Best Practices for Governmental Financial Management Policies

A version of this article first appeared in the California Special Districts Magazine

Financial management policies provide clarity and enhance fiscal decision-making of any government. Without a sound financial management policy, board members, management, and staff must rely on assumptions to make critical decisions.

Relevant policies differ for each government structure, operating environment, and size. For example, a government primarily funded by grants will benefit from a robust grant management policy, whereas an enterprise funded by ratepayers may not invest as much energy towards such a specific policy.

Key policies to consider

These key financial management policies are universally beneficial to all governments regardless of their size or purpose.

• A reserve policy can be defined in several ways, but healthy reserve balances represent disciplined cash management practices. Common types include operating, capital, emergency, and rate stabilization reserves.

  • Operating reserves are the lifeblood for cash flow management and ensure continuity of service during economic shortfalls. These should be calculated based on expected cash flows. In general, keep three months of operating expenditures at a minimum and assess if a higher target is needed. For example, property tax dependent governments receive installments twice a year and would benefit from a target closer to six months.
  • Capital reserves are established to fund future infrastructure, upcoming projects, and new equipment. To determine a reserve balance, governments might consider a five year average of capital expenditures, a percentage of capital assets, or a specific dollar amount based on future projects.
  • Emergency reserves preserve stability by preparing for unexpected emergencies. These reserves can target a set amount or fixed percentage of revenues or expenses. COVID-19 is a great example where many governments suffered revenue loss for an extended period.

• An investment policy should set clear guidelines for allowable investments and be reviewed and adopted annually.

  Governments should follow the SLY method, prioritizing safety, liquidity, and yield. First, the top priority must be investing safely with minimal risk of losing principal. Second, investments should be kept liquid for cash flow needs. And last, take yield into consideration, but do not make it the driving force in evaluating investment options.

• A budgeting policy should define what is considered a responsibly balanced budget for the government. This could include funding targets for working capital or other reserves within the budget process.

  Be sure to clarify the budget monitoring process, the frequency of monitoring, budget adjustment authorizations, and circumstances when a budget amendment is needed and should be approved by the governing body. The policy might also require pairing the budget with long-term cash flow projections. Budget formats vary and the policy should address the unique needs of the budget process.

• An accounting and financial reporting policy provides timelines for the preparation of reports as well as performing accounting duties. It dictates what reports are to be provided to management or the governing board (monthly or quarterly reporting is common practice). The audit firm selection process, auditor rotation frequency, and maintenance of sound internal controls are also important to consider in the policy.
• A debt policy establishes debt limits, debt capacity, and in what situations debt can be issued. Certain parameters can be discussed in-depth such as the purpose for which debt proceeds can be used. This could stipulate that debt will not be used to fund operating expenses, the revenue requirements for debt repayment or specific types of capital assets that would be appropriate to fund with debt.

• A grant management policy clarifies when and where to seek grant funding and the requirements for approval. It should also address how grant funding will be managed. Advance funding and reimbursement funding can be difficult to manage, especially if managing both grants simultaneously.

  The policy should include guidelines outlining how grants are monitored for compliance with associated terms. Indirect costing and sub-recipient monitoring should also be addressed within the policy. Language such as “all indirect costs related to grant administration will be recovered to the maximum allowable level” provides clear direction to recover as much indirect costs as allowed by any grant.

The importance of financial management policies

Financial management policies serve as a strong foundation for long-term financial health and perpetuate tactful decision-making. To unlock the full potential of these policies be sure to make them clear and concise. Monitor these adopted policies for potential improvements and implement updates as conditions change.

Sound financial management policies are just one way governments can run efficiently.
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