1. City Auditors/Finance Directors/City Administrators Workshop August 16, 2016 1

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3. Reserves are the cornerstone of financial flexibility. They provide a government with options to respond to unexpected issues and afford a buffer against shocks and other forms of current and future risks (e.g., revenue shortfalls and unanticipated expenditures) and to ensure stable tax rates. Managing reserves, though, can be a challenge in the face of several questions. First, there is the matter of how much money to maintain in reserve. How much is enough and when does a reserve become too high? This can be a sensitive question because money held in reserve is money taken from constituents and the argument could be made that excessive reserves should be returned to citizens in the form of lower taxes. 3

4. Further, there is the question of what reserves can be spent on. Political pressure to spend reserves on current services, rather than holding them back for when they are needed, is all too common. A financial policy helps an organization answer these fundamental questions. The general fund’s reserve is typically the most visible one a government maintains and enterprise funds or government-owned utilities are often large operations that provide an important service to the public and are generally expected to be self-sufficient, and are probably the most important fund type outside the general fund to develop a strong reserve policy. 4

5. The primary reason for a fund balance reserve policy is to be prepared for contingencies, but other reasons also exist. The six most important purposes of a reserve policy are to help:  Plan for contingencies.  Maintain good standing with rating agencies.  Avoid interest expenses.  Generate investment income.  Ensure cash availability when revenue is unavailable.  Create a better working relationship between the governing board and staff. 5

6. Recommendation (General Fund): GFOA recommends that governments establish a formal policy on the level of unrestricted fund balance that should be maintained in the general fund for GAAP and budgetary purposes. Such a guideline should be set by the appropriate policy body and articulate a framework and process for how the government would increase or decrease the level of unrestricted fund balance over a specific time period. In particular, governments should provide broad guidance in the policy for how resources will be directed to replenish fund balance should the balance fall below the level prescribed. 6

7. Appropriate Level (General Fund): The adequacy of unrestricted fund balance in the general fund should take into account each government’s own unique circumstances. For example, governments that may be vulnerable to natural disasters, more dependent on a volatile revenue source, or potentially subject to cuts in state aid and/or federal grants may need to maintain a higher level in the unrestricted fund balance. Articulating these risks in a fund balance policy makes it easier to explain to stakeholders the rationale for a seemingly higher than normal level of fund balance that protects taxpayers and employees from unexpected changes in financial condition. 7

8. Appropriate Level (General Fund): Nevertheless, GFOA recommends, at a minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures. The choice of revenues or expenditures as a basis of comparison may be dictated by what is more predictable in a government’s particular circumstances. Furthermore, a government’s particular situation often may require a level of unrestricted fund balance in the general fund significantly in excess of this recommended minimum level. 8

9. Interim Fund: The governing body of any county, city, park district, or municipality, other than a school district, which is authorized to levy taxes may include in its budget an item to be known as the "interim fund" which must be carried over to the next ensuing fiscal year to meet the cash requirements of all funds or purposes to which the credit of the municipality may be legally extended, for that portion of such fiscal year prior to the receipt of taxes therein. In no case may the interim fund be in excess of the amount reasonably required to finance the municipality for the first nine months of the next ensuing fiscal year. The interim fund may not be in excess of three-fourths (75%) of the current annual appropriation for all purposes other than debt retirement purposes and appropriations financed from bond sources. 9

10. See illustration…  Revenues and expenditures are reviewed monthly for proper coding.  Current year budget is revised and updated in March, June, July, and August.  Budget Policy does not allow operating deficits unless approved by the Board.  Budget Policy allows one-time expenditures (capital outlay) and capital lease payments to be paid from funds in excess of the minimum fund balance reserve.  Budget Policy requires a minimum fund balance reserve of 17% or 2 months of operating expenditures, excluding one-time expenditures (capital outlay) and capital lease payments. 10

11. Revenue declines:  1% City Sales Taxes = $125K decrease o Budget Policy requires 50% of 1% city sales tax revenue to be transferred to the General Fund for property tax reduction.  State Aid Distribution = $686K decrease  Highway Tax Distribution = $396K decrease 11

12. Expenditure decisions:  Salaries and Benefits o Fill vacant Police and Fire positions vs. hiring freeze. o No new full-time positions. o No salary increase for employees (2016 and 2017). o Health insurance increase.  Who pays the cost? The City, the employees, or both?  Operations and Maintenance o No increases above the department O&M spending cap unless recommended by the Budget and Finance Committee.  Capital Outlay o Defer or postpone major capital outlay purchases or utilize capital lease programs to improve cash flow. 12

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15. Recommendation (Enterprise Funds or Utilities): It is essential that a government maintain adequate levels of working capital (i.e., current assets minus current liabilities) in its enterprise funds to mitigate current and future risks (e.g., revenue shortfalls and unanticipated expenses) and to ensure stable services and fees. GFOA recommends that local governments adopt a target amount of working capital to maintain in each of their enterprise funds. Ideally, targets would be formally described in a financial policy and/or financial plan. 15

16. Appropriate Level (Enterprise Funds or Utilities): Because the purposes, customers, and other characteristics of enterprise funds can vary widely, GFOA recommends that governments develop a target amount of working capital that best fits local conditions for each fund. However, GFOA recommends that under no circumstances should the target for working capital be less than forty-five (45) days worth of annual operating expenses and other working capital needs of the enterprise fund. A target of 45-days would only be appropriate for those enterprise funds with the least amount of need for cushion or buffer. 16

17. Appropriate Level (Enterprise Funds or Utilities): In order to arrive at a customized target amount of working capital, governments should start with a baseline of ninety (90) days worth of working capital and then adjust the target based on the particular characteristics of the enterprise fund in question (using 45 days as the minimum acceptable level). 17

18.  Water and Sewer Utility Fund  Solid Waste Utility Fund  Street Light Utility Fund Budget Policy requires a minimum fund balance reserve of 25% or 90 days of operating expenditures, excluding one-time expenditures (capital outlay) and debt service payments. 18

19. City Ordinances and Debt Covenants typically address fund reserve requirements: Separate accounts within the Water and Sewer Utility Fund shall be permanently maintained for the purpose of segregating the revenues required to meet the several expenses and obligations of the utility, as provided below, and such revenues shall be administered and accounted for as follows:  Operation and Maintenance Account. There shall be credited at least once in each calendar month to the Operation and Maintenance Account of said fund, as a first lien and charge on the gross revenues of the utility such sum as shall be needed, over and above any credit balance then held therein, to pay all claims due which by accepted accounting practices constitute normal, reasonable and current expenses of operation and maintenance of the utility, and to pay such expenses estimated to accrue for a period of approximately one month, and to maintain a reasonable reserve for contingencies. Moneys in said account shall be used only to pay expenses of the foregoing type, and not for repairs or replacements or for capital improvements properly chargeable to replacement and depreciation reserves or surplus funds. 19

20. Sources:  Government Finance Officers Association “Financial Policies”, Chapter 4 – General Fund Reserve Policies.  Government Finance Officers Association “Best Practice”, Determining the Appropriate Level of Unrestricted Fund Balance in the General Fund (2015), at www.gfoa.org. www.gfoa.org  Government Finance Officers Association “Best Practice”, Determining the Appropriate Levels of Working Capital in the Enterprise Funds (2011), at www.gfoa.org. www.gfoa.org 20

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