While stable doors are bolted to restrict future commercial investment, local authorities need to put the balance sheet at the core of their financial management writes Alison Ring.
With restrictions on their ability to increase core funding streams to match significant cost pressures, many local authorities have sought to generate income in other ways, such as turning in-house functions into revenue generating units, or making debt-financed investments in commercial property or renewable energy schemes.
There were concerns, even before the pandemic, about whether local authorities were over leveraged and taking on too much commercial risk. Central government—the insurer of last resort for failed councils—was already taking steps to restrict the ability of councils to use the Public Works Loan Board to “borrow for yield”.
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More recently, there are suggestions that advice in the Prudential Code precluding borrowing for financial yield should be converted into a statutory requirement, to put it into law. While this might restrain councils from further expanding their balance sheets, it would not address the financial risks that local authorities are already exposed to.
Theory and practice
In theory, managing local authority finances should be relatively straightforward, absent an emergency such as a pandemic. The bulk of principal income streams like council tax, business rates, and housing rents are predetermined at the start of each financial year, while the overwhelming majority of costs are recurring expenditures that are similar from month to month.
In practice, local authority financial management is much more challenging. Demand for services such as social care and emergency housing is high and can fluctuate significantly. Tight budgets and limited reserves following a decade of austerity mean that almost any budget overrun, or shortfall in ancillary income streams such as car parking and market fees or leisure centre charges, can have a significant knock-on effect.
Constrained budgets can also be counterproductive to long-term planning, leaving limited amounts of revenue funding available to invest in staff or processes. The consequences can include poor employee retention, leading to excessive reliance on agency staff, or inefficient processes that exacerbate the social problems that local services are there to address.
The increasing tendency of central government to require councils to bid against each other for development funds doesn’t help. This results in local authorities dedicating resource to submitting grant requests, rather than focusing on service delivery.
Investing risks
Investing has been positive for many local authorities, who have generated additional funds to invest back into service provision. For example, despite controversy about its debt financed £1bn investment portfolio, Spelthorne Council earned £26m in income after interest from investment properties in the year to March 2021, equivalent to just over half of its cost of services, excluding housing, of £50m.
Risks remain however, and several local authorities have got into financial difficulty, with a few issuing s114 notices.
With hindsight, commercial property such as retail outlets and office buildings may not have been the best assets to invest in as shoppers move online and flexible working becomes more popular; trends given a rocket boost by the pandemic. There have also been high profile failures of ventures such as Nottingham’s Robin Hood Energy and Croydon’s housing company Brick by Brick. Other ventures have just underperformed, failing to generate cash the councils concerned were hoping for to support local services.
Some of the recent hits to income generation have been directly caused by the pandemic and may only be temporary, with councils that rely on tourism like Bath and Northeast Somerset, Westminster, Luton, and Manchester hoping their retail and airport investments will recover once all international travel restrictions are lifted.
Balance sheets are core
The reality is that outside smaller parish councils most local authorities are no longer simple delivery vehicles for collecting local taxation and disbursing it to provide services to their local communities.
Instead, they are complex publicly owned businesses, with balance sheets that are many times the size of their annual council tax revenue streams, and capital expenditure programmes that put them among the biggest procurement sources in their localities. They are also owners of extensive commercial and residential property portfolios, and investors and managers of commercial ventures.
Unfortunately, you often wouldn’t realise this from the financial information that is provided to councillors, residents, and voters.
This gives rise to the question of whether existing financial reports, budgets and strategy documents are fit for purpose? Most budgets contain very limited commentary on balance sheet risks local authorities are exposed to, in contrast with extensive detail provided on individual costs.
For example, the budget document for one local council extends to over 700 pages, most of which comprises extensive cost-centre level detail on £70m or being spent on providing services, with just a three-page high level summary for almost £200m of capital investments. The document had no commentary at all on the financial risks in its £1.3bn balance sheet and what they might mean for financial performance in the coming financial year or in the longer-term.
This is not to suggest that local authority finance teams do not worry about their balance sheets—they do. However, any concerns they may have or risk assessments they might undertake are rarely visible in financial reports and budget documents, externally and internally.
It is time this changed. Irrespective of whether the Prudential Code is altered to make future commercial investments unlawful or not, more focus should be put on balance sheets as a central element in financial management to reflect the large complex enterprises that local authorities are today. Only by councils clearly articulating how they are managing their organisations, and the financial risks to which they’re exposed, can they demonstrate that their finances are under control.
Alison Ring is public sector director at ICAEW (the Institute of Chartered Accountants in England and Wales).
Photo by Scott Graham on Unsplash
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