Focus on Finance - Summer 2017
Key Financial Indicators – What is right for you?
Your Council has Key Financial Indicator targets but are they really right for your Council?
The LGA ‘Financial Sustainability’ Information Paper No. 9: Financial Indicators – Revised May 2015) suggest the following targets:
- Operating Surplus Ratio - average over time of between 0% and 10%
- Net Financial Liabilities Ratio - between 0 and 100%, possibly higher in some circumstances
- Asset Sustainability Ratio - greater than 90% but less than 110% of the level proposed in the Infrastructure and Asset Management Plan (I&).
As your Council starts to prepare for the 2017/18 Annual Business Plans and Budgets it is timely to consider these indicators and what is right for your Council both now and into the future.
Operating Surplus Ratio: If a Council had operating revenue of $30m and operating expenditure of $28.5m leaving a surplus of $1.5m, they would have an Operating Surplus Ratio of 5%. If this was their target and they aimed for this each year, then over 10 years their surplus will accumulate to $15m (ignoring inflation factors).
If the Council has not set this target in order to fund special strategic projects, asset requirements or debt reduction, their ratepayers may be wondering what all this money is for and why rates increase each year. In this case the ratio appears to be set too high.
If the Council has an issue in one or a couple of years (maybe flooding) which results in a deficit, they would be working outside of the target for that time although the average might be ok, and they appear to have spare cash from other profit years which enable them to cope.
This issue highlights the need to consider the ratio over a period of time rather than one single year. The LGA suggested target indicates an average over time and perhaps that average should be set over 10 years and clearly correlate with Council’s Long Term Financial Plan.
Net Financial Liabilities (NFL) Ratio: The average NFL ratio for Councils in South Australia in 2015 (Grants Commission Database) was 18%, with the highest being 103% and the lowest being (159%).
A Council may have a temporary issue that lasts for a few years only, such as a large infrastructure project and that activity may push their debt ratio above the target for this period but the average over time is within targets. If a Council only sets a target for a single year they might decide not to do a project that pushes them outside their target. If they set their target as an average over the term of the LTFP then they can more easily see if a project is affordable for them.
There are also different types of debt. It can be argued that debt for a Council business that generates income is different to debt that doesn’t bring in any corresponding income. For Councils in rural areas that can mean their Community Wastewater Management Systems. Ratepayers with access to these systems pay charges so that the expenditure is offset by the income. Perhaps a different liabilities ratio should be set for this type of debt, compared to debt for infrastructure that doesn’t correlate with additional income, such as roads.
Asset Sustainability Ratio: Is your Council financing it’s I&? There may be years where emergency asset spending due to unplanned events such as flooding or fires requires a different level of asset expenditure which may not be within targets set. So if Council sets its ratio at 100%, there will be some years that it may be higher and some lower. The range that is suggested by the LGA paper works better but considering the ratio over a longer term will make more sense and allow for unforeseen temporary events.
Altogether now: The ratios should be considered together. An ongoing large surplus for a Council that has little debt and is funding all of its I& requirements doesn’t make sense. This is also true for a Council that is consistently achieving a deficit but has large levels of debt and isn’t funding its I&A requirements.
Align Council’s budgets with Long Term goals: Consider Council’s long term situation, set targets that work for your Council before considering the next year’s budget.
UHY Haines Norton