AGENDA #5b

MEMORANDUM

TO:                  W. Calvin Horton, Town Manager

FROM:            Kay Johnson, Finance Director

SUBJECT:       Report on Fund Balance

DATE:             February 24, 2005

The purpose of this report is to review the Town’s fund balance policies, current fund balance in the General Fund and possible impact of additional use of fund balance.

BACKGROUND

Fund balance is basically the difference between revenues received and expenditures made in a given year plus any residual balance remaining at the end of the previous year.  A portion of fund balance is reserved for specific purposes required by North Carolina statute and is not available for appropriation and a portion may be designated for use in the subsequent year.  The remaining amount is unreserved, undesignated fund balance.  (See attachment 1 for the Town of Chapel Hill’s fund balance on June 30, 2004.)

The undesignated, unreserved fund balance is an accumulated cash balance.  Part of the balance is retained to meet the reserve recommendations of the North Carolina Local Government Commission, and part of the balance is retained to meet Town reserve policies, as illustrated in the chart above.  The remaining balance is available to be used for additional appropriations.  Since 1994, the Town has appropriated $800,000 of fund balance in the General Fund under a plan that presumes that a combination of revenue in excess of budget and costs below budget in the preceding year will allow us to reappropriate the $800,000 in the following year.  The Town has achieved this goal each year.

Town practices with regard to fund balance include the following:

• The North Carolina Local Government Commission requires a minimum fund balance of 8% for cash flow purposes, since receipt of cash does not necessarily coincide with needed cash disbursements (see attachment 2).
• The Government Finance Officers’ Association recommends a minimum of 5% to 15% fund balance reserve (see attachment 3).
• Town policy has been to maintain a fund balance of at least 10% to 12% so that, in addition to the need for cash flow, we can have cash available for emergencies and opportunities.

· The Town seeks to maintain a level of fund balance which is sufficient to retain its high bond ratings:  Moody’s Investor Service—AAA and Standard and Poor’s—AA+. Bonding agencies use the percentage of unrestricted fund balance as a key indicator when assessing the Town’s creditworthiness. 

Bond rating agencies look favorably on governmental units that establish and abide by their fund balance policy.  A reduction in fund balance could be viewed by the bond rating agencies as a negative direction in the Town’s fiscal management.  The result of a lowered rating could be thousands of dollars in interest over the life of a borrowing.  All the regulatory and advisory groups discourage the use of one-time revenue sources to fund operating costs or continuing debt service.  Fund balance should only be used for one-time costs. 

The Town of Chapel Hill’s fund balance policy has enabled us to respond promptly after hurricanes, ice storms, and unanticipated reductions in State-shared revenues. The reserves have also allowed us the flexibility to take advantage of land purchases and unanticipated grants which have required local matches in order to provide additional services to the Town, for example, additional police officers. 

The statewide average fund balance available for comparably sized municipalities to Chapel Hill in 2004 was 23.07% of their General Fund costs.  We note that the Town of Chapel Hill does not provide the utility services that demand as high a fund balance reserve as is needed in some municipalities.

DISCUSSION

Per our Comprehensive Annual Financial Report for the year ended June 30, 2004, our unreserved fund balance reserve was $7.1 million as of June 30, 2004.  We designated $1,499,000 of the $7.1 million for our original 2004-05 budget including: 1) $491,000 of one time use from 2002-03 revenues, 2) our usual use of $800,000 which we propose to replenish from a combination of revenues in excess of budget and costs less than budget, and 3) $208,000 for additional capital improvements approved by the Council.  The remaining $5.6 million is the amount that is available for appropriation, so long as we maintain our policy of retaining 10 to 12% of our budget in our fund balance reserve.

Since the 2004-05 budget year began we have made several appropriations as shown below:

After the use of $277,714 of unreserved fund balance this year, the remaining unreserved fund balance is $5,356,836 or 12.19% of our current General Fund budget.

Other Funds

The Town applies the policy of maintaining 10% to 12% of budget as an unreserved balance in all funds.

Conclusion

We believe that our fund balance policy has served the Town well.  Fund balances have been carefully calculated in the General Fund and in the Town’s other funds.  The balances provide the Town with adequate cash flow and emergency reserves.  The amounts take into account the sources and uses of the funds and the need for maintaining our current bond rating.  We do not recommend that the Town make any additional reductions in fund balance.

ATTACHMENTS

1. Fund Balance for the General Fund as of June 30, 2004 (p. 4).
2. Local Government Commission Memorandum #1014 (p. 5).
3. Government Finance Officers Association fund balance policy (p. 7).