14.5 Normative Questions and Empirical Answers
14.5.1 Fund Balance Policies and Practices
Under the new reporting model, information about a government’s financial condition is intrinsically more useful if that government has clearly stated financial management policies. For example, longitudinal trends in fund balance and net assets are good indicators of financial condition so long as a government has a policy that dictates the conditions under which slack resources will be saved and used. In the absence of such a policy, it is difficult to determine whether trends in fund balance are attributable to managerial discretion, deliberate political action, simple organizational inertia, or something else. The GFOA has actively encouraged governments to promulgate formal reserve fund policies, and a recent analysis indicates that all but 3 states have carried forth on this recommendation by adopting legislation governing their countercyclical reserve or ‘‘budget stabilization’’
funds (Hou, 2003). State-level slack resource management, therefore, clearly comports with these recommended practices.
But the same cannot necessarily be said for municipalities. In a nearly two decades old study, Wolkoff (1987) found most of the 27 largest U.S.
cities maintained some sort of countercyclical reserve fund, but less than half had adopted an ordinance or other formal legislative action to govern the use of that fund. The remainder of this section presents findings from a comprehensive analysis (and perhaps the first of its type) of slack resource management practices in small municipalities (Marlowe, 2004) designed to augment the original Wolkoff study. This new analysis was based on data collected from the survey responses of 245 municipalities in Minnesota and Michigan with populations 1000–50,000, and its findings highlight three key areas where municipal fund balance behavior deviates noticeably from both the states and the financial management community’s conven- tional wisdom.7
First, less than half the responding municipalities have adopted a general fund balance policy, and less than one quarter maintain a policy regarding
the use of unrestricted assets and retained earnings in enterprise/proprietary funds. Moreover, only 42% of cities that have a policy have formalized that policy through an ordinance or other legally binding agreement between the governing board and municipal staff. Instead, fund balance policies are most often characterized as informal, intra-organizational direc- tives from management. While this lack of formalization is not necessary problematic, it calls into question the legal enforceability and political trans- parency of local fund balance management practices.
A second key finding surrounds the characteristics of the adopted fund balance policies. Figure 14.1 presents a detailed flow chart and relative proportions of fund balance policies that exhibit particular characteristics.
The top of the chart shows that 49% of the total respondents, or 115 municipalities, have adopted some sort of fund balance policy. It then flows to the numbers of each type of policy adoption method, then to the measurement basis for the actual fund balance policy, then to the average targeted fund balance amount for each measurement basis. Three main trends in these data are worth noting. First, most policies (42% for the formal agreements between council and staff and 60% of informal, intra- organizational policies) do not specify a particular amount or measurement basis for the expected fund balance level. They instead speak in vague terms such as ‘‘fund balance will be kept at a level deemed appropriate by the board and city staff,’’ or ‘‘the city administrator will maintain fund balance sufficient to cover fiscal contingencies.’’ An additional 8% of policies (5% of the informal, intra-organizational policies and 3% of the formal agreements between council and staff) specify a target balance but do not specify a basis for that balance. In either case, these policies provide a clear endorsement of management’s discretion, but are of limited use to financial statement users.
These data also suggest targeted fund balance levels are for the most part uniformly distributed across the budgeted vs. actual and expenditure vs. revenues bases. There is clearly no single preferred base for fund balance planning, despite the fact that the GFOA recommended practices suggest actual current expenditures. And finally, these findings indicate that every policy, regardless of its basis, includes a targeted balance between 31%
and 39%. Therefore, expected balance levels tend to be (1) roughly the same, regardless of their basis, and (2) much higher than the 5–15% range typically cited in the professional literature. Taken as a whole, these trends suggest municipalities have adopted a wide variety of fund balance policies, and that the simple 5–15% rule of thumb does not characterize much of what his happening in actual practice.
And third, these survey results suggest fund balance is used for many purposes beyond fiscal stabilization. The previously mentioned survey included a series of questions asking the CAO of the responding
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municipality to rate the importance of 12 different motivations for maintaining fund balance resources. Those reasons were rated along a three point scale where 1ẳ‘‘not important,’’ 2ẳ‘‘somewhat important,’’ and 3ẳ‘‘most important,’’ and the tabulated results are presented in Table 14.1.
The highest mean score is for ‘‘protection from economic downturns, natural disasters, and other fiscal shocks,’’ which implies fund balance is principally a fiscal stabilization tool. But other reasons, mainly the desire to maintain Figure 14.1 Fund balance policy characteristics and target balances.
consistent cash flow, the desire to create flexibility during the budget process, and the need to keep fund balance as a tool for strategic manage- ment, also received comparatively high scores.
The fact that fund balance is an important cash flow management tool is not surprising, considering many municipalities receive most of their revenues in two main cash infusions — property tax collections and state aid disbursements. Since these infusions happen only once per year (for example, property tax collections in January and state aid disbursements in July) they must keep a pool of resources to meet current obligations during the time between these disbursements. The high mean scores for ‘‘creates flexibility in the budget process’’ and ‘‘facilitates strategic management’’ also support the claim that fund balance is often used for strategic purposes beyond fiscal stabilization.
This section has described, albeit briefly, the state of the practice in municipal fund balance policies. This brief overview highlights a tremen- dous diversity in the methods, objectives, and operating procedures that municipalities have brought to bear on their fund balance management practices. From a normative perspective, this lack of homogeneity is reas- suring as it indicates local governments have crafted a broad array of policy tools to fit their diverse fiscal and management needs. That diversity does, however, complicate the process of evaluating municipal financial condition and the role that slack resources play in maintaining that condition.
Table 14.1 Responses to ‘‘Why do you maintain fund balance resources?’’
Reason Mean
Protection from economic downturns, natural disasters, and other fiscal shocks
2.84
Helps maintain consistent cash flow 2.42
Helps maintain consistent tax rates 2.04
Serves as a ‘savings’ or ‘Pay-As-You-Go’ account for capital projects 1.80
Improves bond ratings 2.12
Lowers procurement costs 1.48
Good indicator of government’s ‘bottom line’ 1.90
To comply with a state mandate/regulation/law 1.45
Because citizens demand it 1.24
Because neighboring communities do it 1.03
Because the local business community demands it 1.10
Creates flexibility during the budget process 2.20
Facilitates strategic management 2.26
Nẳ199
Note: Items are scored according to the following scale: 1ẳnot important, 2ẳsomewhat important, 3ẳmost important.
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