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POLICY BRIEFING

Financial health of local government: Audit Commission

27 October 2014

Mark Upton, LGIU Associate

Summary• The Audit Commission have published a report providing a national overview of

the financial health of local government as viewed through changes in a small number of financial ratios.

• Since 2007/08 the ratio of assets to liabilities fell for two-thirds of top-tier councils but went up for more than half of district councils since 2008/09.

• In 2012/13 half of all councils – including 71% of districts – had assets which were double in value compared with their liabilities and nearly a third of districts councils had more than four times as many assets as liabilities. 16% of all councils and 42% of metropolitan districts had more liabilities than assets.

• District councils also had much higher levels of usable reserves (compared to gross revenue expenditure) than other councils. In 2012/13 their reserves made up on average a fifth of their revenue spending, while for other councils the ratio ranged between 9% to 13%.

• This briefing will be of particular interest to cabinet portfolio members, overview and scrutiny members and senior officers with responsibilities for corporate finance in all local authorities.

Briefing in fullThe Audit Commission have published a report (“Interpreting the accounts – a review of local government financial ratios 2007/08 to 2012/13”) providing a national overview of the financial health of local government as viewed through changes in a small number of financial ratios; showing changes over the period 2007/08 to 2012/12 and the variations between councils in 2012/13.

The origins of the report lie in work conducted by the Audit Commission in 2009

© Local Government Information Unit, www.lgiu.org.uk, Third Floor, 251 Pentonville Road, London N1 9NG. Reg. charity 1113495. This briefing is available free of charge to LGiU subscribing members. Members are welcome to circulate internally in full or in part; please credit LGiU as appropriate. You can find us on Twitter at @LGiU

http://www.audit-commission.gov.uk/2014/09/audit-commission-invites-local-government-to-help-armchair-auditors-interpret-the-accounts/




POLICY BRIEFING(”Summing Up: A Review of Financial Management in Local Government 2005-2008") which, among other things, devised five key financial ratios to help put different aspects of a council’s finances into context. See table 1 below taken from this latest Audit Commission report.

A publicly available web-based tool exists’ - Financial ratios analysis tool – to enable comparisons between councils and identify trends in an individual council’s financial performance.

In the Audit Commission report, and in this briefing, ratios are referred to as a number that represents how much larger or smaller the numerator was than the denominator (see table above). For example a ratio of ‘0.5’ shows the numerator (e.g. current assets) was half the denominator (e.g. current liabilities). While a ratio of ‘2’ shows the numerator was twice the value of the denominator. Sometimes the relationship is expressed in percentage terms, for example, a numerator was less (or more) than 50% of the value of the denominator.

The ratio of current assets to current liabilitiesThis is an indicator of how a council manages it short term finances and whether they can pay their debts in the short term.

The ratio went down for 64% of single-tier and county councils from 2007/08 to 2012/13 (i.e. their liabilities increased relative to their assets) falling from 1.6 to 1.4. The most common reason was a decrease in current assets combined with an increase in current liabilities.

The average ratio for district councils was also lower in 2012/13 than in 2008/09 – 2.8 compared to 2.5 – but still consistently higher than for other types of councils. In contrast metropolitan districts had on average only 10% more in asset value than liabilities (i.e. a ratio on 0.1). See diagram below.


http://archive.audit-commission.gov.uk/auditcommission/nationalstudies/localgov/Pages/summingup23april2009.aspx.html




http://profiles.audit-commission.gov.uk/_layouts/acwebparts/NativeViewer.aspx?Report=/Profiles/FR_Landing


POLICY BRIEFING

Half of all councils in 2012/13, including 71% of districts, had assets worth more than double their liabilities, while 18%, including 31% of districts, had current assets that were four times greater than their current liabilities. 16% of all councils and 42% of metropolitan districts had more liabilities than assets. See diagram below.

The Audit Commission advises that those councils with low ratios should ensure that they have arrangements in place to meet their liabilities. Short term borrowing to pay debts gives rise to additional costs. Councils with high ratios are advised to consider


POLICY BRIEFINGwhether they are effectively managing their current assets by reviewing short term investments and the adequacy of their debt collection arrangements.

The ratio of useable reserves to gross revenue expenditureThis ratio highlights how much money councils are retaining for future plans and to cover unexpected spending. The Audit Commission analysis shows a rising trend for many but also wide variations on the extent of reserves held in 2012/13; explaining that “the cost and risks associated with service transformation, and uncertainty about future funding, have resulted in some councils increasing reserves, while others have been using reserves to make up shortfalls between their funding and spending plans.”

The ratio went up for 79% of single-tier and county councils between 2007/08 to 2012/13, commonly because reserves went up proportionally more than spending, or went up as spending fell - increasing most for county councils and London boroughs and less for unitary and metropolitan authorities (see Figure 5 below). The average ratio was consistently higher for district councils than for other types of councils over this period, with usable reserves rising from 15% to 21% of gross revenue expenditure. For counties and single tier councils they rose from 8% to 11%.

23% of all councils in 2012/13 – including 55% of unitary authorities – had useable reserves that were less than 10% of their spending; while in a third – including more than half of districts – reserves were on average a fifth of revenue spending; and in 9% – including 15% of district councils – they were greater than 40% of their spending. See diagram below.


POLICY BRIEFING

The Audit Commission advise that “all councils should continue to ensure that their reserves remain adequate for planned future needs and contingencies without placing undue constraints on current expenditure”, adding that where they are relatively high and particularly where they are increasing, their purpose should be clearly communicated through the annual accounts.

The ratio of long-term borrowing to tax revenueThis ratio gives an indication of the potential for debt repayments to impact on future spending plans. Tax revenue for this indicator includes revenue support grant from central government as well as council tax and business rate income.

This ratio rose for all councils over the period due to increased borrowing, coupled by an inability of tax revenue to keep pace. It also reflects the impact of some councils taking out extra debt as a result of government reforms to the housing revenue account system: rising for 63% of single-tier and county councils from 1.1 from 1.3 (i.e. borrowing is rose from 110% to 130% of tax revenue). This varied by type of councils, rising for London boroughs and unitary authorities and falling slightly for counties and metropolitan councils. Average borrowing significantly rose for 92% of district councils from zero to 70% of tax revenue; with the number of districts councils reporting no long-term borrowing, falling from 96 (in 2008/09) to 36 (in 2012/13) though this borrowing ratio is still well below other types of councils.


POLICY BRIEFING

46% of all councils in 2012/13 had long-term borrowing that was lower than their tax revenue; although this was the case for only a quarter of London boroughs and metropolitan districts. One third of all councils had long term borrowing double that of their tax revenue; and a fifth (72 councils) – including 35% of district councils – had long-term borrowing that was four times greater than their tax revenue; though the average long term borrowing for districts is just 70% of tax revenue for metropolitan districts it was 155%. See figure 10.

The Audit Commission warn that “all councils, but especially those with high ratios, need to consider the affordability of their borrowing in the light of likely future levels of tax revenue”. Councils have already seen reductions in the level of revenue support grant from government. Further reductions are expected, while interest rates are set to rise in the years ahead. The Commission also note that while the introduction in 2013 of the local retention of business rates has created an incentive for councils to increase income from this source, it has also increased councils’ exposure to the risks of volatility in business rates yield.


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The ratio of long-term borrowing to long-term assetsThe level of existing long-term borrowing and the value of long-term assets such as property, plant and machinery and long term investments influence decisions about how to finance investment in public services.

The majority of councils saw an increase in long term borrowing compared to the value of long-term assets over the whole period. This was put down to the level of long-term borrowing rates along with a decrease in long-term asset values due to a combination of asset sales and transfers, notably of schools and housing, and changes in property value.

The ratio went up for 77% of single-tier and county councils from 2007/08 to 2012/13, with borrowing as a proportion of assets rising from 20% to 30%. The increase was greatest for unitary councils and smallest for county councils. London boroughs were most likely to have a lower ratio in 2012/13 than 2007/08 and metropolitan districts were more likely to have a higher ratio. The average ratio rose significantly for district councils albeit from a very low level, but remained much lower than other types of council. See figure 11, below.


POLICY BRIEFING

Just over a quarter (27%) of all councils in 2012/13 – including 44% of district councils - had long-term borrowing that was less than 10% of the value of their long-term assets; while 21% – including 42% of metropolitan district councils – had long-term borrowing that exceeded 40% of the value of their long-term assets. See below.


POLICY BRIEFINGThe ratio of school balances to dedicated schools grantThis ratio shows whether local authority maintained schools are retaining a high or low proportion of government grant provided for education.

The majority (56%) of councils had a lower ratio of school balances to dedicated schools grant in 2012/13 than 2007/08, with balances falling from 0.8% to 0.7% of funding. Most commonly because school balances increased proportionally less than dedicated schools grant. Ratios have been rising since 2009/10 and are slightly higher in London boroughs with metropolitan districts more likely to have lower ratios. See diagram below.

In 2012/13 13% of councils had school balances that were less than 0.5% of the value of their dedicated schools grant; while 35% – including 52% of London boroughs – had school balances that exceeded 0.1% of the value of dedicated schools grant (i.e. 10%). See figure 16.

The Audit Commission have advised that councils should consider whether there are specific reasons why schools are retaining particularly high or low balances and whether there is more they can do to help schools manage their budgets effectively. Pointing out that councils may introduce mechanisms to recover excessive uncommitted balances ‘where some level of redistribution would support improved provision across a local area’. See Department for Education’s “Schemes for Financing Schools: Statutory Guidance for Local Authorities”.


https://www.gov.uk/government/publications/schemes-for-financing-schools




POLICY BRIEFING

CommentThere are a number of issues which the Audit Commission analysis gives rise to:

The contrasting fortunes of shire district and metropolitan districtsThe analysis reveals the contrasting financial fortunes of districts and metropolitan councils:

• While almost three-quarters of district councils had at least double the amount of assets than they had liabilities, and a third had four times the amount of assets. 42% of metropolitan districts had liabilities which exceeded their assets.

• More than half of all districts had unused reserves equivalent to 20% of their gross revenue expenditure; while over 40% of metropolitan districts’ reserve levels were only half that and less.

• While 44% of districts had long-term borrowing level that was less than 10% of their long-term assets, 42% of metropolitan districts had borrowing levels more than 40% of their assets.

These are long term characteristics, reflected in trends since 2007/08. In part they reflect the wider set of responsibilities which unitary metropolitan areas have; though


POLICY BRIEFINGthese ratios should balance this factor out. Nonetheless according to the Audit Commission’s last assessment of the financial health of the sector, metropolitan districts have presented the highest level of on-going risk since 2010.

Many would argue that a key determining factor is that the greatest cuts to government grant support (as a share of revenue spending) has been seen in metropolitan urban areas in the north and the midlands (as well as inner London boroughs).

The relative extent of reserves continue to rise, though not as much as ministers’ claimThe increasing levels of reserves held by councils has been a ministerial cause celebre; Eric Pickles has accused those councils complaining about having to make cuts in frontline services of ‘hypocrisy’ pointing to the £19 billion which councils hold in reserve (in 2012/13). An exaggerated picture, as this does not take account of those reserves which have been earmarked for specific projects or other uses; when you do, this figure falls to £4.5 billion.

This is the figure which the Audit Commission chooses to focus upon; nonetheless they found that levels of useable reserves were up to 40% of gross revenue expenditure. But it has only risen on average from 8% to 11% for single tier and county councils. While nearly a quarter, and half of unitary authorities who are often in the ministerial firing line on this issue, had useable reserves of less than 10% of their revenue expenditure. Shire districts tend to have proportionally twice the amount in reserves.

Going forward it is still going to be tough for councilsThis will be the last such report from the Audit Commission before it closes its doors next April. It has invited the Local Government Association to incorporate the ratios and data compiled to date in its Local Government Inform benchmarking service. The LGA say they are considering this.

The National Audit Office are currently conducting their own national study into council sustainability, looking at the cumulative impact of the spending cuts on local authorities, and how well government departments, co-ordinated by the Department for Communities and Local Government, understand these impacts. Their previous report, and the related and subsequent Public Accounts Committee report, was critical of the lack of collective Whitehall assessment and understanding of the impact of the cuts on local areas. The NAO are expected to report in the next month or so.

It will be interesting to see the NAO’s conclusions this time around. Up to now the analysis produced by the NAO, by the Audit Commission and others, notably Grant Thornton, has been that while there may be challenges, and regional variations (for example, Grant Thornton last year revealed less confidence in the South West and in the Midlands) the sector is likely to get through the rest of this and next year. However, it is what comes after in the second and third year of the next Parliament (i.e. 2016/17 and 2017/18) and beyond that is concerning; especially given the © Local Government Information Unit, www.lgiu.org.uk, Third Floor, 251 Pentonville Road, London N1 9NG. Reg. charity 1113495. This briefing is available free of charge to LGiU subscribing members. Members are welcome to circulate internally in full or in part; please credit LGiU as appropriate. You can find us on Twitter at @LGiU

http://www.local.gov.uk/about-lginform

http://www.local.gov.uk/about-lginform

http://www.nao.org.uk/work-in-progress/financial-sustainability-local-authorities/

http://www.nao.org.uk/work-in-progress/financial-sustainability-local-authorities/

http://www.grant-thornton.co.uk/en/Publications/2013/2016-tipping-point-Challenging-the-current-/




POLICY BRIEFINGrealism about that whatever the outcome of the General Election next May, local government will not see radical changes in current funding levels.

While each of the three main parties seem to have broadly the same deficit reduction targets, but different ways of achieving them, it does not seem that local government will be a beneficiary. Though Labour say they will introduce a fairer distribution of government grants to local government and the Liberal Democrats will extend the protection of schools’ budget to include early years and 16-19 education. The NHS is first in the queue to receive any funding relief, where it is available, from all three parties; leaving local government to consider the sustainability of the local government model beyond next May.

External Links

• Interpreting the accounts – a review of local government financial ratios 2007/08 to 2012/13

• Audit Commission Financial Ratios Tool

LGIU related briefings

Tough Times 2013: Councils’ Responses to Financial Challenges from 2010/11 to 2013/14

Assurance to parliament on local government funding: NAO report

For more information about this, or any other LGiU member briefing, please contact Janet Sillett, Briefings Manager, on [email protected]








http://www.lgiu.org.uk/briefing/tough-times-2013-councils-responses-to-financial-challenges-from-201011-to-201314/




http://www.lgiu.org.uk/briefing/nao-report-assurance-to-parliament-on-local-government-funding/




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