As local governments face budget challenges caused by the slowdown in sales tax collections (and associated hold-harmless funding), the end of ARPA-related funding, and potential instability in Federal aid, a healthy fund balance may be more important than before.
But what even is the fund balance, and why is it so important?
Fund balance is basically the measure of financial resources (aka cash money) that a local government has available for use that is not otherwise allocated to operations or other liabilities. Basically, you can think of this like the money in the government’s checking account that is left over after paying all the bills.
If local governments are collecting this money from taxpayers, why are they keeping this money instead of sending it back to constituents or spending it on improving the community? Well, for many of the same reasons individuals like to keep some cash on hand, and for a few local government specific reasons, like keeping the LGC off your back.
Keep the LGC off your Back
The LGC routinely evaluates the fund balance available to a local government and uses it as a factor in assessing the unit’s fiscal health and when developing the Unit Assistance List. While the LGC likes to see fund balances of at least 8%, roughly enough for one month’s expenses, they are most often looking to see whether the government’s fund balance is consistent with the balances of their peer communities. The LGC publishes a list of the fund balances of each government unit each year which can be used to assist in this comparison.
Local governments that want to stay on the LGC’s good side and off the Unit Assistance List should maintain a healthy fund balance each year and take care to avoid extended downward trends in the balance which can raise flags during an LGC application or annual review. We agree with the LGC’s recommendation that local governments develop a fund balance policy. This policy will help ensure a fund balance commensurate with their peers and should include actions to be taken if the fund balance falls below the governments identified balance target.
Facilitate Cash Flow and Long-Term Planning
Cash kept in the fund balance safeguards the local government’s ability to pay its bills (something we like our local governments to do!). Because the cash-flow needs of a local government are rarely stable throughout the year, fund balance can help address this fluctuation. For example, local governments may expect higher cash-flow demands at the start of a construction project to pay associated professional costs such as for architects and engineers. While unrestricted fund balance may not be the only source of cash on hand to pay bills, it is the most reliable source.
Maintaining a fund balance also enables local government’s long-term planning. It can act as a backup stream of funding for certain projects or assist in weathering cuts in state aid or federal grants, all while maintaining service levels or work on priority projects.
Respond to Emergencies and Opportunities
Cash on hand is crucial to a local government’s ability to respond to the unexpected- both costs and opportunities. Coastal communities frequently carry higher fund balances to provide for a response to a hurricane. But, if Hurricane Helene taught us anything, it’s that there is not a single community in North Carolina that’s immune from the risk of a natural disaster. Even if FEMA will reimburse for clean-up costs, that process can take months, or even years, and local governments may need money available to respond to loss and even pay deductibles.
It’s not just unexpected emergencies that might require the local government to expend a few unplanned dollars quickly. Hot property might suddenly hit the market that’s perfect for the planned school expansion, or a downtown eyesore might finally be available for purchase from the absentee landlord. In those cases, it may not be timely for a government to borrow or reallocate funds and using money from the fund balance might be the fastest way to take advantage of the opportunity.
Keep your rating high and borrowing costs low
Fund balance is also an indicator used by rating agencies to determine the local government’s credit rating which can influence the costs of borrowing money. Information published by Moody’s shows that a local government’s fund balance is an important indicator of its financial position which “determines its cushion against the unexpected, its ability to meet existing financial obligations, and its flexibility to adjust to new ones.” Per Moody’s publication, a fund balance of between 5% and 15% is generally indicative of an A rating, while fund balances of >30% can suggest AAA. A higher rating generally results in lower borrowing costs which can save government’s money at closing and over the lifetime of the project.
Takeaways
Local governments should maintain a fund balance that enables them to operate smoothly, plan for the future, and react to the unexpected. A healthy fund balance also can ease interactions with the LGC and make borrowing money less expensive.
We recommend that local governments asses their unique operating environment- fiscal, environmental, political- to determine the appropriate level of fund balance. Local governments should also factor in the fluctuation of its revenues and costs throughout the year and write out a fund balance policy that ensures a healthy fund balance is always in place.
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