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HomeMy WebLinkAboutICMA - The Municipal Financial Indicators Evaluation kit • International City/County ICMA Management Association icma.org The IndiKit The Municipal Financial Indicators Evaluation Kit AN EASY-TO-USE,EASY-TO-UNDERSTAND KIT FOR EVALUATING FINANCIAL CONDITION • Adapted from Evaluating Financial Condition:A Handbook for Local Government,4th edition, by James A.Hough,MBA,MA,MPA,ICMA-CM Former City Manager,Reedsport,Oregon International • City/County ICI ICMA Management Association icma.org The International City/County Management Association(ICMA) is the professional and educational organization for appointed administrators and assistant administrators in local government.The mission of ICMA is to create excellence in local governance by developing and fostering professional local government management worldwide. To further this mission, ICMA develops and disseminates effective approaches to management through training programs, information services, and publications. ICMA's interests and activities include public management education;voluntary credentialing and standards of ethics for members; an information clearinghouse; local government research and development; data collection and dissemination; technical assistance; and a wide array of publications, including Public Management magazine, newsletters,management reports, and texts. ICMA's efforts toward the improvement of local governmentoas represented by this bookoare offered for all local governm ents and educational institutions. For further information about the publications or services for local governments offered by ICMA,write to Publications Department, ICMA, 777 North Capitol St.,N.E., Suite 500, Washington,D.C. 20002. To order publications, call 800/745-8780 (outside the United States, call 770/442-8631, ext. 377) or visit the ICMA Bookstore online at http://bookstore.icma.org. ©2003 by the International City/County Management Association, 777 North Capitol St.,N.E., Suite 500, Washington, D.C. 20002.All rights reserved, including rights of reproduction and use in any form or by any means, including the making of copies by any photographic process; or by any electronic or mechanical device,printed,written, or oral; or recording for sound or visual reproduction; or for use in any knowledge retrieval system or device,unless permission in writing is obtained from the copyright owner. Item number E-43127 • 2 The IndiKit AUTHOR'S PREFACE This"kit"was originally produced for the public administrator in a small local government(population under 5,000) in Oregon,who might not have the benefit of experience or training in public financial management, but who needed to use sound financial practices for the public good. The first IndiKit helped identify easily produced measures (or indicators) of financial condition in a small local government and provided guidance as to what to do with the resulting data,trends, and analysis. This new version of The IndiKit has been adapted to a national audience and updated to reflect the new indicators and information in the fourth edition of Evaluating Financial Condition:A Handbook for Local Government(ICMA, 2003). A vast number of local government managers, administrators, and clerks throughout the country serve in cities, counties,towns,townships, boroughs, and other incorporated municipal entities where they must be a jack-of-all-trades. They must be simultaneously knowledgeable in civil engineering (water treatment and distribution, wastewater collection and treatment, street construction and maintenance, etc.), planning(traffic slowing, zoning, subdivision regulations, etc.), public safety(law enforcement, fire prevention and fire fighting, emergency medical services, etc.), human resources management, and financial management. Some aspects of the job tend to be pushed into the background when other more immediate needs crowd forward. Many small local governments do not have a separate treasurer, or a specifically designated financial officer or assistant. On the other hand, local governments are not created and incorporated for short-term purposes but rather to serve extremely long-term community needs. Before a local government floats a bond issue to incur debt, a g reat deal of analysis is performed by financial experts in the investment banking industry to check the financial health of the community selling the bonds. Certain measures are calculated that enable analysts to rate a particular local government in terms of financial risk, in order to be able to set the true value of the bonds. Public administrators should be able to do the same thing on a regular basis so that they can provide advice to their governing body regarding policies that have a long-term as well as a short-term effect on the local government. The Financial Trend Monitoring System (FTMS), first published by the International City/County Management Association(ICMA) in 1980 and now revised and republished in the fourth edition of Evaluating Financial Condition:A Handbook for Local Government, is a coherent system of measures that can tell the administrator about the financial condition of his or her local government organization. The IndiKit pulls key indicators from the FTMS to provide basic financial management tools for the small local government. By streamlining the FTMS; eliminating measures that are cumbersome for the small,perhaps overburdened, local government staff;and presenting the most useful measures in linked, automated worksheets, I hope I have created a user-friendly system for documenting the measures and for understanding their resulting calculation. • 3 The IndiKit The IndiKit does not provide direction or policy for an individual local government to follow. That function is appropriately left to the governing body, in concert with the chief executive officer(CEO). Rather,this kit provides a means for taking a snapshot of the local municipal financial status. With this snapshot in hand, and acting on the advice of the CEO, governing officials can explore the actions necessary to maintain or regain the financial health required of a small local government. It seems appropriate to make The IndiKit as easy to use as possible,but if you, the reader, "outgrow"The IndiKit as you use it, I will have succeeded in my goal of enhancing financial management in small local governments and will be extremely pleased. James A. Hough May 2003 • • The IndiKit 4 TABLE OF CONTENTS • I. Introduction to The IndiKit The IndiKit and Evaluating Financial Condition 6 What Is the IndiKit? 6 The Data Assembly Worksheets 7 The Indicator Sheets 8 II. The Data Assembly Worksheets Introduction 9 Data Assembly Worksheet 1, General Accounting Data 9 Data Assembly Worksheet 2, Revenues 10 Data Assembly Worksheet 3, Expenditures 12 Data Assembly Worksheet 4, Fixed Cost Summary 13 Data Assembly Worksheet 5, Repair&Maintenance of General Fixed Assets 13 Data Assembly Worksheet 6, Pension Plan Data 13 Data Assembly Worksheet 7, Economic-Demographic Data 13 Data Assembly Worksheet 8, Other Local Data 14 CPI Base Conversion Worksheet 15 III. The Indicator Sheets • Introduction 16 An Analysis Strategy 16 Revenue Indicators 17 Revenues per Capita 17 Intergovernmental Revenues 18 Tax Revenues 19 Uncollected Property Taxes 21 Expenditure Indicators 22 Expenditures per Capita 23 Expenditures by Function 25 Operating Position Indicators 26 Operating Deficit or Surplus 27 Fund Balances 28 Debt Indicator 29 Long Term Debt to Assessed Value 30 Unfunded Liability Indicator 32 Unfunded Pension Liability 33 • The IndiKit 5 I. INTRODUCTION TO THE INDIKIT kit,n.,...2 a(2):a set of tools or implements (3):a set of parts to be assembled or worked up (4):a packaged collection of related material Merriam-Webster Dictionary,OnLine(2003) The IndiKit and Evaluating Financial Condition The IndiKit is based on and adapted from Evaluating Financial Condition:A Handbook for Local Government, 4th edition,written originally by Sanford M. Groves and Maureen Godsey Valente, and revised by Karl Nollenbergerl. The IndiKit includes information, data, and advice from a variety of other sources, as well, because it is designed especially for smaller local governments. Of the 42 indicators included in Evaluating Financial Condition, The IndiKit develops 10 that were chosen for their importance in measuring financial condition and for the accessibility of the data needed to the manager or finance staff in the average small local government. The IndiKit includes all seven of the data assembly worksheets included in Evaluating Financial Condition, but only those lines relevant to the 10 indicators used in The IndiKit are visible. The user who has read Evaluating Financial Condition and wishes to expand on the presentation contained in The IndiKit can easily"unhide"the hidden lines, and add and link new indicator sheets. • What Is The IndiKit? Perhaps a description of The IndiKit should start by saying that it is not a comprehensive financial management program or tool. It will not provide a complete analysis of a particular local government's financial condition. The IndiKit's linear trend analysis is not the most sophisticated or always the most appropriate analysis to use in local government. As stockbrokers always say, "Past performance is not indicative of future earnings." Likewise, although The IndiKit can show you where you have been, it does not predict what will occur in the future. The IndiKit does provide the local government administrator with a starting point for financial trend monitoring: it explains what to examine on an annual basis to identify trends in revenues and expenditures. It provides an orderly, easy-to-use format for gathering multi-year data that will instantly calculate a number of distinctive ratios. These ratios can then be used to show where the local government has been headed in the last five years. The ease of using The IndiKit will enable you to clarify what is happening in your local government and compare that to expectations and assumptions. Armed with this information,you are ready to make a clear and constructive presentation to your budget committee or governing body. The IndiKit is accompanied by a User's Manual (which you are reading). The IndiKit itself is in Microsoft®Excel 20002 format. The IndiKit includes eight data assembly 11110 Karl Nollenberger,Evaluating Financial Condition:A Handbook for Local Government,4`"Edition(Washington: International City/County Management Association,2003). 2 Excel is a registered trademark of the Microsoft Corporation. 6 The IndiKit worksheets plus a CPI base conversion worksheet, and ten indicator sheets. The worksheets are linked, so that data entered in the data assembly worksheets appears automatically in the indicator sheets. The indicator sheets can be used for examining and presenting trend information. The IndiKit can be used year after year. After the first year,the user simply adds the next year's data to move the five-year window for analysis forward. Note for the User:Protecting Your Program The IndiKit and the User's Manual are protected by a"Read Only"function. Upon opening the User's Manual for the first time,it is recommended that you immediately perform a Save As function,naming the new file for your local government. You can then remove the protection while retaining an original protected file copy of the manual. To remove the read-only protection,go to the File menu and click on Save As and the Tools button of the Save As toolbar. Then click on General Options. Then,in the"Password to modify box,remove the nine asterisks(the protection password"p r o t e c t e d"). Then click on the OK box and the Save box to return to the main document(which is now unprotected.) The Data Assembly Worksheets The terminology used in the data assembly worksheets reflects,to the extent possible, the terminology used in generally accepted accounting principles(GAAP), as promulgated by the Governmental Accounting Standards Board. Revenues and expenditures recorded on these worksheets should use whatever basis the local government uses for its financial reporting. The data assembly worksheets are practical and complete in general terms and have been designed to apply to a broad range of jurisdictions. However, local governments vary greatly in their revenue and expenditure structure, and in the way they maintain accounting records. If you find certain aspects of the worksheets unsuitable, feel free to tailor them to the circumstances and needs of your local government. The data assembly worksheets are not intended as rigid formats to be followed to the letter, but as guides to compiling and organizing information. If, however,you change the format of the data assembly worksheets,thereby also changing the numerical sequence of the data,try to retain the original"line number" for each piece of data: This will help to maintain the correlation between the data assembly worksheets and the indicator sheets; and it will make calculations relatively easy once the data are collected. Before you begin to collect data, first review the data assembly worksheets themselves to get a sense of how the data are defined and which data are needed. Note that some of the data, such as net operating revenues, are used in more than one indicator and should,therefore,be defined in a consistent manner for all of the indicators that use those elements. Note, also,that each data assembly worksheet lists the indicators for which each piece of data is used. When you begin to collect the data, start with the most recent complete fiscal year. This is the year with which you are probably most familiar and therefore it will be the easiest to work with. As you work backward through earlier years,you may find that 7 The IndiKit the methods for recording financial data about a particular service have changed. For example, for the past two years,the municipal golf course may have been an enterprise with its own fund, but before that it may have been a general municipal service for which revenues and expenditures were recorded in the general fund. If you come across such changes, you need to decide whether the amount involved will materially affect the indicators. If the amounts are significant,then you should choose the most logical way to treat the golf course and should treat it consistently for the period covered by the indicators. The recommended approach is to treat it in a way that most accurately reflects the current situation. In this example,this would mean regarding the golf course as an enterprise for the entire period. Such decisions can be noted in the indicator sheet for the next few years and can be part of the analysis itself The Indicator Sheets The ten indicator sheets are designed to present the concept of each indicator(in ratio format), a warning trend, and the display of the data used in the calculation(s). On the bottom of each indicator sheet is a graphic display of the indicator as well as a linear trend to ease the analysis. It is quite easy to see an upward slope of a trend line and to know that for the last five years the indicator has been generally increasing, no matter what happened last year or the year before that. The indicator sheet is also set up on a single page so that a printed copy can be used in any document you may wish to submit to your governing body. It is also easy to copy onto a transparency for overhead display. • Note for the User:Charts and Graphs You will notice that when you open The IndiKit there are no data entered. Hence,there will be no bars on the bar charts and no linear trend lines showing. Bars and trend lines will automatically appear when data are entered into the appropriate data boxes(outlined cells)in the data assembly sheets. You can safely enter"dummy data"into the data boxes to check the system out before actually using it. ••••• • 8 The IndiKit II. THE DATA ASSEMBLY WORKSHEETS da ta,n.p1.,but singular or plural in construction 1 : factual information(as measurements or statistics)used as a basis for reasoning,discussion,or calculation 2:information output by a sensing device or organ that includes both useful and irrelevant or redundant information and must be processed to be meaningful Merriam-Webster Dictionary,OnLine(2003) Introduction Open The IndiKit and notice that the first eight worksheets are data assembly worksheets, numbered 1 through 8, left to right. Click on the first data assembly worksheet and follow the explanations displayed below. "Line"numbers refer to the labels in the far left column of each data assembly worksheet. Note for the User:Hidden Lines The data assembly worksheets in The IndiKit are based on the worksheets in Evaluating Financial Condition.Because The IndiKit uses only 10 of the 42 indicators in the FTMS,it is not necessary to collect all the data provided for in the original data assembly worksheets.Many lines of the original data assembly worksheets are hidden in The IndiKit,but can be revealed if the user wishes to develop more indicators.These lines are indicated in the discussion below by shaded text,e.g.,Line 11.(To reveal a hidden line in a worksheet,highlight the row above and the row below the hidden line,click on Format,click on Row,and choose Unhide.) Data Assembly Worksheet 1: General Accounting Data Lines 1 through 9 General, special revenue, and debt service funds only. For ease of computation, a separate worksheet for each fund could be set up. Then the consolidated data for lines 1 through 9 could be listed(by linking sub-worksheets) in this data assembly sheet. �� acs~ Line 10 I. 01,( Net direcnbrided'long-term_debt- direct debt minus self-supporting debt. (See the discussion of the long-term debt indicator in the Debt Indicator section of this manual. 1_.ine 1 1. Hidden Line 12 For general fund operating deficit or surplus, deficits of other funds should also be considered and should be included if material. Surpluses can be treated as negative deficits. Line 13 Hidden Lines 14 and 15 Line 14, Fund balances, and line 15,Encumbrances and other reservations against fund balances, are calculated to provide line 16,Unreserved fund balances. Figures 9 The IndiKit should be listed separately for the general fund, each special revenue fund, and each debt service fund. Line 16 Unreserved fund balances(available for appropriation) (line 14 minus 15.) Figures should be listed separately for the general fund, each special revenue fund, and each debt service fund. Lines 17 and 18 Hidden Data Assembly Worksheet 2: Revenues Your local government's accounting records may already make good distinctions between operating and non-operating revenues, as well as among the other categories named on this worksheet. If so, use those definitions and adjust the worksheet accordingly. If you do this, keep in mind that the corresponding indicator narratives and labels may not apply either, and will also require adjustment. If your local government's records do not make good distinctions for the purpose of this worksheet, use the following definitions as written, or as starting points to develop your own. Be sure to record the definitions you use, for future reference and consistency in the outyears. Revenues from fees and user charges that are intended to support service costs (see line 2)are specific revenues from fees and user charges that are intended to support all or part of the related service costs. Include full costs, including overhead, of providing services that are to be financed by the fee or user charges. Revenues from other fees and user charges(see line 3) (usually"nominal" in scope or magnitude) in general should be tallied separately. Gross operating revenues (see line 10) are revenues to the general, special revenue, and debt service funds. Net operating revenues (see line 13) are those portions of gross operating revenues that are available for general municipal operations. Therefore,net operating revenues are the total revenues to the general, special revenue, and debt service funds before any interfund transfer and less those revenues legally restricted to capital improvements or other special purposes, as explained below in subsections A,B, and C. Enterprise and internal service funds should be analyzed separately. Three types of revenues should be subtracted from gross operating revenues to obtain net operating revenues. They are the following: A. Revenues that are restricted to capital improvements and that remain in operating funds. Although these revenues are initially recorded in one of the operating funds, they are required by law, grant, or other legal obligation to be spent on capital improvements, and capital improvement expenditures will eventually be charged against them. An example would be gasoline taxes that are required by state law to be used for road construction. These revenues are initially recorded in and remain in a special revenue fund, and are used to fund the capital improvements. 10 The IndiKit ■ B. Mandated capital improvement transfers. These revenues are initially recorded in • one of the operating funds but are later transferred to a capital project fund because a law, grant, or other legal obligation requires that they be spent on capital improvements. An example would be grant revenue for construction of a storm drain, which would initially be recorded as revenue in a special revenue fund,but would then be transferred to a capital project fund. Under this definition, revenue such as a general fund property tax transferred at local option to a capital improvement fund would still be considered to be an operating revenue, even though it is being used for non-operating purposes. The test is as follows: If the local government is required to use the revenue for non-operating purposes, it should be considered a non-operating revenue; if the local government chooses to use the revenue for non-operating purposes, it should be considered an operating revenue. The local government's decision to use a revenue for non-operating purposes does not alter the availability of the revenue for other purposes;the revenue therefore represents part of the local government's ability to finance its operating expenditures (defined on data assembly worksheet 3). C. Special-purpose revenues. These are revenues that are initially recorded in, and remain in, one of the operating funds but that are legally restricted to special non- operating purposes. Special-purpose revenues may also be transferred to a fiduciary fund to be used for non-operating purposes. If the amounts involved are significant, special-purpose revenues should be treated on a case-by-case basis. Fiduciary and capital project funds are not normally included as part of general operations,but can be included if a special situation warrants it. For ease of computation, set up separate worksheets for each fund group. Lines 1 through 5 Local operating revenues. A local revenue is one that is generated at local discretion from a local source, such as a property tax, a building permit, or a municipal income tax. Line 2 List only those fees and user charges(revenues) intended to finance all or part of the services with a fee or charge that represents a significant portion of the operating budget. Line 3 List those other fees and user charges (revenues)that are"nominal" in scope or magnitude. Line 4 The guidelines above recommend that you include revenues received to the general, special revenue, and debt service funds before any interfund transfer. In a few local governments,however, excess revenues from another fund, such as a city-owned utility, are annually budgeted to be transferred to the general fund, and are considered by the government as regular general fund operating revenues. In this case, omitting this interfund transfer would understate the net operating revenues. Interfund transfers that fit this description should therefore be included, and this line item is designed to accommodate that situation. 11 The IndiKit Lines 7 through 13 Non-local operating revenues. A non-local revenue or intergovernmental revenue is generated by an external entity such as the state, and would include grants3 as well as other subventions from state, federal, and other local governments (such as special districts, and education entities). A state tax shared with a local government can be considered either a local or non-local tax, depending on how much control the local government has over the revenue. The distinction between local and non-local is necessary for the Intergovernmental Revenues Indicator,which measures a local government's dependence on such intergovernmental revenues. In deciding whether or not to classify a revenue as local or non-local,keep the purpose of the Intergovernmental Revenues indicator in mind. Lines 14 through 17 Hidden Data Assembly Worksheet 3: Expenditures Lines 1 through 5 Net operating expenditures. A net operating expenditure is an expenditure of the general, special revenue, or debt service funds, less capital project expenditures that are charged against one of these funds. (Capital project expenditures might be charged against one of these funds because the revenue to finance the project was recorded and remained in that fund.) For example, if road construction expenditures • were charged directly to a special revenue fund because the gasoline tax revenues to finance that construction had been recorded in that fund,those expenditures should be deducted from the total expenditures of the general, special revenue, and debt service funds when operating expenditures are calculated. Line 1 "Salaries and wages"refers to compensation paid directly to employees. Line 2 Fringe benefits includes costs for contributions to FICA, pension, life insurance, health insurance,workers compensation insurance, etc., as well as current contributions to any self-insurance funds for fringe benefits. Line 5 As noted above, expenditures listed under capital outlay are not to include expenditures for construction of major capital projects. Lines 6 through 12 Net direct debt service. See the Long-Term Debt indicator for the definition of net direct debt. Line 11 Total net operating expenditures is the sum of lines 1 through 5, and lines 8 through 10. • 3 A grant of money,as by a government or some other authority,in aid or support of some institution or undertaking,esp. in connection with science or the arts. The furnishing of aid or relief. 12 The IndiKit • Lines 12 through 16 Hidden Lines 17 through 24 Operating expenditures by function Line 17 General and administrative expenditures are linked to the Expenditures by Function indicator. Lines 18 through 24 Hidden Data Assembly Worksheet 4: Fixed Cost Summary This worksheet is not used in The IndiKit and all lines are hidden. Data Assembly Worksheet 5: Repair&Maintenance of General Fixed Assets This worksheet is not used in The IndiKit and all lines are hidden. • Data Assembly Worksheet 6: Pension Plan Data ��nn Line 1 � u�� The unfunded actuarial accrued liability is taken from the current actuarial report.• Lines 2 through 5 ���('� Hidden Data Assembly Worksheet 7: Economic-Demographic Data Line 1 Per capita calculations depend on accurate and consistent population figures in order to be comparable. Most states have a central population research center designated to stipulate the population for each municipality in the state. This designated research center should be consulted for annual population data pertaining to your municipality. For example, Oregon has a readily available population data source in the Center for Population Research and Census,Portland State University(PSU). Other data sources can be used, including the U.S. Census,but some considerations apply. U.S. Census data for the 2000 Decennial Census are contained in the publications Census of Population and Census of Housing. These publications include different v+iies. Within each volume,there are separate tables for jurisdictions of different sizes. The volumes are indexed to enable you to find the appropriate tables. The • publications include data on almost all classes and sizes of cities,towns,townships, and counties. 13 The IndiKit U.S. Bureau of the Census,Number of Inhabitants,Part 1, Section 1, chapter A of • Characteristics of the Population, and Volume 1 of Census of Population 2000 both give 2000 population figures. U.S.Bureau of the Census,Population Estimates and Projections, series P-25 (published annually with a two-year lag) also contains per capita income estimates. When comparing different data sources, especially for income-related data, check to be sure that population bases and definitions are the same. When comparing data over time, keep in mind any changes during that time period that would affect the data, such as annexations or incorporations of new areas. Since many state-oriented programs use state-specific figures,those data are the best to use in this line and,hence, in all of the indicators in The IndiKit. Note for the User:Population and Fiscal Years Some state population research centers display the population in calendar years,whereas the rest of the data assembly worksheets display fiscal years. For consistency,the calendar year should be linked into the fiscal year that begins sometime during that calendar year(the logic is simple if -somewhat arbitrary: Population data for a particular calendar year are calculated as of a particular date(e.g.July 1st),and therefore are most easily linked into the particular fiscal period in which it is used,e.g.,calendar year 2002 data are linked to fiscal year 2002/003.) This only presents a problem the first time the calculation is made. Subsequent calculations will follow the trend pattern and over time will provide a relatively accurate trend line. Lines 2 and 3 Hidden Line 4 Personal income is tabulated for the Long-Term Debt indicator. Lines 5 through 7 Hidden Line 8 Assessed valuation is tabulated for the Long-Term Debt indicator. Lines 9 through 23 Hidden Data Assembly Worksheet 8: Other Local Data This data assembly worksheet was created to conveniently locate minor calculations not provided for in the other worksheets. (Note the cross-references between lines 7 and 8 and data assembly worksheet 1, lines 18 and 17 respectively.) Line 1 The area Consumer Price Index for All Urban Consumers (CPI-U) is presented here but can be replaced by any CPI that you think is more appropriate, or which you have used more often in other analyses and might wish to continue using. CPI information can be obtained over the Internet. Go to the Bureau of Labor Statistics web page: http://bls.gov/cpi/ 14 The IndiKit The Base Period 1982-84= 100 is used since it is the most recent for presenting all of • the last 5 years of data. The January figure is used, even though it might contain data from a previous municipal fiscal year,because most municipal budgets are created in the spring and the January CPI is made available in February. Over time,this calculation provides a relatively accurate trend line. Line 2 The Consumer Price Decimal is calculated here for convenience. Lines 3 through 6 Lines 3 through 6 make up the net property tax levy noted in data assembly worksheet 1, line 18, and used in the Uncollected Property Taxes Indicator. Line 7 Net property tax levy is calculated here for convenience,but is calculated directly on the Uncollected Property Taxes Indicator. Line 8 Uncollected property taxes is tabulated here for convenience and linked with data assembly worksheet 1, line 17, for continuity with Evaluating Financial Condition. CPI Base Conversion Worksheet Adjusting for inflation involves three steps: (1) selecting a price index, (2) selecting a base year as the starting point for comparison, and(3) dividing the figures for each year by the price index. The indicators,which are calculated in constant dollars,have been set up to do that as follows: 1. The price index chosen is the January CPI-U. 2. The base period chosen is the standard currently being used by the Bureau of Labor Statistics, 1982 / 84 = 100. 3. Constant dollar calculations are made by dividing the dollar amount by the January CPI-U using the same base throughout. Although the index can be used as it stands,with 1982 / 84 as the base years, comparing today's costs with those of two decades ago may not be helpful. To make the numbers more useful,you may want to establish a new base year. For example, if you are developing an indicator for the five-year period from 1998 to 2003,you might want to set 1998 as your base year. This has been done for you on this worksheet for potential base years 1998 through 2008 (when the CPI data become available in the outyears, of course). Note for the User:Hidden Rows and Columns Some rows and columns in this worksheet are hidden to avoid confusion.If you want to understand the methodology of the calculations,you can"unhide"any of them.Highlight the row or column on both sides of the hidden area,click on Format,click on Row or Column,and choose Unhide.) ••••• 15 The IndiKit • III. THE INDICATOR SHEETS indicator,n., ...3:an organism or ecological community so strictly associated with particular environmental conditions that its presence is indicative of the existence of these conditions 4:any of a group of statistical values(as level of employment)that taken together give an indication of the health of the economy Merriam-Webster Dictionary,OnLine(2003) Introduction With The IndiKit program open, scroll past the eight data assembly worksheets and the CPI base conversion worksheet to the indicator sheets. Notice that there is nothing to enter on these worksheets, as they are already linked to the data entered on the data assembly worksheets. Once data have been entered,the indicator sheets display the numerical indicator results with the corresponding graphed results on the lower part of the sheet. Each indicator sheet can be printed and used as is. Analysis of the information displayed on each indicator sheet is explained below. Note for the User:Worksheet Protection Each indicator sheet is protected,which means that no entries can be made to any cell as long as the Worksheet Protection is in place. There is no need to change any of the cells in an indicator sheet when The IndiKit is used for the first time. But next year,when you want to add a new fiscal year,you will need to deactivate the Worksheet Protection and"unhide"the next fiscal year column. Remember to reactivate the Worksheet Protection to make sure no further changes are made inadvertently. The chart on each indicator sheet goes out for two additional years;the data columns • are set up(and linked)to go out five years(to 2008). The Worksheet Protection does not have a password. To protect an Excel worksheet,just click on the OK button without entering a password and the protection is activated without need for a password to deactivate. Note,also,that an Unprotect Sheet I Protect Sheet button can be installed on the Excel worksheet toolbar,which allows this function to be toggled back and forth easily. The toggle button gives the user a quick reference to determine the status of the individual indicator sheet. An Analysis Strategy If, after calculating an indicator,you observe a warning trend,try to identify the causes using the following questions: Why is this happening? (try to identify the cause or causes) Is it important? (assess the significance of the trend) What can be done? (devise an action strategy) Analyzing trends in an orderly manner may help clarify what policies should be recommended for implementation to reverse an adverse trend. Caution should be exercised to make sure you don't adopt a new policy that then leads to unintended • consequences. Systematic analysis will permit the manager or administrator to begin to understand what is necessary to effect a needed change. 16 The IndiKit • Revenue Indicators Revenues determine the capacity of a local government to provide service. Important issues to consider in revenue analysis are growth, flexibility, dependability, diversity, administration, and elasticity. (Definition: an elastic revenue can be defined as one that directly responds to changes in inflation and the economic base; i.e., as inflation and the economic base increase, elastic revenues increase in roughly the same or greater proportion, whereas, if inflation declines or the economic base shrinks, elastic revenues drop in proportion.) Revenues per Capita Examining per capita revenues shows changes in revenues relative to changes in population size. As population increases, it might be expected that revenues (and the need for services)would increase proportionately, and therefore that the level of per capita revenues would remain constant in real terms. If per capita revenues are decreasing,the government may be unable to maintain existing service levels unless it finds new revenue sources or ways to save money. This reasoning assumes that the cost of services is directly related to population size. Warning trend. Decreasing net operating revenues per capita. Tip. A key part of this indicator is that it adjusts for inflation (i.e., current dollars are • converted to"constant dollars") and then calculates the revenues per capita. This indicator also introduces the concept of"net operating revenues," a combination of revenues from several different funds to determine which revenues are available for general government operations. Tip. Notice that there is an extra worksheet titled"Net Revenue Source Calculation" after the Revenues Per Capita worksheet. This may help organize (and document) which revenues are used to calculate Net Operating Revenues for this indicator. Feel free to use it as you see fit. (Note that it comes with sample numbers entered for fiscal year 1998/999. Erase those and enter your local government's numbers). Suggestions for analysis. If the warning trend is observed, use the"analysis strategy"mentioned above. Also consider these questions: Is the community experiencing general economic decline (temporary or continuing)? Is the decline related to changes in population? Is the decline due to problems inherent in the revenue structure? Are state or local restrictions (such as tax limitations)preventing the community from instituting the appropriate taxes, fees, or charges? 17 The IndiKit Can revenues be increased by: • • revising revenue collection procedures • reducing tax delinquencies • instituting or increasing service charges, etc. • instituting or increasing user fees for facilities and equipment • updating property assessments • establishing special assessment districts • investing a greater proportion of idle cash • selling surplus property or equipment • securing special-purpose grant funding? Is it reasonable to assume that the increased level of revenues will continue? Is an increase in revenues per capita a sign that costs will increase in future years-- as would be the case, for example if the new revenues were derived from an increase in building construction? Intergovernmental Revenues Intergovernmental revenues (revenues received from another government entity) are important because an over-dependence on such revenues can be harmful. The federal and state governments have struggled with their own budgetary problems in the last decade, and frequently they have withdrawn or reduced payments to local • governments as one of their cutback measures. Local governments with budgets largely supported by intergovernmental revenues have been particularly harmed during this period, but almost all have shared the pain. The reduction of intergovernmental funds leaves the municipal government with the dilemma of cutting programs or funding them from general fund revenues. Nevertheless, a municipality might want to maximize its use of intergovernmental revenues, consistent with its service priorities and financial condition. For example, a city might want to rely on intergovernmental revenues to finance a federally or state mandated service or to fund a one-time capital project. The primary concern in analyzing intergovernmental revenues is to know and monitor the local government's vulnerability to reductions of such revenues, and to determine whether it is controlling its use of the external revenue -or whether these revenues are controlling local policies. Warning trend. Increasing amount of intergovernmental operating revenues as a percentage of gross operating revenues. Tip. When presenting this indicator to the budget committee or governing body,you might describe in a note which intergovernmental revenues you have included. Suggestions for analysis. If the warning trend is observed,use the"analysis • strategy"mentioned above. Also consider these questions: 18 The IndiKit Does your local government depend on intergovernmental revenues to fund • ongoing, basic services? Do you have contingency plans in case the revenues are significantly reduced or discontinued? Have fixed-term grants for special programs been accepted? Will the local government be able to continue the special programs when such grants end, or will there be social and economic consequences if such programs are discontinued? Are matching funds for intergovernmental revenues increasing as a percentage of operating expenditures? Are intergovernmental revenues authorized by ongoing agreements, and do the agreements suggest that the revenues will continue at a specific level? Tax Revenues Property, sales, and income taxes should be considered separately from other revenues because most local governments rely heavily on them. A decline or a diminished growth rate in taxes can have a number of causes. First, it may reflect an • overall decline in property values; a decline in national, state, or local economic health; a decline in total number of households; or the movement of retail or industrial operations to other communities. Second, it may result from default on property taxes by property owners or an inefficient assessment or appraisal process for property. Third, it may result from sales or income tax-payers moving their base of operations to other jurisdictions. Finally, a decline can be caused by deliberate default by property owners who realize that delinquency penalties are less than short- run interest rates and that nonpayment is thus an economical way to borrow money. Likewise, citizens who owe income taxes may deliberately delay payment. Warning trend. Decline in tax revenues. Tip. This is a"health of the community" indicator. Depending on state statutes and home rule charters, local governments overwhelmingly use property, sales, or income taxes as a major source of general governmental revenues. If property taxes, sales taxes, or income taxes are a significantly large resource for your government,you need to be especially attuned to any changes in this indicator and to try to understand their causes. Note, again,that this indicator calculates the trend of tax revenues over the years in constant dollars. When presenting this indicator,you should show it for each of the three types of taxes, if applicable, and also in both constant and current dollars to help display the impact of inflation on tax revenues. Tip. For property taxes,whether they are increasing or decreasing,you could • construct a table that shows property taxes by type (real vs. personal) and by class (residential, commercial, industrial) for the period you have chosen. The table should The IndiKit 19 enable you to identify sectors in which change has occurred. To demonstrate the impact of changes,you could also compute the rate of change in property tax • revenues(current year minus prior year;remainder divided by prior year) and graph these figures. Tip. For sales taxes,whether they are increasing or decreasing,you could construct a table of the types of sales taxes collected in your local jurisdiction(goods, services, auto sales, etc.) and the geographic areas within the local community for the period you have chosen. Tip. For income taxes,you could construct a table of the types of income taxes (personal, business, industrial, service industry, etc.) and a similar geographic area analysis within your community for the period you have chosen. Suggestions for analysis. If the warning trend is observed, use the"analysis strategy"mentioned above. Also consider these questions: Have poor economic conditions reduced market values of property, sales within the community, or overall income of the population? In what sectors -residential, commercial, or industrial -has the decline occurred? For property taxes, has the assessed value of properties or classes of properties S drop• The IndiKi ped as a percentage of market value? (Note: In some states,because of voter initiatives, property taxes can rise only at a certain rate per year;but the analysis is still valid and useful.) Is the drop in property taxes caused by an inefficient assessment system or by the fact that reassessments are not sufficiently frequent? Is the percentage of nontaxable property increasing? Is an increase in the percentage of nontaxable property due to an increase in govt ernment ownership or other tax-exempt status and, if so, can payments in lieu of taxes be instituted for tax-exempt properties? Is an increase due to an increase in tax incentives designed to attract or retain businesses and, if so, are the incentives beneficial in the long term? Are property tax delinquencies increasing? (See the next indicator, Uncollected Property Taxes.) Are the reductions in property taxes offset by increases in sales or income taxes from these businesses? For sales taxes, are the levels of sales taxes levied in the community driving consumers to shop in other communities? 20 • • Are retail outlets relocating outside the community or are new retail stores outside the community attracting consumers? Are retail companies properly reporting all sales taxes collected from sales in the community? For income taxes, are all provisions of the local income tax being adhered to? Are there companies or individuals avoiding the income tax through provisions that can be corrected? Is the income tax motivating higher-income individuals to leave the community? Can an economic development strategy be designed that will increase the taxable property values,number of retail businesses, or level of income in the community? Uncollected Property Taxes Every year, a percentage of property owners are unable to pay property taxes. If this percentage increases over time, it may indicate overall decline in the local government's economic health. Additionally, as uncollected property taxes rise, liquidity is decreased, and there is less cash on hand to pay bills or to invest. Warning trend. Increasing amount of uncollected property taxes as a percentage of net property tax levy. Tip. Credit-rating firms(Standard&Poor's, Moody's Investor Service, and Fitch's Investor Service) assume that a local government normally will be unable to collect 2 to 3 percent of its property taxes within the year that the taxes are due. If uncollected property taxes rise to more that 5 to 8 percent,rating firms consider this to be a negative factor because it signals potential instability in the property tax base. An increase in the rate of delinquency for two consecutive years is also considered a negative factor. Tip. A ten-year history of uncollected property taxes is part of the statistical section of the Comprehensive Annual Financial Report(CAFR)that many governments prepare. Tip. If uncollected property taxes are rising, further investigation is needed to determine which classes of property taxpayers are not paying;whether nonpayments are rising in commercial, industrial, or residential properties;whether certain neighborhoods are experiencing more trouble than others; and whether one demographic group, for example,the elderly, is having more trouble than others. If, for example,the investigation shows that uncollected property taxes are high among low-income elderly, it might make sense to examine the possibility of instituting tax- relief programs that allow property taxes to be deferred until they can be paid from estate proceeds. 21 The IndiKit Suggestions for analysis. If the warning trend is observed, use the"analysis strategy"mentioned above. Also consider these questions: Is general economic decline affecting taxpayers' ability to pay their taxes? Are a growing number of low- or fixed-income property owners having difficulty paying property tax bills? Would optional installment payments lessen the impact of one or two large payments? Is the proportion of distressed properties within the municipality increasing? Can rehabilitation programs be initiated? Can new uses be found for property whose original use is no longer economically viable? Are collection procedures adequate, especially in regard to delinquent taxes? Is the percentage of uncollected taxes higher than is assumed in revenue estimates? Is the time lag between the due date for property tax payments and the date of lien • foreclosure short enough to encourage timely payment? Can delinquency penalties be tied to the prime interest rate or to other short-term interest rates to discourage nonpayment as a means of"borrowing"? Can delinquencies be made public to discourage this practice? Expenditure Indicators Expenditures are a rough measure of a local government's service output. Generally, the more a local government spends in constant dollars,the more services it is providing, although this axiom does not take into account how effective the services are or how efficiently they are delivered. To determine whether a government is living within its revenues,the first issue to consider is expenditure growth rate. Because most local governments are required to have a balanced budget, it would seem unlikely that expenditure growth would exceed revenue growth. Nevertheless, the annual budget can be balanced in a number of subtle ways that will create a long- run imbalance in which expenditure outlays and commitments grow faster than revenues. Some of the more common ways are to borrow, use reserves, use bond proceeds for operations, or siphon small amounts from intergovernmental grants. Other ways are to defer maintenance on capital stock or to defer funding of a future liability such as a pension plan. In each of these cases,the annual budget remains • balanced, but the long-run budget develops a deficit. Although long-run deficits The IndiKit 22 might, conceivably, be made up through windfalls such as state grants or revenue • surges created by inflation, allowing such deficits to develop is risky. A second issue to consider is expenditure flexibility. Expenditure flexibility is a measure of a local government's freedom to adjust its service levels to changing conditions, and considers the level of mandatory or fixed costs. Ideally, a government's expenditure growth rate will not exceed its revenue growth rate, and the government will have maximum flexibility to adjust spending. An increase in mandatory costs such as debt service, matching requirements, and pension benefits renders a government less able to adjust to change. Analyzing your government's expenditure profile will help you to identify the following types of problems: Excessive growth of overall expenditures as compared to revenue growth or growth in community wealth(personal and business income) An undesirable increase in fixed costs Ineffective budgetary controls A decline in personnel productivity Excessive growth in programs that create future expenditure liabilities. • Expenditures per Capita Changes in per capita expenditures reflect changes in expenditures relative to changes in population. Increasing per capita expenditures can indicate that the cost of providing services is outstripping the community's ability to pay, especially if spending is increasing faster than the residents' collective personal income. From a different perspective, if the increase in spending is greater than can be accounted for by inflation or by the addition of new services, it may indicate declining productivity-that is,that the government is spending more real dollars to support the same level of services. Warning trend. Increasing net operating expenditures per capita. Tip. In communities where revenues are not growing rapidly, local government officials have found that they must focus their attention on the expenditure side of the budget, so that they can analyze the trends in this indicator carefully. Tip. This indicator uses the concept of"net operating expenditures,"which is similar to the concept of net operating revenues used in previous indicators. Suggestions for analysis. If the warning trend is observed,use the"analysis strategy"mentioned above. The IndiKit 23 Also consider these questions: Is the increase caused by increases in the levels of existing services or by the addition of new services? Are there increased revenues to pay for these increased services? Can user charges (fees)be instituted or increased to pay for these services, or should the services be reduced? If the increase cannot be explained by the addition of new services, is personnel productivity or service efficiency declining? Is the local government's employee base aging? Older senior employees get higher pay. Can changes in management practices or technology deal with this trend? Is the increase linked to an increase in fixed costs, or is it due to increases in programs that can be cut back at the discretion of the municipality? Is the increase due to an increase in externally funded programs that are now fully funded and will be for their duration, or is it due to externally funded programs for which only seed money has been supplied, and for which the local government will • have to assume future funding responsibility? (How will these programs be funded in the future? Is the increase due to an increase in mandated services? Can the level of government that mandates the services provide funding? Is the increase due to construction of capital facilities that were funded by debt, meaning that the expenditure burden will be spread out over many years? Will the debt service plus operating costs of the new facilities strain future budgets? (For instance, see the debt indicators for Long-Term Debt and Debt Service below.) Can expenditures be reduced by: • consolidating support services • cross-training personnel • contracting services out • using more advanced technology • transferring functions to other levels of government • eliminating programs • pooling funds with other jurisdictions • entering into mutual aid and cooperative purchasing agreements with other • jurisdictions? The IndiKit 24 Expenditures by Function • Expenditures by Function shows a more detailed break down of the general governmental funds expenditures of the local government. This information can help to analyze the cause of the increases in governmental spending over time. This indicator can provide further analysis of the trends indicated by the Expenditures per Capita indicator. The information is available in the statistical section of the Comprehensive Annual Financial Report(CAFR) if your municipality creates one. Functional areas usually shown in the CAFR table for general governmental funds are: General and Administrative Judicial Highways and Roads Capital Outlay Public Safety Health and Welfare Retirement Intergovernmental Debt Service Warning trend. Increasing operating expenditures for one function as a percentage of total net operating expenses. • Tip. The relative percentages of each functional group to the total helps the user to analyze the causes of increases in expenditures overall. Tip. Standard&Poor's reviews expenditure composition and stability in the context of revenue patterns. Tip. This indicator can be easily expanded to a ten-year analysis since most tables in the statistical sections of a CAFR have ten years of data. Tip. Refer to the discussion and analysis of the Expenditures per Capita indicator (above) for further understanding of the importance of this indicator. Suggestions for analysis. If the warning trend is observed, use the "analysis strategy"mentioned above. Also consider these questions: Is the increase in expenses for the functional area caused by increased services or by the addition of new services? Are there increased revenues to pay for these increased services? If the increase cannot be explained by the addition of new services, is personnel • productivity or service efficiency declining? The IndiKit 25 Can changes in management practices or technology deal with this? Is the increase due to an increase in externally funded programs and will the funding be on a continuous basis? Is the increase due to an increase in mandated services? Is there alternative funding available? Are there any alternatives available for reducing expenditures without significantly reducing services? Operating Position Indicators The term"operating position"refers to a local government's ability to (1) balance its budget on a current basis, (2) maintain reserves for emergencies, and(3) have sufficient liquidity to pay its bills on time. Balancing the current budget. During a typical year, a local government 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. In rare instances, revenues and expenditures balance exactly. An operating surplus or deficit may be created intentionally, by a policy decision, or unintentionally, because of the difficulty of precisely predicting revenues and expenditures or trends in the underlying local and national economies. Deficits are usually funded from unreserved fund balances; surpluses are usually used to increase fund balances. Reserves. The accumulation of operating surpluses builds reserves, which provide a financial cushion against the loss of a revenue source; an economic downturn; unanticipated expenditures required by natural disasters, insurance loss, and the like; unexpected large-scale capital expenditures or other nonrecurring expenses; an uneven cash flow; and similar events. Reserves may be budgeted in a contingency account or carried as a part of one or more fund balances. If they are carried as an unappropriated part of a fund balance,they may never appear in a local government's budget or be discussed during budget deliberations. Liquidity. Liquidity refers to the flow of cash in and out of the treasury. Local governments often receive their revenues in large installments at infrequent intervals during the year. If revenues are received before they need to be spent, the government will have a positive liquidity or cash flow position. Excess liquidity or "cash reserves" are a valuable cushion against unexpected financial pressures. If a municipality has a negative cash flow and no cash reserves, it must borrow on short- term notes or put off paying its bills, either of which is extremely undesirable. An analysis of operating position can help to identify the following situations: A pattern of continuing operating deficits A decline in reserves The IndiKit 26 A decline in liquidity • Ineffective revenue forecasting techniques Ineffective budgetary controls. Operating Deficit or Surplus An operating deficit or surplus occurs when current expenditures exceed current revenues or are lower than current revenues. A deficit does not always mean that the budget will be out of balance ("budget deficit"), because reserves("fund balance," "balance brought forward,""opening fund balance," "unappropriated ending fund balance") from prior years can be used to cover the difference. It does mean, however,that during the current year, the municipality is spending more than it is receiving. This could be caused by an emergency(such as a natural catastrophe) requiring a large immediate expenditure. Or,the spending pattern may be part of a stated policy to use accumulated surplus fund balances. An operating deficit in any single fiscal year may not be cause for concern, but frequent and increasing deficits can indicate that current revenues are not supporting current expenditures, and that serious problems may lie ahead. This indicator is especially important because a pattern of operating deficits can be one of the first signs of an imbalance between revenue structure and expenditures. Of course, it would not indicate a problem if the municipality had planned the operating deficits and were deliberately drawing down fund balances or using extra revenues from • another fund for temporary needs. Likewise, consistent surpluses in the general fund may indicate accumulation of too much of a carryover and may become noteworthy to the auditor during the annual audit. Surpluses can, of course, be placed into planned reserves to accumulate until needed. Warning trend. Increase in general fund operating deficit or surplus as a percentage of net operating revenues. Tip. Budgetary analysis does not always reveal operating deficits because they can be temporarily financed by short-term loans or by accounting transactions that, for example, inappropriately accrue future revenues or transfer surplus fund balances from other funds. An analyst looking for operating deficits should consider each fund separately, so that a surplus in one fund cannot mask a deficit in another. Tip. Analyzing funds separately helps to pinpoint emerging problems. Tip. A credit-rating firm would regard a current-year operating deficit as a minor warning signal; funding practices and the reasons for the deficit would be carefully assessed before it would be considered a negative factor. The following situations, however,would be given considerably more attention and would probably be considered negative factors: • An abnormally large deficit—more than 5 to 10 percent—in one year A current operating fund deficit greater than that of the previous year The IndiKit 27 Two consecutive years of operating fund deficits An operating fund deficit in two or more of the last five years. Suggestions for analysis. If the warning trend is observed, use the "analysis strategy"mentioned above. Also consider these questions: Was the deficit anticipated during budget preparation? Is it expected to continue in future years? Will surpluses or other sources of funding be available? Is the deficit being funded by borrowing from surpluses in other funds? Can these other funds afford the loan without creating problems later? Was the deficit due to revenue shortfalls? Was the deficit caused by expenditure overruns? Were these due to inaccurate expenditure estimates at budget time or to ineffective expenditure controls during the fiscal year? Was the deficit caused by an emergency? Are sufficient reserves left for future emergencies?(See the next indicator, Fund Balances.) Was the surplus anticipated during budget preparation? Is it expected to continue in future years? Will surpluses or other sources of funding be available? Is the surplus being used to fund other deficits? Will it be used for unplanned reserves? Was the surplus due to unanticipated, or windfall, revenues? Was the surplus caused by expenditure "underruns?" Were these due to inaccurate expenditure estimates at budget time or to ineffective spending plans during the fiscal year? Fund Balances Positive fund balances can also be thought of as reserves, although the"fund balance" entry on a local government's annual report is not always synonymous with "available for appropriation." The report may show reservations on the fund balances, such as"reserves for prior year's encumbrances"(also sometimes referred to as"unappropriated ending fund balances.") The size of a local government's fund balances can affect its ability to withstand financial emergencies. It can also affect its ability to accumulate funds for capital purchases without having to borrow. It can also be politically controversial. Nonspecific or general reserves are usually carried on the books as an unreserved • .111° fund balance in the general operating fund. Sometimes special reserves are The IndiKit 28 maintained in a separate fund. For example,reserves for replacing equipment such as computers or copying machines may be kept in the fund balance of an internal service fund(i.e., a fund used to charge operating departments for the use of equipment). Reserves can also be appropriate as a budget item in some form of contingency account. Regardless of the way in which reserves are recorded, an unplanned decline in fund balances may mean that the municipality will be unable to meet a future need. Warning trend. Declining unreserved fund balances as a percentage of net operating revenues. Tip. While this indicator is sometimes called "General Fund Balance,"it is displayed here as a summary indicator representing the balances in each of the general, special revenue, and debt service funds. To identify the size and type of your reserves, you could develop sub-indicators for the fund balances of each individual fund. Tip. While the availability of unencumbered reserves is a positive, it should be noted that Standard and Poor's views "too large"a fund balance as a red flag. Suggestions for analysis. If the warning trend is observed, use the"analysis strategy"mentioned above. Also consider these questions: Are fund balances dropping lower than is considered desirable? Can they be rebuilt? Are fund balances being used to subsidize operating deficits? (See the previous indicator, Operating Deficits or Surpluses.) Are reserves being used for purposes other than those for which they were originally set aside? Debt Indicator Debt is an effective way to finance capital improvements 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 municipality's credit rating, which can in turn increase the cost of future borrowing and can in some states cause the local government to lose some of its autonomy to state and other regulatory bodies. Municipalities usually use short-term debt to make up for uneven cash flows. Revenue shortfalls or over-expenditures may occasionally prevent repayment of a short-term debt during the year it was borrowed, in which case a local government may choose to repay the loan and then reborrow the money. The original loan is, in effect, repaid from the proceeds of the new loan. This is called "rolling over"the • debt and has the net effect of turning a short-term debt into a long-term debt. If this practice continues over a number of years, and the amount of outstanding debt The IndiKit 29 increases each year, it may be an indication that debt is being used to finance • operating deficit--a sure sign of financial problems. The most common forms of long-term debt are general obligation, special assessment, and revenue bonds. Even when these types of debt are used exclusively for capital projects, municipalities need to ensure that their outstanding debt does not exceed their ability to repay as measured by the wealth of the community(property value or personal and business income). Another way to evaluate ability to repay is to consider the amount of principal and interest, or debt service,that the government is obligated to repay each year. Also to be considered is overlapping debt and other jurisdictions'debts against which the government has pledged its full faith and credit (such as school or wastewater districts). Under the most favorable circumstances, a municipality's debt is proportional in size and rate of growth to its tax base; does not extend past the useful life of the facilities that it finances; is not used to balance the operating budget; does not require repayment schedules that put excessive burdens on operating expenditures; and is not so high as to jeopardize the government's credit rating. An examination of a municipality's debt structure can reveal the following: Inadequacies in cash management procedures or expenditure controls Increasing reliance on long-term debt Decreasing expenditure flexibility (due to increased fixed costs in the form of debt • service) Use of short-term debt to finance current operations Sudden large increases or decreases in future debt service The amount of additional debt that the community can absorb. Long-Term Debt to Assessed Value Direct debt is bonded debt for which the local government has pledged its full faith and credit. It does not include the debt of overlapping jurisdictions, such as separate school or sewer districts, even if the local government has pledged its full faith and credit for such debts. Self-supporting debt is bonded debt that the local government has pledged to repay from a source separate from its general tax revenues. Examples would include a water bond that is repaid from the income of the water utility, and special assessment bonds that are repaid from special charges levied on specific properties within a special assessment district. Net direct debt is direct debt minus self-supporting debt. An increase in net direct bonded long-term debt as a percentage of assessed valuation can mean that the government's ability to repay is diminishing--assuming that the local government depends on the property tax to pay its debts. Long-term debt dependent on other • revenues, such as sales tax, should be calculated as a percentage of the revenue sources on which it depends. The IndiKit 30 Warning trend: Increasing net direct bonded long-term debt as a percentage of • assessed valuation. Tip. The Long-Term Debt indicator uses assessed valuation in the denominator and assumes that property taxes are the primary source of debt repayment. You may, however, want to use per capita personal income instead of, or in addition to, assessed valuation if any of the following characteristics apply to your community. Property values have been rising very quickly and the local government is restrained by law from raising the property tax levy. Property values are rising faster than the personal income of residents. The local government's primary source of revenue is not the property tax. The community has little industrial or commercial tax base. Any of these factors could render assessed valuation a misleading representation of your community's ability to repay long-term debt. Debt can also be monitored on a per capita basis. This approach is especially useful for communities that do not rely heavily on property taxes and that cannot easily compute a substitute revenue base for comparison. The per capita measure relates debt increases to changes in population size. As the population increases, capital • needs and, hence, long-term debt would be expected to increase. If, however, long- term debt is increasing as population stabilizes or declines, debt levels may be reaching or exceeding the local government's ability to pay. This assumes that the ability to generate revenue and to repay debt is directly related to population size, but this may not be true if the population change is caused by a change in family size and not in number of households. In this case, substituting per household for per capita figures in the denominator may make sense. Long-term debt should not exceed the local government's resources for paying the debt. If this does occur,the local government may have difficulty obtaining additional capital funds, may have to pay a higher rate of interest for them, and may have difficulty repaying existing debt. When graphing this indicator, it might be helpful to draw in warning lines as suggested in the discussion on credit industry benchmarks, below. Credit industry benchmarks. Credit industry benchmarks for assessing long-term debt often include the net direct bonded debt of the local government, as well as the bonded debt of overlapping jurisdictions that is geographically applicable to the local government. As noted above, net direct bonded debt plus overlapping bonded debt is referred to as overall net debt. Warning signals for overall net debt are as follows: Overall net debt exceeding 10 percent of assessed valuation • An increase of 20 percent over the previous year in overall net debt as a percentage of market valuation The IndiKit 31 Overall net debt as a percentage of market valuation increasing 50 percent over the figure for four years earlier Overall net debt per capita exceeding 15 percent of per capita personal income (note: this index was developed by Standard&Poor's bond rating firm and is also known as the S &P Index.) Net direct debt exceeding 90 percent of the amount authorized by state law. Suggestions for analysis. If the warning trend is observed, use the"analysis strategy"mentioned above. Also consider these questions: Is assessed valuation, population, personal income in the community, or another primary revenue base declining? Is long-term debt increasing?If so, consider the following questions: • Is the local government becoming more reliant on long-term debt to finance capital projects? • How much additional debt will the local government need to incur in the next three to five years? • Are debt proceeds being used to fund ongoing operations? • • Is the increase a trend, or is it caused by a debt issued for a one-time-only capital project, such as a new municipal building? What was the amount of long-term debt before the increase? Was it low to moderate, or was the amount already straining the municipality's ability to pay? Unfunded Liability Indicator 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 have not been set aside. It is similar to long-term debt in that it represents a legal commitment to pay at some time in the future. If such obligations are permitted to grow over a long period of time,they can have a substantial effect on a local government's financial condition. Financial managers generally watch two types of unfunded liability: pension liability and post employment benefits (compensated employee leave upon termination and health insurance benefits for retirees). Both have significant potential to affect a local government's financial condition because (1)they do not show up in the ordinary financial records in a way that makes their impact easy to assess, and(2)they • accumulate gradually over time. Pensions and post employment benefits liabilities may go unnoticed until they have created severe problems. Many municipalities also The IndiKit 32 operate under a state mandated public employee retirement system that should be considered at some point in time for any unfunded liability situations. An analysis of a local government's unfunded liabilities can answer the following questions: Is the pension liability increasing? How fast is it growing? How much is unfunded? Are pension contributions, pension system assets, and investment earnings keeping pace with the growth in benefits? Is the amount of unused vacation and sick leave per employee increasing? Are policies for the payment of unused vacation and sick leave realistic compared to the government's ability to pay? Are the costs of future health insurance premiums for retirees a significant future obligation for the local government? Unfunded Pension Liability Pension plans can represent a significant expenditure obligation for local • governments. The GAAP require that the cost of defined benefit pension plans be accrued as an expense by employers in their financial statements as benefits are earned by employees, regardless of whether the employer actually funds these amounts. The present value of the projected cost of pension benefits earned by employees is known as the "actuarial accrued liability." The difference between this amount and the actuarial value of the resources of the pension plan is known as the "unfunded actuarial accrued liability." As a rule, the actuarially determined annual required contribution(ARC) is the measure of pension cost accrued as expense by employers in their financial statements. The ARC includes both the cost of pension benefits earned by employees during the current period("normal cost") and an additional amount designed to amortize the unfunded actuarial accrued liability over a period not to exceed 30 years. If an employer fails to fully fund the ARC in any given period, a net pension obligation is reported in the statement of net assets to reflect the underfunding. Conversely, neither the actuarial accrued liability itself, nor the unfunded portion of that liability is ever reported on the face of the employers' financial statements. Warning trend. Increasing pension obligations as a percentage of payroll. Tip. This indicator is more important to municipalities that manage their own IP. pension program, and less important to municipalities that are part of a statewide pension program. Having said that, if a small municipality is considering joining a statewide pension program (usually referred to as a"pool") it should be recalled that The IndiKit 33 pooling can shift some of the pension obligation risk away from the municipality. This is important when a small local government contemplates the pension risk that occurs when a relatively young employee is retired due to a disability. In that case, such a liability could be devastating to the financial situation of the small jurisdiction. Tip. An municipal employer's pension obligation for defined benefit pension plans is best understood by examining trends over a five-year period using data provided in the pension plan's financial report. Specifically, the following trends should be considered carefully: Funding ratio. The schedule of funding progress expresses the actuarial value of pension plan resources as a percentage of the actuarial accrued liability(e.g., 90%). Ideally, the funding ratio should be increasing over time. Employer contributions. The schedule of employer contributions expresses annual employer contributions as a percentage of each year's ARC. Ideally, an employer should be contributing 100%of the ARC each year. Tip. Because a net pension obligation is the product of a municipal employer's failure to fully fund its ARC in one or more periods,the presence of a net pension obligation in the statement of net assets is always a potential cause for concern. Tip. When employers fail to fully fund their ARC in a given year, actuaries are required to take this factor into account when calculating the ARC in future years. Consequently, if an employer fully funds each future year's ARC, the net pension obligation ultimately should be eliminated. Therefore, if a net pension obligation is reported in an employer's statement of net assets, special attention should be paid to the schedule of employer contributions to ensure that the government has reestablished a pattern of fully funding each year's ARC. Suggestions for analysis. If the warning trend is observed, use the "analysis strategy"mentioned above. Also consider these questions: Is there any history of underfunding the Annual Required Contribution (ARC)? Have recent changes in pension plan benefits or actuarial assumptions increased unfunded pension liability?Can employee contributions be increased or future benefits reduced? Has the interest earned from pension assets decreased?Is this due to general economic conditions, increases in pension plan costs, or poor cash and investment management? Have actuarial assumptions been too optimistic?Has the plan been designed and analyzed by a professional actuary? • If the actuarial analysis of the pension plan is current and available, a comparison of the unfunded actuarial accrued liability to the total actuarial accrued liability will be The IndiKit 34 of value in conducting the analysis. This calculation will show the level of unfunded • liability to total liability and the progress, over time, toward full funding. The level of funding can change because of the market value of investments, and changing assumptions for interest rates as well as other assumptions in the actuarial study. Progress towards full funding is a trend that shows financial progress. ••••• • • The IndiKit 35