Financial Analysis, Forecasting and Planning

Financial Analysis Financial Forecasting Financial Planning

Analysing Financial Condition

financial condition can be broadly defined as a LGs ability to finance its services on a continuing basis. More specifically, financial condition refers to a LGs ability to (1) maintain existing service levels, (2) withstand local and regional economic disruptions, and (3) meet the demands of natural growth, decline, and change.
Maintain existing service levels

Withstand local and regional economic disruptions

Meet demands of natural growth, decline and change

Framework for Evaluating Financial Condition

Budget, balance sheet and other financial statements fails to provide multiyear perspective of emerging good or bad Financial Condition of LG Most financial problems do not develop suddenly  A decline in revenues  An increase in expenditure pressures,  Decreasing cash and budgetary surpluses  A growing debt burden  The accumulation of unfunded liabilities  The erosion of capital plant  A decline in tax base or an increase in the need for public services

Framework for Evaluating Financial Condition

Need to ask following questions  Can the LG continue to pay for what it is now doing?  Are there reserves or other ways for financial crisis?  Is there enough financial flexibility to all the LG to adjust to change?

If LG can meet these challenges, it is having a sound condition

Environmental/ Organisational Aspects of Financial Condition

External Economic Conditions
Inflation Employment Economic wealth Interest rates

Intergovernmental Constraints
National constitutions Laws

Natural Disasters and emergencies Political Culture

Practices and policies that jeopardise financial condition

Repeated use of one-time revenue resources reserves, sale of assets etc Deferring a large amount of current costs to the future deciding maintenance, pension Ignoring long-range or full life cost of a liability purchasing assets with examining long term costs These practices can
 Create problems or  compound existing problems or  delay recognition of existing problems

Practices and policies that jeopardise financial condition

Practices that sustain an operating deficit
 Use of internal borrowing  Selling assets  One-time accounting changes

Practices that defer current costs

 Deferred pension liabilities  Deferred maintenance expenditures

Practices that ignore full-life costs

 Non-salary employee benefits  Capital assets

Financial Forecast
An estimate of future financial outcomes for an organisation. Undertaken using historical internal accounting and sales data, external economic and market data and economic indicators etc. A financial forecast is a best guess of what will happen for a company over a given time period. Predicting revenue rather than cost is most difficult aspect Can be undertaken by an outside researcher

Purpose of Financial Forecasting

Two purposes  Quantifies the future impact of current decisions, programs and policies (impact analysis), and  Identifies and provides information for analyzing the revenue and expenditure adjustment options needed to close the difference between revenues and expenditure (gap analysis) Forecast relies on  Policy assumption for impact analysis  Economic assumptions for gap analysis Budget is balanced estimates while forecasting tend to be unbalanced one

Benefits of Financial Forecasting

Link the LGs policy with specific financial plans to achieve a governing bodys longrange strategic goals Develop a picture of the LGs financial future and create more time to respond to adverse events Prepare the LG for shifts in responsibility Improve the quality of financial decision making Develop alternative decision strategies

Obstacles, limitations of Financial Forecasting

Political and staff resistance Changing LG revenue system Lack of development time Lack of knowledgeable and skilled personnel Lack of historical data Dilemma of circularity Importance of assumptions

Types of Financial Forecasts

Short Term Medium Term Long Term
Short-term Number 0-1 year of years Use Operating budget Cash management Monitor budget implementati on Mediumterm 1-5 years Budgeting Policy analysis Fiscal impact of legislation Identify financial trends Capital investment programming Long-term 10+ years Strategic planning Physical and economic development planning Fiscal impact analysis

Methods of Forecasting
Expert or Best Judgment Trend Deterministic Econometric

Comparison of Forecasting Methods

Method Advantages Disadvantages y Lack of an explicitly stated technique makes it difficult to determine what was right or wrong when analyzing the forecast methodology. y Dependence upon a single individual may hamper LGs effectiveness if that person leaves the organization. y Likely to prove weak when the forecast is extended beyond one year, because of the greater number of factors that must be taken into account. Expert or y Produces reasonably Best accurate forecasts. Judgment y Relatively low costs.

Comparison of Forecasting Methods

Method Advantages Trend Disadvantages y Simple technique y Does not predict a turning point in a variable (i.e., it to use. will continue to project y Fairly accurate increases [decreases] in the predictor of the variable regardless of what next one or two the economy does because future years. it is historically based.) y Reliable tool for y Not useful in policy revenues and analysis (i.e., to anticipate expenditures not economic or demographic sensitive to changes in the economic conditions. community.) y Inexpensive.

Comparison of Forecasting Methods

Method Advantages Disadvantages
yRelies on fixed relationships between inputs and activities. yUses averages as a major variable in the forecast, making it less responsive to changes in the economy. yDepends on assumptions usually based on experience. yLess likely to accurately forecast revenues and expenditures in areas of decline using the deterministic method

Determini ySimple to use. stic yAccurate for revenue and expenditure short and medium forecasts for variables not subject to changes in economic conditions. yUseful for economically determined variables over long periods of time because changes in business cycles tend to cancel out and averages become more dependable. yAccurate and suitable for forecasting growing areas. yInexpensive.

Comparison of Forecasting Methods

Method Advantages
yOnly methodology that lends itself to projecting revenues or expenditures based on changes in the economy. yMore accurate than other techniques because, unlike the best judgment method, it is based on behavioural relationships that can be measured and evaluated. yIt (regression technique) is not limited to forecasting in one direction like trend line techniques. yTests whether a relationship between variables is, in fact, statistically significant. yConsiders multiple variables in making projections rather than the single variables in deterministic techniques.

Disadvantages
yMore costly. yRequires a person trained in economics and statistics to develop the forecasting equations. yRequires considerably more time for data collection and input for regression analysis. yMore complex than the other alternatives and has more potential for errors.

Econome tric

Steps in Financial Forecasting

Step1: Define the Purpose Step 2: Address Citizen Input/ Technical Issues Step 3: Decide your approach to Forecasting Step 4: Determine Data and Information Requirements Step 5: Determine Resources Step 6: Management and Political Support

Steps in Financial Forecasting

Step 7: Determine length of Financial Forecast Step 8: Evaluate methods of forecasting based on length of forecast Step 9: Decide on approach for Forecasting Revenues Step 10: Decide on approach for Forecasting Expenditures Step 11: Combine Revenue and Expenditure Forecasts Step 12: Understand linkages to other planning efforts

Financial & Operating Plan

The Financial & Operating Plan

Features of the FOP
 Determines ULBs priority objectives in terms of resources, service provisioning and management aspects in the medium to long term  Objective is to reach a level wherein there is an optimisation of what the local financial situation can permit in terms of raising levels of services

Components of the FOP

   

Multi-Year Investment Plan Income & Expenditure Plan Capital Investment Plan Debt-servicing Plan

Multi-year Investment Plan (MIP)

Multi-Year scheduling of public physical improvements and investments- with associated O&M expenditure plans
 Derived from a demand-supply gap analysis hinged on city VISION/ GOALS  A long list of projects that the ULB intends to take up for the City  Phased based on City priorities  Would facilitate annual capital budgeting exercise, that is responsive to city needs  Would form the base for planning for prudent fund allocation and revenue enhancement

Income & Expenditure Plan

Features of Income & Expenditure Plan
 Projection of revenue income based on assumptions w.r.t base, basis and rules of taxation & charges, efficiency in revenue realisation and nominal growth rates incorporates additional revenue from remunerative projects of the MIP  Projection of capital income based on scheme-based grants from State/ Central Government based on funding pattern (loan-grant mix) adopted for the MIP

Income & Expenditure Plan

 Projection of revenue expenditure based on past trends/ rules for salary and other establishment expenses, estimated charges for O&M of infrastructure services, past trends, clearing of overdue and regular liabilities incorporating additional O&M expenditure due to the MIP incorporating additional debt-servicing burden due to borrowing plan for funding the MIP  Projection of capital expenditure based on the scheme-based grants received from State/ Central Governments based on the MIP

Capital Investment Plan (CIP)

Features of the CIP
 Sized MIP for public capital facilities catering to citys needs/ priorities based on investment sustaining capacity  Arrived through an iterative process of Income & Expenditure Plan and and MIP sizing/ prioritizing  Objective is to reach a level wherein there is an optimisation of what the ULBs Fund can sustain in terms enabling capital investments/ raising levels of services  CIP provides a framework for annual budgeting and hence requires constant updating

CIP is based on
 Investment sustaining capacity  Choice of specific improvements to be made

Debt Servicing Plan

Features of the Debt Servicing Plan
 Annual borrowing plan- linked to ULB borrowing powers  Annual debt-servicing commitment  Ratios/ indicators of debt-burden

Significance of the Debt Servicing Plan

 Indicates the credit-worthiness of the ULB  Lenders requirement- to assess the risks on lending  Helps ULB & Lenders to structure the debt  Helps ULB to restrict debt exposure to safe levels

Working of the FOP

1- Service Levels Contains details of existing levels of service prevalent in the town/ city 4- Service Norms- based on sectoral strategies Compares the indicators of the current service levels in the town/ city with the recommended levels/ norms 5- Demand-Supply Gap Analysis Estimates at the macro level, the gaps in service levels, which need to be converted into projects 6- Project Costing (MIP) Determines capital investments (based on unit costs) and associated O&M for achieving desired service standards 7- FOP Assumptions Provides for entry of the assumptions for: projecting the income & expenditure of the ULB- current items & new items due to CIP funding pattern for the CIP and the debt terms. 8- Income & Expenditure Plan (5-10 Years) Contains the item-wise projected income and expenditure of the Municipal fund under different budgeting heads 9- Capital Investment Plan (5-10 Years) Contains the Capital Investment Plan for the ULB based on investment sustaining capacity of the ULB. 10- Debt Servicing Plan (5-10 Years Contains the debt drawl and servicing plan of the ULB based on the o/s debt liabilities and the funding pattern for the CIP 2- Actual Financial Data Basic input sheet with provisions for entry of the actual financial data as made available with the ULB in the Municipal Accounting Code format

3- Municipal Finances Contains the summary of the Municipal Fund and consists of consolidated income & expenditure statement under revenue & capital accounts; analysis of income & expenditure- sectoral contributions; growth trends; per capita levels

Financial Planning
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