AGENDA #3d

 

BUDGET WORKING PAPER

 

TO:                  W. Calvin Horton, Town Manager

 

FROM:            Kay Johnson, Finance Director

 

SUBJECT:       Preservation of 12% Level for Unreserved Fund Balance

 

DATE:             April 27, 2005

 

 

The purpose of this report is to explain the importance of retaining unreserved fund balance at an amount as close as possible to 12% of budget or higher.

 

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 required to be reserved by North Carolina statute for specific purposes 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. 

 

Town practices with regard to fund balance include the following:

 

·        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

 

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.    

 

We selected a level of unreserved fund balance within the context of long-term financial forecasting.  The policy takes into account:

 

 

Use of Unreserved Fund Balance during a Fiscal Year

The money in unreserved fund balance provides the Town with adequate cash flow and allows the Town to take advantage of unexpected opportunities and to be prepared for emergencies.  Given past experiences, we have had opportunities or needs for fund balance reserves during the year in many years.  In the current year, we have used unreserved fund balance for a total of over $300,000 since the original budget was established, as shown in the following table.

 

Cash Flow Needs for On-going Projects in Other Funds

In a period when we are experiencing major building projects, a fund balance reserve is especially important since we must pay the building costs up front and may only subsequently request reimbursement from the borrowed funds for the project. 

 

Emergency Needs

If we establish our fund balance below 12%, we reduce our flexibility and we increase the possibility that we cannot take advantage of an opportunity or cannot cover the cost of an emergency.  For example, during the ice storm of December 2002, we were required to pay for our emergency needs which totaled $1.5 million.  In June 2003 we received intergovernmental assistance which reimbursed us for about $500,000 of our expenses.  The balance was not received until the following fiscal year.  If we began the year with a reduced fund balance, we might have had trouble covering the expenses of the storm. 

 

One-time Opportunities

We have also been able to use unreserved fund balance to cover the costs of purchases in other funds.  For example, we were able to purchase open space in December 2003 for $1,050,000 when we only had $389,000 in available bond funds.  When we issued General Obligation bonds in fall of 2004, we were able to repay the General Fund.

 

Need to Retain Bond Agency Ratings

An additional reason for keeping fund balance at a higher balance is that available unreserved fund balance is a key factor that rating agencies use in determining bond ratings.  With our current schedule for issuing general obligation bonds, we need to ensure that our fund balance remains high.  We are small in comparison with other municipalities rated AAA and AA+, so maintaining a continuously solid fund balance is an important factor.

 

We currently expect the unreserved fund balance to be approximately $5,350,000.  A budget at $44 million would require a fund balance of $5,280,000 at the 12% level and $4,840,000 at the 11% level, a difference of $440,000. A budget of $47 million would require a fund balance of $5,640,000 at the 12% level and $5,060,000 at the 11% level, a difference of $460,000. 

 

ATTACHMENT

 

Memorandum of February 24, 2005.