffré Editore.
D’Alessio L.. Id Uo di efficienza nelle aziende pubblich
Roberts E.B. 1984. Managerial Applications of System Dynamics. The MIT Press Cambridge, Mass.
Sedehi H. 1992. System d; ics for budget planni luation in public envi Pi di
System Dynamics 1992 Conference.
Business Decision-Making, page 204
