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Local Government: Results of the 2006-07 Audits 5. FINANCIAL SUSTAINABILITY OF LOCAL GOVERNMENT At a glance
In past reports, we have undertaken an analysis of the financial performance and position of the local government sector, using information available in the published financial statements of local governments. Four years ago we developed, and began reporting on, a series of financial viability ratios. These ratios established a set of interrelated indicators that local governments could use to assess their own financial performance and position. The indicators can be used to analyse past and future results to identify any trends that may give rise to concern about the sustainability of local governments. This part of the report presents, for the first time, a much expanded and more detailed analysis of these indicators and trends over the past 5 years, and the next 3 years. Appendix D to this report contains data on each indicator for each council covering the period 2003 to 2010. To provide context for our analysis of sustainability, we have first analysed in the next section, the recent financial performance and position of the sector. 5.2 Financial performance of local governments Financial performance is measured by the operating result – the difference between revenue inflows and expenditure outflows. The objective for local governments should be to generate a sufficient surplus from operations over time to be able to fund asset replacement, new asset acquisition and the retirement of debt. The ability of local governments to achieve this objective depends largely on their funding and expenditure policies, reflected in the composition and rate of change of their operating revenues and expenses. Composition of, and changes in, operating revenues In 2006-07, the local government sector collected $5.7 billion in operating revenues ($5.2 billion in 2005-06), an increase of $488 million, or 9.4 per cent on the prior year. The most significant increase in local government revenue this year was developer contributions1 which grew by $176 million or 36 per cent to $659 million ($483 million in 2005-06). Other items of revenue that increased were rates and charges which grew by 7.8 per cent, and user fees and charges which grew by 6.3 per cent. Grants revenue to the sector overall remained constant. The composition of operating revenue for the local government sector is provided in Figure 5A. Figure 5A  Source: Victorian Auditor-General’s Office. The composition of operating revenue for the sector as a whole has remained unchanged over the past 3 financial years, with rates accounting for 48 per cent of revenue, grants at 19 per cent and, at a constant 15 per cent, user fees and charges. The proportions vary significantly between councils. Own-sourced revenues (rates and charges, and user fees and charges) are typically higher in metropolitan councils compared with rural councils, for example. Transfers (grants and contributions) are relied on more heavily by rural and regional councils. Composition of, and changes in, operating expenditures In 2006-07, total local government operating expenditure grew by $158 million, or 3.5 per cent. The main areas of growth were: • wages (up $109 million or 6.6 per cent) • materials and contract costs (up $96 million or 5.5 per cent) • depreciation (up $39 million or 4.8 per cent). Figure 5B  Source: Victorian Auditor-General’s Office. The composition of total expenditure is provided in Figure 5B. This shows that employee benefits and contract payments for goods and services accounts for 74 per cent of total council expenditure. In contrast, only one per cent of total sector expenditure is borrowing costs, and this is consistent with the low level of debt for the sector. Trends in operating results for the sector As indicated above, in 2006-07, for the sector as whole, total revenues grew at a faster rate than expenditures. This indicates that the sector is collectively generating larger operating surpluses. The increase in own-sourced revenue, rates and user fees and charges, of However, the increases in revenues compare more favourably against the increases in overall costs of 4 per cent, and against the increases in wages costs of 6.6 per cent. The increase in wages costs is higher than the wage price index for 2006-07 of 4 per cent, indicating growth in the total number of staff employed in the sector. Figure 5C shows trends in local government over the last 4 years for total revenue and expenditure in comparison with rates revenue and wages expenditure. Figure 5C  Source: Victorian Auditor-General’s Office. Figure 5C shows that collectively, over the past 4 years, local government revenue policies have kept pace with increased operating costs and also provide for a sufficient surplus to meet future financial requirements. 5.2.1 Financial position of local governments Financial position is generally measured by reference to net assets – the difference between total assets and total liabilities. However, this measure is less relevant in the public sector context, as most public sector entities are not-for-profit, and do not hold assets from which they generate own-sourced revenues. Instead, they largely hold infrastructure assets, for which they need to fund operating costs, repairs and maintenance, and their replacement and renewal. As the revenue base for local governments is not tied to the value of their asset base, and given that they cannot sell most of their assets to obtain funds, their objective should be to maintain the infrastructure assets for which they are responsible, while managing debt levels to ensure that it can be paid back from future operations. The ability of local governments to achieve this objective depends on their asset and debt management policies, reflected in the composition and rate of change of the values of their assets and liabilities. Composition of, and change in, assets The total assets of local government entities grew in value by $2.4 billion (or 5.3 per cent), to $47.7 billion at 30 June 2007. While current assets grew by $426 million, most of the increase is attributed to continued growth in the value of infrastructure assets. Around $1 billion was added to the non-current asset base from additions, with the balance relating to asset revaluations. This growth indicates that local governments are maintaining and adding to their asset base. The values used in financial statements for non-current assets reflect their current replacement cost – that is, how much would it cost today to replace the existing assets in the current condition. The future challenge for local governments to replace their existing assets when they become unserviceable or obsolete, is compounded by their large infrastructure asset base relative to their funding levels. Local governments’ revenue base relative to its asset base is around 12 per cent. By way of comparison, the State’s revenue base relative to its asset base is 31 per cent. Another way of looking at this is that local governments are responsible for around 25 per cent of combined non-current assets in Victoria, but only receive 12 per cent of combined revenues. Composition of, and change in, liabilities Current liabilities, primarily employee leave provisions, grew by $114 million (or 13 per cent) in 2006-07. This rate of growth is reasonable in comparison with the increase in current assets (23 per cent). It indicates that local governments are maintaining sufficient working capital to meet their short-term commitments. Non-current liabilities grew by only $63.3 million (9.4 per cent) to $735.6 million. Non-current liabilities are composed almost totally of employee long service leave provisions and borrowings. The rate of growth of non-current liabilities compares favourably against the growth in asset additions and the growth in wage costs. It also compares favourably with the growth in revenues – indicating that, collectively, local governments are generating sufficient funds to repay their debt. 5.3 Indicators of council financial sustainability Financial sustainability is defined in a number of different ways. A generally accepted definition3 at State and Commonwealth level is whether local governments have sufficient current and prospective financial capacity (inflows) to meet their current and prospective financial requirements (outflows). To be sustainable, local governments need to have some excess capacity at any point in time, to be able to manage future financial risks and shocks without having to radically adjust their current revenue or expenditure policies. While this definition is generally accepted, there is less consensus on what indicators should be used to measure and assess sustainability. The indicators we have selected tell us about short- and long-term viability, by measuring whether local governments: • generate enough revenue from all sources to cover operating costs (including the cost of replacing assets reflected in depreciation expense) – operating result • have sufficient working capital to meet short-term commitments – liquidity • generate sufficient operating cash flows to invest in asset renewal and repay any debt it may have incurred in the past – self-financing • are not overly reliant on debt to fund capital programs – indebtedness • have been replacing assets at a rate consistent with the rate at which they are being consumed – investment gap. No one indicator is sufficient to measure sustainability, however, the operating result takes on most significance, as it bears directly on the definition of sustainability. The other indicators are interrelated, to the extent that some measure flexibility to respond to future risks (self-financing and indebtedness), and others measure capacity to meet current known short- and long-term requirements, respectively, (working capital and investment gap). Our analysis of sustainability takes account of all the indicators, but places most weight on the operating result, and on the investment gap (because of the relatively large infrastructure asset base of local governments). Figure 5D  Source: Victorian Auditor-General’s Office. Figure 5D describes the viability indicators we use in this report. These indicators have been applied to the published financial information of councils for the period from 2003 to 2010 – the prospective data obtained from the councils. The results are in Appendix D of this report. We have first analysed the indicators for the sector as a whole in the following section – this provides overall benchmarks for the sector. We follow this with analysis of the indicators by local government category – inner metropolitan, outer metropolitan, regional cities, large shires and small shires. This provides a more detailed frame of reference for benchmarking and comparative analysis. 5.4 Financial viability trends for the sector This section provides an analysis and commentary on the trends for each indicator and includes a summary of the results for the local government sector as a whole for the past 4 financial years and the 2006-07 financial year. It should be noted that the financial data used for the indicators for 2003 is based on superseded accounting standards and, therefore, will not be directly comparable with more recent results. The overall underlying result for the sector in 2006-07 was 6.5 per cent. The lowest result was negative 11.1 per cent and the highest result 31.2 per cent. The trend indicates that the sector as a whole is reporting stronger surpluses. There has been a further improvement at the council level in 2006-07 with only 12 councils having reported negative underlying results, compared with 23 in 2005-06. Figure 5E  Source: Victorian Auditor-General's Office. The overall liquidity ratio for the sector in 2006-07 was 2.22, which is a strong result. The highest liquidity ratio reported was 5.34 and the lowest was 0.74. The liquidity indicator shows a marginal improvement between 2005-06 and 2006-07. It should be noted that the fall in the ratio from 2004 to 2005 is largely attributable to reclassification of a large proportion of long service leave liability from non-current liabilities to current liabilities, in accordance with the requirements of new accounting standards. Figure 5F  Source: Victorian Auditor-General's Office. The indebtedness ratio for 2006-07 was 19 per cent of own-sourced revenues, which is the same result achieved for 2005-06. The results varied significantly between councils, with the highest relative debt ratio being 112.6 per cent, and the lowest at 0.8 per cent. Figure 5G  Source: Victorian Auditor-General's Office. The self-financing indicator for the sector overall for 2006-07 was 22.9 per cent, with the lowest result recorded being 7.9 per cent and the highest being 40.7 per cent. This means that all local governments had positive operating cash flows this year – a strong feature of performance over the past 5 years for most councils. Figure 5H
 Source: Victorian Auditor-General's Office. The investment gap ratio for the sector overall for 2006-07 was 1.29. This result is positive and consistent with the 2005-06 result of 1.30. The highest ratio was 2.53, but the lowest ratio was 0.40 (a decline on 2005-06). The results for the sector over the past 5 financial years indicate that spending on infrastructure is increasing when compared with the level of depreciation. Figure 5I  Source: Victorian Auditor-General's Office. The indicators of financial viability have improved consistently over the past five years when looking at the sector as a whole. This result sets an overall frame of reference for councils to consider when assessing their performance. 5.5 Financial sustainability assessment of councils Each council’s financial health has been assessed in the following sections using the risk criteria outlined in Figure 5J. Figure 5J  Source: Victorian Auditor-General's Office. An overall sustainability risk rating for each council has been calculated from the risk ratings determined for each viability indicator. The criteria we used to rate sustainability risk are outlined in Figure 5K. This sustainability risk rating provides our assessment of those councils that are at a relatively higher risk of becoming unsustainable. Figure 5K  Source: Victorian Auditor-General's Office. 5.5.1 Sustainability of inner metropolitan councils The 17 inner metropolitan councils that are predominately urban in character:
Inner metropolitan councils collectively received $2.1 billion in revenue and paid $1.8 billion in expenses in 2006-07. Figure 5L provides an analysis of the total revenue. Inner metropolitan councils have significant capacity to raise revenue through a combination of rates and user fees and charges, accounting for 77 per cent of total revenue in 2006-07. For inner metropolitan councils, the high level of user fees and charges arises partly from parking fees and fines. Inner metropolitan councils set the levies for parking charges and, therefore, have the capacity to increase revenue by increasing these charges. The high levels of own-source revenue and strong operating accrual and cash flow surpluses typical of councils in this group moderate the short-term liquidity issues and provide a strong source of revenue to meet future requirements. Consequently, actual operating performance over time will be impacted by expenditure policies, and the ability of these councils to constrain cost growth. Figure 5L  Source: Victorian Auditor-General's Office. For each inner metropolitan council, we calculated the 5-year average underlying result using the audited financial results since 2002-03. Figure 5M shows the results of this analysis for the group. We found 8 out of the 17 councils in the inner metropolitan group reported underlying deficits on average for the 5-year period. Figure 5M  Source: Victorian Auditor-General's Office. Councils with continuing operating deficits are at relatively greater risk of longer-term sustainability issues, particularly where the other long-term viability indicators are also rated as high risk. Our analysis of the 5 viability risk indicators for each council in the group is provided in Figure 5N. Figure 5N  Source: Victorian Auditor-General's Office. While no councils in this group show evidence of short-term liquidity risks, the results of the 4 inner metropolitan city councils assessed as a moderate risk are analysed as follows: • Banyule – reported a 5-year average underlying result of -5.24 per cent coupled with average capital spending equivalent to 97 per cent of depreciation. However, the trend in underlying result across the 5 years shows a steady improvement with break-even achieved for 30 June 2007. Looking forward, Banyule is projecting a positive underlying result and increased capital spending over the next 2 financial years. • Kingston – spent on average over the past 5 years only 51 cents for every dollar charged in depreciation on capital works and asset acquisitions. While the future plans for Kingston show increased spending on assets, the investment gap will still be well less than one by 2010. • Moreland and Maroondah – both reported capital spending over the past 5 years to be less on average than the level of depreciation. An analysis of each council’s forward plans indicates that both councils plan to continue to spend less on capital works over the next 3-year period than the rate at which existing assets are being consumed. Unlike Banyule, Maroondah and Moreland project operating deficits for the next 4 years. RESPONSE provided by the Chief Executive Officer of the Banyule City Council Council will maintain a positive underlying result and increased capital spending in coming years. RESPONSE provided by the Chief Executive Officer of the Kingston City Council Our figures for the average spend on capital compared to depreciation is low due to the interpretation you take on capital expenditure. We take a very conservative view on what is charged to capital compared to the operating statement. We believe you should be using the figures as per the standard statement of capital works which reflects what we are spending of a capital nature. Further audit comment Audit uses Australian Accounting Standards to determine capital expenditure for this ratio. The standard statement of capital works is not considered a relevant measure, as the expenditure in it relates to the overall capital budget, which includes maintenance and other asset-related expenditure which is not capitalised. RESPONSE provided by the Chief Executive Officer of the Moreland City Council Moreland City Council recognised this issue 5 years ago and, following consultation with our community, implemented a financial plan to address it. A key feature of the community consultation was the capacity of residents to pay increased rates. The strategy has been successful as the annual plan gap has narrowed and the trend is positive. 5.5.1 Sustainability of outer metropolitan councils The 14 outer metropolitan councils are:
Outer metropolitan councils received $1.7 billion in revenue for 2006-07 and paid $1.3 billion in expenses for the same period. Figure 5O provides an analysis of the revenue figures. Figure 5O  Source: Victorian Auditor-General's Office. Other than rates, significant revenue was received through developer contributions, making up 20 per cent of total revenue for the group. This is as expected given that the councils are on the urban fringe and, therefore, include many new housing estates which give rise to developer-contributed cash and assets. The level of contributions in any year is dictated by the level of demand for development and the timing of completion of developments. An outer metropolitan council has little control over this source of revenue other than through its role as the planning authority in its municipality. Figure 5P  Source: Victorian Auditor-General's Office. The assets of outer metropolitan councils totalled $13.1 billion at 30 June 2007, compared with total liabilities of $541 million. The level of liabilities in this group is comparable with the level of borrowings of inner metropolitan councils ($563 million), however, this is against a much lower total asset base. Analysis of our lead indicator, underlying result, showed strong performances for most of the outer metropolitan councils’ operating performances for the current year. This was also the case for the 5-year average as indicated in Figure 5P. Only 3 of the 14 councils in the outer metropolitan group have an average underlying deficit over the past 5 years. The results for all the 5 viability risk indicators are provided in Figure 5Q for each council in the group. Figure 5Q  Source: Victorian Auditor-General's Office. As with inner metropolitan councils, no councils in this group exhibited any short-term viability risks. Three did however have a combination of risk ratings that suggest some level of caution is required: • Cardinia Shire has a high indebtedness level of 97.8 per cent. This is an improved position on the past financial year where an indebtedness level of 118 per cent was reported at 30 June 2006. The council’s budget and strategic resource plan for the next 4 years indicate that this level of indebtedness will continue decreasing over the coming 3-year period. • In assessing the investment gap ratio indicator, Frankston City, Melton Shire and Yarra Ranges Shire spent less on capital works compared to the depreciation over the past 5 years. This is an unexpected result for growth councils, where significant capital works could be expected in establishing areas. The high level of developer contributions may mitigate this to some extent – however, this points to a growing infrastructure asset base that will require increased rates of capital expenditure as time goes on. RESPONSE provided by the Chief Executive Officer of the Frankston City Council According to your records, and ours, Council’s ratio of capital works compared with depreciation was less than one, for only four of the last five years. Further audit comment The ratio has been negative for the last 4 years, and on average, has been negative over the last 5 years. RESPONSE provided by the Chief Executive Officer of the Yarra Ranges Shire Council The Shire has put in place an increased capital budget for the next four years to bridge the asset gap, after which, investment will be maintained at greater than a 1:1 ratio of asset depreciation. 5.5.2 Sustainability of regional city councils There are 11 regional city councils that are partly urban and partly regional in character. These councils are:
The 11 regional city councils received total revenue of $795 million in 2006-07 and paid expenses totalling $701 million. Figure 5R provides an analysis of the revenue figures. The revenue streams of regional city councils provide for some flexibility, with 45 per cent of revenue coming from rates and 18 per cent of revenue generated through user fees and charges. As with inner metropolitan councils, some regional cities have the capacity to raise revenue through parking fees and fines in city centres, providing a further primary source of revenue. Figure 5R  Source: Victorian Auditor-General's Office. The balance sheet position of regional cities is strong with significant assets totalling $6.43 billion at 30 June 2007 compared with a small level of liabilities totalling $312 million. Figure 5S  Source: Victorian Auditor-General's Office. Figure 5S shows the results of our analysis of the operating performance for the group over the past 5 years. We found 4 out of the 11 regional city councils reported underlying deficits on average for the 5-year period. Underlying deficits are not sustainable in the long-term. The results for each council in the group for all 5 sustainability indicators is provided in Figure 5T. Figure 5T  Source: Victorian Auditor-General's Office. No regional city councils exhibited any immediate liquidity concerns. However, a large proportion show heightened sustainability risks: • Wodonga has reported a negative underlying result for this financial year which is in contrast to positive results over past periods and also future plans and budgets. Wodonga has reported a high indebtedness level coupled with a low self-financing indicator which may indicate long-term debt servicing issues with the council having high debt levels yet generating little own-source revenue to repay the debt. • Three councils in this group have reported a 5-year average investment gap ratio equal to or less than one. These councils were Ballarat, Swan Hill and Warrnambool. RESPONSE provided by the Chief Executive Officer of the City of Wodonga Whilst we agree with the accuracy of the data with respect to the City of Wodonga, we do not agree with the conclusions drawn with respect to sustainability and long term self financing. We believe the conclusion fails to take into account significant investment in land and infrastructure held by the City of Wodonga at its newly developed industrial and transport hub. Even at its conservative value in the balance sheet of $24 million City of Wodonga’s current remaining holdings of land and infrastructure at its industrial and transport hub almost totally extinguishes long term borrowings of 26 million as at 30 June 2007. City of Wodonga is confident however that eventual sales will be significantly higher, and private and confidential land valuations commissioned by City of Wodonga have confirmed this. The City of Wodonga has communicated a clear and concise financial strategy to its community. This includes a steady and predictable rates increase path not exceeding 4.25 per cent per year. It is our strong and clear view that the City’s finances are both sustainable and self funding, and that strategies already in place will ensure this published rates growth will not be compromised, whilst delivering the services, assets, and events expected by the Wodonga community. RESPONSE provided by the Chief Executive Officer of the Ballarat City Council Council has a number of strategies in operation to constantly improve its financial position. The biggest hurdle facing Council is to maintain the current range of service the community demands, provide sufficient funds to tackle the infrastructure issue, with limited funding options. Council has increased its reliance on rate funds from 34 per cent of total revenue in 2003-04 to 48 per cent in 2007-08, this will further increase to 50 per cent by 2009-10. Councils’ financial viability has significantly improved since 2003-04, and over the next 5 years is expected to improve further, though there will be individual years where the result maybe adversely effected by the timing of major projects, the long term trend is the slow improvement of the Councils’ financial viability. RESPONSE provided by the Chief Executive Officer of the Warrnambool City Council The investment gap ratio for Warrnambool City Council for the next 4 years averages 1.8 reflecting Council’s commitment to capital reinvestment in it’s Strategic Resource Plan. The capital works profile for Warrnambool, like most regional cities, tends to fluctuate in accordance with major facilities upgrades. 5.5.3 Sustainability of large shire councils Shire councils are predominately rural in character, Victoria’s 15 large shire councils are:
Figure 5U  Source: Victorian Auditor-General's Office. Large shire councils received $604 million in revenue and paid $555 million in expenses for 2006-07. Figure 5U provides an analysis of the revenue figures. Large shire councils depend on grant funding for around one-third of their revenue. Our analysis of the average underlying result for each council over the past 5 years shows 4 out of the 15 councils in the large shire group have underlying deficits. Within the large shire group, only Colac Otway exhibited immediate liquidity concerns. Surf Coast has reported consistently positive results for the past 4 financial years with the current result influenced by higher other expenditure of $5 million. Colac Otway has reported mixed results over the past 5 financial years making it difficult to identify a pattern of performance. Colac Otway has, on average over 5 years, underspent on asset renewal, as well as reporting an average negative underlying result for the same period. The level of spending on asset renewal as measured by the 5-year average investment gap results also indicated insufficient spending by Surf Coast and Wellington. Figure 5V  Source: Victorian Auditor-General's Office. Colac Otway has been rated as high risk both because of the combination of its relatively high operating deficits and its underspending on infrastructure renewals over the past 5 years, and because its forecasts for the next 3 years for these items remain negative. Moorabool is rated as high risk due to sustained underlying deficits. RESPONSE provided by the Chief Executive Officer of the Colac Otway Shire Council Colac Otway Shire has been rated as high risk based on trend data over the past 5 years. However, trend data over the past 2 years and forecasts for the next 3 years clearly indicates that Colac Otway has met and will meet all targets related to the 5 viability measures as a result of strong financial decisions Council has made over the past 3 years. Council's underlying result over the past 5 years has been significantly influenced by one off extraordinary factors such as recognition of landfill rehabilitation costs. Our Strategic Resource Plan indicates that Council will achieve ongoing operational surpluses, achieve asset renewal expenditure targets and continuing reduction in loan liability which ensures the Shire's long term financial viability. Council acknowledges that over the past five years it has operated with a constrained ability to meet the required level of infrastructure spending. With significant growth occurring within urban areas of the Shire, there has been a need to develop new and upgraded community infrastructure whilst trying to maintain existing infrastructure. RESPONSE provided by the Chief Executive Officer of the Moorabool Shire Council Council has now adopted a five-year financial plan that demonstrates a commitment to significant improvement in its underlying operating result and net cash flows from operating activities that will directly lead to an increased ability to fund infrastructure spending. RESPONSE provided by the Chief Executive Officer of the Surf Coast Shire Council The results reported appear to reflect the Council position, however, our view is that they do not take sufficient account of the underlying context of the broader financial framework, as reflected in Council’s Strategic Resource Plan. Underlying results in previous years have been significantly reduced due to the creation of one-off provisions of $1.2 million, $1.1 million and $0.5 million in 2003, 2004 and 2005 for future site remediation of an industrial estate and landfill rehabilitation works that continue to be responsibly funded over the life of the landfill. Further, Council made a final payment of $0.7 million to fund the unfunded superannuation liability in 2003, reducing earlier underlying results. Expenditure commitments of this nature are not expected in the future. The 2007 underlying result shows 2 extraordinary events resulting in $3.9 million write-off of assets reported as “higher than expenditure of $5 million”. This relates to one-off events whereby coastal assets were donated to the Department of Sustainability and Environment and assets deteriorated and road pavement failure occurred from an extreme weather incident. The timing of significant future cash developer contributed revenues is also expected to peak significantly in 2009 and again in 2011, hence the appearance of a downward trend in the underlying result in 2010. Council’s investment in asset renewal expenditure is increasing and in relation to Council’s largest financial asset class, roads, expenditure has and continues to increase into the future. Council has supporting data from asset condition audits to demonstrate improved asset condition over time. Council road condition and customer survey data also confirms that Council’s renewal spend is reasonable. RESPONSE provided by the Chief Executive Officer of the Wellington Shire Council Wellington Shire Council have reviewed the figures resulting in the overall assessment, and are confident that they are correctly represented indicating insufficient spending on infrastructure renewal over the 5-year average. Figure 5W  Source: Victorian Auditor-General's Office. 5.5.4 Sustainability of small shire councils The 22 small shire councils in Victoria are:
Small shire councils received total revenue of $414 million in 2006-07 and paid expenses totalling $390 million. Figure 5X provides a breakdown of the revenue. Figure 5X shows that small shire councils rely heavily on transfer payments (government grants) and have less flexibility to raise revenue over which they can make autonomous spending decisions. Councils have little control over the level of government grants received from year-to-year, and any sustained decrease in the Compounding this, small shires are constrained in their ability to increase rate revenues because of: • relatively low income levels of ratepayers • in some cases declining population is shrinking the rate base • the current drought conditions4 • unbundling of water rights from the value of properties for rating purposes. Figure 5X  The sensitivity of small shires to grant revenue makes it difficult to adequately plan and budget into the future. It is, therefore, critically important for small shire councils to tightly control and monitor expenditure to maintain viability. Figure 5Y shows the 5-year average underlying result for all small shire councils – 13 of the 22 small shire councils have reported an average underlying deficit since Figure 5Y  Source: Victorian Auditor-General’s Office. The results of our viability risk indicators are set out in Figure 5Z. We have identified 2 councils with immediate liquidity concerns due to sustained underlying deficits. Debt for this group of councils is small and largely under control. However, a clear pattern that emerges is that most of the councils in this group are currently investing sufficiently in infrastructure renewal. Benalla has reported negative underlying financial results for 4 of the past 5 financial years. The indebtedness level has increased this financial year, yet spending on asset renewal has been less than the level of depreciation. In accordance with the criteria, Benalla has been rated as low risk. However, it has received medium assessments on all 5 indicators. Large underlying deficits and high debt levels have been a feature of this council since it was de-amalgamated from Mansfield in 2002-03. It is pleasing to note that Benalla is forecasting a break-even result by 2009, and a small surplus in 2010. It will be important that these forecasts are achieved so that the council can focus on building capacity to sustain its asset renewal program. Central Goldfields has been rated as high risk because of its relatively large, persistent operating deficits over the past 5 years. Hepburn have been rated as a moderate risk, however, it is noted that Hepburn forecast positive operating results over the next 3 years. If surpluses are able to be achieved and sustained the risk rating will reduce. By contrast, Central Goldfields continues to forecast operating deficits. It also forecast a decline in its current ratio and its debt level is large relative to its own-source revenue base. Also, its average investment gap ratio over the past 5 years and next 3 years remains less than one. While it generates sufficient operating cash flows, these other indicators point to a high risk of medium-term sustainability issues. Buloke, Mount Alexander and Yarriambiack have been rated as moderate risk primarily because of their underspending on asset renewal. None of these small shire councils will achieve a positive ratio for asset renewal when averaged over the 8 years of our analysis. Capital investment policies that continually fall short of the rate of consumption of assets create long-term sustainability risks for these mall shire councils. RESPONSE provided by the Chief Executive Officer of the Central Goldfields Shire Council Central Goldfields understands that ongoing operational deficits are not sustainable and is actively focusing on economic and community development with the goal of growing the local economy. A strategic short-term loan borrowing program to assist the above aim was initiated in 2006-07 with Council being in a position already to repay $1.5 million of interest bearing liabilities in the current financial year. Central Goldfields current long-term financial plan forecasts to 2011-12 include projected surpluses in 2010-11 and 2011-12. Central Goldfields is aware that current investment in infrastructure asset renewal is insufficient and unsustainable. Our economic development goals will assist with improving our infrastructure investment through the application of increased operating revenues. RESPONSE provided by the Chief Executive Officer of the Mount Alexander Shire Council Council has adopted an independently assessed 20 year long term financial strategy plan which targets asset expenditure improvement over the long term and indicates an average investment gap of 1.45 over the next 3 years. Figure 5Z  Source: Victorian Auditor-General’s Office. The above analysis shows that a number of local governments have a high or moderate risk of becoming unsustainable over the long-term. Figure 5AA summarises the results of our sustainability risk assessment. The 3 councils rated as high risk, namely Colac Otway, Central Goldfields and Moorabool, have experienced recent persistent operating deficits. There are also indications that their investment in infrastructure asset renewals has not kept pace with the rate at which they are using up their assets. The moderate risk ratings achieved by a number of councils relate primarily to their widening infrastructure asset renewal gaps and their limited capacity to increase own-sourced revenues to address this issue. Figure 5AA  Source: Victorian Auditor-General’s Office . Recommendations 5.1 Councils rated as high risk should critically review their current and forecast financial capacity and responsibility against their revenue and expenditure policies. 5.2 Councils should benchmark their financial performance, and their financial viability ratios, against other like councils to better understand whether their current revenue and expenditure policies are sustainable. 5.6 Regional library corporations Regional library corporations (RLCs) are wholly-owned by councils and are largely dependent on their owners for financial support. They generate relatively little own-sourced revenues, being highly reliant on transfers (annual operating contributions from each owner and grants). An analysis of the composition of revenue for 2006-07 for RLCs shows that 62 per cent of RLC funding came from council contributions, and 29 per cent from government grants. The low proportion of user fees and charges means RLCs have little or no flexibility in terms of their financial capacity. They must therefore focus predominantly on containing their financial requirements within existing capacity. 5.6.1 Analysis of financial performance In 2006-07, the total operating revenue for RLCs grew more than costs. Figure 5AB shows trends over the last 3 years in total revenue, expenditure, council contributions and wages expenditure reported by the RLCs. Figure 5AB  Source: Victorian Auditor-General's Office. Figure 5AB indicates that the RLC sector’s financial performance is improving, as the gap between expenditure and revenue is growing. However, our analysis of the financial performance of individual RLCs indicates that a number have pressing liquidity issues. 5.6.2 Financial viability indicators Analysis of the financial sustainability of RLCs needs to be considered in the context of the funding policies of the councils which own them. In particular, operating results and cash position will be influenced by how much each council contributes. Therefore, we have limited our analysis to 3 key risk indicators – operating result, liquidity and investment gap. An overall sustainability risk rating for each RLC has been calculated from the risk ratings determined for each viability indicator. The criteria we used to rate sustainability risk are outlined in Figure 5AC. This sustainability risk rating provides our assessment of those RLCs that are at a relatively higher risk of becoming unsustainable. The individual results for each RLC for the 2006-07 financial year against each financial viability indicator is summarised using the key identified in Figure 5AC. In 2006-07, the total combined surplus of all RLCs was $20.7 million, compared with a combined surplus of $2.7 million in 2005-06. The number of RLCs reporting an underlying deficit went from 4 in 2005-06 to 6 in 2006-07 (excluding Yarra-Melbourne Regional Library Corporation which ceased operating at 31 March 2007 and had reported an underlying deficit for the operating period). Figure 5AC  Source: Victorian Auditor-General's Office. The combined underlying deficit of these 6 RLCs in 2006-07 was $843 000 compared with $345 000 last year. In 2006-07, the liquidity position of RLCs improved overall, however, 5 are operating with negative working capital. Without the financial support of their owners, these RLCs would find it difficult to meet short-term commitments. The level of spending on capital is decreasing in comparison with the level of depreciation, measured as the investment gap ratio. This may indicate that RLCs are not maintaining their collections. The long-term viability of Goulburn Valley Regional Library has been rated a high risk because it also has a high level of debt compared to its revenue base which is not reflected in Figure 5AD. Figure 5AD  Note: Yarra-Melbourne Regional Library has been excluded from the table as it ceased operating on 31 March 2007. Source: Victorian Auditor-General's Office. RESPONSE provided by the Chief Executive Officer of the Goulburn Regional Library Corporation The underlying ‘going concern’ concept you rely on is not valid for a regional library, which is no more than a vehicle for member councils to provide library services to their communities. The reality is that funding (approximately 70 per cent from member councils of the region and 26 per cent from the state government) is received on an annual cash requirements basis and committed prior to the commencement of each financial year. The debt is confined to relatively short-term lease payments of capitalized IT and furniture and equipment acquisitions and accrued employee benefits which are annual budget line items. As at one minute to midnight on 30 June 2007 the ratio is as you report, but at one minute past midnight, i.e. 1 July 2007, the corporation has additional current debtors (member councils and state government) of $2.2 million which provides an entirely different picture, further demonstrating that the measure is not valid in the context of the regional library. Taking the results of RLCs as a group, the financial position of RLCs appears to have improved. However, this masks the poor performance of a number of RLCs, including: • immediate liquidity issues at 5 RLCs • one RLC with both short-term and long-term debt management issues • half of all RLCs not spending sufficient money to maintain their assets (including library collections) at the current levels. Recommendation 5.3 All local councils as owners, contributors and users of RLCs should: • critically asses the financial health of their RLCs • develop strategies to ensure the long-term viability of their RLCs. 1 Developer contributions are assets provided to local governments by developers – they can be in the form of either cash or property and infrastructure assets. 2 Australian Bureau of Statistics 2007, Consumer Price Index, 6401.0, September Quarter 2007, Cat. No. 6401.0, Australian Bureau of Statistics, Canberra. 3 Most recently confirmed in a study undertaken for the Australian Local Government Association – p.96, ‘National Financial Sustainability Study of Local Government’, November 2006, PricewaterhouseCoopers. 4 The Commonwealth Government is assisting farmers to pay council rates and will provide farmers in drought affected areas with funding to cover 50 per cent of the council rates on application. |