Operational Boundary and Authorised of FRS - Case Study Example

FINANCIAL MANAGEMENT Review of Financial Statement of Fire Authorities 1. Introduction The Fire and Rescue Service like any other businesses is subject to financial management and operating within operational boundary and authorised limit. For this reason, they have to operate within the allowable safety margin. Moreover, the FRS have to recognised several issues and risks such as financial, economic, political, and business risk. The following section discusses the Operational Boundary and Authorised of FRS as stated in their latest financial statement and several risk and uncertainties they need to address. 2. Critically assess the Operational Boundary and the Authorised Limit for your Fire and Rescue Service. Authorised limit generally represents the limit to external borrowing and includes capacity for short term borrowing over and above the established long term debt outstanding. The authorised limits of FRS were set in accordance with the authority’s approved treasury management policy statement and practices, existing commitments, plans, and proposal for capital expenditure and financing. The authorised limits were calculated and set based on the worst-case scenario to avoid spending beyond what is duly allotted. In addition, the limits was based on the assumption that it only needs short-term borrowing to fund short-term cash flows needs thus long-term borrowing to fund capital expenditure is not required. For instance, the authority is determined to set a budget that is both affordable and sustainable over the medium-term thus it had considered funding service improvements from savings and use reserves in order to provide funds for large off budget spending. These savings and reserves were the result of under spending of the previous year’s budget leaving a net under spend of more than half a million pounds. For this reason the authority decided to roll these funds forward in reserves and grants unapplied to meet capital expenditure commitments for 2009/10. Operational Boundary generally represents the total of expected long term debt, excluding short term movement. It is normally recommended that this limit be set at 6.5 for the year, The operational boundary limits was set based on the authorised limits and indicate that the FRS has indeed decided not to take out any new loans and use internal cash balances to fund capital expenditure for the time being. In addition, the move was due to the impact of the credit crunch that led to concerns regarding security of temporarily surplus cash balances and lower investment rates of interest. The 3 year financial statement sees the need to provide funds and avoid any sharp fluctuations by utilising reserves. The external long term debt of the FRS with the Public Works Loan Board is included in the current liabilities which is due to be repaid in 2009/10. The FRS is obliged to set aside a certain amount from the revenue each year for the redemption of debt of about 4% MRP (Minimum Revenue Provision) representing the outstanding borrowing liability. Moreover, the FRS is also charging extra for the repayment of debt to align the charges made to revenue to the life of assets that have been financed from borrowing. However, the debt repayment is not include in the net cost of services but rather charging services with the cost of depreciation on operational fixed assets and the differences between MRP. 3. Calculate the safety margin of the Operational Boundary to the Authorised Limit. Comments on the result. Year: 31/03/2009 Operational Boundary of FRS = £14,029,000 Authorised Limit of FRS = £15,000,000 Proportion of Authorised Limit used: = £14,029,000/ £15,000,000 = 0.935 Safety Margin: = 100% /93.5% = 6.5% Recommended SM is 6.5% thus FRS is operating within suggested SM otherwise FRS is operating within the critical limit. GMFRS have the same safety margin and also operating within the recommended SM. 4. Identify six categories of risk facing the FRS. For each category comment on whether the risk has a financial impact on the FRS and if so, whether it has been recognised in the financial statements. If your opinion it has not been recognised, explain why you believe there has been recognition in the Summary. The FRS in its medium-term approach involves the identification and assessment of key issues and risks which they need to address in the coming years. Their medium term financial strategy ensures financial risks and its implications are properly assessed and taken into account before any decisions are made. Each year the FRS sought to set a budget based on risk assessment that will determined the level for General Fund Balances and in 2009, it has been moved from 5% to 6% over the medium term. Risks facing the FRS in terms of financial strategy is the potential impact of economic recession, slow housing growth that is impacting the amount of council tax can be collected, additional budget pressures that may arise from on some contracts as a direct result of the falling exchange rates, the impact of credit crunch on suppliers which would eventually pressure the FRS pay suppliers sooner, low government grants and borrowing. a. FINANCIAL AND POLITICAL RISK Even before the economic downturn, there was always a pressure to keep council tax increases low. For instance, the Government’s Spending Review for 2009 suggest further efficiency target thus the FRS is expecting the following fiscal year would be very difficult. Although there are a wide variety of local sources for funding of fire and rescue services, the major types of local funding sources for fire and rescue departments include taxes. Taxes are important as they are the most convenient source of funding for fire and rescue service (US Fire Administration, 2000, p.9). Slow housing growth means lesser real state taxes which have been known to provide additional source of revenue for public safety and public works projects. An advantage of this type taxes over other property taxes is that it comes from those with income sufficient income to own and sell real estate. Although first time home buyers may be exempted, these taxes are a good revenue source even in times of economic downturn because if often generates substantial revenue stream. Moreover, aside from the fact that they are easily collected, these taxes can be taken along with payment of property taxes at the time of closing on the mortgage or when the deed of transfer is registered. This risk is included in the financial statement as evidenced by the statements on the need to raise council tax in the next three years. b. ECONOMIC RISK The variability of the exchange rate induces variability in the future cash flow (Shim & Constas, p.73) thus changes in exchange rate, particularly when its lower, increases the amount payment that will be made to foreign contracts in local currency and pressure in FRS’s budget occurs. Moreover, as the exchange rates fluctuates the risk in investment and cash losses increase. For instance, in their 3 year financial statement from 2008/09 to 2010/11, the budget includes purchases of items such as appliances, vehicles, and operational equipment which can vary significantly from time to time due to the exchange rate. However, although it has been mentioned as a financial risk, fluctuation of exchange rates is not included or recognized in the summary. The impact of exchange rate on the financial capacity of the FRS is unavoidable and considering its purchases and future facility improvement plan, its budget up to 2010/11 should take into account this potential risk. c. BUSINESS RISK A credit crunch is commonly known as an excess demand for credit under prevailing interest rates or a situation where credit is rationed through non-price mechanisms (Lindgren p.24). However, in the FRS situation, credit crunch has no direct implication but on their ability to pay the suppliers who are actually affected by the banks credit crunch. This kind of credit crunch is the fall in real credit to the private sector which the suppliers belong. Moreover, according to Lindgren (p.24), growth rate of real credit in most countries has declined sharply since late 1997 and may be affecting suppliers of FRS till now. This is probably the reason why the FRS is concern over the security of temporary surplus cash balances and lower investment rates of interest. In addition, they also decided not to take out any new loans and use internal cash balances to fund capital expenditure. Credit crunch from wider perspective is also one of the causes of the council’s tax problem concerning slow housing growth. In UK, the government acknowledges the risk poses by credit crunch to its social housing targets because house builders are coming under serious pressure to remain a viable business and households seeking a mortgage or credit to trade up on their property (Communities and Local Government 2009, p.79). Moreover, banks refuse to continue to offer revolving credit for the purchase of inputs by state enterprises or enterprises themselves refused to borrow because of high interest rates and reduced output accordingly (Winiecki 2004, p.35). The FRS has the same problem thus it has included this risk in the summary evidenced by considerations taken for short-term borrowing and use of reserves in its financial statement. d. POLITICAL Included in the number of new and continuing issues and risk to the FRS financial stability is the impact of smaller grants from the government in 2011/12. This constraint coupled with other budgetary pressures such as expectations of further improvement of national resilience to major agencies and equal pay and employment benefits for retained fire fighters on appeal in court can bring significant financial difficulty to FRS. In addition, staff related cost for the FRS is just over 82% of the budget and consequently the annual pay awards would significantly impact the future expenditure levels. The FRS commitment for staff pay is heavily affected by the annual pay awards including unavoidable commitments such as the inflationary growth in ongoing injury related pension payments and ill health retirements. The Central government has effective control over the general operations of the FRS because it has been providing the statutory framework in which the FRS operates. Moreover, the FRS is getting majority of its funding from the government in the form of grants. For this reason, the central government also prescribes the terms of many of the transactions of the FRS including those with other parties. This is evident in the Cash Flow Statement and notes to the core financial statements of the FRS for 2008/09. e. FINANCIAL In the three year pay award for fire-fighters has ended but the uncertainty over the future pay levels still present a risk to the FRS. Although a fund from recycled savings has sufficiently covered the expenditures and avoided budget pressures, the FRS is still concern that new savings cannot continue to be identified. As far as their financial strategy is concern, this risk can affect the continuous improvements of services being provided aside from the fact they are aspiring to see the FRS fit for the future. The financial constraints comprising of low council taxes, limited grants and borrowing, credit crunch, etc greatly contributes to the potential of this risk as it entirely depends on funding. For this reason, the FRS includes in its core financial statements pensions that will be payable in future years although these are not actually payable until an employees retires. However, it has resulted in an increase in liabilities measured at today’s prices. In 2009, for instance, the FRS has entered inflation, salary, and pension increases with expected rates of 3.1%, 4.6%, and 3.1% respectively. f. POLITICAL The Prudential Code allows the FRS to borrow additional funds for capital expenditure purposes with the need for government consent provided they can afford to service the debt. However, although it may be viewed as freedom for the FRS to enter into self finance borrowing arrangements, it can only benefit the FRS if the decision is prudent, sustainable, and affordable. Consequently, the FRS limits its borrowing to the amount that is supported by the Government in settlement thus none of it is assumed in the development of its financial plan. For this reason, any plans to improve the fire station’s premises must have to wait and back-logs would accumulate. Although the FRS had already decided to use their reserves and savings to avoid further financial difficulty, this does not mean they would not take loans in the near future. In time, the FRS may need to review their spending plans for the 2010/11 if the current recession continues. Similarly, future investment plans which at present were calculated base on their ability to produce capital receipts and funds coming from self financed borrowing may need to review to cope with its future needs. This risk have recognised in the summary of accounts since this issue have been part of the comprehensive spending review since 2007 where the level of grant funding being provided for the FRS is inline with estimates provided by the government including the pressure to keep the council taxes low. 5. Conclusion In my opinion, the FRS has a strong financial control as evidenced by their financial statement and the move to temporarily avoid borrowing and use their savings to finance their capital expenditure. It had also recognised some of the risk associated with their operation in their financial statement and express their strategies to counter the effects of these risks. However, further care is recommended in assessing key operating issues and risks since these could affect the financial stability in the near future. They should ensure that their medium-term financial strategy can address the potential impact of economic, financial, and political risks and uncertainties. 6. Bibliography Communities & Local Government, 2009, HC Paper 101 House of Commons Communities and Local Government Committee: Housing and the Credit Crunch, The Stationery Office, UK Greater Manchester Fire and Rescue Authority, 2008, Statement of Accounts 2008/09, GMFRA, UK Lindgren C. 1999, Financial sector crisis and restructuring: lessons from Asia, International Monetary Fund, UK Shim J. & Constas M. 2001, Encyclopedic dictionary of international finance and banking, CRC Press, US US Fire Administration, 2000, Funding Alternatives for Fire and Emergency Services, FEMA, US Winiecki J. , Benacek V., and Laki M., 2004. The private sector after communism: new entrepreneurial firms in transition economies, Routledge, UK Read More