The government fund focus on current assets implies fund balance is synonymous with working capital (Granof, 2001, 33–36). Like many other indicators, such as the current ratio, working capital is viewed as a measure of an organization’s capacity to address unforeseen contingencies, and is therefore expressed as a percentage of current expenditures. A typical or target working capital ratio is 1:1, which suggests an organization holds enough liquid assets to cover its current liabilities (Finkler, 2000, 476–477).
Working capital management is a term generally used to describe the process of maximizing the productive use of fund balance resources.
There are three unique perspectives on how best to accomplish that objective. The first suggests a sizable working capital reserve is necessary to take advantage of discounts and other short-term procurement opportu- nities, to prevent fees resulting from late payment of liabilities, and to pro- tect against catastrophic losses resulting from natural disasters and other unforeseeable events. Proponents of this view also suggest working capital provides organizations with a pool of financial resources to meet debt service obligations during tough fiscal times. Credit analysts therefore look
favorably upon large working capital reserves, and often award higher ratings to organizations that practice effective working capital manage- ment. This perspective suggests organizations ought to keep as much fund balance as possible and manage that balance according to a well-designed working capital strategy.
An opposing perspective suggests working capital is a drag on productiv- ity. Rather than contributing to the production of public goods and services, it instead conceals stale inventory and accounts receivable that may not be realized, unnecessarily quick payment of outstanding liabilities, and other slack resources that detract from overall financial condition. Proponents of this view therefore argue that fund balance should be minimized whenever possible and placed in short-term investments until needed for some specific purpose.
Most public organizations cannot afford wholesale implementation of either strategy due to their uniquely public missions. For example, many entities must tolerate working capital inefficiencies because their missions demand they be prepared for worst-case scenarios such as natural disasters, terrorist attacks, and other situations that require a safety stock of resources.
Many public organizations also face severe constraints on the number of available vendors and providers of certain goods and services, which in turn inhibits their ability to manage when and how goods and services will be delivered. These and other considerations suggest a third working capital strategy characterized by the maintenance of working capital for a wide variety of strategic purposes. That strategy was articulated by Shelton and Tyer (2000), who suggest public organizations ought to maintain four different types of working capital reserves:
1. Transaction balances — which allow organizations to realize economic gains by paying bills quickly and taking advantage of trade credits.
2. Compensating balances —which improve an organization’s standing with financial institutions by increasing the amount of money these institutions have available for lending.
3. Speculative balances — which allow an organization to take advantage of near-term procurement and other opportunities.
4. Precautionary balances — which provide necessary protection against economic downturns and other fiscal shocks.
Public financial managers, according to Shelton and Tyer, are most con- cerned with speculative and precautionary balances. Speculative balances are often maintained as reserved and designated fund balance, and
Fund Balance, Working Capital, and Net Assets g 363
precautionary balances are often equated to unreserved undesignated fund balance. This application of working capital concepts suggests fund balance is more than simply the difference between current assets and liabilities.
It is, according to the working capital management perspective, a pool of strategic resources that can be applied to a variety of financial manage- ment concerns.
14.3.1 Net Assets versus Fund Balance
Net assets, or the difference between total assets and total liabilities, are reported in three components. The first is ‘‘Invested in Capital Assets Net of Related Debt,’’ or the difference between the value of a government’s total assets and debt that was issued to acquire or construct those assets.
It is comparable to the equity or residual value derived from capital asset activity. The second is ‘‘Restricted Assets,’’ which describes assets other than capital assets that have been restricted for some purpose.
Common examples include intergovernmental support for specific services such as public safety or homeland security, grant dollars for a targeted programmatic goal such as community policing or environmental education, and user fees earmarked for service upgrades or expansion of a government enterprise. Restricted net assets are a major portion of many governments’
total net assets, and are therefore central to overall financial condition assessment. However, they can also distort the amount of discretionary resources a government appears to have because they are not necessarily available for discretionary spending. It is therefore important to recognize what portion of total net assets is restricted when using those figures as a financial condition indicator. The third category, unrestricted net assets, is the difference between total net assets and the other two net asset components. They have no restrictions on their use, and represent a government’s total equity that can be used to meet current or future obligations.
Net assets and fund balance therefore provide financial managers and public organization stakeholders with two different but related pieces of financial information. Fund balance is a good indicator of current finan- cial condition because it illuminates the current or liquid resources a government can bring to bear on immediate demands. Net assets provide a long-term view of the organization’s overall economic condition, and are therefore useful in evaluating debt issuance practices, capital infrastructure condition and needs, program creation or expansion, and other decisions that impact the organization’s long-term economic prospects. These two indicators ought to be used in tandem to determine a government’s overall financial condition.