The fund balance of a city or town government is not unlike the working capital that a business would use for its ongoing operations. It is defined simply as the sum of the municipality’s current net assets, subtracted by its current liabilities. Municipal leaders will sometimes debate the fund balance level that their city should target.
While fund balances are sometimes criticized as an unnecessary accumulation of money that should be put to use, but they serve as a valuable protection against financial uncertainties and risks.
What does a fund balance accomplish?
A fund balance can help mitigate the challenges of irregular cash flow from the city’s revenue cycles.
As a city provides its services regularly, it faces recurring costs — everything from payroll to utilities, fuel, maintenance and other regular operating expenses. However, many of the city’s revenue sources, things like property taxes or business license taxes, will have annual payment cycles that do not match with the timing of the city’s expenses. A fund balance helps the city to have cash available at the time it is needed.
Fund balances can also provide an alternative to tax anticipation notes, which are short-term debt securities that cities sometimes use to raise funds for a project, but which come with financing expenses.
Balances also impact the municipality’s credit rating. Banks and credit rating agencies have historically relied heavily on the size of a city’s fund balance level when making decisions about loans to the city.
Revenue shortages, resulting from economic downturns or from natural disasters, can bring a city into financial danger — sometimes quickly — and fund balances can help the city weather the financial storm. Disaster response will often require a city to spend its own funds before insurance reimbursements or state and federal aid can arrive. Cities responding to disasters can easily expend 20% or 25% of their annual budget before assistance becomes available.
Under SC Code Section 6-5-10, municipalities may invest money under their control, including fund balances, into certain investment vehicles. South Carolina’s Local Government Investment Pool provides one option for political subdivisions.
How much fund balance should the city keep?
Deciding on where to set a fund balance requires reviewing the city’s financial goals and risk tolerance, as well as local public opinion about funding. Other items to consider are the timing of the beginning of the fiscal year relative to major expenses and revenues, volatility of expenses and revenues, natural disaster vulnerability, the prospect of taking loans, and local economic conditions.
The Government Finance Officers Association publishes “Fund Balance Guidelines for the General Fund,” available online.
The guidelines recommend, “at a minimum, that general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures.”
Such guidelines would amount to a balance of at least 17% to 20% of the general fund.
Setting a fund balance policy
Municipalities should set a formal fund balance policy in ordinance, which can help address possible criticism for maintaining a balance. Such a policy can specify
- a mandatory minimum level of funding,
- circumstances under which drawing on the fund balance is appropriate, and
- what budget items could be funded in cases where the fund balance exceeds the minimum set by council.
Ultimately, a fund balance can help a city by bridging cash flow when needed, avoiding interest costs from short-term borrowing, preserving a credit rating, and providing a buffer against revenue shortfalls or expenditure overruns.
The Municipal Elected Officials Institute of Government addresses key aspects of local government finance in its on-demand course "Basic Budgeting and Municipal Finance."