MRSC has joined with Toni Nelson, Small Cities Specialist, State Auditor's Office, Gayla Gjertsen, Finance Director, City of Tumwater, and Mike Bailey, Finance Director, City of Renton, to bring you the "Finance Advisor" column. The "Finance Advisor" will feature a new article each month with timely local government finance information and advice you can use.*

What are Fund Balances and Why do we need them?

November 2005

Toni Nelson, Small Cities Specialist, State Auditor’s Office

City fund balances become a favorite topic of conversation during this budget time of year. What are they? Do we need them? If so, how much should they be? These are questions commonly asked by newly elected officials and members of the public who participate in the budget review process.

Let’s start with what they are. Whether fund balances are referred to as “beginning” cash and investments or “ending” fund balance, the general premise is the same. Fund balances represent the net cash after all revenues have been deposited and all expenses have been paid. Just like your checkbook at home at the end of the month, it represents how much you have in the fund. Whether those future needs are cash flow considerations to pay expenses, savings for capital projects or simply reserves for a rainy day, the fact is that fund balances are a necessity.

Cash flow

The first and foremost reason to have an adequate fund balance is “cash flow.” Cities revenues are cyclic in nature. For example, property taxes are due from homeowners on April 30 and October 30. For many cities, this tax is the primary revenue source for the general fund. Cities receive most of this revenue in May and November. To meet the financial obligations throughout the year, cities must maintain a certain fund balance. The same cash flow scenario can be demonstrated in a water utility fund in which increased revenues during the summer irrigation season must carry the fund through to the next summer watering season. Measuring a city’s fund balance on December 31 of each year is equivalent of looking at your checkbook the day after payday. Without sufficient cash flow reserves, cities would be forced to borrow operating cash.

Reserves for capital projects or contingency

Cities are just like you and me. They must save (or reserve) enough cash before they can start a capital project. The city fund balance may include the savings for these future capital projects. Understanding what portion of the fund balance represents cash flow and what portion represents reserves for a capital project will help you understand how much fund balance is enough.

An additional consideration is a “contingency” or rainy day reserve. For those cities with a heavy reliance on a single source of revenue, it is prudent to consider a contingency reserve. Hurricane Katrina has left a lasting impression on all of us. The City of New Orleans has lost retail sales taxes and property taxes that will never be made up. Having a contingency reserve for natural disasters would help to reduce the effect of financial disaster. Another reason for considering a contingency reserve is if your city has a heavy reliance on one or two major employers. If the thought of one of these employers leaving your community makes your worry, then perhaps a contingency reserve is worth considering.

So how much fund balance is enough? Several different methodologies may be used to calculate this number. The Government Finance Officers Association has developed a “recommended practice” for fund balance levels. It generally suggests a minimum of 15 percent, but many issues come into play when making this determination. Keep in mind your city has numerous factors that make it unique. Try to evaluate all of these factors, along with consideration for capital reserves and cash flow needs when deciding what the fund balance number should be.

Toni Nelson is the “Small Cities Specialist” for the Washington State Auditor’s Office, providing both on and off site financial training and assistance to smaller cities and towns throughout the State. Ms. Nelson has been working with the Auditors office for 6 years and prior was the Clerk/Treasurer for a small town in for 9 years. She has co-authored the “Small Cities Manual” a detailed reference guide for new clerk/treasurers on governmental accounting procedures and presents numerous training workshops throughout the State for AWC, WFOA, WMTA, WMCA and local/regional organizations such as EWFOA and SCWMCA. Ms. Nelson is also a member of and conference track coordinator for the WFOA Education committee.

*The Articles appearing in the "Finance Advisor" column represent the opinions of the authors and do not necessarily reflect those of the Municipal Research & Services Center.