6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ILLUSTRATION 10­2 Indicator 35—Rate of Employment https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 Page 413 1/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 2/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Page 414 Disaster Risk The need to consider and plan for natural disasters is incumbent on all top governmental officials. As the past few years have shown, no place is immune from such events, although some locations are more vulnerable than others. The question that should be asked is: What would happen if a major earthquake or hurricane were to strike or a terrorist attack were to occur? Related questions that need to be asked are these: (1) Does the city have sufficient insurance and reserves to cover possible losses? (2) Does the government have sufficient resources (and a plan) for evacuation, protection against looting, and cleanup? In addition to natural disasters, it can be equally difficult to prepare and budget for man­made disasters, for example, oil or chemical spills from industry. Political Culture This perhaps is the most difficult of all factors to measure but is certainly critically important to determining how the administration will react to the other environmental factors in shaping the government's fiscal policy. Political culture includes such factors as form of government (e.g., mayor­council—weak or strong, council­ manager, commission) and the entity's economic, political, and social history. The entity's history may reveal underlying community philosophies regarding willingness to support higher taxes, issuances of long­term debt, and increased social services. https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 3/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Page 415 External Economic Conditions No local or state government operates independently of the regional and national economy. Regional economic activity affects local business activity, employment, and income by influencing the demand for manufactured, agricultural, and service products as well as the levels of wholesale and retail sales. Similarly, inflation at the national level influences regional and local prices, including wages and the cost of debt financing. A good example of the impact of national events is the national subprime mortgage crisis, which negatively affected the prices and number of home sales. Recently, the local housing markets in most areas have seen significant improvements in both the price and number of home sales as the national economy overcomes the effect of the mortgage crisis. Although consideration of external economic conditions is essential to assessing the local economy, the linkages can be difficult to pinpoint and quantify. Organizational Factors As indicated by their pivotal location in Illustration 10­1, management practices and legislative policies play a crucial role in determining fiscal policy in response to the environmental factors just discussed. Sound financial management and the political will to resist easy solutions can minimize financial problems that might otherwise result from factors such as economic downturns, plant closings, or natural disasters. Financial crises often build over a number of years during economic recessions. Politicians may be either unwilling or unable to curtail expenditures for services in response to revenue shortfalls. Results of past policies, such as heavy reliance on debt or an excessive labor force, may make it difficult or infeasible to reduce expenditures sufficiently in the short run. Short­run solutions, such as deferring needed maintenance, curtailing capital expenditures, or underfunding pensions, may lead to even more serious problems in the future. Thus, sound financial management means planning for adverse environmental conditions or events and devising long­run solutions when problems do occur. Although management practices and legislative policies are critical determinants of financial condition, they are among the most difficult factors to measure. Evidence of mismanagement or management practices that sustain an operating deficit include using existing fund balances, short­term borrowing, internal borrowing, sale of assets, or one­time accounting changes to balance the budget. Other signs of deficient fiscal policies include deferring pension liabilities, deferring maintenance expenditures, failing to fund employee benefits, and ignoring full­life costs of capital assets.13 Financial Factors Examples of governmental fund financial ratios typically used in assessing financial condition are shown in Illustration 10­3. Although the ratios contained in Illustration 10­3 represent what the authors consider key ratios, they are not intended to represent all ratios that might be useful in evaluating financial condition. In fact, the ICMA handbook provides for a total of 27 financial indicators across the six financial factors shown on the right­hand side of Illustration 10­1. For those interested, the handbook provides worksheets and an electronic spreadsheet that guides the user in defining the terms used in the ratios. The data to calculate the financial ratios shown in Illustration 10­3 are readily obtainable from most CAFRs. Except for population, which is usually disclosed in the statistical section, data for most of the ratios can be obtained from the statement of revenues, expenditures, and changes in fund balances—governmental funds (see Illustration A2­5) and the balance sheet—governmental funds (see Illustration A2­3). Data for the remaining ratios usually can be found in the notes to the financial statements. https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 4/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ILLUSTRATION 10­3 Selected Financial Ratios Based On CAFR Governmental Funds Page 416 Information https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 5/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 6/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Page 417 The ratios displayed on Illustration 10­3 indicate whether all governmental funds or only the General Fund should be used in the calculation. However, analysts differ on preferences with some preferring to utilize General Fund data only, whereas others utilize combined data for all governmental fund types. This decision depends, in part, on how large the General Fund is relative to all governmental fund types. In calculating operating revenues, capital project fund revenues should be excluded since the capital project fund is not an operating fund. For purposes of calculating revenues and expenditures in these ratios, other financing sources are often added to revenues and other financing uses are often added to expenditures; although by definition other financing sources and uses are not considered revenues and expenditures. The government­wide financial statements offer additional opportunities for analysis of financial factors relating to the governmental entity as a whole and are discussed next. https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 7/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ANALYZING GOVERNMENT­WIDE FINANCIAL STATEMENTS Page 418 The CAFR provides information about the government as a whole that should assist citizens, bond analysts, governing boards, and other financial statement users to answer questions that are not easily answered with disaggregated fund financial statements. The management's discussion and analysis and two accrual­based government­wide financial statements that focus on the flow of total economic resources in and out of the government offer a level of analysis about the real cost of government services, the means of financing them, and the financial condition of the government as a whole. One firm that has developed a method to describe and report ratios designed to take advantage of aggregated information is Crawford & Associates, P.C., a public accounting firm that developed a financial analysis and rating tool to use in measuring a government's financial health and success. The firm suggests a number of performance indicators that measure financial position, financial performance, and financial capability from basic financial statements. A brief description of the questions best answered by some of these ratios is presented here, along with Crawford & Associates’ “plain English” statement of the questions to be addressed by the performance measure.14 Financial Position Ratios: 1. Unrestricted Net Position (Assets). How do our rainy day funds look? 2. Capital Asset Condition. How much useful life do we have left in our capital assets? 3. Debt to Assets. Who really owns the government entity? 4. Current Ratio. Will our employees and vendors be pleased with our ability to pay them on time? 5. Quick Ratio. How is our short­term cash position? Financial Performance Ratios: 6. Change in Net Position (Assets). Did our overall financial condition improve, decline, or remain steady over the past year? 7. Interperiod Equity. Who paid for the cost of operating the city—current, past, or future tax and rate payers? 8. Sales Tax Growth. What is the state of our local economy? 9. BTA Self­Sufficiency. Did current year business­type activities (BTA), such as utilities, pay for themselves? Financial Capability Ratios: 10. Revenue Dispersion. How much of our revenue is beyond our direct control? 11. Bonded Debt per Capita. What is our long­term general obligation debt burden on our taxpayers? 12. Available Legal Debt Limit. Will we be able to issue more long­term general bonded debt, if needed? 13. Property Taxes per Capita. What is our property tax burden on our taxpayers? 14. Sales Tax Rate. Will our citizens be likely to approve an increase in sales tax rates, if needed? Illustration 10­4 provides additional descriptions of the above ratios, along with formulas for calculating them. Other ratios that capture these dimensions are change in overall financial position, reported as a percentage of total net position, and levels of reserves or deficits, employing expenses as a denominator instead of revenues. Chaney, Mead, and Schermann suggest these ratios, as well as general revenues minus transfers as a percentage of expenses, to measure financial performance. They also recommend change in net position plus interest expense as a percentage of interest expense as an additional solvency measure.15 https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 8/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ILLUSTRATION 10­4 Financial Indicators Using the CAFR https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 Page 419 9/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 10/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Despite the complexity of evaluating government­wide financial condition, there are recognizable signals of fiscal stress. These include (1) a decline or inadequate growth in revenues Page 420 relative to expenses, (2) a decline in property values, (3) a decline in economic activity (such as increasing unemployment, declining retail sales, and declining building activity), (4) erosion of capital plant, particularly infrastructure, (5) increased levels of unfunded pension and other postemployment obligations, and (6) inadequate capital expenditures. Warning signals such as these, particularly if several exist simultaneously, may indicate a potential fiscal crisis unless the government takes action to increase revenues or decrease spending. USE OF BENCHMARKS TO AID INTERPRETATION Regardless of how the ratios are calculated, the more difficult task is how to interpret the ratios to make an informed judgment about a government's financial condition. Checking each ratio in Illustration 10­3 and 10–4 against a target or acceptable range is a critical step in the process of analyzing financial performance. Benchmarking is a very useful tool in the continual process of monitoring performance of “the plan,” allowing for identification of needed improvements in the delivery of government services. A benchmark, broadly defined, is any target, range, or “red flag” that provides an analyst with a basis for comparison in order to draw conclusions about whether performance indicators suggest good or bad news. Appropriate benchmarks for comparisons can be found inside or outside of the government. Internal monitoring of trends over time within an organization is the most common method of assessing whether the government has performed better or worse than prior years. According to the Government Finance Officers’ Association (GFOA), a government's past performance is usually the most relevant context for analyzing current­year financial data16 and, at a minimum, five years of data should be compared. The ICMA's Financial Management Trend System is a good example of a tool that has been used by many governments as a way to compare current­period ratios to those of prior years for a variety of performance indicators. Illustration 10­5 shows the use of time­series trend monitoring by the City of Columbia, Missouri, for one indicator of financial condition —Excess of Revenues over Expenditures for the General Fund over a 10­year period. A narrative description of the ratio is provided as well as the mathematical formulation of the ratio. Graphical display of the trend in addition to data tables assists the analyst in drawing conclusions about the government's performance. Providing a “warning trend” helps the reader understand whether increasing or decreasing trends are positive or negative signals. Illustration 10­5 also presents benchmark information from outside the government. A section called “Credit Industry Benchmarks” provides metrics and ranges that reflect credit analysts’ assessment of what is appropriate for a government of this type. https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 11/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ILLUSTRATION 10­5 Indicator 16—Excess of Revenues over Expenditures: General Fund https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 Page 421 12/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 13/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. Page 422 Illustration 10­6 presents a comprehensive look at all the financial and economic indicators the City of Columbia, Missouri, tracks over time with a rating of whether the indicator has improved, declined, or remained the same from the prior year. Additionally, an indication is provided as to whether the trend is stable/improving, in need of close attention, or poorly performing (warning). A caveat to keep in mind in using external benchmarks is that comparison groups may not always be appropriate. A good example is that in a few states, local school districts are legally part of the government of the city in which they are located, whereas in most states school districts are independent governments. In some governments population may be the best denominator for a per capita ratio and in others households are more appropriate. In addition to analyzing ratios, one should evaluate the stability, flexibility, and diversity of revenue sources; budgetary control over revenues and expenditures; adequacy of insurance protection; level of overlapping debt; and growth of unfunded employee­related benefits. Socioeconomic and demographic trends should also be analyzed, including trends in employment, real estate values, retail sales, building permits, population, personal income, and welfare. Much of this information is contained in the statistical section of the CAFR; the remainder can be obtained from the U.S. Bureau of the Census publications available from its Web site, www.census.gov. Sources of Governmental Financial Data Currently, there are no comprehensive benchmark values based on up­to­date financial data available for easy­ to­use comparisons. Raw data, such as that compiled by the GFOA in its Financial Indicators Database from CAFRs submitted to the Certificate of Achievement for Excellence in Financial Reporting program, must be converted to useful geographic and population strata benchmarks. https://phoenix.vitalsource.com/#/books/1259751120/cfi/6/46!/4/4/4@0:0 14/38 6/26/2017 University of Phoenix: Accounting for Governmental & Nonprofit Entities PRINTED BY: enkhan@email.phoenix.edu. Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted. ILLUSTRATION 10­6 FY 2013 Columbia Financial Trend Monitoring System—At a Glance Page 423 Electronic Municipal Market Access In 2009 a new source of municipal financial information was provided to the public. Through the Municipal Securities Rulemaking Board (MSRB), the Electronic Municipal Market Access, or ...
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