Local Government: 2015–16 Audit Snapshot

Tabled: 24 November 2016

3 Financial sustainability

In this Part we review the financial results and performance of Victoria's local government sector for the 2015–16 financial year. We also provide an assessment of each council cohort according to six financial sustainability risk indicators at 30 June 2016.

We discuss the main reasons for the net results achieved, and analyse the trends in key balances—such as types of revenue and capital expenditure—for eight financial years from 2011–12 to 2018–19.

3.1 Conclusion

At 30 June 2016, the local government sector had a relatively low financial sustainability risk assessment.

However, the small shire council cohort is facing an increased financial sustainability risk, with budget projections for the next three financial years showing a fall in expected revenue. This will reduce the funds these councils have available to invest in new and replacement assets which may adversely affect the services they can provide to their communities.

3.2 Financial sustainability risks

To be financially sustainable, councils should aim to generate enough revenue from their own operations to meet their financial obligations, and to fund asset replacement and asset acquisitions.

We use six financial sustainability risk indicators over a five-year period to assess the potential financial sustainability risks in the local government sector. The financial sustainability indicators, risk assessment criteria and benchmarks we use in this report are described in Appendix D.

Figure 3A summarises the financial sustainability risk ratings for the sector at 30 June 2016 based on the council cohorts. The financial sustainability risk indicators are calculated using the financial transactions and balances of each council's audited financial report.

Figure 3A

Financial sustainability risk indicators for the local government sector at 30 June 2016

 

Average across councils for year ended 30 June 2016

Indicator

All councils

Metro

Interface

Regional

Large

Small

Net result

per cent

11.4

13.7

29.0

9.4

4.9

–0.1

Liquidity

ratio

2.4

2.2

2.9

2.1

2.2

2.7

Internal financing

per cent

138.0

211.7

171.6

111.7

101.8

93.2

Indebtedness

per cent

26.1

16.3

27.6

36.2

30.3

20.2

Capital replacement

ratio

1.5

1.6

1.6

1.5

1.3

1.2

Renewal gap

ratio

1.0

1.1

0.9

0.9

1.0

1.0

Note: Yellow result = medium risk assessment; green result = low risk assessment.

Source: VAGO.

3.2.1 Overall analysis

Figure 3B shows that, over the past five years, the local government sector is in a financially sustainable position.

Figure 3B

Financial sustainability risk indicators for the local government sector at 30 June, 2012 to 2016

 

All councils for 30 June

Indicator

2012

2013

2014

2015

2016

Net result

per cent

13.0

13.7

8.0

15.6

11.4

Liquidity

ratio

2.1

2.1

1.9

2.3

2.4

Internal financing

per cent

128.1

100.0

92.0

147.8

138.0

Indebtedness

per cent

28.7

23.1

23.7

26.3

26.1

Capital replacement

ratio

1.8

1.6

1.6

1.5

1.5

Renewal gap

ratio

1.2

1.1

1.1

1.0

1.0

Note: Yellow result = medium risk assessment; green result = low risk assessment.

Source: VAGO.

The slight drop in the net result indicator between 2015–16 and 2014–15 reflects the disparity in the payment schedules for the financial assistance grant. However, the result is still positive. This—when combined with a strong liquidity result for all cohorts—indicates that councils are in a good financial position, and able to meet their commitments when they fall due over the next 12 months.

Our review of councils' financial statements has highlighted that the strong financial position is driven by a high level of cash and investment assets and a low level of borrowings at 30 June 2016. As shown in Figure 3C, this trend has been in place over the last five financial years, and is projected to continue over the budget period.

Figure 3C

Cash and investments and borrowings for the local government sector from 2011–12 to 2018–19

Figure 3C shows cash and investments and borrowings for the local government sector from 2011–12 to 2018–19

Note: Dashed line represents budget information.

Source: VAGO.

Figure 3C highlights:

  • a peak in cash holding across the 79 councils at 30 June 2016—reflecting councils' building cash reserves
  • an increase in borrowings from the 2012–13 financial year—this is linked to the Municipal Authority Victoria setting up a sponsored funding vehicle that enabled councils to borrow at lower rates.

As councils seek to increase their debt profile, they need to ensure that they are able to meet the repayments when they fall due.

The indebtedness indicator measures councils' ability to meet their non-current liabilities through own-source income—meaning, can they meet their longer-term debts through rates and other income raised by the council, rather than relying on grants for this purpose. Although this covers more than just the repayment of borrowings, it is a good indicator of whether the council is at risk of defaulting on a debt.

At 30 June 2016, the local government sector is rated strongly for this indicator, and is in a position to meet commitments as required. This is consistent with prior years.

The capital renewal indicator provides a snapshot of councils' spending on renewing and replacing their non-current physical assets. This is assessed against the level of depreciation expense for the financial year as this represents use of the assets within the same period. The internal financing ratio assesses whether this capital expenditure can be met from council funds, or additional funding is required.

3.2.2 Small shire councils

When compared with the local government sector as a whole, the small shire council cohort is facing a relatively higher level of financial sustainability risks—particularly in the forecast years. Figure 3D summarises the financial sustainability risk ratings for this cohort from 30 June 2012 to 30 June 2019.

Figure 3D

Financial sustainability risk indicators for the small shire cohort, 2012–19

Small shire cohort

Indicator

2012

2013

2014

2015

2016

2017

2018

2019

Net result

per cent

16.1

12.4

0.2

12.7

–0.1

8.2

3.4

1.2

Liquidity

ratio

2.7

2.6

2.1

2.8

2.7

2.1

2.0

1.8

Internal financing

per cent

148.3

98.8

78.1

140.9

93.2

93.3

103.7

99.4

Indebtedness

per cent

23.9

15.7

16.4

19.2

20.2

18.4

17.4

13.8

Capital replacement

ratio

2.1

1.7

1.8

1.4

1.2

1.7

1.3

1.1

Renewal gap

ratio

1.4

1.5

1.5

1.1

1.0

1.4

1.0

0.9

Note: Yellow result = medium risk assessment; green result = low risk assessment.

Source: VAGO.

Overall, small shire councils are facing additional pressures due to smaller year-on-year revenue increases, and steady increases in expenditure. This has a direct impact on the level of funds these councils have available for capital expenditure. This could potentially have an adverse impact on the services and infrastructure that councils are able to offer to their communities.

Net result

The small shire council cohort reported a net deficit of $0.1 million for the financial year. This reflects:

  • a reduction of $69.8 million in revenue compared to the prior year, reflecting the receipt of the first payment of the 2015–16 financial assistance grant in 2014–15
  • a combined deficit of $0.3 million from the councils' joint ventures, compared to a $0.2 million surplus in 2014–15.

The small shire councils are not budgeting to rebuild a strong surplus over the upcoming three financial years.

Figure 3E shows the revenue and expenditure for the small shire council cohort over the financial years ended 30 June 2012 to 2019.

Figure 3E

Revenue versus expenditure for the small shire council cohort at 30 June, 2012 to 2019

Figure 3E shows the revenue and expenditure for the small shire council cohort over the financial years ended 30 June 2012 to 2019

Note: Dashed line represents budget information.

Source: VAGO.

Figure 3E shows that the revenue for these councils is expected to fall slightly over the budget period, decreasing from $494.3 million in 2016–17 to $476.9 million in 2018−19, a fall of 3.5 per cent. This fall in revenue is linked to an expected 42.5 per cent reduction in capital grants. For these financial years, councils are expecting to generate only small increases in rates revenue—due to rate capping—and expect limited increases in their financial assistance grant.

Over the same period, the cohort's expenditure is expected to increase by 3.6 per cent, from $453.0 million in 2016–17 to $469.3 million in 2018–19. This will result in a small surplus, reducing each financial year. By 2018–19, the cohort projects to generate a collective surplus of $7.6 million.

Capital renewal and renewal gap analysis

Figure 3F shows the capital renewal indicator for the small shire council cohort from 2011–12 to 2018–19. This chart indicates that the cohort is facing an increasing risk that they will not be able to replace or build new assets as required.

Figure 3F

Small shire council cohort—capital renewal financial sustainability indicator results, 2011–12 to 2018–19

Figure 3F shows the capital renewal indicator for the small shire council cohort from 2011–12 to 2018–19

Note: 2016–17 to 2018–19 analysis based on unaudited budget information.

Source: VAGO.

Figure 3G shows our assessment of the renewal gap indicator for the small shire council cohort. It shows our analysis of the level of capital renewal expenditure that was—or is forecast to be—spent on renewing their existing assets, and illustrates that spending on capital renewal is reducing, therefore spending will not be focused on replacing existing assets.

Figure 3G

Small shire council cohort—renewal gap financial sustainability indicator results, 2011–12 to 2018–19

Figure 3G shows our assessment of the renewal gap indicator for the small shire council cohort

Note: 2016–17 to 2018–19 analysis based on unaudited budget information.

Source: VAGO.

Although building new assets and infrastructure is important for the local community, councils need to ensure that existing assets can continue to be used as required. Councils need to find the right balance between new and replacement asset expenditure to offer the best outcomes for their community.

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