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Capability-focused Resource Management: Financial Decisions
Dr Teri McConvilleCranfield Defence and Security
04/20/23Capbility-focused mgt - finance
2
Some Basic Economics
To understand debates about defence spending and its impact, we need some idea of what happens in an economy
‘The Economy’ is made by people
04/20/23 3
Farmer
Shoemaker
Taxi driver
Teacher
Carpetmaker
Miner
Doctor
Tailor
Theeconomy
Each contributes to the economy
04/20/23 4
Farmer
Shoemaker
Taxi driver
Teacher
Carpetmaker
Miner
Doctor
Tailor
Theeconomy
And (in the cash economy)gets back cash
National Income = total of all incomes
or total of all production for cash
Sudan 2010
04/20/23 6
Everything has a price
less moreproduct
pric
e
less
moresupply
demand
Trade = goods in & goods out
7
Farmer
Shoemaker
Taxi driver
Teacher
Carpetmaker
Miner
Doctor
Tailor
Theeconomy
Trade balance
Sudan 2010
Impact of Government
9
Farmer
Shoemaker
Taxi driver
Teacher
Carpetmaker
Miner
Doctor
Tailor
Theeconomy
Governmentcollects taxes
and payspeople to
provide someservices,
including defence and security
04/20/23 10
Inflation• Things cost more• money is worth less
because• The supply or flow of money
grows faster than the growth in the production of goods and services
• The government spends more than receives;
• Full employment raises cost of labour
Sudan 2010
Impact of Defence Spending
Advantages Provides security: which
encourages investment Provides employment Stimulates technological
advance that might be applied in civil sector
Can train soldiers with skills that are useful in civil the sector
But defence spending …x … takes government
resources away from other priorities
x … may lead to Government over-spending, causing excessive taxation and/or inflation
x … absorbs good brains in non-productive activity
x … can cause neighbours to spend more on defence
Defence Spending: How Much is Enough?
• Defence is like an umbrella• Defence sector can have power as a single
customer, but– It has the capacity to absorb infinite resources
• Defence industries might have a monopoly• Defence & security spending should not damage
the society it is supposed to protect.• IMF and NATO – 2% of GDP is maximum/norm
14
Financial management & planning - Why?
• To provide Commanders with a means of planning, resourcing and assessing the delivery of security outputs, in particular the delivery of Capability, in the most effective and efficient manner– i.e. financial management is central to effective
overall security management
Top levels of balance of investmentGovernment
revenues
Personnel Training
Defence
EquipmentInfrastructure
other
Newequipment
Modernisation In-servicesupport
disposal
Basic terms
Budget– a year’s envisaged income and expenditure– predicted flow of income and expenditure over
the year– the predicted breakdown of spending over the year:
labour, materials etc
The bottom line of the defence budget, and the information about how it is derived, should tell the legislators and public about how much money is to be devoted to defence and security… and how much is spent.
Basic terms
• Budget• Plans
– Multi-year anticipated/assumed income and expenditure
– Enables affordability forecasts to be made– Countries vary in how they plan
• UK rolling four year spending plan and 10 year equipment plan
• France - five year spending plan including capital investment• Georgia?• Others?
Basic terms
• Budget• Plans• Current spending and capital
spending (investment)
TanksBuildings
SalariesRations
CapitalCurrent
AmmunitionTraining
Easy distinction
in principle, hard in
practice?
Basic Terms• Budget• Plans• Current spending and capital spending • Inputs – resources used to carry out particular
tasks (money, people, equipment, time, information)Outputs – results of an individual’s or an organisation’s activities– pieces of equipment delivered– soldiers trained for a task– policy guidance agreed
Output
______ = Productivity
Input
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• What am I responsible for producing (outputs)?
• Am I managing the finances/other resources (inputs) involved in responsible manner?– efficiently and effectively?
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• How well have I delivered the outputs for which I am responsible?
• Do I answer to someone if I haven’t?• Are there penalties for me or my
organisation?• Are funds being used legitimately?
– For purpose intended and in accordance with law/rules
• Need to combat fraud & corruption– control procedures and supervision of
staff– separation of duties: those who decide
what is to be bought should not actually buy
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• Clarity of roles and responsibilities• Openness in budget preparation,
execution, reporting. • Benefits
– helps ensure accountability– reduces scope for abuse– allows society to question
government– helps people to know what they
are entitled to
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• Set objectives• Set resources• Hold to account
UK Oversight mechanismsExternal Parliament and specialist committeesDefence & Public Accounts Comms.Auditor General/National Audit Office/Finance MinistryInternal:Minister of Defence/ Defence CouncilInspector General: Internal Audit & anti-Fraud Unit; (MOD) Police
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• Include all payments and receipts• Allows prioritisation• Essential for effective
accountability, transparency & oversight
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability (Stability)• Efficiency?
• Resources being available in long term
• Longer term strategic objectives
• Essential for effectiveness BUT counter to control by the legislature
Basic principles of publicexpenditure management
• Responsibility• Accountability• Transparency • Oversight• Comprehensiveness• Predictability• Efficiency?
• Economy • Efficiency (Doing things
right!)• Effectiveness (Doing the
right things!)
Value formoney
Budget process
Policy Review
StrategicPlanning
Budget preparation
Budget execution
Reporting & audit
Accounting & Monitoring
Budget process
Policy Review
StrategicPlanning
Budget preparation
Budget execution
Reporting & audit
Accounting & Monitoring
Transparency Oversight, responsibility, predictability
Transparency, comprehensivenessefficiencytransparency
Oversight,Accountability
efficiency
FINANCIAL DECISION MAKINGDelivering Value
04/20/23 30
04/20/23 31
Making Financial Decisions
• Costs versus benefits• Notion of Relevant Costs
– Future costs
• How do we value intangible outcomes (e.g. morale, reputation)?
Escalating Commitment
04/20/23 32
Example of Relevance• A defence supplier invested
£50 000 in equipment for a new project. The project has been cancelled. Should the company:
A. Leave everything intact and look for a new contract?
B. Scrap the equipment (save £1,500)?
C. Use the equipment for spares (cost £500 but save £8 000)?
D. Modify equipment for an existing project (cost £15,000, saving £35,000)?
Extra cost
Benefit Net Benefits
A Nil Nil* Nil
B Nil £1500 £1500
C £500 £8000 £7500
D £15000 £35000 £20000
04/20/23 33
Make or Buy
• Motor transport spends £65 per day on hospital transport.
• Two private bids:– £46– £43
• Make or buy?
• Other considerations
Cost (£)
Labour 19
Fuel 6
Operating costs
40 80% fixed
Total 65
Need to account for the fixed cost (£32) –real saving is 19+6+8 = 33
04/20/23 34
Return on Investment
• Expected benefits
• Minus initial cost
• Divided by number of years
• Timing may be a problem
Initial cost (£000)
benefit↓
Red
50
White
70
Blue
50
Year 1 10 10 10
2 20 10 20
3 20 10 10
4 20 20 13.5
5 10 30 3.5
6 5 30 3.5
7 2.2 30 3.5
Gross benefit 87.2 140 64
Nett benefit 37.8 70 14
Average return 5.4 10 2
As % 10.8 14.3 4
04/20/23 35
Pay Back (Rate of Return)
• How long does it take for initial costs to be recovered?
• If income is steady:= Initial outlay / number of
years
• If income varies we need to do some arithmetic!
Red
50
White
70
Blue
50
Year 1 10 10 10
2 20 10 20
3 20 10 10
4 20 20 13.5
5 10 30 3.5
6 5 30 3.5
7 2.2 30 3.5
Gross benefit
87.2 140 64
04/20/23 36
Discounted Cash Flow
• Considers what money will be worth in the future.
• Discounting is the opposite of compounding– (There are tables to work
this out!)
• Example:• £1000 attracts 20%
compound interest over 4 years = £2074
• £1000 with inflation at 20% will be worth£482.3 after 4 years.
Expressed as ‘Nett Present Value’
04/20/23 37
For our three projects:Discount rate at 10%
Red White
Initial Outlay 50 70
Net benefit 37.8 70
Net Present Value 14.466 19.486
Discount rate at 15%
Red White
Initial Outlay 50 70
Net benefit 37.8 70
Net Present Value 6.365 3.430
04/20/23 39
The End
Well done for persevering.Any questions?
Let’s take a break!