Financial Health Indicator Program

By JAY R. HEDGES, Director
Department of Commerce and Community Affairs

In last month's column, I mentioned our Department's Financial Health Indicator Program for municipalities. Since then, a number of local officials have inquired about the details of the program.

This is a very appropriate time to discuss the Financial Health Indicator Program. Local officials are faced with continuing financial challenges — including the possible loss of the Federal Revenue Sharing program and the increased cost of liability insurance.

During the late 1970's, both the International City Management Association (ICMA) and the Government Finance Officers Association (GFOA) developed procedures to help local officials monitor the financial health of their cities using a number of financial indicators. By tracking the financial indicators, local officials could analyze the financial condition of their local government over a five year period. Local officials could determine whether there had been an improvement or deterioration in their municipality's financial condition.

Based on the pioneering work of ICMA and GPOA, the Illinois Department of Commerce and Community Affairs also has developed a Financial Health Indicator Program. It is geared specifically to Illinois local governments. As part of this effort, our department has prepared a booklet entitled, Financial Health Analysis Handbook for Illinois Municipalities. The booklet describes a step-by-step process that municipal officials can use to analyse their local government's financial health — using 35 different financial health indicators.

Local governments throughout the state have used the Financial Health Indicator Program. The Handbook gives guidance to the local official — showing where to get information for each indicator and some thoughts on interpreting the results. Most of the information is readily available in a local government's recent annual audits. Our staff have helped many local governments conduct the financial health studies and are available to help you.

The advantage of a financial health analysis can be summed up in one word: "Awareness". One feature common to almost all governments that have experienced financial problems is that the officials failed to recognize either the cause or the seriousness of their problems in time to avert a fiscal crisis. A financial health study provides a number of benefits to local officials. It permits the local official to become fully aware of the complex factors that affect the financial condition of a municipality, to identify emerging or existing financial problems and to take appropriate action before the problems reach serious proportions, and to help evaluate the strengths and weaknesses of a government's financial position.

Of course, no single indicator by itself can show with certainty whether a government is financially strong or weak — but a series of indicators looked at together can provide some important insights into a municipality's financial stability. Financial indicators do not provide solutions. Rather, they raise questions to be answered which can provide an understanding of what is happening to the community.

Let me describe just a few of the indicators in our department's Financial Health Indicator Program. One is "Operating Revenues per Capita". This indicator combines a municipality's revenues from various funds and shows how revenues are changing in relation to population. Because revenue is adjusted for inflation and is measured on a per person basis, increases or decreases can clearly be seen. Declining operating revenues per capita (in constant dollars) is a warning signal. For example, if revenues per capita decreased from $200 to $175 over a five year period, this may indicate that the government is losing its ability to finance existing levels of service and may need to look for other sources of revenue. A drop in revenues per capita may result from many factors including population shifts, sagging retail sales, a decline in property values or an

June 1986 / Illinois Municipal Review / Page 19

overall decline in the area's local economy. Growth in revenues per capita may be attributed to growth in commercial or industrial sectors or major annexations.

Another indicator is "Local Taxes per Capita". This indicator measures the burden of local taxes on community residents to support the municipality. An increasing amount of local taxes per capita can be a warning signal. Local taxes include property taxes, sales tax, vehicle license tax, utility tax, permits, foreign fire insurance tax, etc. Increases in this indicator may affect the ability of the local government to retain or attract commercial and industrial businesses to the community.

The "Intergovernmental Revenues" indicator is particularly revealing as to a municipality's dependence on revenue from other governments. Federal revenue sharing, state income tax, motor fuel tax, and personal property replacement tax are examples of intergovernmental revenues. An increasing amount of intergovernmental revenues as a percentage of total local revenues is a warning signal to a government that it may be overly dependent upon other governments for its financial stability. This can be a serious problem if the providing government chooses to eliminate the program — such as the case with the Federal Revenue Sharing program.

In addition to these indicators, there are five other indicators that focus on revenues: Restricted Revenues, Uncollected Property Taxes, Elastic Revenues, Property Tax Rates Approaching Legal Ceilings (non home rule only), and One-Time Revenues. These revenue indicators taken as a whole are important to review because a local government's capacity to provide service ultimately depends on its ability to raise revenues. Ideally, revenues should be growing fast enough to offset the effect of inflation on the government's purchasing power. Also, a government's revenue structure should be diversified and not overly dependent on a few major sources.

Our Financial Health Indicator Program also has a series of expenditure indicators. One is "Operating Expenditures per Capita". This indicator is computed by totaling the expenditures in a number of funds, adjusting the data for inflation, and then dividing the amount by the population of the municipality. The indicator shows how expenditures are changing relative to changes in population and also tells if expenditures are growing faster than inflation. An increasing level of operating expenditures per capita can be a warning signal that a government cannot long ignore.

Another important expenditure indicator is "Employees Per 1000 Population". Increases in this area may mean that productivity is declining — or service levels are increasing. Personnel costs represent more than two-thirds of a typical local government's budget. Thus, it is important to determine if the number of employees is growing in relation to the population served. Other expenditure indicators include: Fixed Costs, Personnel Costs, Level of Equipment Expenditures, and Fringe Benefit Costs.

Our Financial Health Indicator Program has additional indicators. Some relate to a local government's operating position. For example, the "Operating Fund Deficit" indicator measures deficits or declining operating surpluses as a percent of operating revenues. An operating deficit occurs when current revenues are insufficient to meet current expenditures. This situation may occur when anticipated revenues may have been delayed, an emergency outlay was required, or the government anticipated using surpluses accumulated from prior years. An operating deficit in any one year may not be cause for concern. Frequent and growing deficits over several years, however, can indicate that current revenues are not supporting current expenditures, and serious problems may result if steps are not taken to correct the problem.

Space does not permit a review of all of the indicators here. However, the Financial Health Analysis Handbook for Illinois Municipalities, which describes the indicators in detail, can be obtained by calling our toll-free local government telephone number, 1-800-562-4688.

To simplify the computations of the indicators, the program also is now available to run on a Lotus 1-2-3 electronic spreadsheet. It requires an IBM compatible personal computer. To obtain a copy of the Financial Health Indicator template, send two blank discs to DCCA, 620 East Adams, 5th floor, Springfield, Illinois 62701.

If we can help you in this important area, just let us know. •

Page 20 / Illinois Municipal Review / June 1986