An automated five-year financial model: applications in Michigan cities.
In exploring the potential use of financial models, government officials raise a number of questions relating to fundamental issues:
* How will this process be of benefit to the community?
* What does a five-year financial model look like?
* What financial information should be included in the model?
* What is the procedure for developing a model?
* What level of software/computer proficiency is required?
* How do we develop future assumptions?
This article attempts to respond to each of these questions in a balanced fashion, providing overview information as well as some technical detail for current and prospective practitioners. It draws upon the experiences and lessons learned by staff of the Michigan Municipal League's Municipal Consulting Services while assisting Michigan municipalities in developing financial models.
Benefits of a Five-year Model
Although all municipalities obviously have unique circumstances and requirements, municipalities also are largely subject to the same three-step municipal cycle:
* the growth stage, a stage in which planning and service expansion are the overriding concerns and revenues approach their peak;
* the maintenance mode, a stage in which the entity is fully developed, revenue growth has become more static, and maintaining current infrastructure and service quality are the overriding concerns; and
* the retrenchment mode, a stage in which economics are worsening, cutbacks are imminent, and reorganization and redevelopment are critical.
Depending on a municipality's position in the municipal cycle, a well-developed, five-year financial model can be utilized to achieve different objectives. Five Michigan communities offer cases in point.
Delta Township. A financial model provides this rapidly developing community of 25,000 with the ability to monitor and plan service expansion effectively for both general government and utility operations.
Rochester Hills. As this city of 65,000 nears the end of its growth phase, officials sought a rational method of planning for and evolving into the maintenance mode. A financial model provides the ability to assess future capital and resource requirements and associated cost impacts, thus facilitating sound financial and service planning.
Milan. This small city of 4,000 has successfully utilized a tax increment financing authority (TIFA) to capture property tax growth and dedicate the resources to rebuild much of the city's infrastructure and facilities. With the expiration of the TIFA, the city's financial circumstances and its information needs are markedly different. The financial model responds by providing a basis for determining the financial requirements associated with post-TIFA operations and capital requirements.
Lincoln Park. Here, the initial financial modeling process revealed negative financial trends at work in this mature post-industrial community of 42,000. Utilizing this forecast as a starting point, the city developed a five-year action plan for fiscal health - including a long-range collective bargaining strategy, operational reconfiguration, early-out retirement incentives and capital financing. The model's capacity to analyze "what if" scenarios enabled the city to develop this strategy and monitor ongoing success effectively.
Ecorse. This small steeltown of 12,000 residents was on the losing end of a recent tax appeal ruling granted to the city's primary taxpayer/corporation. The ruling, which is being appealed by the city, has multimillion-dollar financial implications. The financial model developed for the city provides a basis for evaluating potential outcomes related to the litigation and long-range financial and operational strategies.
Developing a Five-year Financial Plan
A five-year financial model can be developed on off-the-shelf spreadsheet-based software. As seen in Exhibit 1, the model developed by the Michigan Municipal League's consulting service is organized in a number of separate files, or notebook pages, each concerned with a different area of financial concern. Its construction enables the following operations.
* The files (or pages) are "linked", thus providing a comprehensive, interactive program.
* An assumptions file/page can be added. In this instance, changes to the model, or "what if" analysis, can be easily accomplished with a single entry (e.g., wage rate increase for 1998 or for the period 1998-2003).
* The "bottom line" for the general fund is summarized in a single exhibit, allowing the user to identify quickly the impacts of different assumptions. Detailed information related to revenue and expenditure estimates is also included in separate exhibits.
A financial model may be developed inhouse or with consulting assistance, depending upon available expertise and/or resources. The model can be designed so that, once completed, it requires users to have only a basic knowledge of spread-sheet operations to update and maintain assumptions and financial data. The seven steps that constitute the process used in constructing this model are displayed at the bottom of Exhibit 1. The following guidelines may be useful.
* The model should be custom designed for the particular entity, consistent with the budget format. Although some supporting files, such as property tax, can serve as templates with only minor modifications, the bulk of the model will be unique to each entity.
* The modeling process is similar to the budget process in the sense that all departments must be involved. Some orientation regarding project objectives may serve to enhance the cooperative effort.
* Expert sources such as auditors, actuaries, insurance providers, state agencies, and others should be consulted when formulating assumptions concerning future financial trends. Assumptions must be meticulously documented.
In regard to software, factors to consider include
* the likelihood of pending obsolescence if existing, older software is used;
* current in-house experience and expertise with particular packages; and
* special features, such as enhanced graphics, that may be desired.
Utilizing the Financial Model
This model's "what if" ability is its key attribute. By using the master assumptions file or by entering a change anywhere in the program, budget officials and planners can quickly and easily evaluate various operational or financial scenarios. These might include the long-range impact of union and city wage proposals; modifications to benefit offerings; changes in operating millage; legislative proposals that impact taxing authority, revenue sharing, or other conditions; varying levels of capital funding; additions to or reductions in personnel; and countless other scenarios.
A five-year financial model can provide municipal government with an important tool for financial and resource management. As with most endeavors, the value gained will be in direct proportion to the effort expended. A well-constructed model should provide many years of utility, as well as accurate and reliable future estimates.
MARK NOTTLEY is manager of Municipal Consulting Services (MCS) for the Michigan Municipal League. JOHN KACZOR is a municipal consultant with MCS. MCS provides management consulting services to public entities throughout Michigan, focusing on financial, operational, and human resource issues. The authors can be contacted at 313/662-3246.
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|Author:||Nottley, Mark; Kaczor, John|
|Publication:||Government Finance Review|
|Date:||Aug 1, 1997|
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