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![Page 1: McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10 Analysis of Governmental Financial Performance.](https://reader033.fdocuments.net/reader033/viewer/2022061306/551473945503462d4e8b6194/html5/thumbnails/1.jpg)
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter
10Analysis of Governmental Financial
Performance
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10-2
Learning Objectives
After studying Chapter 10, you should be able to:
Explain the importance of evaluating governmental financial performance
Distinguish among and describe key financial performance concepts, such as:
Financial position
Financial condition
Economic condition
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10-3
Learning Objectives (Cont’d)
Explain the relationships among environmental factors, organizational factors, and financial factors in determining governmental financial condition
Identify, calculate, and interpret key ratios that measure financial performance
Analyze financial performance using government-wide statements
Describe how benchmarks can aid financial analysis
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10-4
An “early warning” system of impending financial difficulty can serve to prevent disruption in critical government services
Taxpayers now, more than ever, demand better performance and greater transparency from government officials
Analytical tools have evolved to better track governmental financial performance
Why Evaluate Governmental Financial Performance?
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10-5
Government managersBond investors CreditorsLegislators and oversight bodiesCitizensTaxpayers Intermediaries, e.g., media, watchdog groups
Who Needs to Know About Governmental Financial Condition?
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10-6
What Do They Need to Know?
Whether the government will continue as a viable entity providing the desired level of services to citizens in the future
Whether future debt service payments will continue to be covered
Whether the government is in compliance with all laws and regulations
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10-7
Financial position focuses on assets and liabilities that require cash or are normally converted to cash in the short-term (i.e., liquidity)
Financial condition refers to a government’s ability to meet its financial obligations to creditors and others as they become due, as well as its service obligations to constituents currently and in the future (i.e., solvency)
Economic condition is a term GASB uses to capture a composite of the government’s financial position and its ability and willingness to meet its financial obligations and service commitments on an on-going basis
Comparison of Key Terms Describing a Government’s Financial Health
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10-8
Economic Condition: Components
Financial position – previously defined
Fiscal capacity – ability and willingness to meet obligations as they come due
Service capacity – ability and willingness to meet commitments and provide services to citizens
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10-9
Financial Condition: Types of Solvency as Defined by the ICMA
Cash solvency—ability to generate enough cash over a 30- or 60-day period to pay bills
Budgetary solvency—ability to generate enough revenue over budgetary period to meet expenditures and not incur deficits
Long-run solvency—ability in the long-run to pay all the costs of doing business
Service-level solvency—ability to provide services at the level and quality that are required and desired for the health, safety, and welfare of the community
(Note: the similarity between the ICMA’s solvency measures and the GASB’s economic condition definition)
Source: ICMA’s 2003 Evaluating Financial Condition: A Handbook for Local Government
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10-10
What Factors Affect Financial Condition?
ICMA’s financial trend monitoring system identifies three broad groups of factors (see Ill. 10-1)
Environmental factors
Organizational factors
Financial factors
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10-11
Community needs and resources (e.g., population, age, income, employment, crime rate)
Intergovernmental constraints (e.g., mandates and restrictions on revenue)
Disaster risk (e.g., potential for natural disasters and local preparedness)
Political culture (e.g., attitudes toward taxes and political processes)
External economic conditions (e.g., national inflation and employment rates, financial markets)
Environmental Factors
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10-12
Management practices and legislative policies that shape or influence how environmental factors affect the outcome of the financial factors
The willingness and ability of managers to make tough fiscal decisions can prevent a fiscal crisis from occurring, even in the face of adverse environmental conditions
Organizational Factors
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10-13
Revenues (e.g., growth and diversity of revenue sources)
Expenditures (e.g., priorities, mandates, and effectiveness of expenditures)
Operating position (e.g., operating results, fund balances)
Debt structure (e.g., short and long-term debt burden) Unfunded liabilities (e.g., pension, OPEB obligations) Condition of capital plant (e.g., deferred maintenance,
capital outlay)
Financial Factors
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10-14
Ratios are useful analytical tools in examining relationships among elements of the financial statements
Data are readily obtainable from sections of the comprehensive annual financial report (CAFR) and other publicly available documents
Examining multiple-year trends in financial factors, as well as those for one year or a single point in time, is useful
Financial Analysis
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10-15
Data for Financial Ratio Analysis
Data for calculating financial ratios may come from Government-wide statements Fund financial statements Notes to the financial statements Introductory section of the CAFR, including the
MD&A Statistical sections of the CAFR and
supplementary information Other publicly available sources
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10-16
Ratios for Governmental Funds(Ill. 10-3)
Revenue measures: Revenues per capita Operating
revenues
Population
One-time revenues One-time revenues
Operating revenues
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10-17
Ratios for Governmental Funds (Ill. 10-3) (Cont’d)
Expenditures measures: Expenditures per capita
Operating expendituresPopulation
Employees per capitaNumber of municipal employeesPopulation (or households)
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10-18
Ratios for Governmental Funds (Ill. 10-3) (Cont’d)
Operating position measures:
Operating surplusOperating surplus(deficit) Operating
revenues
Fund balances General Fund balances Operating revenues
Liquidity Cash and short-term investments Current liabilities
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10-19
Ratios for Governmental Funds (Ill. 10-3)(Cont’d)
Debt indicators: Long-term debt
General obligation long-term debtAssessed valuation (or population
or personal income)
Current liabilities Current liabilities Operating revenues
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10-20
Ratios for Governmental Funds (Ill. 10-3) (Cont’d)
Unfunded liability measures: Pension obligations Pension obligations
Salaries and wages
Post-employment benefitsLiability for postemployment
benefitsNumber of municipal employees
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10-21
Ratios for Governmental Funds (Ill. 10-3) (Cont’d)
Capital plant measures:
Capital outlayCapital outlay from operating funds
Operating expenditures
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10-22
Performance Measures for Government-wide Statements (Ill. 10-4)
Examples of Financial Position Ratios: Unrestricted net position – How do our rainy day funds
look?
Capital asset condition – How much useful life do we have left in our capital assets?
Pension plan funding – Will we be able to pay our employees when they retire?
Debt to assets – Who really owns the governmental entity?
Quick ratio – How is our short-term cash position?
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10-23
Performance Measures for Government-wide Statements (Ill. 10-4) (Cont’d)
Examples of Financial Performance Ratios: Change in net position – Did our overall financial condition
improve, decline, or remain steady over the past year?
Interperiod equity – Who paid for the cost of operating the city – current, past, or future tax and rate payers?
Business-type activities self-sufficiency – Did current year BTA, such as utilities, pay for themselves?
Debt service coverage – Were our revenue bond investors pleased with our ability to pay them on time?
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10-24
Performance Measures for Government-wide Statements (Ill. 10-4) (Cont’d)
Examples of Financial Capability Ratios: Revenue dispersion – How much of our revenue is beyond
our direct control? Debt service load – How much of our annual budget goes
to pay off long-term debt? Bonded debt per capita – What is our long-term general
obligation debt burden on our taxpayers? Legal debt limit – Will we be able to issue more long-term
general bonded debt, if needed? Property taxes per capita – What is our property tax
burden on our taxpayers?
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10-25
Benchmarking
Analysis can be based on past performance and trends over time (e.g., 5 or 10 year trends) within a government
Ratios can be compared to targeted values for performance indicators
Ratios can be benchmarked against average data for similar governments (e.g., credit industry benchmarks)
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10-26
Analysts at bond rating agencies, bond insurers, and underwriters (brokers) benchmark government ratios to the large set of information available to them from all municipalities whose bonds are rated or insured over time
Bond rating agencies include Moody’s Investors Service, Standard & Poor’s, and Fitch Inc.
Credit Analysts Models
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10-27
Bond analysts consider these factors important in assessing the current financial condition and long-term solvency of a government:
Debt Finances Debt’s legal security Economy and demographics Management strategies (e.g., conservative
budgeting techniques and fund balance policies)
Factors Considered by Municipal Bond Analysts
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10-28
Interpretation of trend or benchmark comparisons involves a great deal of professional judgment
Usually a pattern of above or below average financial condition emerges
Comparison to “red flag” levels is also
useful
Interpretation of Financial Analysis Data
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Interpretation of financial analysis is challenging, but these are recognizable signs of fiscal distress:
Decline in revenues relative to expenditures Declining property values Declining economic activity (e.g., retail sales) Erosion of capital plant Increasing levels of unfunded obligations Inadequate capital expenditures
Signs of Fiscal Distress
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10-30
It is vital to monitor government financial performance on an ongoing basis in order to sustain services in the long-run when governments periodically experience fiscal distress
Numerous environmental, organizational, and financial factors affect governmental financial condition
Analysis of financial ratios is a useful management tool, although interpretation is subjective
END
Concluding Comments