Indra Nooyi, CEO of PepsiCo, once said that you can either run an organization for your duration or you can strive to run it for the organization’s duration. The latter simply alludes to a strategic mindset to understand the implications of your actions in the future and preparedness towards future contingencies.
After some of the well-known bankruptcies of U.S. municipalities, including Detroit and Stockton, more and more local governments are breaking the monotony of simply following their revenue and expenditures and turning toward building a sustainable framework of long-range financial strategy to make budget decisions over future budget cycles.
In this article, we will take a closer look at understanding the need for long-range financial plans (L-RFPs) for local governments and how they can bring sustainable growth.
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What Is an L-RFP?
An L-RFP serves as a strategic framework which local governments can use to improve understanding of their financial situation, evaluate the impacts of budgetary decisions and gain insights about costs associated with planning, policy, strategies, services and local government operations. In conjunction with the budget process, an L-RFP can help a local government forecast potential financial shortfalls in the future and build contingency plans.
Let us consider the example of the City of Calgary to highlight the need for a long-range financial plan. The L-RFP identifies systemic issues that have placed considerable pressure on the organization’s ability to provide services in a financially sustainable manner. Calgary’s current L-RFP estimates that the city will face significant annual operating and capital budget funding shortfalls in the next decade, which cannot be addressed through projected levels of existing revenue sources. Without action to address these issues, the city will become increasingly challenged to fulfill its municipal mandate and provide the services and infrastructure that citizens expect and value. Calgary’s city council also expressed its concerns by recognizing that the status quo is not a viable option and that existing principles and practices governing municipal finance must change for Calgary to maintain its current financial position.
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Guiding Mechanisms of an L-RFP
Local governments often face challenges to meet a wide range of community needs and wants while adhering to fixed budgeted revenues in the form of taxes. In addition, these challenges often meet with ongoing debates over what services and levels of these services are really needed by the community and what revenue sources can be pledged to provide these services.
Here are some of the key guiding philosophies of an L-RFP for a local government and its constituents.
- Link between revenues and services provided: A long-range financial plan serves as a financial framework; it’s imperative for city or county executives to effectively communicate the tax revenues and the services provided to the communities.
- Service priorities: Elected officials and the executive/leadership staff of any local government must build financial planning towards service priorities to meet the larger needs and expectations of the community.
- Long-term impacts of expenditure commitments: As mentioned above, you can either run an organization for your duration, or you can run it for the organization’s duration. It’s imperative to forecast and properly understand the financial detriment before deciding on any expenditure commitments. The financial planning process involves considering and addressing the social, economic and environmental impacts of all decisions.
L-RFP: Sustainability Objectives and Financial Preparedness
A well-constructed L-RFP in conjunction with budget documents can encourage progress toward an organization’s long-term financial goal of sustainability. A local government must have clear understanding of its financial objectives to ensure financial sustainability.
For instance, here are the typical financial objectives highlighted in the State of New York’s multi-year financial plan that can be supported with a long-range financial plan for every local government:
- Revenue and Expenditure Projections: This demonstrates trends in existing revenue streams to illustrate the level of available resources given current policy and projected economic assumptions. In addition, expenditure projections estimate the future costs of current services including any projected or budgeted increases or inflation. Revenue projections can be done in the aggregate by major revenue type, or they can be very detailed to show variations in individual revenues, where expenditure projections are based on the service level, program level or a combination of both.
- Annual Surpluses or Deficits: Through the annual budget process, local governments determine their projected revenues and expenditures; however, if those numbers are off throughout the yearly tracking, an L-RFP can highlight budget imbalances that can often widen in future years.
- Fund Balance or Reserve Fund Balance: In addition to the operating budget, the reserve fund balances reflect the reserves available to municipalities to help endure short-run fiscal pressures such as revenue shortfalls or unanticipated expenditures. These balances can be kept in either dedicated or general form.
- Fiscal Improvement Plan (FIP): This part of the plan identifies goals to improve the long-term fiscal condition of the local government, specifies the local actions necessary to achieve those goals and defines performance measures that will help measure progress.
In addition, an implementation of a planning document like an L-RFP is looked at quite favorably by many credit rating agencies and other agencies involved in evaluating the ability of any local government to repay future debt obligations.
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Implications for Muni Investors
Strategic financial planning through an L-RFP or other measures for municipal governments can send a strong message to municipal debt investors and others about the municipality’s financial preparedness. If an investor is comparing two different municipal debt issuers for his or her potential purchase of municipal debt, given financial indicators being equal, an L-RFP document can highlight the proactive approach of top management and long-term commitment towards their institution.
As mentioned before, these strategic tools add significant value for rating agencies and their assessment of various debt issues by any given local government, as it forecasts the contingencies and whether or not a local government is prepared for them.
The Bottom Line
The financial crisis in 2008 serves as a great testament for many local governments which created huge financial deficits for some and brought them to the verge of financial insolvency. The L-RFP provides a projection of operating and capital requirements for a local government and a statement of financial position over a set number of years in the future. It also presents the key financial strategies that will influence the building of a more sustainable long-term financial future.
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Disclaimer: The opinions and statements expressed in this article are for informational purposes only and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication and are subject to change without notice. Information has been derived from sources deemed to be reliable, the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professionals and advisors prior to making any investment decisions.