Financial Management for Merseyside Fire and Rescue Authority - Case Study Example

FINANCIAL MANAGEMENT FOR MERSEYSIDE FIRE AND RESCUE AUTHORITY Abstract Financial management seeks to provide an entity’s executive authority with raw data on the entity’s financial position as well as its cash flows and financial risks. Towards effecting sufficient financial management techniques, it is important to identify the basic operations of an entity and the distinctive risks that the entity faces. With this information, financial and risk management measures are undertaken carefully eventually bearing positive results for the entity. With the use of financial statements, the financial manager is able to compare the entity’s financial performance over the years and develop adequate financial policies aimed at controlling the entity’s cash flows and monitoring its performance. Executive Summary Merseyside Fire and Rescue Authority has overcome quite a number of financial pressures over the financial year 2008/09 by developing innovative internal process to improve on its resource efficiency. Financial pressures have presented the FRS with numerous financial risks that have been managed through its Integrated Risk Management Plan. Through this plan, the authority has decided to reduce its workforce, embrace efficient technologies and avoid compulsory redundancies. As a result of these developments, the authority recorded key successes in its fire and rescue services management as well as in its overall institutional management. Similar to the private sector, financial management in the public sector ought to be complemented by effective management policies within the entire entity. In the absence of this harmony, counter productivity is achieved whereby the gains achieved through effective financial management are reduced by poor management policies. Having realised this, the authority’s management has strived towards ensuring a cohesive operating environment to ensure the growth and development of the FRS. TABLE OF CONTENTS Introduction 1.0 Calculation of the Operational Boundary and Authorised Limits. 2.0 Setting the Operational Boundary 2.1 Main Considerations of Merseyside Fire and Rescue Authority 3.0 Merseyside Fire and Rescue Authority 3.1 Characteristics of the FRS 3.2 High Risk Areas 3.3 Accommodation of the High Risks in the Accounts Conclusion References Introduction This report seeks to discuss on various financial management issues within the Merseyside Fire and Rescue Authority and their impact on the FRS’s operations. Towards achieving this objective, the author will utilise both the financial statements provided as well as other scholarly material sourced from the libraries and the internet. Majority of the data will be gathered from the relevant financial statements that will be compared over a definite period of time. The author will eventually give his conclusion on the state of the FRS’s financial management measures and advice the senior financial manager accordingly. 1.0 Calculation of the Operational Boundary and Authorised Limits. Through the calculation of the operational boundary, the authority seeks to identify the available funds that can ensure the sustainability of their operations within the financial year. On the other hand, the authorised limit adjusts the available funds identified as the operational boundary to cater for the upward and downward cash movements incurred during the normal operational activities of the FRS (Operational Boundary, p2). Cash Flow 2008/09 £‘000’ Use of Capital Fund for Capital Programme 10.0 Capital Financing Requirement 2008/09 9.992 Use of Revenue Balances (1.115) Revenue Set Aside (Statutory MRP) (2.0) Revenue Set Aside (Voluntary Addition) (2.1) Estimated Operational Boundary at 31.03.2009 14.777 The Authorised Limit is calculated as 5% of the operational boundary. 1.05*14.777 = 15.516 Proportion of Authorised Limit Used = Operational Boundary/Authorised Limit = 14.777/15.516 = 0.95 Therefore, safety margin = 100%-95% = 5% It can therefore be conclusively stated that Merseyside Fire and Rescue Authority operates within the recommended safety margins. 2.0 Setting the Operational Boundary In setting the operational boundary, the authority considers its cash flows by identifying the various natures of their revenue sources and expenditures. A major component in the setting of the operational boundary is the determination of the future capital expenditures. Capital expenditures span over a number of financial years and the authority ought to determine the amount of funds required in the implementation of the capital project in the current financial year. Secondly, the use of revenue balances enables the management to determine how much of the retained revenues were used to fund other institutional commitments such as the world fighter games. Lastly, the revenue’s set aside are considered as they enable the authority to source funds during uncertain circumstances such as increased spending over and above the budgetary amounts (Operational Boundary, p2). On the other hand, the FRS has the choice of channelling a portion of their funds to various reserves for the authority’s welfare. Authorised limits are set as a percentage of the identified operational boundary that provides the authority with an estimate of their available operational funds within the current year. Considering the increase and decrease of the budget estimates, the authority ought to factor this in their budgetary allocations and hence the setting of the authorised limits. The authorised limits are calculated at 5 per cent of the operational boundary to cater for these cash movements during the financial year (Operational Boundary, p2). 2.1 Main Considerations of Merseyside Fire and Rescue Authority The FRS has two main considerations towards the commitment of their funds to ensure smooth internal processes. These two considerations enable the authority undertake sound financial management practices and risk minimisation. Firstly, the authority’s revenues and expenditures have a huge impact on the authority’s operational capabilities (Merseyside Fire & Rescue Auth. 2009, p5-8). These two financial elements ought to move in tandem with the authority’s financial strategy that seeks to enable the authority achieve its operational objectives. Due to their importance to the authority’s operations, the management required regular financial reviews that indicated the budgetary amendments relating to the capital and revenue budgets. From the financial statement, the authority sought to achieve savings totalling to £1.9 million (p6). This objective required the authority to reduce its spending and increase its revenues by deploying regular financial monitoring measures. Secondly, the movement of the authority’s reserve accounts are monitored to ensure that the reserve accounts are not depleted. Reserve accounts enable the authority to retain a portion of their surplus to counter any cash movements within the financial year. Additional amounts identified by the authorised limits over the operational boundary are transferred to the reserve accounts (Merseyside Fire & Rescue Auth. 2009, p9). The authority maintains several reserve accounts that hold funds for the various capital expenditures. Surplus amounts on the various reserve accounts are transferred to the general reserve account that provides funds to general financial obligations. Towards the maintenance of the reserve accounts, the authority conducts regular monitoring on the movement of reserves that reviews the anticipated and actual movements in reserves. Due to the economic recession, the authority has identified a smoothing reserve that is part of a medium term strategy aimed at mitigating the effects of the recession on the FRS’s operations (Merseyside Fire & Rescue Auth. 2009, p9). These two main considerations of the FRS enable it to observe and achieve its financial objectives. Towards ensuring the availability of funds within the authority, it ought to ensure adequate revenues, minimal expenditures and sufficient reserve accounts. 3.0 Merseyside Fire and Rescue Authority 3.1 Characteristics of the FRS Serving in the Merseyside County, the FRS serves an urban population of 1.4 million people covering an area of 653 square kilometres. The FRS was created in 1974 together with the establishment of the County and its administration includes members from the five boroughs. Merseyside Fire and Rescue Authority employs approximately 1800 staff located in the 25 stations across the region. These stations have a total of 42 fire engines that are installed with the latest fire fighting technologies to enhance service delivery (The Beacon Scheme 2010). Comparatively, the GMFRS serves a higher population of 2.5 million people with 41 fire stations. Due to the high population served by the GMFRS, the authority employs over 2,500 staff personnel that administer fire and rescue services across the ten boroughs. However, both FRS’s serve urban populations that require demanding fire and rescue services (Oneplace 2009). 3.2 High Risk Areas 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 Bergmann (2009, p56), 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. 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. 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 (Deegan 2009, p71). Transportation during an emergency response may result into accidents hence necessitating compensation for the affected. 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. Economic risks reduce the fair values of financial investments especially infrastructural investments that give rise to negative cash flows. 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 (Christoffersen 2003, p29). 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. Political risks have high impacts on the internal processes of the FRS as they arise from and result into a change in policies. A change in policy requires some duration of time to facilitate a smooth transition process from the old administration system to the new one. This could negatively impact on the authority’s cash flow and hence their high risk classification. 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 (Bergmann 2009, p116). 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. 3.3 Accommodation of the High Risks in the Accounts Having identified the high risk areas, the authority’s management has ensured that they are accommodated into the accounts to facilitate the regular monitoring of these areas. In accommodating the debtors and creditors, the authority recognises debtors at the moment they provide services to the customer. On the other hand, creditors are recognised when goods or services are provided to the authority (Merseyside Fire & Rescue Auth. 2009, p38). Deegan (2009, p83) states that in determining the debtor and creditor amounts to be charged to the balance sheet, the authority ought to maintain both the debtor and creditor control accounts that facilitate them in account for their receivables and payables. The authority debtors arise from salary advances and pensions, investment interests that are overdue, tax refunds and vehicle loans. On the other hand, the creditors arise from deferred taxes, interests on advanced loans and other accruals. Notably, these entities arise from the normal business operations and it is important that the organization keeps trace of these movements. In accommodating the price risks, the authority values its closing stocks at an average cost that takes into consideration the high and low market prices associated with the product. This value is charged on the stock account but charged on the balance sheet at the lower of cost. The difference between these amounts is transferred to the revaluation account then to the general reserve account. Valuing stocks at the lowest value reduces the total amount used in acquiring the stocks hence lowering the balance sheet amount. However, the amount in the stock account ensures that the reduced amount is included in the balance sheet in the form of the revaluation amount (Merseyside Fire & Rescue Auth. 2009, p42). In turn the general reserve account mitigates the effects of the price risks on the operations of the authority. Liquidity risks arise from the authority’s inability to finance its current liabilities by disposing its current assets. Towards the management of this risk, the FRS often engages in borrowings that enable the authority to undertake its operations. This risk is accommodated in the FRS’s accounts by analysing its various borrowings. As at 31st March, all the outstanding loans had been sourced from the Public Works Loans Board (Merseyside Fire & Rescue Auth. 2009, p39). These financial instruments are included in the balance sheet as either short or long-term borrowing. As a financial requirement, the calculation of the loan’s fair value involves the calculation of the present value over the remaining loan period. The fair value is then compared with the loan’s carrying amount whereby if the fair value is more than the carrying amount then the interest rate amounts accosted to the loan are higher than the prevailing market interest rates and vice versa (Bergmann 2009. P119). The loan’s carrying amount should be charged to the balance sheet as it represents the authority’s financial obligation pertaining to the outstanding loan. By analysing the borrowed funds, the authority accommodates the re-financing risk in its accounts. In the loan valuation process, the authority derives two important figures in managing the re-financing risk. These values are the carrying amount and the fair value of the loan. As noted earlier, a high fair value than the carrying amount indicate that the prevailing interest rates in the market are lower than the rates charged on the loan by the financier. Bearing this in mind, the authority’s management may choose to fully pay the principal plus interest amounts upon the maturity of the financial instrument. This will enable them seek another financial instrument that has an interest rate closer to the prevailing market rate. The authority also maintains a Financial Instruments Adjustment Account that seeks to balance the various interest repayments on the financial instruments (Statement of Accounts, p40). This account also handles the interest rate risk that arises from the financial borrowings undertaken by the FRS. Amounts in this reserve account are reflected on the balance sheet by matching the financial borrowings and investments. Conclusion From my perspective, the authority has placed sufficient financial measures that ensure that reliability of the financial management process. Risk identification enables the authority to establish reserve accounts to mitigate the effects of the various financial risks on the operations of the FRS. However, amidst the credit crunch, the authority ought to cautiously embark on its capital investments especially infrastructural properties due to their sharp decline in their values. References Bergmann, A 2009, Public Sector Fin. Mgmt, New York: FT Prentice Hall. Christoffersen, PF 2003, Elmnts of Fin. Risk Mgmt, Chicago: Academic Prss. Deegan, CM 2009, Financial Accounting Theory 3RD Ed, New York: McGraw-Hill. Elliott, B & Elliott, J 2007, Financial Accounting & Reporting, New York: FT Prentice Hall. GMFRS 2007, Stmt of Accounts 2007/08 Khan, A & Hildreth, WB 2004, Fin. Mgmt Theory in the Public Sector, Michigan: Greenwood Pub. Grp. Merseyside Fire & Rescue Auth. 2009, Stmt of Accounts 2008/09. Operational Boundary Oneplace 2009, GMFRS Organizational Assessment 2009, Accessed on Jan 4, 2010 from < http://oneplace.direct.gov.uk/infobyarea/region/area/localorganisations/organisation/ pages/default.aspx?region=53&area=423&orgId=1025 > The Beacon Scheme 2010, Merseyside Fire & Rescue Auth, Accessed on Jan 17, 2010 from < http://www.beacons.idea.gov.uk/idk/core/page.do?pageId=5098717 > Read More