In late 2015 Mark Zuckerberg, founder of Facebook, launched a plan to give away most of his $45 billion fortune. Along with his wife Priscilla Chan, he announced the creation of a philanthropic organization known as the “Chan-Zuckerberg Initiative.” This “Initiative” defies conventional labels. At one level it’s similar to a traditional non-profit organization. It can deliver social services, participate in public policy debates, and partner with other non-profits. It’s also like a traditional philanthropic foundation, with plans for grant-making in areas like education reform in the US and clean water in developing countries.
But the Initiative is also decidedly non-traditional. It’s organized as a for-profit limited liability corporation. That means when it wants to, it can do many things non-profits and governments can’t. It can invest money in other for-profit entities. It can fund election campaigns. It can manage and invest money on behalf of other non-profit and for-profit organizations. So the important question around Chan-Zuckerberg is not what will it do, but rather, what won’t it do? With $45 billion at its disposal, and few if any limits on how to spend it, the possibilities are endless.
Some are calling this “philanthro-capitalism.” Chan-Zuckerberg is the largest and most visible recent example. But there are many others. If you’ve ever bought a sweater at Patagonia, worn a pair of TOMS shoes, or used a shot of insulin from by Novo Nordisk, you’ve participated in philanthro-capitalism. These are all for-profit companies with a social purpose hard-wired into their mission. This also works from the other direction. Strange as it sounds, IKEA – whose founder Ingvar Kamprad was once the wealthiest person in the world – is controlled by a charitable family foundation.
Maybe you didn’t think public finance has anything to do with cat videos, Fair Trade Certified™ fleece vests, or the FJÄLKINGE shelving unit. Turns out it does.
Philanthro-capitalism brings the glamour and prestige of big business to the decidedly un-glamorous work of feeding the hungry, housing the homeless, and the other essential efforts of governments and non-profits. That’s important. But even more important, it’s forced us to re-think what it means to manage “public” money.
Showtime’s hit show “Billions” is the story of a hedge fund that operates in the shadowy underworld of finance. That fund – known as Axe Capital, for its founder Bobby Axelrod – will do anything to turn a profit. It’s traders buy and sell stocks on inside information, bribe regulators, and spread market-moving rumors, among many other nefarious tactics.
Season 2 features a compelling storyline ripped from the proverbial public finance headlines. Axe learns through a back-channel that the Town of Sandicot, a long-struggling upstate New York community on the verge of bankruptcy, is about to be awarded a state license to open a new casino.
Axe sees an opportunity. When a government is on the verge of bankruptcy investors steer clear of it. As a result, Sandicot’s municipal bonds (a form of long-term loan) are available for pennies on the dollar. Axe believes the new casino will drive an economic recovery, and once that recovery is under way, investors will look to buy up Sandicot’s bonds. So he decides to get there first. He “goes long” and buys several hundred million of Sandicot municipal bonds.
But then the story takes an unexpected turn. Word of the Sandicot play leaks out, and Axe’s opponents persuade the State to locate the casino in another town. At that moment Axe faces a difficult choice: Sell the bonds and lose millions, or force Sandicot to pay back the bonds in full. Unfortunately, Sandicot can repay only if Axe forces it to enact savage cuts to its police, firefighters, schools, and other basic services. Axe is leery of the bad press that will surely follow a group of billionaire hedge fund managers profiting at the expense of a struggling town.
When asked for their opinion, a superstar Axe analyst named Taylor Mason – the first gender non-binary character on a major television show – says:
“In many ways, a town is like a business. And when a business operates beyond its means, and the numbers don’t add up, and the people in charge continue on heedless of that fact, sure that some Sugar Daddy, usually in the form of the federal government will come along and scoop them up and cover the shortfalls, well, that truly offends me. People might say you hurt this Town but in my opinion, the Town put the hurt on itself. Corrections are in order. There’s a way to make this work and that way is hard, but necessary…Once we do this the town will face that challenge and come out stronger. Or it will cease being. Either result is absolutely natural.”
Governments and non-profits tend to have a “retrospective” view on money. To them, an organization’s money is well-managed, if it stayed within its budget, complied with donors’ restrictions, and completed its financial audit on time. To them, bigger questions like “is this program working?” or “does this program deliver more benefits than it costs?” are best answered by elected officials and board members. In their view, if we mingle the different sectors’ money, taxpayers will never know what they get for their tax dollar, and elected officials and board members won’t know if programs they worked so hard to create and fund are delivering on their promises. To public organizations, financial accountability has often meant looking back to ensure that public money was spent according to plan.
Zuckerberg and many others who now operate in the public sector see public money in “prospective” terms. To them, public money is a means to an end. It’s how we’ll end racial disparities in public education, cure communicable diseases, close the gender pay gap, and pursue other lofty goals. These folks are not particularly concerned with how government tax dollars are different from charitable donations or business profits. If money can move an organization closer to its goals, regardless of where that money comes from, why not add it to the mix? They don’t think of financial contributions as a way to divvy up credit for a program’s success. They want to know how their money was spent, but far more important, they want to know what their money accomplished.
The opposite is also true. Taylor Mason, and many others who share their views, also sees public money in “prospective” terms. But instead of thinking about what the public sector could accomplish, they also believe no public sector organization is “too big to fail.” If a local government like Sandicot is no longer accomplishing its mission, they argue, it should cease to exist.
Both these perspectives – philanto-capitalism and “government is like a business” – are big departure from public financial management’s status quo. They’re also why public organizations have tended to segregate themselves into “money people” and “everyone else.” Money people tend to see the world differently.
And to be clear, both these perspectives illustrate a much broader recent trend: blending the financial lines across the sectors. Many non-profits now operate profitable lines of business that subsidize other services they provide for free. Governments around the world have created for-profit corporations that allow private sector investors to build, operate, and maintain public infrastructure like bridges, subways, and water treatment facilities. Charitable foundations of all sizes now act as “Angel Investors.” They buy stock in small start-up companies that develop products to improve the quality of life in the developing world. Many of those investments have turned a handsome profit that in turn subsidized other, far-less-profitable endeavors.
Philanthro-capitalism and “government is like a business” are also animated by pressure on governments to do more with less. For roughly 50 years, taxpayers around the world have said no to new taxes, but yes to a steady expansion of the size and scope of government. They have demanded more spending on health care, education, environmental conservation, and other services, but left unclear how to pay for it. They have allowed their governments to borrow record amounts of money, but denied them the financial means to repay that money. Many governments today are simply maxed out. They have little or no new money to commit to innovate programs of the sort that Zuckerberg and others would like to see.
These trends – blurring of the sectors, emphasis on outcomes, scarce government resources – are redefining what it means to manage public money.
You got into public service because you want to make a difference. Maybe, like Mr. Zuckerberg, you want to tackle big, complex public problems. Maybe you want to make governments and non-profits work just a bit more efficiently. Maybe you think government should do a lot more in areas like health care, education, and transportation. Maybe, like Taylor Mason, you think government should get out of the way and make room for non-profits and for-profits. Regardless of your goals, to make that difference you’ll need to speak the language of public financial management. You’ll need to translate your aspirations into cost estimates, budgets, and financial reports. You’ll need to show how an investment in your program/product/idea/initiative/movement will produce results. You’ll need to understand where public money comes from, and where it can and can’t go. You probably didn’t get into public service to manage money, but in today’s rapidly changing public sector, “we’re all money people now.”
And the opposite is also true. In today’s public sector money people must also step outside of their comfort zone. They must be able to communicate with program managers, board members, and many other stakeholders from whom they don’t traditionally interact. They must help others translate their ideas into the language of finance. As a public manager, a big part of your job will be learning to inspire your money people to step far outside of their comfort zone in the name of accomplishing your organization’s goals.
What is Financial Strategy?
Money is to public organizations what canvas is to painting. The painter wants to bring his or her artistic vision to life on the canvas. But to do this they must work within the confines of that canvas. If the canvas is too small, too rough, or the wrong shape, the painter must adapt their vision. If they stray too far from their vision, they must know when to find a different canvas.
As a public servant, you are like a painter. You know what you want your organization to accomplish, but you must bring those accomplishments to life on its financial canvas. Every organization’s financial canvas is a bit different. Some have many revenue streams that produce more than enough money, where others depend on a single revenue source to generate just enough money to keep the organization running. Some have broad legal authority to raise new revenue and borrow money, where others must get permission at every step from their board, taxpayers, or other stakeholders. Some have sophisticated financial experts to produce their budgets and manage their money, where others have no such expertise.
It’s not a problem that each public organization’s financial canvas is different from the rest. In fact, those differences are an important part of what makes public financial management an exciting and dynamic field of study. The problem, however, is that many great policies and programs fail because they’re painted on the wrong financial canvas. Public organizations often take on policy challenges without the right financial tools, authority, and capacity. By contrast, some organizations are too modest. They have the tools, authority, and capacity to take on big challenges, but for a variety of reasons they don’t. Financial strategy is how public organizations use their financial resources to accomplish their objectives. It’s how they put their organization’s vision to its financial canvas.
All public organizations must confront limits on the amount and scope of financial resources they can access. So in practical terms, financial strategy is often about tempering our expectations to match what our financial canvas can support. It’s about analyzing a program’s cost structure to make it more efficient, scaling back its goals and objectives, or finding partner organizations to help launch it. Sometimes strategy means finding a new canvas. That might mean forming a new organization, re-purposing an existing program, or recruiting a new foundation or venture capitalist to invest. This book tells you how to understand the many different types of canvases available to you, and the many different ways to put your organization’s vision to one of those canvases.
Technique Supports Strategy
This book is organized around a simple idea: technique supports strategy. There are many fine textbooks on public financial management, and almost all of them focus on technical skills. For more than a generation students of this subject have learned how to forecast revenues, build budgets, record basic transactions in an organization’s financial books, and many other useful skills. At the same time, students have rarely been asked a far more important question: Where and how should they apply those skills? We believe technical skill is useful only if it informs actual management decisions. A cost analysis is useful only if tells us whether and how to launch a new program. Financial statement analysis is a powerful tool because it can inform when to build a new building, start a capital campaign, or invest unused cash. Budget variance analysis is important because it tells program managers where to focus their attention. And so forth. We present these and other techniques, but more important, we try to explain how those techniques can and should inform crucial management, strategy, and policy decisions.
Strategic thinking is at some level about “knowing what you don’t know.” It’s about stepping outside of your own experience. It’s about looking into your organization’s future. It’s about putting yourself in your stakeholders’ shoes. That’s why one of the most valuable tools in financial strategy is asking the right questions. No one can be an expert on all things financial. But if you can ask the right questions and access the right expertise, you can know enough to drive your strategy.
That’s why one of the most important techniques in public financial management is asking good questions. This book is littered with questions. In fact, each chapter begins not with learning objectives, but with the kinds of questions managers ask, and how the information, conceptual frameworks, and analytical tools from financial management can help answer those questions. It includes exercises to help you refine your financial management technique. But more important, it includes cases and other opportunities for you to apply that technique in support of a genuine financial strategy. In fact, the centerpiece case at the end of the book – “The Cascadia Hearing School” – offers several opportunities to develop a financial strategy for a real public organization.
Strategy is not entirely sector-specific. What works in the for-profit sector might work in non-profits or governments, and vice versa. And as sector distinctions matter less, the origins of financial management strategy also matter less. That’s why most of the discussion in this book is predicated on the idea that all governments, non-profits, and “for benefit” organizations (i.e. for-profit organizations with an explicit social purpose) are mostly alike. You’ll see “public organization” and “public manager” used often. These are generic terms to describe people who interact with the financial strategy of any of these types of organizations. To be clear, “public manager” includes policy analysts, community organizers, for-profit contractors, and anyone else who has a stake in a public organization’s finances. Where necessary and appropriate, you’ll see discussions that highlight how each sector’s technical information, legal environment, and strategic directions are different. But for the most part, this text assumes that public organizations have a lot in common.
How this Book is Organized
First and foremost, this is a book about people and organizations. To many of us finance and budgeting are abstract subjects. They’re numbers in a spreadsheet, but not much more.
In reality public financial management is how real public servants in real public organizations bring their passions to life. That’s why all of the technical information is presented in the context of specific people, organizations, and strategies. Throughout this book you’ll also find lots of illustrations and examples drawn from real public organizations.
The first chapter is titled “How we Pay for the Public Sector.” It covers where public organizations’ money comes from, and where it goes. It also highlights some of the pressing challenges now facing public organizations – namely shrinking public resources, debt, and entitlements – and how those challenges present tremendous opportunities for entrepreneurial public managers.
Each of the subsequent chapters covers a bundle of tools that public financial managers use to inform financial strategy. The second chapter covers the basic financial statements. Financial statements are an essential and often overlooked tool to understand an organization’s financial story. This chapter introduces those statements, the information they contain, and the questions they help public sector managers ask and answer.
Chapter 3 is about financial statement analysis. If financial statements tell an organization’s financial story, financial statement analysis is the annotated bibliography of that story. It’s a tool to understand the specific dimensions of an organization’s financial position, to place that position in an appropriately nuanced context, and to identify strategies to improve that financial position in both the near and long term.
To truly understand the numbers in the financial statements, and how those numbers might change as an organization pursues different financial strategies, you must also understand the core concepts of accounting. To that end, the fourth chapter is an applied primer on core accounting concepts like accruals, revenue and expense recognition, depreciation and amortization, and encumbrances. These concepts and their application to actual financial activity are collectively known as “transaction analysis.”
Chapter 5 is about cost analysis. Many public organizations struggle to meaningfully answer a simple question: What do your programs and services cost? They struggle not because they’re lazy or inept, but because it’s challenging to measure all the different costs incurred to produce public services, and then express those costs in an intuitive way. It’s even more challenging to think about how those costs change as the amount of service changes, or as the scope of a service expands or contracts. It’s challenging, but it’s also essential. Every successful public program ever devised was designed with a careful eye toward its cost structure. In this chapter you’ll learn the different types of costs, the core concepts of cost behavior, and how to think about ways to improve an organization’s financial position given its cost behavior.
Chapter 6 covers budgeting. A public organization’s budget is its most important policy statement. It’s where the mission and the money connect. Budgeting is at one level a technical process. It demands solid cost analysis, revenue and expense forecasting, and clear technical communication. But more important, it’s a political process. It’s how policymakers bring their political priorities to life, and shut down their opponents priorities. It’s how the media and taxpayers hold public organizations accountable. It’s where sophisticated public managers can advance their own priorities. This chapter focuses on budgeting as a technical process, with particular emphasis on the different types of budgets and the legal processes by which budgets are made. But it also covers some of the common political strategies that play out in the budget process, and how public managers do and do not engage those strategies. The discussion of those strategies is loosely organized around concepts borrowed from the burgeoning field of behavioral economics, such as loss aversion and the “endowment effect.”
At the outset it’s also worth highlighting what this book does not cover:
- Unlike other textbooks in this space, we do not give special attention to healthcare financial management. Health care financial management has much in common with public financial management. But recent trends in the former – especially the Medicare Modernization Act, the Affordable Care Act (i.e. “Obamacare”), and the collapse of the municipal bond insurance market – have made it too distinct to cover in a coherent way within the framework of this book.
- We gloss over government budgeting systems and processes. We cover the steps outlined in law that governments are supposed to follow to arrive at a budget. But for roughly a decade now the actual budget processes in Washington, DC and many state governments have been quite different from what’s prescribed in law. Terms that used to describe deviations from that process, like “continuing resolution,” “sequestration,” “sweeps” and “recissions” now seem like parts of that process. That’s why it seems silly to devote much attention to the budget process. Instead, we treat budgeting as the place where money, politics, and priorities come together in predictable and unpredictable ways.
- Financial managers find themselves in the throes of some transformational changes in public organizations. They are asked to push the boundaries of what traditional procurement and contracting processes will allow. They are often asked to implement massive new information technology projects. They find themselves leading new initiatives around “evidence-based decision-making,” “lean management”, and “performance benchmarking,” among others. Woefully, we do not have time or space to devote to these processes. We hope to cover these topics in future iterations of this text.