Warning Signs of Fiscal Stress

1. Warning Signs of Fiscal Stress Sharon Edmundson, North Carolina Department of State Treasurer December 7, 2011

2. Warning Signs of Fiscal Stress • What are the signs a unit of government is in trouble? • Are the signs different for governmental funds than for enterprise funds? • How can you evaluate the unit as a whole?

3. In North Carolina…. • Local Government Commission, formed in early 1930’s as a result of record number of government defaults in our State • State and Local Government Finance Division of Department of State Treasurer serves as staff to the Commission • Commission must approve most debt financings of local governments • Statutes dictate that certain findings must be made before a unit can issue debt • One is that unit has good debt management practices, which we have translated in part to good fiscal management

4. Annual Audit • Each municipality, county, school system, public hospital, public housing authority, water and sewer district, and all other public authorities must report to the LGC on an annual basis • Audit must be conducted by independent auditor approved by LGC • Audit must be in compliance with Federal and State requirements as well as generally accepted auditing standards • Financial statements must be GAAP – no exceptions

5. Annual Audit • Audits reviewed for compliance with General Statutes, Federal and State regulations, and for financial soundness • Results of our reviews on presentation are communicated in writing to the units and their auditors • We are party to the audit contract, and approve all invoices from auditor to unit of government. Approval of final 25% of fee is withheld until we receive, review, and approve the report

6. Annual Audit • As much as 140 pieces of data are pulled from each audit and stored in our database • Software interface used to manipulate data into a one page summary sheet that gives us a snapshot of unit’s financial condition • Concerns are communicated to the unit’s elected officials with copies going to management and auditors • Concerns can include: • Unit falls below certain benchmarks in performance • Unit has statutory violations • Unit has internal control significant deficiencies and/or material weaknesses noted in communications from auditor • Unit has specific grant-related findings

7. Governmental vs. Enterprise Funds • Different basis of accounting, different signs of fiscal stress? • Yes and no • Yes – budgetary issues and some fund balance calculations • No – calculations of most other benchmarks

8. General Fund • Fund balance • NC statutes require governments to maintain a reserve equal to the amount of receivables for which revenue was not deferred • Also reserve for non spendable items • What’s left is “fund balance available” • Primary benchmark for General Fund • Minimum acceptable is 8% of expenditures – equivalent of one month’s expenditures • Most units maintain more • Publish annual statistical report of fund balance available by population grouping

9. General Fund • Revenues and other sources v. expenditures and other uses • Look for patterns of unit spending more than it takes in • Strongly encourage units to use capital projects funds to make General Fund more comparable year over year • Reduce revenues by amount of debt proceeds and expenditures by like amount to smooth out deviations year over year

10. General Fund • Comparison to budget • NC requires balanced budget • Can appropriate fund balance as a source up to the amount available as dictated by state statute • Do not like to see appropriations of fund balance on a regular basis for operations • Watch for patterns of over-expenditures and/or over-estimation of revenues

11. Other Governmental Funds • Look at similar markers as for General Fund • Concept of fund balance available still applies • Funds budgeted on a multi-year basis reviewed for reasonableness • Watch for fund deficits that won’t be resolved over life of project • Especially true if General Fund is not in good shape

12. Enterprise Funds • Dual review – look at both full accrual and modified accrual (budgetary)statements • Full accrual • Quick ratio – quick assets/total current liabilities • Working capital • Net income/loss before capital contributions and transfers • Modified accrual • Appropriation of fund balance to balance budget • Over appropriation of fund balance • Compliance with budget • Net income/loss including capital outlay and debt service

13. Enterprise Funds • Benchmarks: • Quick ratio over 1.0 • Compares quick assets on hand to current liabilities (due within one year) • Indicates ability to liquidate payables • Sometimes get comment that ratio is below 1.0 due to accrual of debt service payment • Ratio below 1.0 indicates no reserves on hand to pay debt service or other payables in event of unexpected revenue reduction

14. Enterprise Funds • Benchmarks (cont.): • Net income before capital contributions and transfers • Capital contributions usually cannot be liquidated to pay liabilities • Reliance on transfers to achieve income not a good sign • Consider the amount of net loss is a result of depreciation • Positive working capital • Indicates the relationship between current assets, which include liquid assets, to liabilities due within one year

15. Enterprise Funds • Benchmarks (cont.): • Net income on budgetary basis • Indicates if revenues that are measurable and available are enough to cover expenditures made in the current period • Consider if large amounts of capital outlay are recorded in operating fund that may have been one-time expenditures

16. Enterprise Funds • Benchmarks (cont.): • Compliance with budget • Over-expenditures and over-estimation of revenues • Indication of budgetary management • Appropriation of fund balance on a regular basis not a good sign • Over-appropriation of fund balance – statute applies to enterprise funds as well as governmental

17. Enterprise Funds • Benchmarks (cont.): • Positive cash flow from operations • Look for positive cash flow from operations • If unit has debt outstanding, look for sufficient cash flow to cover debt service payments for the year – principal and interest

18. Enterprise Funds • Enterprise Capital Project Funds • Look for reasonableness of budget • Compliance with budget • If deficit, will funding be realized? • Can unit absorb deficit if not?

19. Compliance Reports • Reviewed for proper opinions, findings, and status of prior year findings • Grant specific findings • Material weaknesses or significant deficiencies related to accounting systems and/or internal controls • Violations of General Statutes

20. Evaluating the Unit as a Whole • Budgetary control • Rare to find a unit that exercises good budgetary control in one fund and poor control in another • Cash and liquid investments unit-wide • Is there enough to support operations? • Are there large deficits that need to be eliminated by moving fund balance from another fund? • Statutory violations • Serious statutory violations and stewardship issues indicate poor management and higher likelihood of fiscal stress • Material weaknesses and/or significant deficiencies in the overall internal control structure of the unit of government

21. Some Tools Available to Us • Annual statistical reports – data analysis • Fiscal analysis tool – benchmark with units of user’s choice

22. Data Analysis • Publish statistical reports annually on fund balance available for counties and cities • Grouped by population • Municipalities segmented between those with Electric Funds and those without • Tax collection rates • Tax rates, adjusted tax rates, assess to sales ratio, tax rate equivalent of uncollected taxes and investment earnings

23. Data Analysis • Publish statistical reports annually on water and sewer system operations • Compare units of similar size • Show results of operations, transfers in and out, days cash on hand, days sales in receivables • Data is for five most recent years • Allows units and other users to compare various municipalities • County and municipal data available on our website

24. Fiscal Analysis Tool • Collaborative project with DST and UNC SOG • Five years of data available • User can select from four different areas: • Governmental activities • General Fund • Water and Sewer Fund • Electric Fund

25. Fiscal Analysis Tool • Selects “home” unit of government and up to four others to use as benchmarks • System gives back graphs of various benchmarks within the area chosen • http://www.nctreasurer.com/dsthome/StateAndLocalGov/lgcreport

26. Questions? • Sharon Edmundson, Director Fiscal Management Section • Sharon.edmundson@nctreasurer.com • 919-807-2380 • http://www.nctreasurer.com