The term “municipal finance” incorporates a number of fiscal components, also called systems, that exist within a town government. These systems exist to determine how local funds are to be spent, to ensure that the funds are spent legally and in a manner consistent with the original intent, and to control the collection of revenues that pay for the services.
The principal components described below exist in one fashion or another in virtually every town in the Commonwealth. Some municipalities have more clearly defined and sophisticated systems, while in others they may be barely evident. The level and sophistication of the fiscal components need not be tied to the size of the community. It is important for each town to be able to define and develop financial systems appropriate to its own needs.
The most common and recognizable financial system is the budget process. The municipal budget is the means by which local officials and town meeting decide how and where available municipal funds shall be spent. In the most basic budget systems, forms requesting funds are completed annually by department heads and transmitted for review to the selectmen and finance committee. The finance committee must then report to the town meeting the committee’s recommended sums of money for each department’s appropriation. An appropriation is the town’s legally allocated sum of money for a given department, or for the municipality as a whole. Appropriations are determined annually for the following fiscal year, which is the 12-month period for which revenues are collected and spent for public purposes. In Massachusetts, the fiscal year runs from July 1 through the following June 30. Town meeting must vote to approve all appropriations for the upcoming fiscal year in advance of setting a tax rate. This collection of appropriations is referred to as the budget.
The budget process, however, is not simply the list of appropriations for a particular fiscal year. It is the entire set of steps by which the final product, the budget document is created and managed.
A good budget process includes six well- defined steps. The first is the planning step. As part of this step, communities should clearly define the time frame within which each subsequent step should be completed. A written calendar or time line distributed to all players involved will inform them of when their responsibilities are expected to be fulfilled.
A key element of the planning stage is developing revenue and expenditure estimates for the coming year so that local officials understand the financial parameters within which they must operate. It should be noted that large portions of a town’s budget are earmarked for fixed costs. The revenue estimates should be developed by the town’s financial officers and based on the following: actual revenue collections of the prior year; projections of current year ’s revenues based on year-to-date collections; and any known or proposed changes (e.g., rate or fee increases, overrides or debt exclusions) that could affect revenues in the coming fiscal year. On the expenditure side, estimates of fixed costs should also be prepared. These should include such items as debt service, insurance, contractual agreements and prior year deficits that must be raised (e.g., snow and ice, revenue and overlay deficits). The combined revenue and fixed cost estimates will give an indication of the amounts of discretionary funding available to finance operating budgets in the coming year.
Based on the amount available for operations, the selectmen and finance committee should jointly develop budgetary guidelines for departmental requests. This is the second step in the process. These guidelines should provide parameters to department heads that will help them prepare budgets that are compatible with the town’s financial goals. For example, such guidelines could state that budget requests are to be level funded (or increased or decreased by a certain amount or percentage) unless the department head can demonstrate that additional expenditures will ultimately reduce costs, enhance revenues or otherwise further the financial goals of the community.
Once guidelines have been established, the third step in the budget process is to distribute forms to the department heads so they can prepare their budget requests. A good budget request form will include space for narrative descriptions of specific projects covered under a budget request, as well as a description of how the spending plan relates to the overall goals and objectives of the town. A budget request should show a budget history including actual expenditures from the prior years, year-to-date and estimated year-end expenditures in the current year, and the departmental request for the ensuing year. It should also provide an estimate of any revenues that may be generated, as well as explicit justification for any new personnel or equipment. Presenting this information in a common format will provide reviewers with a meaningful starting point for budget analysis.
The fourth step in a good budget process is the review stage. Here the budget requests are reviewed against the town’s pre-established departmental guidelines. Budget requests are always reviewed by the finance committee, and should also be reviewed by the board of selectmen and the board’s professional administrator if there is one. As part of this step, department heads, boards or commissioners should be given an opportunity to explain their budget requests in hearings with the finance committee, selectmen or administrator.
Once reviewed, the fifth step in the process is for the finance committee to present the budget to town meeting. Town meeting, as the legislative body of a town, votes on the budget and has the final say on the level of departmental spending. After the budget is approved, the sixth and final step is to monitor the budget throughout the year. This involves reviewing expenditures to make sure they are consistent with the vote of the town meeting, making sure budgets are not overspent and monitoring receipts collected to date. Monitoring actual performance against the original budget can reveal problems early and give a town time to take corrective action and avoid potential deficits.
A good budget process is continuous. One cycle overlaps with the next cycle, year after year. The process starts in the early fall for the following fiscal year (e.g., September for the following fiscal year) with the planning step and the establishment of guidelines. Forms are often distributed to department heads in October or November and are returned to the finance committee, selectmen or administrator in November or December. The budgets are then reviewed in January and February, with final recommendations made in March or April for a spring town meeting.
A good budget process is not simply a mathematical task; it is the major policy- making tool for the town. The budget should clearly identify the town’s service priorities. It should explain not only how much money is to be spent for each service, but how that money will be used and how it will meet the goals and objectives of each department. Most importantly, such explanations should be provided in a way that makes sense to the average voter. The budget process is the foundation on which all the other elements of municipal finance are built.
The budget process just described is for operating expenditures for each fiscal year. However, every town must face some major costs that have a multi-year impact on the finances of the town. A capital item is usually something that has a high acquisition cost but also has an economic life of several years. Buildings, fire engines and dump trucks are common examples of capital items. Because of their expense and longer life, towns should plan carefully and schedule such acquisitions. A capital improvement program is a methodical process by which all the capital needs of the town are identified, prioritized and scheduled for acquisition. Obviously, the schedule must consider the ability of the town to afford such items. Most capital improvement programs plan for five or six years into the future and schedule the acquisition of capital items sequentially in order to be least disruptive to any given annual budget. The greatest value of capital planning is that it helps towns plan for their largest acquisitions in a sensible and prudent manner that considers all of the town’s capital needs, annual appropriations and debt service.
Debt management is the element of municipal finance that deals with the town’s need and ability to borrow money. In municipal finance there is long-term and short-term debt. Long-term debt is used for the acquisition of major pieces of capital equipment and facilities (e.g. dump trucks, fire engines, schools).
Towns must sometimes acquire a facility or piece of equipment that is so expensive it is preferable or necessary to pay for it over several years. Towns wishing to borrow money for extended periods of time issue bonds to investors. The bonds are repaid over time with interest. State laws regulate the purposes for which towns may borrow, and how long such loans may last. (See M.G.L. Ch. 44, Secs. 7 & 8.) Towns that borrow long-term must plan such indebtedness so they do not overextend themselves, yet can still provide needed capital items. Communities facing fiscal constraints may raise funds for certain capital purposes above the amount of their levy limit or levy ceiling through a debt or capital outlay expenditure exclusion.
Long-term debt is usually sold with the assistance of bond counsel and a financial advisor. It involves the preparation of a disclosure document, an application for a credit rating and, usually, a formal sealed competitive bidding process. However, for smaller amounts a town may also explore selling State House serial notes, which involves issuing debt certified by DOR’s Bureau of Accounts rather than a bank. State House notes are usually easier to issue than long- term bonds and typically have lower issuance costs.
The key to good debt management is to carefully identify the town’s capital needs and establish a prudent financing plan that repays the loans over the useful life of the item. In order to do this successfully, many towns have created capital improvement plans that span five or six years at a time. Like budgets, capital improvement plans must be updated continually
Short-term debt is usually issued for a period of less than one year, often in anticipation of a particular revenue source for the town. The most common form of short-term debt is tax anticipation notes or TANs. For example, since property tax collections are not received at the beginning of the fiscal year, some towns borrow money in anticipation of collecting property taxes. Other types of short-term debt relate to funds borrowed prior to the issuance of long-term debt (bond anticipation notes or BANs) or the receipt of a state or federal grant (grant anticipation notes or GANs). The borrowing provides funds to begin a project and is repaid when the long-term debt is issued or when grant funds are received. State House notes are often used for short-term borrowing.
Short-term debt can be managed by ensuing that the monies borrowed do not exceed the revenue source used as repayment. Short-term debt is best managed with the establishment of cash management practices, such as a cash-flow budget, in which the expected revenue and expenditure flow of the town is divided up on a monthly basis so that cash surpluses and deficits can be clearly identified. In addition, towns that issue tax bills on a quarterly basis tend to see a reduction in TAN borrowing and associated interest costs
Treasury operations involve the procedures by which money is collected, deposited into a bank, invested while held by the town and disbursed to fund the operations of town government. It is important that prudent procedures exist for each of these actions involving movement of the taxpayers’ money.
As is the case with all significant service contracts, banking services should be acquired through a competitive procurement process. Some towns pay banks for their services through fees charged by the bank. Other towns pay no fees but leave a certain balance of funds in a non-interest bearing account, letting the foregone interest income act as compensation to the bank. This latter form of payment is called a compensating balance. It is important for the town to estimate the cost of a compensating balance to ensure that the interest income lost is roughly equivalent to the fees that would otherwise be levied by the bank.
Since money has a time-related value, towns must manage their cash as efficiently as possible. The goals of cash management are to collect money due to the town as quickly as possible and to deposit and invest it as soon as possible in an instrument that is safe and produces maximum return. Disbursements should not be made any earlier than necessary so interest income can be maximized.
Timely financial reports are a valuable tool for monitoring the finances of a municipality. They provide information that shows how the community’s funds were collected and expended and allow the community to compare actual financial performance with the intentions and expectations of the government’s budget as originally voted.
A good accounting system is the basis for meaningful financial reports. The basic accounting system consists of a general ledger, general journal and detailed subsidiary ledgers for revenues and expenditures. It is very important that these records be maintained and kept up to date, because it is from these records that appropriations and revenues are monitored and various financial reports prepared. Some financial reports that are of interest to public officials include a balance sheet, Schedule A and audited financial statements.
A balance sheet is the report that shows a community’s financial position at the end of the fiscal year. It summarizes account balances of assets, liabilities, and fund equity and is used by DOR in calculating a community’s free cash.
The Schedule A is a statement of revenues, expenditures, fund balances and other financing sources and uses. This report, prepared at the end of the year for the recently past fiscal year, is sent to DOR, and its information is entered into the Municipal Data Bank. Information from the Schedule A is utilized by the Legislature, Federal Bureau of Census and local government officials interested in analyzing the scope of services provided and in making policy decisions.
Audited financial statements are a set of financial reports prepared by a community’s finance officials that are audited by an independent certified public accountant. The purpose of an audit is to determine whether or not a town’s financial statements present accurately the financial position of the community as of the balance sheet date, and the results of its operations for the year just ended. Some of the reports included in audited financial statements are: a combined balance sheet; a combined statement of revenues, expenditures and changes in fund balance; and a combined statement of revenues and expenditures (budgeted and actual).
There are national standards for such reports. The Governmental Accounting Standards Board (GASB) promulgates accounting standards that are accepted nationwide. In June 1999, GASB issued Statement No. 34, Basic Financial Statements — and Management’s Discussion and Analysis — for State and Local Governments. This statement, known more commonly as GASB 34, is considered by many to be a significant change in governmental accounting. The Commonwealth of Massachusetts has adopted many of these standards for its own Uniform Municipal Accounting System (UMAS). It is important that all financial reports be prepared in a standard format that facilitates greater and easier understanding of the reports by state and federal officials and others (e.g., banks and municipal bond buyers). It is likewise important that financial reports be prepared in a consistent manner and be available on a regular and a timely basis.
In addition to the financial reports that are required to be filed with the DOR, towns and school districts are required to file certain reports with the Department of Education. The principal report is the End of Year Pupil and Financial Report, which details prior year revenues and expenditures and contains current year budget spending. This report plays an important role in determining compliance with and the spending requirements of the Education Reform Act of 1993.
The town accountant should also prepare interim financial reports during the fiscal year. Interim financial reports allow local officials to compare their actual financial status to their projected financial situation (budget vs. actual, year-to-date revenues and expenditures). Interim financial reports are the principal means by which local officials can monitor an annual budget during the fiscal year. They provide information necessary to alert management to potential fiscal problems.
Another critical element of municipal finance is assessment administration. The single largest source of revenue for towns is the property tax, levied on local property according to values determined by the board of assessors. The assessing function is the process by which the value of property is determined for taxation purposes.
A considerable portion of municipal spending consists of the purchase of supplies and materials. As a result, the purchasing function is a key element in a community’s financial management system. The goal of the purchasing function is to ensure that quality goods and services are procured at the lowest possible price. The key elements of purchasing include: setting standards and specifications for the procurement of goods and services; soliciting quotations and analyzing them; awarding bids; receiving goods and services; and paying for purchases. Generally, the purchasing function is performed either on a centralized or decentralized basis, which is determined by the town’s chief procurement officer. Towns can also take advantage of bulk rate discounts available under blanket vendor contracts with the state. Blanket contracts allow purchasing agents to buy specific goods and services at a pre-determined price.
Decentralized purchasing occurs when each department of town government has the responsibility for procuring the goods and services authorized in its annual budget. Centralized purchasing occurs when the responsibility for purchasing for all departments is vested in one department known as the purchasing agent (often the accountant’s office in small towns). One of the primary advantages of centralized purchasing is that the purchasing agent can coordinate the purchase of goods among departments. For example, if three separate departments want to purchase copy paper, rather than soliciting three separate bids (as would occur on a decentralized basis), the purchasing agent can assemble one bulk order in an effort to realize volume discounts.
Another advantage of centralized purchasing is that it facilitates budgetary control. Any requests for the purchase of supplies and materials are submitted to the purchasing agent on a purchase order form. The purchasing agent can then make sure that a departmental request for particular goods or services is authorized by the budget and that sufficient funds are available for its purchase. While state law does not specify how a municipality must organize itself to conduct purchasing (i.e., centralized versus decentralized), it does contain certain requirements. Most purchases of goods and services are governed by M.G.L. Ch. 30B, the Uniform Procurement Code. The procurement code is administered and overseen by the Massachusetts Inspector General.