FINANCIAL MANAGEMENT/Reserve fund balance policy promulgated
Fund balance typically is the most discussed single item in a local government’s financial statements. Governments seek to maintain adequate levels of fund balance to mitigate current and future risks and to ensure stable tax rates. Fund balance also is a crucial consideration in long-term financial planning.
Additionally, credit rating agencies carefully monitor levels of fund balance and unreserved fund balance in a government’s general fund to evaluate a government’s creditworthiness. Ratings agencies favor higher levels of fund balance, although unions, taxpayers and citizens’ groups can consider high levels excessive.
Until recently, local governments had no guidelines on what level of unreserved fund balance they needed to maintain within their general fund. The lack of guidance on the issue was rectified at the winter meeting of the Government Finance Officers Association when the organization’s executive board formally promulgated a recommended practice on the subject.
The group now is on record as urging governments to establish a formal policy on their unreserved fund balance. An adequate fund balance policy would include specific plans for increasing or decreasing the level of unreserved fund balance should it fall outside the parameters established by the policy. It also would specify the appropriate period during which any such adjustment should occur.
There is no single “right” level of unreserved fund balance in the general fund. All the same, it is possible to identify certain minimum levels that should be maintained in the absence of special circumstances. At a minimum, general-purpose governments, regardless of size, should maintain unreserved fund balance in their general fund of no less than 5 to 15 percent of regular general fund operating revenues, or of no less than one to two months of regular general fund operating expenditures. The policy also notes, “A government’s particular situation may require levels of unreserved fund balance in the general fund significantly in excess of these recommended minimum levels.”
A variety of factors may affect the amount of unreserved fund balance a government maintains in its general fund. For example, higher levels of unreserved fund balance may be needed if significant revenue sources are subject to unpredictable fluctuations or if operating expenditures are highly volatile.
Likewise, the availability of resources in other funds may reduce the amount of unreserved fund balance needed in the general fund, just as deficits in other funds may require that a higher level of unreserved fund balance be maintained in the general fund. Similarly, governments may wish to maintain higher levels of unreserved fund balance to compensate for any portion of unreserved fund balance already designated for a specific purpose. As a practical matter, such factors often require smaller governments to maintain significantly higher proportionate levels of unreserved fund balance in the general fund than they do larger governments.
The policy emphasizes that the assessment of the adequacy of unreserved fund balance should take place within the context of long-term forecasting to avoid placing too much emphasis on the level of unreserved fund balance in the general fund at any one time. The new guidelines also remind financial managers of the need for governments to be in compliance with all applicable legal and regulatory requirements.
The full text of the new recommended practice on assessing the “Appropriate Level of Unreserved Fund Balance in the General Fund” can be found on GFOA’s Web site (http://www.gfoa.org/services/rp/).
The author is director of the Technical Services Center of the Government Finance Officers Association, Denver.