Financial policies – why should you bother?

The need for well-designed financial policies continues to play an important role in the overall financial strength of an organization. While the creation of a new policy is time-consuming, the good news is that a well-written financial policy can offer a multitude of ongoing benefits. Does your organization have these financial policies in place?  

• Budgeting
• Capital assets
• Debt management
• Cash and investments
• Fund balance

If so, when was the last time they were updated? If not, why not?

While each policy has potential benefits and potential drawbacks, one common benefit is the ability to identify and capitalize on resource allocation decisions. In addition, setting policy provides management with the guardrails within which to manage and the governing body a framework in which to govern. A potential drawback is the perception/reality that management and the governing body will have decreased flexibility in addressing the organization’s financial affairs. However, to address this, policies can be written with the appropriate level of flexibility to allow governments to realize the benefits without experiencing the associated downsides. 

We recommend considering the following when creating and adopting financial policies: 1) review/create policies annually during the budget process; 2) build transparency into the process, and; 3) adjust the policies as needed based on the future goals and needs of the government. 

Debt policy

One of the more common financial policies is a debt policy. A properly drafted debt policy can assist governments through the life cycle of debt, beginning with the debt limit, continuing through the debt issuance and debt structuring, and concluding with debt management practices. The Government Finance Officers Association (GFOA) has published recommendations to aid governments when adopting a debt policy: ensure the policy is a comprehensive, written policy that has been formally adopted by the governing body, confirm the policy is reviewed periodically, and guarantee the policy reflects the local, state, and federal laws and regulations that the government must follow. A growing trend with the adoption of a debt policy is the relationship and integration between a government’s long-term capital improvement plan and their debt policy. The debt policy can complement the long-term capital improvement plan by addressing the government’s long-term financial considerations and strategies to fund the capital improvement plans.

Fund balance policy

Another common financial policy is a fund balance policy. Fund balance policies assist governments in assessing their financial strength and aids in long-term financial planning. There are five categories of fund balance: nonspendable, restricted, committed, assigned, and unassigned. While not all categories need to be utilized annually for every government, adopting a policy that addresses all five categories assists the governing body and management in their decision making. Following a policy that addresses all five categories can assist a government in monitoring fund balance to ensure balances are maintained at the appropriate levels. While each government’s situation is different, the GFOA recommends a balance in the unrestricted fund balance to be at least two months of either regular general fund operating revenue or regular general fund operating expenditures (whichever is more predictable.) The appropriate level of fund balance depends on numerous factors, many of which are unique to a particular government. Another important aspect to a fund balance policy is the source of replenishment when this is necessitated by economic downturns and/or unanticipated expenditures. The government leaders need to identify real and potential sources for fund balance replenishment as well as a realistic timeline.

Budget policy

Last, a third policy type that is commonly adopted is a budget policy. While budget policies can be as detailed or as broad as the government prefers, keep in mind a few best practices when drafting and adopting a budget policy. A budget policy should:

1. Incorporate a long-term perspective
2. Establish linkages to broad organizational goals
3. Focus budget decisions on results and outcomes

When creating a budget policy, the government can also address the issue of a balanced budget versus a structurally balanced budget. A structurally balanced budget provides a more comprehensive view by focusing on recurring revenues and expenditures, and on the establishment of appropriate reserves.

Overall

Formally adopting financial policies for governments is tremendously important. If written and implemented correctly, financial policies can aid government leaders in decision making and help strengthen the financial health of the government.  

For more information on this topic, or to learn how Baker Tilly state and local government specialists can help, contact our team.