Evaluating Financial Condition of Local Governments
- 1. Evaluating Financial Conditions Strengthening The Financial Foundation of Local Government Training of Trainers Workshop June 4- 15 2007 Nadi, Fiji Based on Financial Management Training Series- UNHSP Dr Ravikant Joshi
- 2. Financial Management for Local Government Managing Operative Budget Managing Capital Investment Plan Citizens’ Participation Financing of Operative Budget Financing of Capital Investment Plan Accounting Performance Measurement Procurement Asset Management Evaluating Financial Condition Financial Policy Making Financial Planning Creating Financial Framework Managing Financial Framework Managing Performance
- 3. Relationship of Evaluating Finacial Conditions with other aspects Evaluating Financial Condition Financial Policy Making Financial Planning Citizens Participation Operating Budget Asset Management Performance Measurement Accounting Financing CIP Policy Capital Investment Plan Financing Op. Budget Procurement EFC is looking at indicators or performance, complementary to PM Provides framework for evaluating financial conditions Indicators pinpoint gray areas of current financial condition Citizens have stake in financial health of their LG. EFC helps in this OB is integral part of overall financial condition EFC is important for determining financing option CIP is integral part of overall financial condition needs EFC EFC is important for selecting financing mechanism for CIP Accounting records provide data for evaluating financial condition How will assets are maintained and performing
- 4. “Basic Framework” Maintain existing service levels “financial condition can be broadly defined as a LG’s ability to finance its services on a continuing basis. More specifically, financial condition refers to a LG’s ability to (1) maintain existing service levels, (2) withstand local and regional economic disruptions, and (3) meet the demands of natural growth, decline, and change.” Withstand local and regional economic disruptions Meet demands of natural growth, decline and change
- 5. Framework for Evaluating Financial Condition ◼ Budget, balance sheet and other financial statements fails to provide multiyear perspective of emerging good or bad FC ◼ Most financial problems do not develop suddenly ◼ A decline in revenues ◼ An increase in expenditure pressures, ◼ Decreasing cash and budgetary surpluses ◼ A growing debt burden ◼ The accumulation of unfunded liabilities ◼ The erosion of capital plant ◼ A decline in tax base or an increase in the need for public services ◼ Can the LG continue to pay for what it is now doing? ◼ Are there reserves or other ways for financial crisis? ◼ Is there enough financial flexibility to all the LG to adjust to change? ◼ If LG can meet these challenges, it is having a sound condition
- 6. Learning Application Go to Page No 307, Vol 1
- 7. Developing The Indicators Organize Project Evaluate Indicators Collect Data for Worksheets Develop Indicators/Plot Develop Policy Statements Evaluate Results
- 8. Indicators ◼ Key Indicators include: ◼ Revenues ◼ Expenditures ◼ Operating Position ◼ Unfunded Liabilities ◼ Capital Assets ◼ Show by ◼ Graph illustrating warning trend ◼ Formula ◼ Description ◼ Suggestions for Analysis Trend Worksheet Line Descripti on Source 2001 2002 2003 2004 2005 1 Net Operating Revenue Work sheet 2
- 9. Examples-Revenues “Revenues determine the capacity of a LG to provide services. Important issues to consider in revenue analysis are growth, flexibility, elasticity, dependability, diversity, and administration.” Key Indicators Include: Revenues per Capita Net Operating Revenue / Population Decrease indicates poor allocation to population Restricted Revenues Restricted Operating Revenue/ Net Op Rev Increase indicates revenue allocation for specific needs Intergovernmental Revenues Intgov Op Revenue/ Gross Op Revenue Increase indicates dependence on other governments Elastic Tax Revenue Elastic Op Rev/ Net Op Rev Decrease indicates poor economy and high inflation One Time Revenues One time Op Rev/ Net Op Rev Increase/ Continuous use indicates overdependence on onetime sources Property Tax Revenue Property Tax Revenue Decrease indicates shortfall in LG revenues Uncollected Property Taxes Uncollected PT/ Total PT Levy Increase indicates decline in LG’s economic health User Change Coverage User Charge Rev/ Related Services Exp Decrease indicates loss in service charges
- 10. Learning Application Go to Page No 339, Vol 1
- 11. Examples-Expenditures “Expenditures are a rough measure of a LG’s service output. Generally, the more a LG spends in constant dollars, the more services it is providing.” Key Indicators Include: Expenditures per Capita Net Operating Exp / Population Increase indicates higher service costs to service charge on population Employees per Capita No of LG Employees /Population Increase indicates LG is becoming more labour intensive Fixed Costs Fixed Costs/ Net Op Costs Increase indicates less flexibility to respond to economic changes Fringe Benefits Fringe Ben Exp/ Salaries and Wages Increase indicates unhealthy LG finances
- 12. Learning Application Go to Page No 349, Vol 1
- 13. Examples-Operating Position “During a typical year, a LG generates either an operating surplus or an operating deficit. An operating surplus develops when current revenues exceed current expenditures, an operating deficit when the reverse occurs.” Key Indicators Include: Operating Deficit General Fund Op Deficit/ Net Op Rev Increase indicates unbalanced budget Enterprise Loss Enterprise Profit/ Loss Recurring losses are bad for LG Fund Balances Unreserved Fund Balance/ Net Op Revenue Unplanned decline indicates lack of funds for future needs of LG Liquidity Cash- short-term invest/ current liabilities Decrease indicates poor state of LG Current Liabilities Current Liabilities/ Net Op Rev Increase indicates lack of flexibility in allocation of funds
- 14. Learning Application Go to Page No 361, Vol 1
- 15. Examples- Debt “Debt is an effective way to finance capital investments to even out short-term revenue flows, but its misuse can cause serious financial problems. Even a temporary inability to repay debt can damage a LG’s credit rating, which can in turn increase the cost of future borrowing” Key Indicators Include: Long term Debt Net direct bonded long term debt / Assessed valuation Increase indicates diminished ability to repay debt Debt Service Net direct debt service / Net Op Rev Increase indicates excessive fiscal strain on LG Overlapping Debt Long-term overlapping bonded debt / Assessed valuation Increase indicates dependence on other repayment sources
- 16. Learning Application Go to Page No 369, Vol 1
- 17. Examples- Unfunded Liabilities “An unfunded liability is one that has been incurred during the current or a prior year, that does not have to be paid until a future year, and for which reserves, or funds, have not been set aside.” Key Indicators Include: Unfunded Pension Liabilities Unfunded Pension Liability/ Assessed Valuation Increase indicates increased burden on tax base Pension Assets Pension plan assets/ annual pension benefits paid Decline indicates problems in the management of the plan Accumulated Employee Leave Total unused- sick leave/ Total employees Increase indicates large termination costs
- 18. Learning Application Go to Page No 375, Vol 1
- 19. Examples-Capital Plant “Most of a LG’s wealth is invested in its physical assets or capital plant streets, buildings, utility networks, and equipment. If these assets are not properly maintained or are allowed to become obsolete, the results are often (1) decreasing usefulness of the assets, (2) increasing cost of maintaining and replacing them, and (3) decreasing attractiveness of the LG as a place to live or do business.” Key Indicators Include: Maintenance Effort Exp of repair & maintenance of cap assets/ Quantity of assets Decrease indicates low maintenance Capital Outlay Cap Outlay from Op funds/ Net Op Exp Decline over 2-3 years indicates capital outlay needs being deferred Depreciation Expense Depreciation Expense/ Cost of depreciable assets Decrease indicates assets being used beyond estimated life
- 20. Learning Application Go to Page No 382, Vol 1
- 21. Examples-Community Needs & Resources “The community needs and resources indicators encompass economic and demographic characteristics including population, personal income, property value, employment, and business activity.” Key Indicators Include: Population Population Rapid change in population size Median Age Median Age Increasing median age of population indicates greater expenditure Personal Income per Capita Personal Income/ Population Decline indicates drop in purchasing power Poverty Households Poverty Households/ Households in thousands Increase indicates greater public assistance receipts Property Value Change in property value/ property value in prior year Decline indicates drop in market value Residential Development Market Val of new residential dev/ Mkt val of total new dvpt Increase indicates greater expenditure demands Vacancy Rates Vacancy Rates Increase indicates sluggish economy Employment Base Local unemployment rate Increase indicates overall economic decline Business Activity Decrease indicates sluggish economy
- 22. Learning Application Go to Page No 401, Vol 1
- 23. Policies for evaluating financial conditions ◼ Financial policies helps officials agree on the kind of financial condition they want for their LG thus serve as goals for EFC ◼ Policies get formulated in scattered manner under different heads – budget, CIP, Grant application and case by case. This results in ◼ Conflicting policies ◼ Inconsistent policies ◼ Incomplete policies ◼ Formal and comprehensive set of policies help EFC
- 24. Benefits of EFC Indicators ◼ Can not explain specifically why a problem is occurring? Or a single number or index to measure financial health ◼ It provides flags for identifying problems, clues about their causes, time to take anticipatory actions ◼ Provides for better planning and policy making ◼ Puts already existing information in context of other economic, demographic data and creates new meaning
- 25. Obstacles In EFC ◼ Resistance to change ◼ Lack of necessary financial and performance data ◼ Nature of LG ◼ Limitation of LG accounting practices ◼ LG financial analysis – lack of world wide normative standards for LG
- 26. Learning Application Go to Page No 411 & 413, Vol 1
- 27. Environmental/ Org Aspects of Financial Condition ◼ External Economic Conditions ◼ Inflation ◼ Employment ◼ Economic wealth ◼ Interest rates ◼ Intergovernmental Constraints ◼ National constitutions ◼ Laws ◼ Natural Disasters and emergencies ◼ Political Culture
- 28. Practices and policies that jeopardise financial condition ◼ Repeated use of one-time revenue resources – reserves, sale of assets etc ◼ Deferring a large amount of current costs to the future deciding – maintenance, pension ◼ Ignoring long-range or full life cost of a liability – purchasing assets with examining long term costs ◼ These practices can – ◼ Create problems or ◼ compound existing problems or ◼ delay recognition of existing problems
- 29. Practices and policies that jeopardise financial condition ◼ Practices that sustain an operating deficit ◼ Use of internal borrowing ◼ Selling assets ◼ One-time accounting changes ◼ Practices that defer current costs ◼ Deferred pension liabilities ◼ Deferred maintenance expenditures ◼ Practices that ignore full-life costs ◼ Non-salary employee benefits ◼ Capital assets