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Fund Balance Financial Management and VERF PoliciesFund Balance, Financial Management & VERF Policies Presentation Overview •Quick Recap of staff recommendation from May 20th Finance Committee Meeting regarding Long-Term Financial Management, Debt Management Policy and Post Debt Issuance Policy. •GAAP vs. GFOA Best Practices and Advisories •Fund Balance Policy •Financial Management Policy •Role of Long-Term Financial and Tax Rate Management •Annual Audit •Budget •Contingent Budget Policy •Capital Planning •VERF •Staff Recommendations •Budget Preview •Is a Future Meeting Review red-line versions of existing financial policies needed? 2 Key Recommendations From Previous Meeting •Plan for a long-term holistic financial approach for managing the Town’s rapid growth that: •Manages debt levels and the debt service tax rate within new policy limits of outstanding debt not exceeding 4% of AV or debt service tax rate exceeding 40% of total rate. •Use unused increment to maintain M & O rate at current level •Gradually increase the Homestead exemption to provide taxpayer relief while also protecting the M & O rate. •Splits M & O tax rate between that needed now for General Fund and that needed to manage debt levels and to fund future staff increases after growth plateaus with out a rate increase. New Levy can be named Capital Dedicated/Future Facility Staffing. •Employ “Just in Time” debt issuance to reduce negative arbitrage and overall debt levels. 3 GAAP vs. GFOA Best Practices •Generally Accepted Accounting Principles (GAAP) are promulgated by the Governmental Accounting Standards Board (GASB) •Purpose of nation-wide GAAP is to provide objective, comparable, consistent and understandable financial statements. •While good reporting often leads to good management, GAAP does not attempt to recommend how a government should manage its finances. •Due to GAAP’s complexity, governments report on a GAAP basis only at year end (one day a year) with budget basis used the rest of the year •Government Finance Officers Association (GFOA) promotes sound financial management through Best Practices and Advisories including: 4 GAAP vs. GFOA Best Practices •Audit Committees •Audit Procurement •Adopting Financial Policies •Achieving Structurally Balanced Budget •Fund Balance Guidelines for the General Fund •Working Capital Targets for Enterprise Funds •Strategies for Establishing Capital Asset Renewal and Replacement Reserve Policies •GFOA Best Practices are generally more suitable for incorporating into financial policies than GAAP and many of the concepts described in these policies and others have already been incorporated in Town policies 5 Fund Balance Policy •Current Fund Balance policy makes extensive reference to GAAP including fund balance categories that are not part of the policy guidelines •Requirement of charter mandated reserve of 20% plus 5% unassigned fund balance •GFOA Best Practice states: •In establishing a policy governing the level of unrestricted fund balance in the general fund, a government should consider a variety of factors, including: •The predictability of its revenues and the volatility of its expenditures (i.e., higher levels of unrestricted fund balance may be needed if significant revenue sources are subject to unpredictable fluctuations or if operating expenditures are highly volatile); •Its perceived exposure to significant one-time outlays (e.g., disasters, immediate capital needs, state budget cuts); •The potential drain upon general fund resources from other funds, as well as, the availability of resources in other funds; •The potential impact on the entity’s bond ratings and the corresponding increased cost of borrowed funds; •Commitments and assignments (i.e., governments may wish to maintain higher levels of unrestricted fund balance to compensate for any portion of unrestricted fund balance already committed or assigned by the government for a specific purpose).Governments may deem it appropriate to exclude from consideration resources that have been committed or assigned to some other purpose and focus on unassigned fund balance, rather than on unrestricted fund balance. 6 Fund Balance Policy •For self supporting enterprise funds, GFOA recommends adoption of a working capital policy that considers: •Strength of collection practices. •Transfers out. •Customer concentration. •Volatility of demand for services. •Control over rates and revenues. •Control over expenses. •Asset age and condition. •Debt position. 7 Financial Management Policy-Tax Rate •Role of Long-Term Financial and Tax Rate Management •Rapid growth produces the following pressures: •High debt levels to address pressing infrastructure and facility needs •Disconnect (often many years) between when revenue growth occurs and when the related operating expenditures hit the budget (1/10th of a fire station or library example) •Combined with inflexibility of General Fund revenues •Four largest revenues, property & sales tax, franchise fees and building permits are 92.4% of revenues •Sales tax (21.7%) is volatile, dependent on economy and vulnerable to large tax payers leaving •Franchise fees 5.4%) are a 20th century revenue competing in a 21st century world (i.e. land lines, cable TV) •Building permits at 13.6% will naturally decline as growth plateaus •Property tax at 51.7% is the largest, most stable and the only revenue the Town has substantial ability to manage from a long-term perspective •Senate Bill 2 provisions, however, makes it difficult to raise the M & O rate quickly without forcing a mandatory election •Planning and setting aside resources now for operating impacts ten years from now offers multiple advantages that are best accomplished through a comprehensive tax rate management policy 8 Financial Management Policy-Tax Rate •Goals for Tax Rate Management •Stable and reasonable total tax rate over time and at build-out •Appropriate balance between O & M and Debt Service components •Ability to add future facilities that have significant operating impact without the need to raise the tax rate •Ability to manage debt levels to avoid negative rating impact while accomplishing capital program and as Town matures and reaches build out, positioning Town for an upgrade •Ability to withstand a recession without overly drastic measures 9 Financial Management Policy-Tax Rate •General Approach to Tax Rate Management •Create category of O & M levy entitled Capital Dedicated/Future Facility Staffing •Record the revenue each year directly in capital projects to make it clear it those resources are not currently available to fund operations •In the interim use levy to reduce total amount of debt needed to be issued •Long-Term can be shifted back to GF to fund staff for new facilities •Protect the O & M Rate using unused increment, gradually raising Homestead Exemption and even raising the rate when allowed by SB 2 by shifting Debt Service tax rate to O & M. •Given voter’s approval of bond election when told it could result in a seven cent tax increase, be willing to raise the DS rate by one or two cents •Let total rate increase by the DS rate increase •60/40 ratio will be a natural limit on how much of an increase •Tie to a year of big debt issuance for a major and popular project and get dirt flying immediately 10 Financial Management Policy-Audit •Governmental Accounting & Auditing is complex •Accounting is different •Lack of a profit motive •Large annual surplus ≠ good, large deficit ≠ bad •Assets that behave suspiciously like liabilities •Heavy emphasis on legal and regulatory compliance including legally adopted budget •Diversity of operations each with different objectives (we are a business of businesses) •Auditing is just as different •Auditor must be able to demonstrate their commitment to SLG practice •Membership in AICPA’s Government Audit Quality Center (GAQC) •Minimum average of 10 local government audits and single audits for last five years •Auditor should be selected by Town Council not staff (GFOA Best Practice recommendation) •Budget & Actual should be part of the basic financial statements and therefore audited (currently it is reported as a schedule in RSI and is not part of the audit opinion) 11 Financial Management-Budget •Definition of Balanced Budget needs refining •Simply defines a balanced budget as: •“Estimated expenditures will not exceed proposed revenue plus undesignated fund balance from the previous fiscal year” •Does not distinguish between recurring revenues and expenditures and non- recurring creating the potential for a structurally unbalanced budget and “budget hangovers” •Example: In Year 1 the Town adopts a budget of $36 million in recurring revenue and $40 million of recurring expenditures with an addition $2 million of one time purchases drawing down surplus fund balance. Current policy considers this a “balanced budget”. In Year 2, even though revenues grew 10% the Town is required to cut recurring expenditures as excess fund balance has been depleted. There are no funds available for non-recurring purchases. 12 Financial Management-Budget Example Year 1 Year 2 Recurring Revenues $36,000,000 $39,600,000 Recurring Expenditures (40,000,000)(39,875,000) Sub-Total (4,000,000)(275,000) One-Time Source-Fund Balance 6,000,000 275,000 One-Time Use-Equipment Purchase (2,000,000) Budget Surplus (Deficit)0 0 Fund Balance-Beginning 16,250,000 10,250,000 Fund Balance-Ending 10,250,000 9,975,000 Ending Fund Balance as % of Expenditures 25%25.02% 13 2022 General Fund Summary 14 No differentiation between recurring and non-recurring. We actually show that we adopted a deficit budget when on a recurring basis, we had a $2.2 million surplus For the next two years, we actually project expenditures going down due to the difficulty of projecting future non- recurring Financial Management-Budget •Current policy and reporting formats do not inform council regarding structural imbalance or if issues have been passed to next year. •Budget hangovers can also be created through budgeting of new positions mid-year so that only half of the annual recurring impact is shown in the current year but the full impact must be absorbed in the following year. •In a rapidly growing municipality that is adding new facilities and personnel every year, budget hangovers must be managed and planned for. •Current multi-year planning years show expenditures going down in the next year as the non-recurring is removed making it difficult to assess future impacts 15 Contingent Budget Policy •Economic downturns including recessions are inevitable even in a rapidly growing community. •As the second largest state economy and one of the fastest growing economies of any state, Texas benefits from significant in-migration and generally fares better than many other regions making most recessions a “pause” rather than a “stop”. •The dynamic economy in DFW and Prosper’s enviable location in the growth path support this conclusion. •However, with high debt levels and a staff and community that are used to adding a significant number of new positions each year to improve services, even a “pause” must be carefully managed 16 Contingent Budget Policy •Contingent budget policy should: •Reinforce commitment to a structurally balanced budget •Emphasize that budget balancing techniques should not sacrifice ability to accomplish long-term goals such as: •Moving capital dedicated tax levy back to the GF to avoid making cuts •Deferring maintenance resulting in the need for larger expenditures in future years •Consider pausing debt issuance if issuance would add significantly to needed DS tax rate •Consider re-prioritizing projects so that the only debt issued will not be for projects with operating impacts •If growth on existing base allows the M & O rate to be increased and there is excess DS rate consider transferring rate to M & O with no impact to total rate 17 Capital Planning •Five year capital plan is comprehensive will be reviewed for possible summary sheets by major asset category and funding sources •No policy changes recommended. 18 Vehicle Equipment and Replacement Fund •VERF smooths budget impact for purchases of existing equipment by funding the purchase over the equipment’s useful life. •This approach also provides a more accurate reflection of the true annual cost of providing a particular service. •VERF is consistent with GFOA Best Practice •No recommended changes to the existing policy 19 Staff Recommendations •Fund Balance •Reduce references to GAAP and simply state “Unassigned Fund Balance” as defined in GASB 54. •Mention GFOA Best Practices for both General Fund and Enterprise Funds and state that staff should annually review the adequacy of Fund Balance targets during budget process using the criteria described in the Best Practices. •Audit •Require auditor to have local government expertise by: •Being a member of the AICPA Government Audit Quality Center •Having at least ten local government audit and single audit clients •Emphasize that auditor is interviewed and selected by the Finance Committee and approved by council •That the General Fund Budget and Actual Statement will be included as a Basic Financial Statements and included in the audit opinion 20 Staff Recommendations •Financial Management-Tax Rate •Create category of O & M levy entitled Capital Dedicated/Future Facility Staffing •Protect the O & M Rate using unused increment, gradually raising Homestead Exemption and even raising the rate when allowed by SB 2 by shifting Debt Service tax rate to O & M. •Given the difficulty in increasing the O & M rate, consideration should be given to raising the DS rate (provided it still complies with 40% cap) rather than transferring rate from M & O •Financial Management-Budget •Require budgetary reporting to distinguish between recurring and non-recurring revenues and expenditures. •Require recurring expenditures to be balanced to recurring revenues •Require total expenditures and transfers to be limited to total revenues, one-time sources and excess fund balance. •Revise multi-year presentation so that it clearly shows the recurring expenditure growth pressure in future years. 21 Staff Recommendations •Contingent Budget Policy •State commitment to a structurally balanced budget •Budget balancing techniques should not sacrifice ability to accomplish long- term goals such as: •Consider pausing debt issuance if issuance would add significantly to needed DS tax rate •Consider re-prioritizing projects so that the only debt issued will not be for projects with operating impacts •If growth on existing base allows the M & O rate to be increased and there is excess DS rate consider transferring rate to M & O with no impact to total rate •Capital Planning-No recommended changes. •VERF-No recommended changes 22 FY 2023 Budget Preview •Reporting Changes •Separation of Recurring and non-recurring Revenues and Expenses •Solid Waste Fund-new Fund for both budget and reporting •Begin tracking and reporting to Council the impact of economic incentives expressing as a tax rate equivalent for property taxes and as a percent of General Fund Sales tax •Also build into future revenue projections the years those incentives will expire •TIRZ incentives will continue to be recorded in the TIRZ fund with tax equivalents being provided •Five Year Staffing Plan •Start with Prosper 2027 •Population projection including number of single-family and multi-family units •Town projects completed by year that could impact staffing needs •Post 2027 Town projects that will have significant staffing impacts •Obtain council buy-in on assumptions •Provide departments benchmarking information on area cities •Identify departmental inter-dependencies (i.e. IT staffing heavily dependent on type and number of new staff and facilities) 23