Fund Balance

Municipal Law Alert, April 2011

Fund balance is a term used in annual audits for municipalities and schools, newspaper articles during the fall budget cycle and public discussions at various times. What is a fund balance? In its simplest terms, a fund balance is the amount on deposit at any particular time in a particular fund. For municipalities, the fund balance usually refers to the balance on hand in its General Fund. The General Fund is the group of accounts through which most transactions in a municipality are handled. The General Fund has revenue accounts and expenditure accounts. The difference between the total revenues and total expenditures is the fund balance. Another way to think of it on a more personal basis is the balance you have in your checking account at any one time. The fund balance varies every day in much the same way as your checkbook balance changes.

Although the fund balance changes throughout the year with every deposit or expenditure, for purposes of understanding the financial health of a public entity, a snapshot of the fund balance is captured at the end of the fiscal year. The fiscal year ends in December for municipalities and on June 30 for schools. The financial audit verifies the fund balance on the last day of the fiscal year. During the course of the year, the balance goes up and down based on the timing of revenues and expenditures. The big revenue items are taxes and state aid. These revenues come in at a couple different times during the year. The date for the receipt of state aid has been pushed back periodically in order to permit state government in Madison to utilize tax receipts for a longer period of time. Expenditures for the municipality occur on a daily basis throughout the year. The timing differences mean that, at certain times of the year, such as just prior to the receipt of tax revenues, state aid or shared revenues, a municipality may not have much cash on hand. If the municipality runs out of cash, it will have to borrow funds on a short term basis. If a municipality needs to borrow funds to pay bills, that means that its fund balance has gone to zero.

Over a period of several years a municipality can accumulate a fund balance by spending less than the revenue it receives. Once a fund balance has accumulated, the municipality can utilize the balance to cover expenditures during the times of the year when it is waiting for expected revenues. Again, comparing this to your personal checkbook, it would mean that you deposit more money in your checking account than you spend, resulting in an increasing balance in your account. Audits generally describe the fund balance in the General Fund as a percentage of annual expenditures from the General Fund. Thus if a municipality has a fund balance of 50%, it means that the year-end fund balance is sufficient to pay one-half of the municipality’s annual expenditures. The amount in the fund balance can be a strong indicator of the relative financial strength of the public entity. The larger the fund balance, the longer a municipality can continue to operate while it waits to receive additional revenues. If the fund balance is sufficient, the municipality can avoid having to borrow funds on a short-term basis. The larger the fund balance, the more prepared the municipality is to handle unanticipated expenditures.

What does it mean if someone advocates using the fund balance to make a capital expenditure, for example to purchase a $100,000 fire truck? Assume that there is an ongoing fund balance of $250,000, which is 25% of the annual expenditures. Spending the money on the vehicle reduces the fund balance to $150,000. By using the funds on hand, the municipality saves the cost of interest on a loan to purchase the vehicle. But, if the purchase comes during a time of the year in which cash is short, the reduced balance may require short-term borrowing or cause a delay in the payment of amounts owed to employees or third parties. It may be necessary to borrow funds on a short-term basis to cover cash flow needs. Public entities must weigh the pros and cons when deciding to make expenditures from the fund balance.

A fund balance contributes to tax rate stability and the orderly provision of municipal services. What percentage should be maintained in a fund balance? Is it one month, three months or six months of expenditures? There is no single correct answer. Generally, smaller communities need to maintain higher percentage balances, because most categories of expenditures do not vary based upon the size of the community – a fire truck costs the same in Milwaukee as it does in New Richmond.

Having a fund balance can provide several positive benefits. The fund may be used to cover capital expenditures, contingencies and avoid the costs of short-term borrowing. The general consensus among financial advisors is that there should be a fund balance of 20% to 25% of operating expenditures. A larger fund balance will improve the credit rating for a municipality when municipal bonds are sold to raise money for major expenditures. Thus, public entities should work toward maintaining a fund balance when possible, keeping in mind that too large a fund balance may signal an unnecessarily high imposition of taxes.

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