Public Sector : An Important Entity
Entities in the public sector
Nationalized industries and local government organisations are examples of public sector entities. They are a significant part of the economies of many countries, and sound financial management is required for them to operate efficiently. The biggest issue here is determining a measurable goal.
In the public sector, financial goals are
We can use the maximisation of shareholder wealth as a working objective for a stock market listed company and know that the achievement of this goal can be tracked using share price and dividend payments. The situation is more complicated for a government entity. The entity's mission statement will outline its main goals. However, such entities are generally run in the best interests of society as a whole, and we should strive to reach a point where the gap between the benefits they provide to society and the costs of their operation is the widest possible (in positive terms). In accounting terms, the cost is relatively simple to calculate. Many of the advantages, however, are intangible. The benefits of organisations like the National Health Service or Local Education Authorities, for example, are nearly impossible to quantify. In investment appraisals, such government organisations typically use a low discount rate (to account for 'time preference') and have complex methods for quantifying non-financial benefits in a standard NPV analysis. With varying degrees of success, economists have attempted to evaluate many public-sector investments using cost-benefit analysis. When weighing all of the advantages, problems are common.
It's worth remembering that organisations with a public sector history or that are natural monopolies are frequently regulated to ensure that the general public is not harmed by their monopoly power. This regulation can take many forms, including a cap on selling prices, taxation of super profits, or simply a limit on the profits these businesses can make.
Entities in the public sector have specific goals
Managers have traditionally focused on financial measures of performance and progress, but non-financial indicators are increasingly being used to assess success across a range of criteria that must be chosen to help an entity meet its objectives, in both the private and public sectors. The government usually establishes the objectives of public sector entities through legislation or other means. A hospital, for example, is established to provide medical care, and a school is established to provide education. In the context of public sector entities, a number of common goals are discussed below.
Compliance with budgetary constraints will be a major goal for public sector entities. These budgets are usually set by central or local government, and it is critical for the entity's long-term survival to meet these budgetary targets. Budgets are also used in the private sector to control costs, set goals, and evaluate performance.
Poor liquidity poses a greater threat to an entity's survival than poor profitability. Cash generation is critical to ensure investment in future profitable ventures unless the entity is prepared to fund growth with high levels of borrowing. Borrowing is a private sector alternative to cash from retained earnings. This option has not previously been available in the public sector, and all growth has been funded by the government. Local governments and other public-sector entities, however, are beginning to raise debt on the capital markets in response to government-imposed cash limits, and are thus confronted with the same choices as profit-making entities.
The value added to an entity's products by its own efforts is referred to as value added. Comparability with other industries, or even other entities within the same industry, is a problem. Many government entities, such as those in the health care system, are now publishing data on their own value added.
Although most of the public sector lacks the concept of profit in its true sense, profitability can be used to link inputs to outputs when a different measure of output is used, such as surplus after all costs, for capital investment.
Return on Assets (RoA)
Although the concept of profit is absent in the public sector, it is not unreasonable to expect organisations to maximise the efficiency of donated assets. If depreciation on such assets were charged against income, the amount of surplus income over expenditure would be reduced. Other factors that may influence RoA interpretation in the public sector include: > difficulty determining value; > no resale value; > are for community use; > charge for depreciation may result in 'double taxation' on the taxpayer.
Share of the market
Market share is a metric that is becoming more important in the public sector, such as universities and health care. Health-care providers must now'sell' their services to trusts that have been established to 'buy' them. Those providers who are seen as failing their customers will lose market share, as trusts will shop around (within certain limits).
Position of competition
In both the private and public sectors, the public sector is increasingly competing with other providers of similar services. Hospitals, for example, must now compete for funds from health trusts. Their advantage is that data from competitors is easier to obtain than it is in the private sector.
Exposure to risks
Because of the political ramifications of failure and the fact that taxpayers, unlike shareholders, do not have the option to invest their money in less (or more) risky ventures, public sector entities are risk averse.