Balance Sheet – Review During City Budget Adoption
Most people at City Hall realize the importance of the Budget that must be adopted by June 30 (or FY end), but ask them about the City’s Balance Sheet and you will likely get a blank stare. During the presentation of the City Budget, the Balance Sheet of each fund is rarely, if ever, presented to the City Manager or the Council. Instead, a summarized extrapolation of the fund balance of each fund is presented, with an estimate of the “spendable” (cash) fund balance for each fund.
City Managers should ask to see the most recent Balance Sheet for each fund, with attached supporting schedules for the following Balance Sheet accounts:
Due From Other Governments
Due from Other Funds
Advances to Other Funds
Other Interesting Large-Balance Asset Accounts
Due to Other Funds
Advances from Other Funds
Other Interesting Large-Balance Liability Accounts
The same could be done for the Fund Balance section of the Balance Sheet.
Bottom Line: The Balance Sheet is less understood than the Budget, but just as important in evaluating the fiscal health of the organization. This is especially important given the looming talk of another recession and the growing pension crisis. As stated, the presentation of the City Budget is a good time to discuss the Balance Sheet for the General Fund and other important Funds of the City.
The fact that the books for the current fiscal year are not yet closed (or audited) is no reason for not presenting a Balance Sheet when adopting the City Budget. The Finance Department can take the March or April Balance Sheet (for all key funds) and prepare an “interim” (unaudited) Balance Sheet projected through June 30. I realize most Finance Directors do not prepare their own financial statements, however, we must keep in mind that the audited opinion letter states “…the financial statements are the responsibility of management”. Of course, Finance Directors will need to be given the resources (staff) to assist with the workload from this additional task.
However by starting the practice of preparing the June 30 Balance Sheet (in-house), especially at Budget preparation time, this will raise awareness for the Balance Sheet, and the often-forgotten fact that “management”, not the auditors”, is personally responsible for preparing the Balance Sheet (and all the other financial statements).
MuniTemps has a strong team of active and retired municipal finance officers with experience preparing the Balance Sheet and other financial statements, without the help of the auditors. We are also provide training to help everybody learn and understand the Balance Sheet during the Budget preparation.
BALANCE SHEET 101…
The Balance Sheet is actually easier to understand than the City budget, yet it is the only financial statement that is “audited” and shows the true financial position of the City at any point in time. You just have to learn the basic terminology, measurement focus, basis of accounting, and the difference between governmental funds and business-type funds.
The Balance Sheet of the General Fund (which is a governmental fund), is of greatest interest to stakeholders because this is where the City pays for discretionary spending programs like General Government, Community Development, Public works, Public Safety, and other public services including Libraries, Parks & Recreation, and other discretionary programs. However, the Balance Sheet of other governmental funds (like Gas Tax, Grants, etc.), which may be considered “Nonmajor” funds, are also important to review because “although they are audited”, their balances may blended together when the audited financial statements are presented, hiding possible cash flow deficits on the Balance Sheet through the use of Pooled Cash accounting.
A lot of the terminology and concepts you use to understand the City budget will help you understand the City’s Balance Sheet. The difference is that the Budget represents financial “activity” during a 12-month period. The Balance Sheet represents financial “position” at a single point in time. The results of the Budget (which ends annually) end up in the Balance Sheet (which goes on forever). This is why Budget accounts are called “nominal” and Balance Sheet accounts are called “real”.
The City Budget requires you to learn the following “nominal” accounts (simplified):
• Revenues: Money that comes in.
• Expenditures: Money that goes out.
• Net Revenues: Revenues less expenditures.
• Fund Balance (Spendable): What you have in the bank (or on route to the bank).
The City Balance Sheet requires you to learn the following “real” accounts (simplified):
• Assets: Accounts showing everything the City Fund “owns”.
• Liabilities: Accounts showing everything the City Fund “owes”.
• Fund Balance (Net Assets): Assets less liabilities of the individual Fund.
You can call MuniTemps anytime and we will explain and expound on the above simplified presentation of the City Balance Sheet. Our team of active and retired municipal finance officers can come in to your City to augment and train staff, especially if you currently have a vacancy in your Finance Department.
RECESSION IS LOOMING…
So why is it especially important NOW to be getting into the nitty-gritty of your Balance Sheet?
Well, it has been about 10 years since the last economic downturn, which we may or may not remember as the Great Recession (the worst recession in 75 years)! Now is a good time to pay detail attention to the Balance Sheet (of each major and nonmajor fund) to understand the City’s “true” financial position.
The stronger your Balance Sheet is, the stronger your City will be in weathering the next economic recession! This is similar to our personal finances. We are told by our personal financial advisors to have 6 to 12 months of operating costs in reserves. Most City fiscal policies call for only 3 months.
The Balance Sheet review is also important to prepare for the adoption of the new budget, as well as to clean up the Balance Sheet for any Assets that may be overstating fund balance or to remove Liabilities which may be understating fund balance.
To acquire the true financial position of the City, staff must perform a bottoms-up analysis of the Balance Sheet, looking at every single asset account (and subsidiary ledgers). The City Manager should feel comfortable to perform inquiries of key management, specifically the Finance Director or other appropriate Finance staff, who can provide supporting documentation for every single item on the City’s Balance Sheet. A bottoms-up approach to understanding the Balance Sheet includes looking at original source documents and subsidiary ledgers, which may have “stale” receivables or payables from the 1990’s or beyond!
After 29 years working in City Finance Departments, I have yet to find a Balance Sheet without material errors, some which may have been carried over for decades. A major challenge facing some City organizations is that there may be key management staff withholding the true financial position of the City by window-dressing the Balance Sheet, or allowing a fund Balance Sheet with large cash deficits to continue. They may be inclined to avoid disclosing material errors on the Balance Sheet for fear of political whiplash from the Council or the community, even if they inherited these fiscal issues.
This is a huge financial risk to the organization because a fiscally troubled City can continue as a “going concern” for many years without addressing serious Balance Sheet issues.
One reason Cities troubled with Balance Sheet issues, especially cash deficits, can continue to fly under the radar of the City Manager or Council is Pooled Cash.
A City may “at this very moment” have a fund Balance Sheet with millions of dollars in cumulative negative cash in one or more governmental or business-type funds, which have hid under the morass of Pooled Cash, remaining undetected for years. The Due To/Due From accounting entries recorded at June 30 allows the negative cash to be buried in the non-cash section of the balance sheet.
The challenge lies in having the courage to scrutinize the Balance Sheet at Budget adoption time to present the true fiscal health of the City. The Balance Sheet is usually presented to the City Manager and Council six (6) months “after” the Budget is adopted, and even then, the Balance Sheet is presented in GAAP (Generally Accepted Accounting Principle) format, which may not detail out Balance Sheet issues related to stale/uncollectible receivables or negative cash balances in funds that are blended with larger funds in audit reports presented on the CAFR (Comprehensive Annual Financial Report).
Yet there are many talented City Managers today “rolling up their sleeves” to study their City’s Balance Sheet, especially when there is a vacancy in their Finance Director post.
During 2007 – 2011, I had the privilege of working with one such City Manager, Charles P. Fuentes, from Pico Rivera, who had the courage to open up the Balance Sheet as part of the budget process. He recognized how important it was to open up the Balance Sheet given the fiscal crisis of 2007/2008 and the looming economic downturn. He told me to “look for any creepy crawlers that might be lurking around” in the Balance Sheet. Mr. Fuentes was willing to be the bearer of bad news with the City Council, disclosing millions of dollars of Balance Sheet discrepancies. This was very controversial, but telling the truth often is, isn’t it?
Since 2011 I have worked with many other talented City Managers, being creative in getting them to buy out time out of their busy schedule to focus their attention on their City’s Balance Sheet; the benefits have been great for their organizations.
You might question, why would a City Manager expose financial “dirty laundry” to the public, especially if he/she inherited a Balance Sheet with millions of dollars in cash deficits? There are good reasons.
At the City of Pico Rivera in 2007/2008, the reason was not just a need for accountability, transparency, and good fiscal stewardship. City Manager Fuentes was determined to “get his fiscal house in order” as he put it, and to show the community the need for a new tax.
I had the privilege of serving as Finance Director for the City of Pico Rivera in 2008, making numerous presentations to the public on the City’s Balance Sheet to ultimately obtain community and business support on November 4, 2008 for a new 1% sales tax measure that today is generating about $8 million a year in new revenue (with no “sunset” clause). On November 4, 2008, our 1% sales tax over-ride (Measure P) achieved 67% voter approval, which was amazing given the fact that in November 2008 the global financial crisis was well understood, especially “after” the fall of Lehman Brothers, which contributed largely to the Great Recession!
As a little background, the General Fund balance sheet in Pico Rivera had been presented with $3 million in cash that did not really exist; other fund Balance Sheets had negative cash due to excessive transfers to the General Fund. This was an example of Pooled Cash mismanagement and lack of proper disclosure. Without a thorough review (and disclosure) of the Balance Sheet of all funds, and a willingness to bring forward the “bad news”, the City could have continued to operate at the same level as long as “total” Pooled Cash covered the inter-fund deficits, which were growing incrementally in funds with negative Net Revenues in their Budget.
You might ask, but didn’t the City’s independent auditors render an unqualified audit opinion on the Balance Sheet? The answer is yes. But you need to read the audit opinion letter to see how “creepy crawlers” sometimes fall through the cracks and in some cases, grow and multiply over time in the Balance Sheet. Only the “management” of the City is in a position to deal with internal Balance Sheet issues, not the auditors.
As I said above, the audit opinion letter reminds the City (every year) that the accuracy of the Balance Sheet “is the responsibility of the City’s management”; the auditor’s job is to audit the Balance Sheet “on a “test basis” to render an opinion that the “financial statements are fairly stated in all material respects”.
Most Cities have their auditors prepare or draft their financial statements. The problem is that this often results in complacency and an erroneous assumption by management that the auditors are responsible for the accuracy of their Balance Sheet and other financial statements.
Most CPA firms do their job auditing Cities and other agencies. For many years, Finance Directors have greatly appreciated having the auditors prepare the financial statements. But the trend at the AICPA is to have management assume greater responsibility for preparing their own financial statements.
Discrepancies and a lack of management’s ability to prepare their own Balance Sheet and other financial statements may be presented as a lack of internal controls and may even be communicated by the independent auditors as such to the City Council.
The issuance of SAS No. 112, No. 114, and No. 115 will eventually result in Cities fully preparing their own financial statements. This may be a good change as there is an analytical advantage to the City from preparing its own financial statements. Cities will not really know their “true” financial position or fiscal health until they can prepare and understand their Balance Sheet.
NOW IS THE TIME TO STUDY THE BALANCE SHEET…
Many Cities may not have the time or the staff to prepare their Balance Sheet or other financial statements in-house. MuniTemps is available to provide a fresh set of eyes on your Balance Sheet, and can provide temporary accounting assistance to clean up the books when your Finance Department is in transition.
The focus is on the Balance Sheet. It is an important measure of the fiscal health of the City.
This brief article has simplified the Balance Sheet for purposes of highlighting a basic understanding of the serious implications from not paying attention to this important financial statement of the City.
We have been alerting City Managers of the need to look into their Balance Sheet since the “first” MuniTemps CitySpeak newsletter was published in January 2009 when we were facing the worst economic recession since the Great Depression of 1929. Email me and I’ll send you a copy!
With the reality of economic cycles every 5 years, and the fact that we have not had a recession in 9 years, NOW is the time to look at your City’s Balance Sheet to clean up your financial position, or to begin a process to incrementally remove potentially large dollar losses that may have accumulated on your Balance Sheet during the last 10 or 20 years (or longer)!
The next recession recovery may not be as smooth as that of the Great Recession. And with the growing pension crisis, the next recession “recovery” may take 10 to 20 years to get out of!
Most of us may be retired by then, but it is still our duty to leave our organizations in better shape than when we took that leadership post under our responsibility.
John Herrera, CPA, MPA
President / CEO & Municipal Finance Officer
MuniTemps – Municipal Staffing Solutions
2018 No. 1