Results of 2017–18 Audits: Local Government

Tabled: 19 December 2018

4 Financial outcomes and sustainability

In this part of the report we summarise the financial outcomes of the local government sector for the year ended 30 June 2018, and comment on the sustainability of the sector.

The detailed data and calculations that underpin our commentary are provided in Appendix E, which lists our financial sustainability indicators, risk assessment criteria, benchmarks and the results of each indicator for each of the councils for the eight financial years 2013–14 to 2020–21.

4.1 Conclusion

Overall, the sector is financially secure with a relatively low level of financial sustainability risk in the short term. At 30 June 2018, most councils have demonstrated strong financial performance and sustainable financial practices, with positive results, continued strong liquidity ratios and low levels of debt. Councils continue to prefer not to borrow funds, utilising accumulated cash to replace or expand their assets.

Rural and regional councils are more susceptible to financial sustainability risks due to their inability to generate significant own-sourced income while also being impacted by sector-wide issues such as rate capping and increased recycling costs.

Councils should make enough money from their operations to meet their financial obligations and fund their asset management plans to be financially sustainable.

While the sector's short-term financial sustainability risk indicators remain strong, the sector continues to demonstrate declining asset renewal and maintenance indicators, highlighting the need to prioritise asset maintenance. Councils will need to develop adequate strategies to allow them to continue to provide services, and maintain and renew facilities for their communities—while maintaining long-term financial sustainability.

4.2 Financial results

Figure 4A summarises the sector's financial sustainability risk indicators for 30 June 2018.

Figure 4A
Financial sustainability risk indicators by cohort, 30 June 2018

Table summarising the sector's financial sustainability risk indicators for 30 June 2018

Key: High risk; medium risk; low risk.

Source: VAGO.

Financial performance

Net result indicator

The net result indicator measures the net result of the council as a per cent of revenue.

In 2017–18, councils collectively recorded revenue totalling $10.66 billion ($10.5 billion in 2016–17), the majority of which consisted of:

  • $5.7 billion of rates and charges ($5.4 billion in 2016–17)
  • $1.7 billion of government operating and capital grants ($2.0 billion in 2016–17).

Council operating expenditure in 2017–18 totalled $8.49 billion ($8.1 billion in 2016–17), including:

  • $3.4 billion of employee expenses ($3.3 billion in 2016–17)
  • $3.0 billion of materials and services ($2.9 billion in 2016–17)
  • $1.5 billion of depreciation and amortisation ($1.4 billion in 2016–17).

Figure 4B shows the split of revenue and expenditure across two categories, while Figure 4C shows the results of the sector over the last five years and next forecasted three years.

Figure 4B
Sector revenue and expenditure for 2017–18

Two donut charts illustrating the sector revenue and expenditure for 2017-18

Source: VAGO.

Figure 4C
Sector revenue, expenditure and net result, 2013–14 to 2020–21

Graph illustrating the Sector revenue, expenditure and net result, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Overall, the sector generated a surplus from operations over each of the last five years and is expected to continue to do so over the next three years. The forecasted decline is due primarily to the ongoing impact of rate capping and increased recycling costs.

Normalised result is the net result adjusted for Commonwealth financial assistance grants received in advance.

We have reported in earlier years that the significant annual spikes and drops in the net result indicator for the sector are mostly due to distortions created by Commonwealth grants timing—these funds being received and recorded in the current reporting period, but which relate to future periods. To obtain a better representation of sector performance, we normalised the net results by shifting the Commonwealth grant funding into the year for which the funding was provided—as shown in Figure 4D.

Figure 4D
Sector net result compared to normalised result, 2012–13 to 2020–21

Graph illustrating the sector net result compared to normalised result, 2012–13 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Forward outlook

Figure 4E summarises budgeted revenue and expenditure (unaudited) for the next three years.

Figure 4E
Council three-year revenue and expenditure budget

Over the next three years

Rates revenue

Grants

Employee benefits

Materials and services

Budgeted to increase by an average of 8.7 per cent

Budgeted to increase by an average of 18.7 per cent

Budgeted to increase by an average of 8.8 per cent

Budgeted to decrease by an average of 1.2 per cent

Source: VAGO.

Funding gap is the amount of money needed to fund ongoing operations or future developments that is not currently provided by cash, equity or debt.

Over this period, councils collectively forecast an increase in their rate revenues of 9 per cent, which accounts for the increased recycling costs. Employee benefits are expected to increase also by 9 per cent over the same period.

Councils have forecasted an average decrease in materials and services of 1 per cent to address the growing funding gap.

Adjusted underlying result

Metropolitan councils have consistently reported adjusted underlying results above 10 per cent over the last four years, and continue to do so in their three‑year forecasted budgets. This demonstrates that these councils can fund their ordinary business activities and meet community service needs.

The adjusted underlying result indicator excludes any revenue received which funds capital expenditure from the net result—it measures a council's ability to generate surplus from its ordinary activities.

In comparison, rural and regional councils have previously reported fluctuating adjusted underlying results. Over 56 per cent of rural and regional councils are expecting an average negative indicator over the next three‑year forecasted budget. The short- and long-term impacts of rural and regional councils budgeting to spend more money than they can collect, include:

  • failing to provide key services and facilities that meet 'community expectations and values'
  • inadequate responsiveness and accessibility of services provided to the community
  • a loss of quality and cost efficiencies of community services.

It is important that councils develop appropriate strategies to generate positive surpluses and deliver services that their communities expect. Figure 4F shows the adjusted underlying result across the two categories of councils.

Figure 4F
Adjusted underlying surplus analysis by category, 2014–15 to 2020–21

Graph illustrating the adjusted underlying surplus analysis by category, 2014–15 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Analysis of financial position indicators

The sector has historically had, and continues to have, a strong net asset position, with a low level of liabilities in comparison to assets.

At 30 June 2018, councils collectively held total assets valued at $108.1 billion compared to total liabilities of $3.4 billion ($97.4 billion and $3.4 billion respectively at 30 June 2017). Figure 4G shows the financial position of the sector over the last five years and next forecasted three years.

Figure 4G
Sector total assets and liabilities, 2013–14 to 2020–21

Graph showing the Sector total assets and liabilities, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Based on the cash and term deposits held at 30 June 2018 in comparison to borrowings, councils overall can adequately service their debts.

At 30 June 2018, councils collectively:

  • held $5.1 billion in cash and term deposits ($4.4 billion at 30 June 2017)
  • owed $1.1 billion in borrowings ($1.2 billion at 30 June 2017).

Figure 4H shows the split of cash and borrowings across the two categories.

Figure 4H
Sector cash and borrowing at 30 June 2018

Two donut charts illustrating Sector cash and borrowing at 30 June 2018

Source: VAGO.

Short-term assets

The local government sector continues to have a strong current asset position and a high level of cash and term deposits—$5.1 billion—an increase of 16 per cent on $4.4 billion at 30 June 2017 that is mostly attributable to the timing of Commonwealth financial assistance grants.

Metropolitan councils continue to hold the majority of cash within the sector—72 per cent at 30 June 2018 (72 per cent at 30 June 2017), which correlates with the higher proportion of borrowings metropolitan councils hold, funding larger capital projects and the service needs of a larger community. While rural and regional councils hold less cash, and conversely less in borrowings, their cash balances have historically been stable and are forecasted to remain stable over the next three years. We have accounted for the advanced receipt of government funding and have normalised balances for our forecasts. Figure 4I shows the cash and term deposit balances held by the two categories of councils at year end.

Figure 4I
Cash and term deposit balance held by category, 2013–14 to 2020–21

Graph showing Cash and term deposit balance held by category, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Indebtedness indicator

The indebtedness indicator shows whether councils can meet their longer-term liabilities from their own-sourced revenue.

At 30 June 2018, 68 of the 79 councils had some form of borrowings on their balance sheet. Metropolitan councils hold the majority of debts within the sector—62 per cent (63 per cent at 30 June 2017).

The average percentage of indebtedness has trended downwards over the last four years to 22 per cent at 30 June 2018, and is expected to remain at this level over the next three years based on forecasted budgets. Borrowing costs represent 0.5 per cent of total revenue and 1 per cent of rates and charges for 2017–18 (1 per cent and 2 per cent respectively for 2016–17). This shows a general reluctance within councils to undertake significant borrowings to fund investments in assets, a position reinforced by the levels of surplus of cash and term deposit holdings. Figure 4J shows the results of the indebtedness indicator across the sector.

Figure 4J
Sector indebtedness indicator analysis, 2013–14 to 2020–21

Line graph showing  Sector indebtedness indicator analysis, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Figure 4K shows the borrowings balance from 2013–14 to 2020–21 by the two categories and across the sector. Metropolitan councils have forecast an increase in borrowings over the next three years, mostly to fund major infrastructure developments, while rural and regional councils anticipate stable levels of debt.

Figure 4K
Borrowings balance by category, 2013–14 to 2020–21

Line graph showing borrowings balance by category, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Internal financing indicator

The internal financing indicator looks at the capacity of the sector to fund capital expenditure using cash generated from operations and government funding.

The timing of Commonwealth grant funding significantly impacts the results of the internal financing indicator. The result for 2017–18 is consistent with prior years and expectation—147 per cent (165 per cent for 2016–17). The projected decline in the internal financing indicator for 2018–19 is largely driven by expected increases in capital expenditure accompanied with a lower cash balance forecast at 30 June 2019, given advanced receipt of government funding in 2017–18. Figure 4L shows the results of the internal financing indicator across the sector from 2013–14 to 2020–21.

Figure 4L
Sector internal financing indicator analysis, 2013–14 to 2020–21

Line graph showing the sector internal financing indicator analysis, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Asset renewal and maintenance indicators analysis

The sector's sustainability requires councils to effectively and efficiently maintain and renew their physical and non‐financial resources such as infrastructure networks, to meet public demand. Our review of capital replacement and renewal gap indicators assess council spending on these assets.

Capital replacement indicator

The capital replacement indicator measures the level of spending on new and renewed assets compared to the related depreciation expenses of these assets.

The sector is forecasting an increase in capital replacement in 2018–19, mostly to fund major infrastructure developments in metropolitan areas—in line with the budgeted increase in borrowings over the next three years. Councils will need to balance capital spending arising from the long-term needs of their communities while managing forecasted decreasing adjusted underlying results—particularly given the impacts of significant events such as rate capping and increases in recycling costs. Figure 4M shows the results of the capital replacement indicator across the sector from 2013–14 to 2020–21.

Figure 4M
Sector capital replacement indicator analysis, 2013–14 to 2020–21

Graph showing the sector capital replacement indicator analysis, 2013–14 to 2020–21

 

Note: Forecast figures have not been audited.

Source: VAGO.

Metropolitan councils continue to buy assets more than rural and regional councils, which is expected, given the population growth within metropolitan areas and the resulting increase in demand for infrastructure. Further, rural and regional councils have historically experienced significant fluctuating adjusted underlying results, and continue to do so—including negative results for some councils. The fluctuations impact their capacity to generate sufficient surpluses from their ordinary business activities to service their communities, which may influence whether rural and regional councils can suitably replace and renew their assets. Figure 4N shows the balance of infrastructure, property, plant and equipment by the two categories of councils at year end.

Figure 4N
Sector infrastructure, property, plant and equipment balance by category, 2013–14 to 2020–21

Graph showing the sector infrastructure, property, plant and equipment balance by category, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

Renewal gap indicator

The renewal gap indicator provides information on assets acquired by councils—whether spending is focused on purchasing new assets or renewing and upgrading existing ones.

The renewal gap indicator broadly mirrors the trend of the capital replacement indicator—with the sector forecasting similar results of an increasing capital trend in 2018–19, particularly metropolitan councils.

Over the three-year forecast, rural and regional councils are expected to trend below 1:1, highlighting the need to prioritise asset maintenance. Similar to the capital replacement indicator results, rural and regional councils need to develop strategies to ensure they can appropriately renew and maintain assets to provide services and facilities that meet community needs. Figure 4O shows the results of the renewal gap indicator across the sector from 2013–14 to 2020–21.

Figure 4O
Sector renewal gap indicator analysis, 2013–14 to 2020–21

Graph showing the sector renewal gap indicator analysis, 2013–14 to 2020–21

Note: Forecast figures have not been audited.

Source: VAGO.

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