Local governments have been working hard to steady the ship after COVID-19-related closures in the spring, and many are still operating in survival mode. But survival mode isn’t sustainable in the long run. With budgeting meetings either starting soon or already underway, many communities may be forced to think about dipping into reserves in order to balance their budgets. And while annual budgeting is necessary, it doesn’t give you a full picture of your future situation. Decisions this year about the costs your local government will incur later can have a tremendous — often, exponential — impact down the line. In other words, the coming year’s budget won’t show you the impact of your decisions three, four, five years from now. Especially today, in the face of revenue declines and an awful lot of uncertainty, long-term financial planning is more critical than ever.
Today’s planning creates tomorrow’s success.
As you hold budgeting discussions in the next few weeks and months, it’s an opportune time to start thinking about the long-term impacts of your community’s decisions. If you’re thinking that long-term financial planning — and by that we mean at least three to five years out — sounds like a luxury, especially in challenging times such as the ones we’re living through now, we get it. That said, the alternative, taking your budget year by year or having a loose, informal plan for the future, isn’t going to position your community for growth and success.
Creating a financial forecast, however, will. Such a forecast can enable resilience and pave the way to an easier future. Following the Great Recession, communities that developed a financial forecast were able to spot negative impacts on their operations earlier than communities that didn’t have a good plan in place. As a result, the forecasters made less severe cuts than local governments without a plan.
The go-to solution for the short term doesn’t always work long term.
Often, when revenues run short, communities decide to defer capital plans. If you can keep those two backhoes running another couple of years, as an example, you can defer the (not insignificant) expense of replacing it now. But older equipment requires more maintenance, and breakdowns are expensive and can negatively impact service levels. The decision to defer the expense could actually cost your community more in the future than incurring it. But you won’t be able to determine that unless you’re forecasting; you won’t know it unless you have a financial plan.
Consider pension and post-retirement legacy costs.
Perhaps nowhere is the impact of today’s decisions on tomorrow’s financial picture more commonly and easily seen than in legacy costs, as pensions and other post-retirement benefit costs that must be funded years into the future. Estimating these costs is difficult. Often, we see communities doing short-term projections, assuming the costs will consistently rise from one year to the next by the rate of inflation. But clearly, healthcare costs can accelerate at a far higher rate than 2 to 3% per year. Pension costs, too, can increase at a much faster rate than revenues. Today, legacy costs might comprise 25% of a local unit’s budget — a few years from now, that figure could rise to 35% or more. If revenue isn’t keeping pace, your community will face some very difficult decisions.
Contribution requirements also are increasing. It’s likely we’ll see reductions in discount rates on a number of pension plans, which will increase required contributions.
Begin with the end in mind.
Before you can develop a financial forecast, you need to have an end goal. Let’s say your community aims to have 15% of expenditures in its fund balance as a reserve at the end of 2025. If that’s your goal, will your current operations and projected revenue and expenditure increases get you there? If so, great. But if you’re not on track to reach that goal, would you like to know that in 2024, or would sooner be better? Which would effectively help you prevent last-minute reactivity? Long-term goals combined with a solid financial forecast help you make decisions along the way to avoid it.
Let’s take rate setting as an example. As you update your water, sewer, and other rates, it’s important to work backward from your goal, in this case, working capital as X% of annual expenditures. With that end number in mind, where does your revenue need to be to reach it? Once you know that, you can develop rates that align with your goals.
Determine who should be involved in goal-setting.
As you build your financial forecast, consider who should have a seat at the goal-setting table. In some communities, it’s the board of trustees; in others, it’s department heads; in others still, it’s a combination. The public can be involved as well if you choose. There’s no one right answer.
Governments need to determine the type of input they want when it comes to setting financial goals and objectives and making the decisions to achieve them. If your community needs to consider raising taxes or decreasing some departments to reach a particular goal, who needs to have a say? In some places, the finance department pushes out financial information to the board, and the board takes it from there using a highly data-driven approach. Others open the discussions up to the community so that those who want to participate in the process can chime in. Again, there’s no one right way — what’s important, rather, is to make a thoughtful, deliberate decision about your approach.
Prioritize your services.
As part of the goal-setting process, questions are likely to arise about the services your community wants to provide going forward. We encourage governments to ask their leaders and their constituents a few key questions to gain clarity:
1. Which services are most important to constituents?
First, local governments need to understand which services are most important to their communities and the highest priority for them to maintain or establish. This process may include direct community outreach in the way of survey, or perhaps having open “Town Hall” meetings that would involve presentation and citizen comments.
2. Are yesterday’s services still a need today?
Frequently, items in community budgets can carry over for decades. Many of these line items exist in the budget simply because they were included the previous year. Some items, public safety for example, are necessary. Others may be nice to have but, in light of declining revenue, may be less necessary. Autumn leaf pickup? Nice to have, certainly. But is it a critical service if cuts need to be made? We encourage organizations to ask themselves this: If you were to start again with a clean slate, would you still think X is a critical service?
3. Which services are self-supporting, and which are funded with projected revenue?
Some fee-based services your government offers may be self-sustaining because their fees cover the costs to deliver them. Those services may make less sense to cut since they pay for themselves.
But what about services with fees that don’t fully cover the costs of delivery? When it comes to funding services based on current or projected revenue, the question at hand gets a bit trickier. Now, you have to estimate how much it will cost to provide these services in the future and determine whether they fall into the “nice to have” or “need to have” bucket. These are the types of questions communities must ask and the types of decisions to weigh when you set goals and work backward in order to reach them.
As you ask and answer these questions and project revenues into the future, keep in mind that revenue doesn’t equal cash flow. We frequently see communities banking on revenues as if they were cash. But recording an amount as revenue isn’t the same thing as having the cash on hand. Instead, keep your eye on cash flow, rather than relying on revenue numbers from your general ledger or financial reporting. Unfortunately, none of us can pay bills with receivables.
Differentiate between operational and capital needs.
Identifying which expenses are necessary in the short-term to keep operations running is another key area that helps local governments forecast the impacts of today’s decisions and create a reliable financial plan for the future. As an example, not filling an open position has a short-term impact on operational costs — in other words, the impact can be seen almost immediately — while the impact of not purchasing those two backhoes used in our earlier example may not be seen for a year or two or longer.
As your organization weighs these short-term and long-term questions, it’s important to understand what can be delayed from both an operations and capital standpoint, and what the impacts are. Some examples we’ve seen include decisions about buying new copiers because they will improve efficiency, renovating office space and updating old furniture, redoing ballfields, or adding a new playscape to a park. Are these likely to have a critical impact on services if they’re delayed? Probably not. With proper planning, your community may be better positioned to make these purchases in a couple of years when the situation is improved.
That said, there’s almost always a cost to delaying expenditures, and you must take these costs into account as well. No new copiers this year, for example, means staff won’t work quite as fast. The costs of not redoing the ballfields might mean a slight reduction in user fees. Determining these costs and impacts are precisely the things to be thinking about as you create your forecast and plan.
Anticipate surprises.
Expecting the unexpected is another important part of your long-term financial forecast. But how can we know what we don’t know? This question is asked a lot. If your financial planning revolves primarily around your annual budgeting process, it’s difficult to anticipate surprises and is dangerously easy to lose focus on what’s coming down the road. Think, again, about the exponential rise in the cost of retiree healthcare in a few years. Or about your water or sewer infrastructure. If your community’s pipes are 70 years old and their estimated lifetime is 60 years, how are you planning for that inevitable expense? Although you may have been lucky so far, we’ve all heard of other municipalities that haven’t been. Use those types of observations and occurrences to inform your own planning. Do we have adequate financial reserves if there were significant declines in property taxes or state-shared revenues. Most governments two primary sources of revenue (property taxes and revenue sharing) aren’t derived by any decision making done at the board level.
Build out your financial forecast.
When we talk about a financial forecast, we’re not talking about a document that’s printed out, put in a nice binder, and set on a shelf. Rather, by financial forecast, we’re referring to a living, breathing document — often a spreadsheet — that includes assumptions you can easily change in order to assess the impacts of decisions and account for surprises and other changes in expenses. It should extend out in time a minimum of three years and, preferably, five. Consider your financial forecast a working model, similar to your budget but with a long-term, bird’s-eye view. And since your forecast looks into the future, you’ll need to make your very best estimates of the expenses you anticipate. As time goes on, you can always adjust the forecast as you gain new information, which enables you to make (proactive rather than reactive) decisions.
Envision the future of your community.
As you envision the future of your community, we can’t emphasize enough how important it is to create a financial forecast if you don’t already have one. Too many local governments operate year by year, just assuming there will be incremental rises in revenue in the future. Sometimes these increases materialize and things work out fine. But more often than not, the communities that plan only from one year to the next end up facing painful decisions at some point. No one wants to be in that position. Instead, take a deliberate approach to financial planning so that your municipality can continue to provide the highest levels of service and greatest community benefit possible — regardless of what challenges might lay ahead.
