Last updated on October 19th, 2020

Developing and implementing sound municipal fund balance policy is crucial to any local government’s ability to plan for the ebb and flow of expenditures and revenue and to deal with unexpected events or expenses, even in the best of times.

A policy that sets out the amount of funds a municipality keeps in reserve, how those funds may be used, and how they will be replenished is a planning tool, helping to guide daily operations as well as longer-term strategies.

There are five categories of fund balance. In order of most restricted to least restricted in terms of use, they are non-spendable, restricted, committed, assigned and unassigned fund balance. The latter three categories comprise what is known as unrestricted fund balance according to Office of the State Comptroller guidance. Under New York State law, counties, villages, towns and fire districts may carry over “a reasonable amount” of unappropriated, unreserved fund balance from one budget year to the next. A municipality must follow proper procedures and legal requirements to transfer funds between these classifications.

Municipal revenues ebb and flow as a matter of course. In Orange and Dutchess counties, for example, most municipalities collect their property taxes, the main source of revenue, early in the calendar year. Sales tax and state aid supplement are other major sources of funds. However, the government body must have enough cash on hand to cover payroll and bills throughout the year, even in the months when revenues are not coming in. That requires a cash flow plan for the entire upcoming year.

Since property taxes are not received at the very beginning of the year, the cash flow plan should contain a provision to cover this temporary shortfall. The standard, according to the New York State Governmental Finance Officers Association, is to maintain enough unrestricted fund balance in the general fund to cover at least two to three months of regular general fund operating revenues or regular general fund operating expenditures.

In addition, government officials should assess their municipality’s unique circumstances and risks to determine what level is appropriate for a sound fund balance policy. If a town or village is vulnerable to natural disaster such as flooding which could generate unexpected expenses, or to an unpredictable revenue source such as state aid that could be cut, officials may need to keep higher levels of unrestricted fund balance in reserve.

A sound fund balance policy provides a framework to guide current budgetary decisions as well as those for the long-term. For example, a municipality’s capital plan should inform officials and taxpayers what needs to be done over the next five years, and how it will be funded. Planning major expenditures in advance allows a government to save funds, minimizing the need to borrow.

Fire districts often set up equipment or building reserves and budget transfers to those reserves each year, to allow them to save for capital purchases such as fire trucks, which can cost from $600,000 for a new engine to $1.2 million for a new aerial ladder truck.

There are consequences to insufficient fund balance. When a municipality with limited reserves finds itself in the throes of an emergency, officials may have to make painful budget cuts that deprive residents of needed services, or they may have to raise property taxes. A municipality may have to undertake short-term borrowings, which can raise costs and hurt its bond rating.

If a municipality carries too much fund balance, it runs the risk of angering taxpayers, who will perceive this as paying extra taxes now to benefit the future.

So what makes good fund balance policy?

According to the New York State Comptroller’s Office, an effective policy is written, formally adopted by the governing body with input from relevant officials, such as the municipality’s financial officer. The policy should be used to develop long-term plans, and should address how surplus balances should be used, as well as how and when to replenish fund balance that has been spent.

A sound fund balance policy provides a cushion against unexpected expenditures and revenue shortfalls, and ensures that government operations can continue even in difficult times.

Contact RBT CPAs, LLP with any questions you may have.