Financial Management Practices of Devon and Cornwall Fire and Rescue Authority - Case Study Example

FINANCIAL MANAGEMENT FOR DEVON AND CORNWALL FIRE RESCUE AUTHORITY NAME: XXXXXXXXXXXX Abstract Public financial management is undertaken to ensure the smooth flow of the internal processes towards the provision of services to the public. The financial management process seeks to identify financial risk areas that have the capability to negatively impact on the organization’s processes. In turn, this information facilitates the executives in making sound management decisions that ensure sustainable internal operations. During the financial management process, the environmental changes are taken into consideration and their impact on the organization’s funds are analysed in order to adjust its operations. In the fire and rescue authorities, financial management ought to ensure that the services are adequately financed and have the capability to meet their legal mandates. TABLE OF CONTENTS Introduction 1.0 Estimation of the Operational Boundary 2.0 Operational Boundary 2.1 Setting the Operational Boundary 2.2 Main Consideration by the FRS 3.0 Major Risk Areas 3.1Characteristics of the FRS 3.2 Financial Risks 3.2.1 Liquidity Risk 3.2.2 Credit Risk 3.2.3 Market Risks 3.2.4 Interest Rate Risk 3.2.5 Foreign Exchange Risk 3.2.6 Re-financing Risks 3.3 Accommodation of the High Risk Areas in the FRS Conclusion References Introduction This report discusses the financial management practices of Devon and Cornwall Fire and Rescue Authority by analysing their financial statements as well as identifying the various financial risks and their impact on the internal operations. On the other hand, the author will conclude on whether the FRS’s operations are a success or not. Upon completion, the financial manager will receive the report for its approval and eventual release to the public. 1.0 Calculation of the Operational Boundary For the FRS, the operational boundary for the year 2008/09 is calculated as follows: Cash Flow 2008/09 £000 Use of Capital Fund for Capital Programme 7.060 Capital Financing Requirement 2008/09 4.415 Use of Revenue Balances (0.175) Revenue Set Aside (Statutory MRP) (0.553) Revenue Set Aside (Voluntary Addition) (0.95) Estimated operational Boundary at 31.03.2009 9.797 The authorised limit is calculated as: 0.05*9.797 = 0.4899 9.797+0.4899 = 10.2869 Proportion of Authorised Limit used = Operational Boundary/Authorised Limit =9.797/10.3 =0.95 As a result, safety margin = 100% - 95% =5% Therefore, Devon and Cornwall Fire Authority operates within the recommended safety margins. Compared to the GMFRS: For GMFRS = £11.698M = Operational Boundary For GMFRS Authorised limit = £12.5M So proportion of authorised limit used = operational boundary/authorised limit = 11.698/12.5 = 0.935 Therefore the safety margin = 100% - 93.5% = 6.5% The recommended safety margin is 5% Therefore GMFRS operates within recommended safety margins If number at 6.5% is less than 5 – FRS is not operating in recommended limits. 2.0 Setting the Operational Boundary The operational boundary seeks to identify the amount of funding required to ensure that the authority performs its duties efficiently throughout the financial year. In establishing the operational boundary, the management seeks to ensure that the authority is adequately financed to meet its mandates and financial obligations (The Operational Boundary). Towards setting the operational boundary, the authority considers the amount of capital funds made available and used for capital projects within the financial year. Additionally, the utilization of revenue balances as well as revenues set aside either voluntarily or by statutes is included in the setting of the operational boundary. On the other hand, the setting of the authorised limits is based on the estimated operational boundary. The authorised limit serves to cushion the authority’s cash flows from financial fluctuations that arise from its normal operations (The Operational Boundary). These fluctuations either increase or decrease the authority’s financial obligations and thus the necessity of continuous financial monitoring. It is set as a 5% variation of the operational boundary and rounded off to the nearest £0.5million. 2. Main Considerations of Devon and Cornwall Fire Authority Annual revenues and expenditures are considered by the FRS as they are incurred or accrued during the normal operations of the authority. Increasing revenues and minimizing expenditures is very vital towards the establishment of sustainable business practices (The Operational Boundary). Therefore, the authority has strived to ensure that key expenditures such as salaries are reduced. From the authority’s financial statements, revenues exceeded the budget estimates that were positive for the authority’s funds availability. The reduction of the expenditures and increase in revenues provided a surplus for the authority and hence proving the sustainability of the internal operations. Comparatively, the GMFRS mainly considers its revenue sources and expenditures that present the basic inputs to the accounting process. Secondly, the financing of capital projects and the subsequent expenditures is important to the FRS as it requires the management to strike a balance between funding capital projects and ensuring the availability of adequate funds to finance the daily operations (Statement of Accounts, p5). Capital projects can be implemented for a number of years and therefore the management should ensure sufficient funds are channelled towards funding daily operations. Surpluses at the end of the financial year can be forwarded to specified reserves and utilised in the completion of the capital projects in the next financial year. Towards financing the capital projects, the authority is forced to undertake borrowings that complement the available funding. It is important for the authority to complete capital projects within the financial year to enhance their service delivery efforts. Comparatively, the GMFRS undertakes various capital programmes that are reviewed regularly over the current financial year (GMFRS, p9). Close monitoring of the capital programmes is done to oversee their completion within the provided period. The management should ensure that the external debts do not surpass the authorised limit that will negatively impact on the authority’s cash flows and service delivery. Lastly, several reserve accounts are maintained by the authority towards the provision of a financial contingency against future expenditures that exceed or fall below the budget estimates (Statement of Accounts, p9). However, reserve accounts are not meant to necessarily cushion the FRS’s financial operations from uncertain financial expenditures but also to channel funds to earmarked projects to facilitate their completion. The FRS maintains two major reserves that account for the revaluations and adjustments in the capital expenditures. The two reserve accounts accommodate increases in the values of assets after a revaluation exercise is conducted and providing capital funds to finalise on past expenditures. Similarly, the GMFRS maintains a general reserve account that caters for the financial surpluses and deficits that are in turn charged to the earmarked reserve accounts (GMFRS, p9). 3.0 Major Risks 3.1 Characteristics of the FRS Established in 1948 under the Fire Services Act 1947, Devon & Cornwall Fire and Rescue Authority serve a rural-urban population in the UK’s southwest region with an estimated size of 3,563 square kilometres. The area served by the FRS has a population of 519,400 whereby majority of the population comprises of the local Cornish. Additionally, the FRS employs over 700 staff personnel whereby two thirds of the FRS fire rescue staff personnel are on-call (Devon & Cornwall FRS). Although the FRS serves a larger area than the GMFRS, the GMFRS has a high number of fire-fighting staff due to the large urban population served by the GMFRS. This in turn increases its operational costs as indicated by the operational boundary. Additionally, the urban population served by the GMFRS presents numerous challenges such as arson and terrorist attacks and therefore the need to have sufficient fire-fighting tools and equipments. Lastly, the urban population in Manchester comprises of different social groups and therefore to ensure the efficient delivery of services, the GMFRS ought to educate the society on coping with fire incidents and accidents (GMFRS). 3.2 Risk Areas Types of Risks and Uncertainties Firstly, the authority is faced with business risks that arise from their service delivery operations. These operations require material stocks such as fire fighting equipments and fire alarms among others. According to Horne & Wachowicz (2005, p93), business risks include operational risks that are significant with the business environment and have a significant impact on the authority’s cash flows. Notably, these risks arise from the normal business operations that are internal to the authority. The provision of general reserves aims at catering for the various business risks that may arise from the authority’s normal operations. Secondly, financial risks arise from the FRS’s financial commitments that comprise of revenues and expenditures as well as assets and liabilities. The authority receives funding from donors among other revenue sources. However, in some instances, the authority falls short in its financial commitments and this requires them to source for additional funds from other financial institutions. Therefore, the movement of operational funds within the authority gives rise to financial risks and should be addressed in the financial statements. Creditors and debtors are a major component of the authority’s operations that present the organization with the credit and default risks. As financial risks, the authority has included them in their statements of accounts to enhance accountability. Thirdly, the physical risks arise from poor storage facilities of the authority’s physical materials. Physical risks reduce the value of the stocks hence resulting into an impairment adjustment in the financial statements. Transportation during an emergency response may result into accidents hence necessitating compensation for the affected. The accommodation of stocks in the financial statements presents evidence of the physical risks. Fourthly, economic risks directly impact on the authority’s operations as they are present within the external operational environment. The FRS’s operations have been negatively impacted upon by the subsiding global economic recession hence the need to reduce their expenditures as funding decreases. Christoffersen (2003, p65) states that economic risks reduce the fair values of financial investments especially infrastructural investments that give rise to negative cash flows. Interest rate movements indicate economic performance and they serve as indicators of economic risks. Political risks arise from politically unstable societies where politics have a direct influence on the authority’s operations. Changes in national administrations require adjustments in the internal operations of entities and this categorically explains the impact that political risks have on the authority’s operations. New policies and procedures administered by the national administration may require a total overhaul of the authority’s operations. Notably, political risks arise at the micro and macro levels that influence the operations internally or both internally and externally (Coombs & Jenkins 2002, p91). Lastly, product lifecycle risks normally arise in manufacturing entities that develop market oriented products. Basically, products undergo a five-stage process that comprises of the conceptual, introduction, growth, maturity and decay stages subsequently. Products in the market undergo this process that gives rise to the product lifecycle risks. As a product reaches the decay stage, the higher the probabilities of incurring the product life-cycle risk. However, the FRS is not exposed to this risk as it offers services that do not lose their importance over time. High Impact on Operations Low Low High Impact on Business Continuity 3.3 Accommodation of the High Risk Areas Towards accommodating the credit risk, the authority has established a treasury management policy that financial institutions transacting business with the authority are required to observe. Similar to the GMFRS, the FRS acknowledges bank deposits, debtors, creditors and other revenue sources separately on the financial statements. These items are also measured separately in distinctive accounts that monitor their movements. These accounts measure the degree of exposure of the FRS’s operations to the credit risk (Statement of Accounts, p43). Characteristically, the authority’s debtor history indicates that no provision of bad debts in necessary as most debtors repay their financial commitments. Financial deposits are due within the financial year and the authority allows 28 days for debt settlement prior to the implementation of the debt recovery process. However, in some instances, almost £114 was overdue although this amount did not necessitate the provision of bad debts. In accommodating the liquidity risks, the FRS begins with identifying its sources of revenues for their operations. Notable of the GMFRS, its financial assets are classified into two distinctive categories namely loans and receivables and assets available for sale (GMFRS, p14). This enables the GMFRS to monitor its liquidity risk by comparing the assets available for sale and the total financial commitments. With the diverse revenue sources, the authority is capable of raising finances to fund their operations. The management breaks down its financial obligations and maturity analysis on the basis of the time frames allocated to the various financial borrowings. However, the FRS is faced with the re-financing risk that involves the renewal of the present financial instruments at disadvantageous terms (Khan& Hildreth 2004, p91). According to the authority’s treasury management policy, strict measures are to be observed during the renewal of the financial instruments and engaging in the borrowing of loans from PWLB. Capital projects may span more than their initial time frame and this in turn requires the authority to renew their financial instruments. In most cases, this renewal may provide the lender with the chance to exploit the borrower and thus the FRS may end up committing itself to an unfavourable agreement. To avoid this scenario, the treasury management policy seeks to provide guidelines on how the authority seeks for loans and their repayments schedule (Statement of Accounts, p44). On the other hand, the FRS’s cash flows are exposed to movements in the interest rates due to its borrowing and investment activities. Although all borrowings and investments are undertaken under fixed rates, movements in the interest rates negatively impact on the fair values of the borrowings and investments (Horne & Wachowicz 2005, p34). The Statement of Accounts state that, during the annual budget monitoring process, the authority assesses its exposure to the interest rate risk that facilitates its decision making process (p44). The impact of the interest rates on the budget estimates is important as it enables the FRS to reach an agreement on the various projects it can sufficiently fund without negatively impacting on its cash flows. Conclusion From my analysis on the FRS’s financial management, majority of the internal process are able to address the arising financial risks and maintain the authority’s operations within the authorised limits and the operational boundary. Compared to the GMFRS, the Devon and Cornwall Fire and Rescue Authority has more control over its cash flows and hence the resultant surplus at the end of the year. References Coombs, HM & Jenkins, DE 2002, Public Sector Fin. Mgmt 3rd Ed, Brooklyn: Cengage Learning EMEA. Christoffersen, PF 2003, Elmnts of Fin. Risk Mgmt, Chicago: Academic Prss. Cornwall Council 2009, CFRS News: Preventing Protecting Responding, Accessed on Jan.15, 2009 from < http://www.cornwall.gov.uk/default.aspx?page=7388 > Devon and Cornwall Fire Rescue Authority Statement of Financial Accounts Devon & Somerset FRS, Retrieved on Jan 15, 2010 from < http://www.dsfire.gov.uk/devonfire >. Elliott, B & Elliott, J 2007, Financial Accounting & Reporting, New York: FT Prentice Hall. GMFRS 2007, Stmt of Accounts 2007/08 Horne, JCV & Wachowicz, JM 2005, Fundamentals of Fin Mgmt, New York: FT Prentice Hall. Jones, R & Pendlebury, M 2000, Public Sector Accounting 5th Ed, New York: FT Prentice Hall. Khan, A & Hildreth, WB 2004, Fin. Mgmt Theory in the Public Sector, Michigan: Greenwood Pub. Grp. McKinney, JB 2004, Effective Fin Mgmt in Public and Non-profit Agencies, Michigan: Greenwood Pub. Grp. The Operational Boundary Read More