What Level of Fund Balance Should be Maintained?
If a government is going to evaluate its financial position, the natural question is, what should the city’s financial position be? There is no right or wrong answer to this question. Furthermore, the answer is dependent upon the fund in question, the type of revenues of the fund, the type of expenditures of the fund, and a sense of the local government’s future needs.
State law 7-6-4034( 2)(b) MCA places a limit on the amount of reserve a city may budget for its tax supported funds equal to 50% of the total amount appropriated and authorized to be spent from the fund during the current fiscal year. Therefore, if the city council appropriates $500,000 from its general fund, the maximum balance the city may include in its general fund budget is $250,000. Montana Municipal Officials Handbook 163. Some simple principles will assist the finance professional and the city council with gauging whether or not they
have adequate reserve levels. The higher the volatility of a fund’s revenues or expenditures, the higher the reserve levels are prudent. Conversely, the more stable the revenues and expenditures of a fund, the less reserve levels are needed. Higher reserve levels are needed for enterprise funds, due to the fact that they are infrastructure intense. Infrastructure needs are not only costly, but generally they are sporadic as well, thus resulting in wide swings in the financial position of enterprise funds, requiring higher peaks (and possibly lower troughs) in the
reserve levels. Funds that are personnel intense (those consisting primarily of city staff), require a lesser reserve level, because of the stability and predictability of the expenditures. As a general rule, the city’s general fund will consist mainly of personnel and the principal revenue source will be property taxes, both of which are highly predictable. As stated previously, the trend of a fund’s financial position is much more important than the absolute value. The key element in managing the city’s financial position is to ensure future revenue sources are sufficient to adequately fund future expenditure needs and to do so with a minimum amount of disruption to normal operations. A well-managed city will have a very good understanding of the volatility or stability of its revenue and expenditures in each of its funds, as well as a good understanding of its future capital needs. A Capital Improvement Plan is one of the very best ways of addressing these responsibilities. The Government Finance Officers’ Association (GFOA) routinely disseminates recommended practices to local government finance officers. The GFOA prepared a recommended practice on the level of general fund reserves in 2002 and 2009 and stated that the adequacy of unreserved fund balance be assessed based on a
government’s own specific circumstances. That being said, the GFOA went on to recommend that:Comparisons with other cities and towns can also provide a useful analysis to gauge the adequacy of a city or town’s general fund reserves. The level of general fund balance can be stated as a percentage of general fund expenditures, thus allowing comparisons to any city, regardless of size. However, because of similarities in tax structure and services offered, it is most useful to compare fund balance levels with other Montana cities of similar size or possibly look to some of the larger cities for guidance.
State law 7-6-4034( 2)(b) MCA places a limit on the amount of reserve a city may budget for its tax supported funds equal to 50% of the total amount appropriated and authorized to be spent from the fund during the current fiscal year. Therefore, if the city council appropriates $500,000 from its general fund, the maximum balance the city may include in its general fund budget is $250,000. Montana Municipal Officials Handbook 163. Some simple principles will assist the finance professional and the city council with gauging whether or not they
have adequate reserve levels. The higher the volatility of a fund’s revenues or expenditures, the higher the reserve levels are prudent. Conversely, the more stable the revenues and expenditures of a fund, the less reserve levels are needed. Higher reserve levels are needed for enterprise funds, due to the fact that they are infrastructure intense. Infrastructure needs are not only costly, but generally they are sporadic as well, thus resulting in wide swings in the financial position of enterprise funds, requiring higher peaks (and possibly lower troughs) in the
reserve levels. Funds that are personnel intense (those consisting primarily of city staff), require a lesser reserve level, because of the stability and predictability of the expenditures. As a general rule, the city’s general fund will consist mainly of personnel and the principal revenue source will be property taxes, both of which are highly predictable. As stated previously, the trend of a fund’s financial position is much more important than the absolute value. The key element in managing the city’s financial position is to ensure future revenue sources are sufficient to adequately fund future expenditure needs and to do so with a minimum amount of disruption to normal operations. A well-managed city will have a very good understanding of the volatility or stability of its revenue and expenditures in each of its funds, as well as a good understanding of its future capital needs. A Capital Improvement Plan is one of the very best ways of addressing these responsibilities. The Government Finance Officers’ Association (GFOA) routinely disseminates recommended practices to local government finance officers. The GFOA prepared a recommended practice on the level of general fund reserves in 2002 and 2009 and stated that the adequacy of unreserved fund balance be assessed based on a
government’s own specific circumstances. That being said, the GFOA went on to recommend that:Comparisons with other cities and towns can also provide a useful analysis to gauge the adequacy of a city or town’s general fund reserves. The level of general fund balance can be stated as a percentage of general fund expenditures, thus allowing comparisons to any city, regardless of size. However, because of similarities in tax structure and services offered, it is most useful to compare fund balance levels with other Montana cities of similar size or possibly look to some of the larger cities for guidance.