By Dan Tienter, Municipal Advisor
and Brian Roemer, Senior Municipal Advisor

Understanding the Annual Comprehensive Financial Report

To paraphrase Warren Buffet…To understand the status of any going concern – from a nationwide confectionery business to a small public utility – you must understand the imperfect language of accounting. And, while Mr. Buffet may be more concerned with stock picking than  the nuances of local public policy making, he would likely tell anyone that, before you make a big decision, make sure you know how to read and interpret financial statements, or as we call them in local government, the Annual Comprehensive Financial Report (ACFR). Thankfully, especially around this time each year, local governments have an opportunity to reacquaint themselves with the language of accounting and what it may tell us about the needs and challenges of an organization.

To support the decision-making process, appointed and elected officials, as well as anyone charged with governance, should develop some basic financial literacy, including the ability to interpret, even if only at a high-level, the information presented in the ACFR. By understanding the financial health of the organization as a whole, as well as their own specific areas of interest or responsibility, local government officials can more effectively manage daily operations and better secure long-term stability.

But, how to begin? What should the users of financial statements look for in the ACFR and what can it tell them? Perhaps unsurprisingly, there are any number of answers to this question. However, for governing boards and senior leadership outside of the finance area, the Government Finance Officers Association suggests three general answers:

1. Review short-term financial health
2. Evaluate long-term financial health
3. Assess economic conditions or expectations

Each of these general areas provide the ACFR user with a well-rounded understanding of the organization and tell them what they can expect moving forward, at least from a financial perspective.

For short-term financial health, elected and appointed officials should focus on the ability of the local government and its component units or underlying operations to cashflow activities. And, while this tends not be an issue for general operations, it can often be a problem for certain enterprise or business-like activities, some of which the local government actively subsidizes. In the case of a municipal golf course, an appointed or elected official may ask “can the golf course support its own expenses and meet its own obligations?” For financial purposes, they should review the Statement of Revenues, Expenses, and Changes in Fund Net Position to understand if that particular enterprise made money or lost it. From there, they can make more informed and thoughtful public policy decisions.

After considering the short-term health of a fund or activity, local government officials should then review the long-term health of their organization, especially given the short-term measurement focus often applied to public entities. They may ask  themselves, “Have we been doing better, worse or about the same over time?” Generally, the best way to answer this question by reviewing fund balances to understand material changes in financial position and the reasons behind them. This analysis should focus on a five- to 10-year period, including at least three years of actuals and five years of projections to identify and respond to any meaningful trends, which will help local government leaders understand when a financial course correction may be advisable or even necessary. Done well, this information helps organizations make more timely financial decisions and avoid drastic adjustments during a single fiscal year.

Once they have analyzed the financial statements to understand both short- and long-term financial health, local government leaders should look beyond their organization to appreciate the context of their activities. Of course, no local government operates in a vacuum and leaders may ask, “How do the happenings of the local, regional, national, and even global economy impact the financial position of our organization?” Often identifying prevailing trends or newsworthy events are an essential part of thoughtful financial management and accurate interpretation of financial statements. Most notably, a local government should consider demographic trends, unemployment rates, state budget activities, tax base changes, supply chain stress, inflationary pressures, and interest rate movements. Additionally, local governments may want to focus on particular data of concern to their own area. For example, a local government with a large tourism industry may be interested in certain weather data or trends. Thankfully, either the statistical section or the required supplementary information found in the ACFR provides a wealth of data to inform these discussions. As part of any financial information discussion with a governing board, Ehlers recommends a brief review of economic conditions or expectations – even just one slide at the beginning of a lengthy presentation can provide critical insight for decision-makers.

Understanding, appreciating, and learning from your ACFR may sometimes be a tricky or even arcane endeavor. However, by reviewing short-term financial health by fund, examining long-term trends over years, and considering the economic environment of an organization, local government leaders may become more conversant in the language of accounting and the financial health of their organization. As a result, they can discover deeper financial insights, better manage financial affairs, improve their responsiveness to ever-changing needs and inspire confidence in their management. And, if that were not reason enough to take the time to learn about the ACFR, we should remember one other quote from Mr. Buffet: “Risk comes from not knowing what you are doing.”

Want to learn more?  See our presentation on Understanding Key Financial Indicators.

Important Disclosures:

Ehlers is the joint marketing name of the following affiliated businesses (collectively, the “Affiliates”): Ehlers & Associates, Inc. (“EA”), a municipal advisor registered with the Municipal Securities Rulemaking Board (“MSRB”) and the Securities and Exchange Commission (“SEC”); Ehlers Investment Partners, LLC (“EIP”), an SEC registered investment adviser; and Bond Trust Services Corporation (“BTS”), holder of a limited banking charter issued by the State of Minnesota.

Where an activity requires registration as a municipal advisor pursuant to Section 15B of the Exchange Act of 1934 (Financial Management Planning and Debt Issuance & Management), such activity is or will be performed by EA; where an activity requires registration as an investment adviser pursuant to the Investment Advisers Act of 1940 (Investments and Treasury Management), such activity is or will be performed by EIP; and where an activity requires licensing as a bank pursuant to applicable state law (paying agent services shown under Debt Issuance & Management), such activity is or will be performed by BTS. Activities not requiring registration may be performed by any Affiliate.

This communication does not constitute an offer or solicitation for the purchase or sale of any investment (including without limitation, any municipal financial product, municipal security, or other security) or agreement with respect to any investment strategy or program. This communication is offered without charge to clients, friends, and prospective clients of the Affiliates as a source of general information about the services Ehlers provides. This communication is neither advice nor a recommendation by any Affiliate to any person with respect to any municipal financial product, municipal security, or other security, as such terms are defined pursuant to Section 15B of the Exchange Act of 1934 and rules of the MSRB. This communication does not constitute investment advice by any Affiliate that purports to meet the objectives or needs of any person pursuant to the Investment Advisers Act of 1940 or applicable state law.