Fiscal Indicator Reports and Ratio Analysis: Benchmarking Ohio Municipalities and School Districts
Petro, Jim, Government Finance Review
The State Auditor's Office provides local governments with ratio indicators to benchmark financial performance and identify fiscal distress.
Editor's note: Each year the Government Finance Officers Association bestows its prestigious Award for Excellence to recognize outstanding contributions in the field of government finance. The awards stress practical, documented work that offers leadership to the profession and promotes improved public finance. This article describes the 1998 winning entry in the Communications and Reporting subcategory of the Budgeting and Financial Planning category.
Predicting when financial calamity may strike is very difficult for local governments. In the wake of recent fiscal crises, many officials are asking themselves how to assess and measure financial distress. What indicators should be analyzed to get a complete and accurate picture of their fiscal situation?
The State of Ohio Office of the Auditor has taken a unique approach to help clarify the picture for many local governments. Last year the Auditor's Office initiated a series of reports detailing key indicators developed from financial statements to measure and benchmark performance. These basic indicators illustrate financial practices among governments and may provide early warning signals for governments drifting toward crisis.
Several factors may make it difficult for officials, especially those in smaller units of government, to assess and thoroughly analyze their "financial condition" or "fiscal health." In its basic form, these terms refer to a government's ability to have resources available to meet both current and future obligations while maintaining services. Analytical problems include the following.
* There are very few standards against which local government finances can be measured with confidence.
* Fiscal difficulties emerge gradually and incrementally, making potential difficulties less obvious.
* It is difficult to compare one local government against another because of differences in populations, enrollments, or other demographic characteristics.
* There is a lack of "useable" and "understandable" dissemination vehicles and formats to assess financial condition.
The barometers vary for assessing a local government's financial condition. Bond rating agencies may employ complex economic models, while an individual legislator may be satisfied if receipts exceeded expenditures for the past fiscal year. The ratio analysis format developed by the Auditor's Office attains the goals of presenting sophisticated financial information and making the information user friendly.
The financial information in these reports are from financial statements based upon both Generally Accepted Accounting Principles (GAAP) and cash basis accounting since not all local governments in Ohio are required to report on the GAAP basis of accounting. Often both bases will be covered in a single report to accommodate governments that have not converted to GAAP - though separate comparison groups are maintained for both bases.
The techniques discussed herein are intended to provide an overview of fiscal health. The results obtained from the benchmark reports are a good starting point for analysis but not a conclusion. With this caveat in mind, there are many advantages to the format presented here.
The most obvious advantage to benchmarking local government finances is the potential to detect impending financial difficulty by plotting trends. Ohio law requires the Auditor's Office to issue - by class of government - summaries of government financial information filed every year. Unfortunately, simply rehashing these summaries as filed does not provide a real basis for identifying trends. This is especially true if one was trying to compare practices among similar governments.
The answer was found through benchmarking certain practices from these financial statements. Benchmarks are information measuring-sticks used for comparison purposes. People use benchmarks every day - from checking the "Blue Book" value of a used car to reviewing statistics of their favorite baseball player against the major league averages.
Through benchmarking, people or organizations can identify, analyze, adopt, and adapt the specific practices of other organizations that excel at a certain activity. Governments also may see where their financial practices may be taking them, and plan accordingly. The following trends were explored through the ratio reports:
* Economic vitality. No local government can avoid fiscal difficulty over the long run if its economy is deteriorating. Certain factors may suggest the economy is on the decline, the most obvious being whether the total population is declining. Subtle indicators include the rate of growth for police and social services as a percentage of general and governmental funds. The recent analysis of Ohio counties showed average public safety and human services costs remained steady between 1995 and 1996 in these categories. There was a less than .5 percent increase for public safety and an almost 1 percent decrease for human services as percentages of total governmental fund expenditures. Steady increases may suggest an economic downturn.
* Financial independence. A financially sound local government typically has control over its finances to enable it to weather fiscal changes without crisis. These governments have the flexibility to respond to various program needs. One major index that indicates a loss of independence is a growing percentage of revenues coming from other sources, generally federal and state governments. These funds are often unpredictable and are accompanied by administrative requirements. As an example, the state of Ohio provided an average of 67 percent of 1996 revenues for 76 school districts classified as "rural" and "poor." It provides an average state share of 43 percent for all school districts.
* Deferred costs. There are several relatively easy ways in the public sector to provide services and benefits today and pay for them later. Deferral of current costs can create an enormous burden on future local revenues. The review of Ohio cities examined accounts payable as a percentage of governmental funds revenue (3.3 percent at year-end 1995). Accounts payable represents a short-term liability account reflecting amounts owed for goods or services. High levels of accounts payable could place a government in statutory fiscal watch or fiscal emergency in Ohio.
* Shrinking reserves. A healthy carry-over of unreserved funds serves as a cushion against unfavorable conditions. All ratio reports measure the percentage of unencumbered year-end fund balances as a percentage of expenditures. This demonstrates a government's ability to fund current operations without considering revenues generated from operations. A sharp or continuous decrease may suggest impending fiscal difficulty. The report on Ohio's 50 largest school districts ranked by average daily membership actually showed a negative average general fund balance as a percentage of total general fund expenditures (-3.26 percent in 1995 and -1.87 percent in 1996).
The benchmark reports clearly explain ratios and consequent potential trends through detailed definitions and narratives. Each narrative section contains average ratios for the class of local government examined, as well as the number of governments falling above or below that average.
Recently, three- to five-year trend analyses of selected practices were presented in the reports for the first time. This data will help give officials a head start in their financial planning, especially if trends suggest potential fiscal distress. Future reports will feature trend indicators (in constant dollars) that specifically denote whether a practice or condition could lead to financial trouble.
This year Money Magazine conducted its annual review of the Best Places to Live in America. Unlike prior years, this year's study ranked the 300 largest cities (by metropolitan statistical area) according to their regional location and size. Communities were now competing against similar regional peers to obtain a fairer comparison.
Money Magazine correctly realized that region and size gave each city a different characteristic. A similar approach has been undertaken with the ratio reports to help local governments compare financial practices. Comparing the practices of Cleveland (population of 500,000) with Clyde, Ohio (population of 6,000) does not provide a fair analysis.
Consequently, the reports now segregate classes of government into peer groups according to size or other demographic characteristics. For example, four groups were formed according to population on 1996 financial statements (less than 50,000; 50,000-99,999; 100,000 200,000; greater than 200,000). Average sizes ranged from 33,476 in the smallest group to 524,356 in the largest.
Exhibit 1 PER CAPITA AVERAGE REVENUE AND SPENDING FOR ALL MAJOR FUND CATEGORIES Population Revenue Spending Less than 50,000 $527 $522 50,000-99,999 $500 $504 100,000-200,000 $481 $468 Greater than 200,000 $557 $548
Some interesting factors were noted in comparing ratio averages among these four groups. Not surprisingly, the highest per capita average revenue and spending for governmental funds went to the counties with the largest populations ($557 revenue and $548 spending). However, the next highest per capita spending and revenues did not go to the 100,000-200,000 cohort or even to the cohort below that, but to the smallest population group. In fact, the lowest per capita spending and revenues went to the 100,000-200,000 group ($481 revenue and $468 spending). See Exhibit 1.
Exhibit 1 shows that it is just a little less expensive to deliver county services to sparsely populated areas than it is to Ohio's heaviest urban concentrations. A good example may be the delivery of human services. While urban counties may hold the greatest number of poor people, some rural counties may hold similar numbers of poor as a percentage of the population. Sparsely populated counties may also have less infrastructure to help coordinate services, such as developed mass transit systems, which can increase costs.
Perhaps the most innovative use of breaking up classes of government has been with Ohio's 611 school districts. They are presented in groupings according to eight district classifications developed by the Ohio Department of Education. Each class of district has specific demographic factors that link them together, from the largest inner-city districts to rural districts with high numbers of poor children to wealthy suburban districts. The organization of the 611 districts into smaller, more homogenous groups gives comparative information more meaning since the districts in each group share a similar set of characteristics.
Earlier this year a report was issued grouping together 76 districts with high agricultural independence, low-median, federal adjusted income, high percentage of Aid to Dependent Children monies, and low commercial valuation. Not surprisingly, the state averages vastly outpaced the group averages in almost every financial category. In 1996, the group average for expenditures per pupil was $4,806 while the state average was $5,545. Yet despite the financial disadvantages, in 1996 this group ranked only one percentage point below the state average for the ninth-grade proficiency test pass rate.
These school reports are crucial now because the state is grappling with an Ohio Supreme Court order declaring the state's system of funding primary and secondary education as unconstitutional. With these reports, policymakers have specific answers to questions for certain types of districts. Combining financial statement data with other demographic and educational performance indicators gathered by other state agencies into one package, can prove an invaluable reference tool in planning for the future of education in Ohio.
A package of suggestive trends and accurate comparisons on government finance are of little use unless they are presented in a clear and understandable format. Finance officers often do not have the time to wade through pages of information to gauge financial trends. Most desire a clear, concise, and accurate snapshot of their finances.
This need has been met through a collection of "snapshot profiles" contained in each report. These one-to-two page sections capture the most critical financial benchmarks and other information for each local government contained in the report. This information is presented through easy-to-read charts and graphs, so even a layperson can comprehend the information. See Exhibits 2 and 3.
Readers can view pie graphs to learn about local government revenue sources and expenditure categories. Profiles may contain bar graphs on financial indicators such as general and governmental fund revenues and expenditures per capita. Often, the graphs also will present peer group or state averages for certain benchmarks, as well as the percentage that an individual government varies from these averages. In the newer reports, the profiles contain the year-by-year trend analyses described earlier in this article.
Along with financial statement information, the school profiles contain critical educational and demographic statistics gathered by other state departments to give readers an overall view on district performance. Many of these statistics are presented in the form of historical trend profiles, including average property valuation per pupil, revenues and expenditures per pupil, average teacher salary, and passage rates for ninth-grade proficiency tests. The report on joint vocational school districts even contained follow-up statistics on whether graduates had related employment or continuing education. Because these profiles combine key fiscal and educational statistics in a concise package, they enable policymakers to better craft a financing solution for Ohio schools.
Scoring Fiscal Health
In its study of American cities, Money Magazine also developed a unique formula to compile 37 quality-of-life benchmarks into a composite score for each community in relation to its peer group. The Ohio Auditor's Office will soon introduce a technique allowing readers to calculate a composite score on the financial condition [TABULAR DATA FOR EXHIBIT 3 OMITTED] of a selected government (GAAP basis only). The formula is an adaptation of the "Ten-Point Test of Financial Condition" developed by Kenneth W. Brown.1
Exhibit 4 MEASURING FISCAL HEALTH Listed are the nine key ratios employed to help Ohio local governments develop a composite index of their financial condition. These ratios apply to governments that use Generally Accepted Accounting Principals (GAAP). Interpretations are included. Ratio Interpretation Total revenues/Population (enrollment) High ratio typically suggests adequate annual resources. Total General Fund revenues from local High ratio suggests sources/Total General Fund revenues government is not reliant on external governmental revenue sources. Operating expenditures (excluding A low ratio typically capital outlay)/Total expenditures suggests infrastructure is adequately maintained. Total revenues/Total expenditures High ratio notes that the government's revenue exceeded expenditures. Unreserved General Fund High ratio suggests balance/Total General Fund revenues resources are available to overcome a temporary revenue shortfall. Total General Fund cash and High ratio suggests investments/Total General adequate cash to pay short- Fund liabilities term obligations. Total General Fund liabilities/Total Low ratio suggests normal General Fund revenues flow of annual revenues can easily meet short-term obligations. Direct long-term debt/Population Low ratio suggests ability (enrollment) to repay general long-term debt. Debt service/Total revenues Low ratio suggests an ability to pay debt service requirements when due.
Nine ratios were adopted, some of which had already been employed in the reports (see Exhibit 4).
These test ratios explore four key areas of fiscal health.
* Revenues-A government's ability to fund its services through annual revenues.
* Expenditures-The way a government uses its revenue to provide services.
* Operating Position-The balance between revenues and the adequacy of liquid assets and reserves.
* Debt Structure-Short-term and long-term debt, including annual principal and interest payments.
Each ratio may suggest a financial trend. For example, in the revenue area, a high ratio of total revenue divided by population or enrollment suggests a government has adequate annual resources. A low ratio of debt service divided by total revenues suggests an ability to pay debt service requirements when they are due.
Our adaptation allows readers to easily assign the ratio under review in a scoring quartile. A number ranging from -1 to +2 is associated with each quartile. Once all the ratios are assigned to quartiles, the reader simply totals the associated numbers and arrives at the composite score. This score can then be compared against others in the peer group.
An Easily Adaptable Project
The benchmark series can be easily replicated by other state and local governments. This is all the more true as technology speeds the flow of information. The Ohio Auditor's Office has already received several requests for information since winning the award.
Despite their seeming complexity, the reports required little staff time. The most time-consuming task was gathering the necessary financial information from hard copy financial reports, ensuring it was uniform, and inputting it into a database. Once the database is established, generating the reports becomes somewhat routine.
The increasing use of standardized financial statement formats that can be submitted electronically makes the process even more efficient.
The most unique aspect of the program is the ability to continually refine the reports, such as the introduction of historical trend analyses. Different benchmarks that governments can use to measure performance will continue to be developed. One day the reports may evolve to reflect the cost per mile of paving a road or the direct expense to local governments of unfunded mandates. The potential for new benchmarks seems endless.
Again, one should not interpret these benchmark reports as a final conclusion on how a government is operating, rather as a solid base for beginning an analysis of finances. They could provide indicators that certain financial practices or conditions are foreshadowing fiscal distress. More important, their user-friendly format allows virtually anyone to attain a basic grasp on the most critical financial practices of local governments in comparison to similar peers.
1 Brown, Kenneth W. "Trends in Key Ratios Using the GFOA Financial Indicators Databases 1989-1993", Government Finance Review, December 1996.
JIM PETRO is the Ohio Auditor of State. The State Auditor has constitutional responsibility to oversee the financial condition of approximately 4,500 units of state and local government. The benchmark reports are easily accessible on the Ohio Auditor of State home page at http://www.auditor.ohio.gov/auditor/under the Ratio Analysis publication link, or call the Strategic Planning Department at 800/282-0370 for more information.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Fiscal Indicator Reports and Ratio Analysis: Benchmarking Ohio Municipalities and School Districts. Contributors: Petro, Jim - Author. Magazine title: Government Finance Review. Volume: 14. Issue: 5 Publication date: October 1998. Page number: 17+. © 1999 Government Finance Officers Association. COPYRIGHT 1998 Gale Group.
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