Financial Management: Developing a Capability Model

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Media Release


Assistant Auditor General: Douglas G. Timmins
Responsible Auditor: Hugh A. McRoberts

Introduction

The Purpose of This Chapter

"I have agreed to work with Treasury Board and the senior financial community to help make financial management more effective. This will include developing a framework of financial management and control standards, assessing the current state of financial management against these standards, determining the skill and experience requirements of financial staff, and helping develop specific measures to advance the state of financial management control."

November 1995 Report of the
Auditor General of Canada

2.7 We have begun, in consultation with the Treasury Board Secretariat, a study of financial management in the federal government. The ultimate objective of the study is to develop a model of financial management that will permit us, the Treasury Board Secretariat and departmental managers to assess the financial management capability of departments against an agreed-upon standard.

2.8 This chapter represents the first step in that process. In this chapter, we briefly review some of the factors that have led us to undertake this endeavour. Second, we set out the scope of the project and propose a definition of financial management and its objectives in the government context by way of a Financial Management Activity Model. Third, we propose an approach to developing a methodology for assessing financial management capability. This methodology is based on an adaptation of the Software Engineering Institute's Capability Maturity Model, which was developed by it to assess software development firms. We believe that this approach can be successfully applied to create a Financial Management Capability Model.

2.9 At the end of this chapter, we indicate the steps in the development process that will need to be followed from here. Critical among these is widespread consultation with financial and operational managers throughout government. This step is important both to take advantage of their wisdom and experience as we develop the Model and to help ensure that it is widely accepted by the financial community once it has been completed. The ideas in this chapter are not being presented as the final word. Rather, we hope that these ideas are seen as a first word and provide the basis for future discussion. Further information on the study's objectives can be found at the end of the chapter in the section About the Study .

Why This Study?

A long-standing concern
2.10 Despite a number of royal commissions, audits, studies and Treasury Board Secretariat initiatives over the years, achieving effective financial management across government organizations remains, in our view, a top priority that continues to require senior management attention. The effectiveness of financial management still varies among organizations and often within an organization over time.

2.11 The Office of the Auditor General continues to observe and report on significant problems, across a broad range of government operations, that occur as a consequence of failings in financial management practices. Examples include:

2.12 These observations and many others raise questions concerning the strength of financial management in the federal government. For instance:

Increased demand for financial information
2.13 Increasingly, there is a demand for complete, accurate and timely financial information that, when combined with meaningful performance information, allows management and parliamentarians to put the cost of government programs in perspective. Some ministers have expressed to our Office their concern and frustration over the lack of appropriate financial information to support strategic decision making.

2.14 Similarly, as government moves to alternative forms of service delivery, the demand for reliable financial and performance information to support strategic decision making is expected to increase. Both financial and performance information will increasingly be required to support such decisions as the implementation of user fees to recover costs or to assess alternative program delivery strategies.

Systemic weaknesses or isolated instances?
2.15 Consideration of this issue raises one further question. Do the observations noted above signal serious systemic weaknesses in the structure of financial management, or are they merely isolated instances? On the one hand, if one judges the financial management capability of the government solely by the reports of financial management failings, then one could be led to be concerned. On the other hand, the Government of Canada is a very large organization in which many important financial management decisions are made every day. Viewed in this context, one could reasonably expect that even in an organization in which the overall level of financial management is satisfactory, a certain number of bad decisions could be made. This study is intended to provide a perspective that will permit us to put our observations in context and respond to the questions posed.

2.16 Current assessment. The Financial Administration Act , Treasury Board policies and Receiver General directives have established at great length, and often in great detail, the standards for financial management in the federal government. To date, financial management activities in departments and agencies have largely focussed on complying with directives from central agencies, adhering to control processes and ensuring that resources are used in compliance with legislative authorities.

2.17 In essence, many organizations have employed a largely mechanical approach to financial management functions. Although this approach may ensure that these functions are performed in accordance with established directives, it does not ensure that operational managers recognize and understand their broader financial management responsibilities. Similarly, this approach does not ensure that financial management activities become integrated into departmental operations and assist the organization in achieving its intended results at "reasonable" cost in terms of human, technical and financial resources. Nor does this approach enable the function to place the financial implications of decisions, directives or policies front and centre for management to consider. In other words, at the point where an organization makes significant operational decisions, financial management staff are not routinely asked to provide the analysis and advice for senior management to assess the financial consequences of these decisions.

2.18 To date, the effectiveness of financial management within government organizations has rested, to a large extent, on the strength, willpower and initiatives of individual senior financial officers. Yet such initiatives have not always been sustainable after those individuals have left the organization. In other words, an individual's initiatives are often not enough to "institutionalize" effective financial management within an organization.

2.19 In discussions with Treasury Board Secretariat officials, we agreed that based on the evidence currently available, neither we nor they could reliably answer the questions raised. At the same time, we agreed that more knowledge is essential to be able to put in perspective the failures in financial control that came to our attention, to provide a systematic basis for improving the quality of financial management, and to be able to provide information to Parliament on the control of the public purse. The purpose of this study is to develop a methodology that will permit a systematic assessment of the financial management capabilities of departments and agencies.

Developing a new approach
2.20 In order to put financial management issues in perspective, the Office of the Auditor General would like to be able to draw broad conclusions on the government's financial management capability. However, existing assessment methodologies have tended to follow a piecemeal approach - focussing on analyzing only particular aspects of financial management. They do not provide an analysis or assessment of the general state of financial management in the federal government. Although existing methodologies include criteria for effective financial management, they do not provide a tool for organizations to determine what type or level of financial management they need. Nor do they provide guidance to organizations on how to improve financial management functions, where necessary.

2.21 Additionally, most of the existing approaches to assessing financial management have their origins in the private sector and tend to emphasize issues, concerns and expectations more appropriate to that environment than to the ongoing realities of public sector management. Put simply, in the private sector, management spends money in order to generate money. The measures used to monitor money spent versus money generated, such as net profit, return on investment and increased share values, are key performance indicators for managers that are closely monitored by them on an ongoing basis.

2.22 In the public sector, money is raised through taxes so that it can be spent to achieve the objectives of the government. For the public sector manager, money is one of several resources that are blended and brought to bear on program objectives. As such, financial information acts much like a fuel gauge - something to be consulted occasionally, and more often near the end of the trip to be sure that there will be enough fuel left to make it to the gas station. The more important information for the public sector manager relates the costs of program delivery to the degree of objective attainment. This information is more difficult to create and, if it were available, could be obtained only occasionally. All of this means that financial management in the private sector and public sector takes on very different forms and appearances. Although the forms may occasionally provide a comforting sense of familiarity looking from one sector to the other, their content is often significantly different.

2.23 Finally, the piecemeal approach to assessing financial management ignores the interrelationships of financial management and other components of organizational control, which together are essential for overall effective management of an organization. We believe that understanding these relationships is critical. Good financial management is more than just the sum of the pieces.

2.24 In saying this, it is not our intent to dismiss the work that has been done. The issues raised are important. Rather, our intent is to build upon the existing work and to give it a structure that will meet current needs.

New approaches to control models
2.25 The impact of technology and the flattening of the traditional organizational pyramid structure demand more reliance on control through informal means such as shared values, shared vision and open communication. As a result, in today's business environment, the term "control" has sometimes taken on a broader meaning than just internal control over transactions and financial reporting. This growing (and possibly necessary) reliance on informal controls, based on shared values and effective communication, is important in compensating for reductions in formal checks and balances. Additionally, these changes have placed increasing importance on strong and clear accountability arrangements supported by systems that will produce valid and timely information on results.

2.26 In response to this trend, the Canadian Institute of Chartered Accountants (CICA) established the Criteria of Control Board (CoCo). Its role is to provide guidance to organizations on designing, assessing and reporting on their control systems. This guidance reflects the broader concept of control as a key element of good management. It describes and defines control in a manner that goes beyond traditional internal accounting controls. It also includes criteria for overall effective control in an organization, which includes the achievement of results and the financial performance associated with achieving these results.

2.27 Similar guidance has also been developed and issued by other professional bodies, for example: Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission in the United States; and the Cadbury report, issued in the United Kingdom.

2.28 All of these concerns and trends, together with the changing nature of government, indicate a need for a revitalized framework for financial management. The framework being proposed in this study is intended to recognize the role of financial management within the broader concepts of organizational control.

Initiatives to Improve Financial Management

2.29 The Office of the Auditor General has set, as a long-standing strategic priority, the goals of influencing the quality of financial management and control within the federal government and improving the understanding of the role that financial management can and should play.

2.30 As discussed earlier, our concern led us to our decision to work together with the Treasury Board Secretariat to begin the present study. We believe that, as part of moving forward, our Office and the government need baseline information about departments' financial management capability. This study is a first step in getting that information. As the study progresses, and as resources become available, the Treasury Board Secretariat has indicated its desire to be more closely involved in this project. We welcome this co-operation.

2.31 The President of the Treasury Board has created an Independent Review Panel on Modernization of Comptrollership. Its task is to review and report on how the comptrollership function should evolve to reflect the changing business and operating needs of the government. The Panel was created because of the profound changes the government is undergoing in how it operates, the resources available to it, and the challenges, risks and opportunities facing it. The Panel's work is considered to be pivotal in helping government deliver on its commitment to provide more effective financial management. The Panel has indicated it will consult broadly on key aspects of comptrollership, including:

2.32 We have been informed that the decision to establish a high-profile Panel like this reflects the seriousness with which Treasury Board Secretariat officials view the concerns that we have raised about financial management. The Office is committed to working with the Independent Panel and the Treasury Board Secretariat in achieving better financial management in the Government of Canada. The Panel's report will be taken into account as this study progresses. We will be interested in seeing the extent to which the Panel addresses the questions raised in paragraph 2.12.

Developing a Financial Management Model

Defining Financial Management

2.33 Experience has shown that financial management is a term that has almost as many meanings as there are people who use it. Indeed, the lack of clarity about what the term encompasses has probably contributed to the difficulties in making progress in the area over the years. Accordingly, we have begun our study by suggesting a definition of financial management in terms of the activities that we believe it includes. In the private sector, financial management is often thought of as including two areas of activity frequently covered by the terms "treasury" and "comptrollership". In government, the activities usually associated with the treasury function, such as cash flow management, debt management, investment and corporate budgeting, are carried out jointly by central agencies - the Department of Finance, Receiver General and the Treasury Board Secretariat. Our current study excludes these activities from its scope. Thus our definition of financial management is intended to refer only to those financial management activities that are carried out in the departments and agencies of the government. We have also excluded, at this time, the issues of financial management in Crown corporations.

2.34 Financial management in departments and agencies is an important component of what financial and program managers do in delivering programs within their organizations. Specifically, in carrying out their financial management responsibilities, the managers' role is to:

2.35 Effective financial management is therefore a critical activity that helps an organization assess the cost of achieving its objectives, account for the results of its operations and discharge its accountability obligations.

2.36 The essential activities and components of financial management are illustrated in Exhibit 2.1 , the Financial Management Activity Model. While not specifically set out in the Exhibit, the Activity Model also includes the informal controls and practices that are essential components of the overall management framework and hence can have a critical effect on how financial management will function in a particular organization. These components include:

2.37 There are several key processes that underlie the Financial Management Activity Model. They include:

2.38 The responsibility for these processes and functions is not restricted to departmental financial managers. Some of the responsibility will also extend to departmental operational and program managers, depending on the nature of the department.

2.39 Exhibit 2.2 extends the Financial Management Activity Model by illustrating how the activities and components of financial management are related to the specific objectives of financial management, which in turn link to the broader objectives of financial management:

Study Approach

2.40 This study is designed to respond to the need that we and the Treasury Board Secretariat have identified for a methodology that will permit us to reliably assess the financial management capability of departments and agencies.

2.41 In developing this financial management framework, we intend to work co-operatively with the Treasury Board Secretariat and the government financial community and to implement a process that incorporates extensive consultation with the management teams within departments and agencies.

2.42 As part of this study, we are developing a Financial Management Capability Model that will describe key elements needed for effective financial management and control. The Model, described in more detail below, is not intended to provide a definitive answer on the expectations for financial management in departments. Nor does it prescribe a complete approach for assessing financial management. Rather, it is intended to provide a basis for beginning discussions and developing consensus on the essential components of effective financial management.

Principles underlying our work
2.43 The main principles underlying this study are the following:

The Financial Management Capability Model

2.44 The purpose of the proposed Capability Model is to provide a tool that a government organization can use to:

2.45 As the size or complexity of an organization or the risk associated with its activities increases, so does the need for more sophisticated financial management capabilities. The proposed Model will set out an evolutionary path that an organization can follow in developing more sophisticated financial management practices, if necessary. It will also show the steps needed to progress from a level of financial management typical of a start-up organization to strong, effective financial management practices associated with a more mature and complex organization.

2.46 An important first step in addressing financial management issues is to treat the entire financial management function as a set of integrated business processes that support the people working in the organization in the achievement of its objectives. These processes, when properly performed, yield an appropriate degree or level of financial control. Clearly, a fully effective financial management framework must consider the relationships of all the required tasks, the tools and methods used, and the skills, training and motivation of the people involved.

2.47 The Model being developed proposes to establish a framework for strengthening financial management based on many small evolutionary steps. These steps have been organized into five progressive "capability levels". To achieve a level of capability, an organization would be expected to satisfy all the requirements of that level and any preceding levels. As depicted in Exhibit 2.3 , the five levels of capability proposed are:

2.48 We have proposed these levels because we believe they:

Characteristics of the Capability Model

2.49 The Capability Model is being designed to be descriptive - not prescriptive. When completed, it will not tell an organization how to improve its financial management practices. Rather it will suggest what will be needed to achieve a certain level of capability. The Model is intended to set out a path for making the needed improvements by defining the financial management requirements for each level.

2.50 The Model will provide a framework for both determining the financial management requirements of an organization and comparing those requirements with the organization's actual capabilities.

2.51 In addition, the Model should reflect specific attributes or financial management capabilities that an organization at a particular level would typically exhibit. An organization could be assessed against these attributes to determine where it is on the financial management continuum according to the Model. While at a lower level on the capability framework, an organization may demonstrate some of the characteristics associated with a higher level of capability.

2.52 In summary, the incremental improvements or practices at each level of the Model are seen as the building blocks that allow an organization to establish effective financial management, and provide guidance for continuous improvement.

The Five Proposed Capability Levels

2.53 Each level will profile different capabilities in each of the key components or activities of financial management illustrated in the Financial Management Activity Model (Exhibit 2.1) .

Start-up level
2.54 The start-up level describes the financial management characteristics of a new organization or program that has not yet established its key policies, practices and controls. Accordingly, this level, unlike the others, would not be viewed as a stable environment in which an organization or a program would wish to remain. Any accomplishments in establishing controls to contribute to the achievement of objectives, or the achievement of the objectives themselves, depend on the often isolated efforts of specific individuals, and there is no certainty that those accomplishments would be repeatable. An organization that has experienced dramatic changes in its operations - for example, amalgamation with another department or the relocation of operations - may also be at the start-up level of its financial management capability if it does not effectively manage the increased risks associated with the change.

Financial control level
2.55 The requirement for departments and agencies to comply with central agency practices and procedures for producing the Public Accounts of Canada and to meet the requirements of the Central Accounting System should ensure that most departments are able to maintain, on a consistent basis, a financial control framework. This control framework would represent the minimum requirements to satisfy the Financial Administration Act , Treasury Board policies and Receiver General directives.

2.56 Organizations at this level would be fully capable of processing their accounts payable. They would have begun to establish accounts receivable systems. Planning would largely be geared toward obtaining approval of appropriations and complying with Treasury Board's minimum requirements, that is, the Business Plan and Part III of the Estimates. Financial information would be historically oriented rather than future-oriented. Control efforts would focus on remaining within the vote and not allowing funds to lapse.

2.57 At this level, organizations' financial management capabilities would primarily be focussed on meeting the requirements of the Central Accounting System in order to have transactions processed.

Enhanced financial control level
2.58 At the enhanced financial control level, an organization's control processes would normally have been tailored to suit its needs, as opposed to only satisfying minimum requirements. There would also be an expectation that a risk-based approach to installing controls would be in place, with the focus on making them cost-effective. Accounts payable and receivables, if applicable, would be well managed and there would be control over assets and liabilities. Management would receive historical financial information on a timely basis. Analytical information would be produced as necessary, and not as part of routine financial reporting. Planning and budgeting processes would be working properly, and the organization may occasionally generate future-oriented information for decision making.

2.59 Since analytical information would not be routinely generated at this level, an organization's ability to make cost-effective decisions may be affected.

Financial management and enhanced financial management levels
2.60 An organization at one of these levels would be expected to be capable of maintaining effective financial control. It would routinely produce quantitative information for decision making (results would be reported and measured in terms of their effectiveness). At the financial management level, the organization would have started to recognize and implement concepts inherent to effective financial management, such as activity-based costing, benchmarking and performance measurement. However, there would still be room to improve the financial control and financial system advice and integrate or institutionalize financial management throughout the organization. This integration would involve linking finance more closely with program operations.

2.61 The enhanced financial management level would represent a fully capable organization where financial management and control would be fully integrated with departmental operations. A financial management culture, as well as a process for measuring whether the organization has achieved its objectives and the cost of doing so, would have been firmly established throughout the organization.

2.62 At these levels there would be a well-established process, such as a strong internal audit function, for providing assurance to management that the organization is operating as it should.

Using the Capability Model

2.63 In keeping with the principle that managers are responsible for financial management, we would expect that the use of the proposed Capability Model, once fully developed, would follow the pattern set out in Exhibit 2.4 . As a first step, we would expect that the senior management of an organization would systematically analyze the cost and effectiveness of each key activity. The purpose of this analysis would be for management to determine three things:

2.64 The second step would be for management to determine, based on the results of its assessment, the level of financial management capability it needs to meet its responsibilities. This step would establish the required level of financial management capability for the organization in light of its responsibilities. That level would be expected to vary substantially among departments and agencies. For some (mainly small agencies whose major financial activities focus on payroll), the basic financial control level of capability might be sufficient. However, organizations with operations involving largely expenditures and policy formation might well find that they require an enhanced financial control capability. The largest and most complex organizations may determine that they need to attain the financial management or enhanced financial management levels.

2.65 As shown in Exhibit 2.4 , the third step would be for management to assess the organization's capability in each process area. This assessment would likely involve a combination of traditional internal audit and review procedures and self-assessment of controls.

2.66 If the assessment process reveals a discrepancy between the necessary level of capability and the actual level, management would be expected to review its earlier analysis to determine whether the discrepancy is the result of either a deficiency needing to be remedied or an overstatement of the required capability. In either instance, the discrepancy would need to be resolved.

2.67 Auditors can also use the Capability Model and the process to assess an organization's level of financial management capability relative to its requirements. As development of the Model proceeds, assessment tools and guidelines will be developed to support an assessment process.

A Process of Consultation

2.68 In developing the Financial Management Capability Model, we recognize that how we will achieve our objectives is as important as achieving the objectives themselves. To this end, a critical component of our work will be extensive consultation with central agencies and financial and operational managers.

2.69 All these efforts are intended to provide input to the proposed Model, to assist in developing a consensus on the framework and, ultimately, to contribute to the achievement of effective financial management within the federal government.

2.70 We intend to carry out this study in several stages. The first stage, represented by this chapter, was to develop the basic elements of a model at a fairly high level of abstraction, and to put that work out for discussion with public servants, parliamentarians, and other interested parties. The second stage will be to elaborate the basic model by setting out for each of the process areas in the Activity Model the capabilities expected at each level of the Capability Model. Again, the results of this work will be the basis of consultations. The third stage will be to develop detailed assessment criteria and to validate them in selected departments. Finally, in conjunction with the Treasury Board Secretariat and departments, we can begin to apply the Model to do capability assessments and to continually refine the Model to improve the effectiveness of financial management in the federal government.

2.71 Our ultimate objective is to be able to assess financial management capability, both to identify areas where improvement will be needed and to be able to place in their proper context the failures in financial management that our Office observes from time to time. We believe that doing this will enable us to meet our objective of encouraging better financial management and to serve both Parliament and the public service better.

Treasury Board Secretariat's comments: The government notes the progress being made in developing a model to determine requirements and assess capabilities in financial management in departments. However, as explained in the chapter, in view of the profound changes the government is undergoing in how it operates, the resources available to it, and the challenges, risks and opportunities it faces, an Independent Review Panel on Comptrollership has recently been established that will review and make recommendations on the comptrollership function within the government. The government will wish to consider the recommendations from the Independent Review Panel before committing to implementation of such a model.


About the Study

Objectives

The focus of this study is the financial management and control activities of departments and agencies.

In carrying out this study, our Office, in conjunction with departments and central agencies, wants to develop:

Study Team

P. Elaine Grout-Brown
Christine S. Kelly
Joyce C.S. Ku
Bruce C. Sloan

For information, please contact Hugh McRoberts, the responsible auditor.