The Neglected Government Balance Sheet

For years, cities have implemented various metrics and scoring systems to assess their fiscal condition. The Government Finance Officers Association provides a “Fiscal First Aid” program complete with a multi-step process for assessing fiscal health. Yet such efforts have not improved cities’ ability to manage their finances. A recent report by the National League of Cities notes that the number of finance officers who were optimistic about meeting their jurisdiction’s financial needs dropped from 64% to 45% in just one year.

The sad irony? Every municipality already produces a comprehensive, third-party audited health assessment. That assessment is contained in the agency’s statement of net position – roughly the equivalent of a balance sheet and integral to the agency’s annual audited financial statements.

What is a Balance Sheet – and Why is it Important?

A balance sheet discloses the relationship between what an entity owns (assets) and what it owes (liabilities). Municipal statements of net position (i.e., balance sheet equivalent) reveal what resources an agency possesses, what obligations it owes, and its capacity to meet future financial needs.

Those who shun municipal balance sheets often argue that “government is not a business.” While true, the math remains the same: the relationship between what you own (assets) and what you owe (liabilities) is a key indicator of sustainability.

When a city’s net position (the difference between assets and liabilities) trends downward, it isn’t just an accounting quirk—it’s a warning that today’s services are being funded by tomorrow’s residents, a serious intergenerational injustice. Further, a growing negative net position can be a leading indicator of threats to an agency’s financial solvency.

When assets are insufficient to cover liabilities, an agency will resort to one or more of the following actions: increase taxes, borrow, defer maintenance, and/or allow services to degrade. Proper attention to the balance sheet would allow municipal leaders to take mitigating measures before their – and their residents’ – backs are against the wall.

The Spendable Funds Trap

The aversion to embracing municipal financial reporting is long-standing. Governmental accounting is convoluted and, at times, impenetrable. The mingling of cash and accrual accounting stirs confusion in all but the experienced practitioners. Over the past fifty years, the Governmental Accounting Standards Board (GASB) has issued more than one hundred accounting and financial reporting rules. Much of this guidance was needed to accommodate the expanding scope and diversity of government activity. Over the past several decades, public agencies have increasingly ventured into commercial activities, land acquisition, charitable activities, pension investments, complex leasing arrangements, and a host of other activities that do not fit the primary meaning of governmental.

In the municipal world of open-ended missions and ever-creeping scope, city council members focus on funds available to spend, regardless of where the funds originated. In such a case, the measurement of assets vs. liabilities (what private industry considers to be equity and government accounting calls net position) is an annoying distraction. The hostility to balance sheet accounting goes back decades. As we turned centuries, most municipalities vigorously opposed the new government accounting requirement to inventory and report governmental assets (e.g., streets, buildings, equipment, etc.).

While organizations such as Truth in Accounting highlight important balance sheet metrics (such as debt and net position), municipal budgeting methodology is impervious to such calls for transparency. Have you ever heard a city council ask: “How will this vote impact our balance sheet?” before approving a new activity or major expenditure. Without such a question, transparency is just an illusion.

Government Goals and Scope

The widespread neglect of government balance sheets sustains the denial that our municipalities are overextended. Public agencies boast about data-driven decision-making while ignoring the financial information that would prompt them to reassess the extrinsic activities, projects, and obligations they have taken on. Under resource pressure, the California State Auditor has abandoned its Local High-Risk Dashboard, which relied heavily on balance sheet information to evaluate cities’ financial condition. (The California Policy Center recently picked up where the State Auditor stopped.)

Government balance sheets will remain underappreciated and irrelevant so long as municipal leaders remain on the treadmill of spending available funds. Further, such an approach will appear to be the right one when an agency’s goals are vague. Vague goals lead to an unbounded scope, thus creating the impression that such unimpeded spending is necessary. Only a delimited scope is compatible with sound balance sheet management. We will not discover the value of government balance sheets until we discover the value of clear government missions and delimited agency scopes.

What Your City Council Should Be Doing Now

Municipal leaders must stop viewing the statement of net position as an accounting relic and start treating it as a vital early-warning system.

• The One-Page Dashboard: Extract key data (including net position) from the multi hundred-page Annual Comprehensive Financial Report into a clear summary for the public.
• Net Position Impact Reviews: Require that every major staff report – especially labor agreements – include a projection of its impact on long-term assets and liabilities.
• Set Appropriate Financial Targets: Keep in mind that the financial health of an agency is not an end in itself. Government agencies exist for the sake of residents and businesses – and not the other way around. This principle should guide the development of what constitutes a healthy net position for a given agency.

Footnotes

¹. There are many technical differences between a statement of net position, used in governmental accounting, and a balance sheet, used in conventional business accounting. Further, the structure and goals of government are distinct from those of organizations operating in the private sector. While such differences affect the standard one should use to analyze governmental financial statements, they do not justify the degree to which the governmental version of the balance sheet is being downplayed when not ignored.

². This is actually an adjusted difference. In addition to assets and liabilities, government accounting uses the concepts deferred outflows of resources and deferred inflows of resources (more on this here). Such technical considerations should not distract from discussions of a government agency’s “balance sheet.”

³. GASB does its best to adapt governmental accounting to the varied activities undertaken by governmental agencies. Inevitably, such attempts fall short. Mirroring private sector accounting for commercial activities taken by a governmental agency ignores the fact that such activities cease to be commercial. GASB is not alone: the conventional approach is to accept anything a governmental agency does as being “governmental.” But by doing so, we lose sight of why government exists (i.e., to define and protect rights) and how (with its legislative and enforcement powers) the nature of its activity is non-commercial.

⁴. For additional background,  this document captures the controversy – and the objections of the GFOA – surrounding GASB 34, which incorporated full accrual accounting for most activities at the government-wide level, and mandated reporting of major infrastructure assets like roads and bridges.

Mark Moses is a senior fellow with California Policy Center. He has thirty years of experience in local government administration and finance. His recent book, The Municipal Financial Crisis – A Framework for Understanding and Fixing Government Budgeting was published by Palgrave Macmillan and is available from major online booksellers.  

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