Deb Wagner – BOA Springfield Office Supervisor
Tony Rassias - BOA Deputy Director of Accounts
Will this be another banner year for city and town certified free cash, continuing a trend that has exceeded the $1 billion mark each of the last four fiscal years? At this point, it appears that will be the case.
As of close of business on Monday, December 12th, 2016, certified free cash for 243 communities has increased $131.3 million (15%) compared to the prior year’s certification for that same group.
The graph below shows total overall certifications doubling from July 1st, 2009 to July 1st, 2016. Should this trend continue, last fiscal year’s record for free cash will likely again be broken.
However, this isn’t the whole story. A review of the last several free cash certification cycles for all communities reveals that not every entity has experienced an increase in its free cash certification.
This article will provide advice and guidance to those cities and towns where free cash certification has decreased, (see graph below) particularly where it has decreased for two certifications in a row. It will also be helpful to municipalities where certification is in the negative and any community that just wants to improve its free cash position.
What is Free Cash?
Free cash is a term believed to be first used in a 1923 letter from the Commissioner of the Department of Corporations and Taxation (now known as the Commissioner of Revenue) to Boards of Assessors. At that time, surplus funds available for appropriation were considered as unappropriated cash on hand. In that letter, the Commissioner referred to this cash as “free”, and the label “free cash” stuck.
Today, 93 years later, the idea of unappropriated cash available for appropriation remains about the same, although its calculation methodology and supporting documentation are somewhat different.
7 Rules for Using Free Cash
It must first be certified by the Bureau of Accounts from the community’s balance sheet accompanied by certain supporting documents as detailed in the Director of Accounts’ annual letter to accountants and auditors.
To be spent, it must be appropriated by the community’s legislative body applying the usual process for appropriating funds.
The certification is only effective from the date certified until the following June 30, after which any certified balance remaining cannot be appropriated until the amount is certified by the Bureau from the community’s next balance sheet submission.
It may be appropriated in particular for any lawful purpose or in general as an amount to reduce the tax rate, thereby releasing it as revenue applied against the entire omnibus budget.
It cannot be appropriated to an amount greater than the amount certified.
Upon request by the community’s accounting officer, the certification as of July 1 may be updated once during the fiscal year by receipts attributable principally to prior fiscal year property taxes, net of refunds, collected in the current fiscal year between July 1 and March 30. Receipts may also include non-recurrent distributions. An update will not be certified if, in the opinion of the Director of Accounts, the update could result in a negative certification as of the following June 30, and no similar update may be requested for the following fiscal year if an update is certified and a negative certification results.
Be very careful if appropriating it for anything other than one-time expenses or uses, such as capital expenses to paying down unfunded pension and OPEB liabilities. Since free cash is not a guaranteed revenue source, it shouldn’t be used to balance the operating budget. Using it to support ongoing expenses can lead to serious structural budget deficits. Also, replenishment must be planned for during the budget process and supported by strong property tax collections. Appropriating it for ordinary operating purposes could result in continued expenses the following fiscal year, with insufficient revenue to fund them.
On Rebuilding or Improving Free Cash
Credit rating agencies look for healthy reserves. Free cash is certainly one such reserve they focus upon to assess a community’s overall fiscal health and its ability to honor its debt obligations. Here are the building blocks of free cash and some tips on how to rebuild or improve free cash position.
Not Using it All - Don’t appropriate the entire certification in the first place. Some communities do; many do not. For certifications as of July 1, 2014, the median average free cash appropriated was 87% of the amount certified. For those that appropriate it all, pay attention to the tips below because your community’s free cash must be entirely rebuilt. For those communities that don’t appropriate it all, what goes unappropriated in one fiscal year becomes a building block for the next fiscal year’s certification.
Strong Tax Collection Procedures - For most communities, the property tax is the largest revenue source. Receivables are not included in free cash until they’ve been collected. Poor collections will affect a free cash position, which could result in a cash shortfall requiring temporary borrowing along with an unplanned payment of interest and other associated borrowing costs.
Conservative Estimated Receipts - State cherry sheet aid must be budgeted in full, but other locally generated receipts (a.k.a. “local estimated receipts”) need to be conservatively budgeted for the upcoming fiscal year. Of course, all else being equal, one should keep in mind that with a greater budgeted estimate comes a greater appropriation for goods and services and with a lesser budgeted estimate, a lesser appropriation for goods and services.
So is the local focus to rebuild/improve free cash or to increase current spending?
“Turn backs” - Return unnecessary or unexpended general fund appropriations (a.k.a. “turn backs”) to fund balance which becomes another building block for the next fiscal year’s certification.
Curing Capital Projects Deficits - Capital projects funded during the fiscal year using the provisions of MGL c. 44, sec. 20A (internal or interfund borrowing) must repay the funds borrowed by June 30. If any capital project is estimated to be in deficit as of June 30, external borrowing is necessary on a temporary or permanent basis to cure the deficit by June 30 or free cash is reduced by the deficit. Project reimbursements to offset the deficit are credited up through September 30.
Curing Grant Deficits - Apply for grant reimbursements timely. Similar to the rule for capital projects noted above and to escape a free cash reduction, deficit balances in grants funded using the provisions of internal borrowing must be cured by either borrowing in anticipation of the grant reimbursement by June 30 or by actual reimbursement by September 30. For Chapter 90 highway apportionments, borrowing for, receipt of or application for reimbursement is allowed by September 30. Borrowing in anticipation of a grant reimbursement, MGL c. 44, sec. 6A, is only allowed when the municipality may incur debt for five years or longer for the grant’s underlying purpose.
Communities should adopt policies on generating and using free cash. The Division of Local Services recommends that free cash:
Be restricted to paying one-time expenditures, funding capital projects, reducing OPEB or pension liabilities, or replenishing other reserves; and
Be maintained between three to five percent of the annual budget.
Credit rating agencies have their threshold percentages for all reserves. Local finance officials should understand these thresholds, especially when intending to borrow funds or when seeking a rating upgrade.
In September of 2015, the Executive Board of the Government Finance Officers Association (GFOA) recommended as a best practice that:
“governments establish a formal policy on the level of unrestricted fund balance that should be maintained in the general fund” and that adequacy “should take into account each government’s own unique circumstances…Nevertheless, GFOA recommends, at a minimum, that general- purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures.”
Additional information regarding GFOA’s position on the appropriate level of unrestricted fund balance in the general fund. Additional information on Free Cash and other reserves can be found in the November 17th, 2016 edition of City & Town.
To view the data used for this article, please see our Data Highlight of the Month.
don't worry about "free cash". we don't believe in it here in templeton !!!
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