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The treasury management service is an important part of the overall financial management of the Council’s affairs. Treasury management can be defined as the management of the organisation’s cash flow, its banking, money market and capital market transactions and the effective management of the risks associated with those activities. Its activities are strictly regulated by statutory requirements and a professional code of practice (the CIPFA Code of Practice on Treasury Management).
Prudential Code – The Local Government Act 2003 requires the Council to adopt the CIPFA Prudential Code. The basis of the Prudential Code is to ensure that the Council is fully aware of the implications of all its treasury actions. As part of the budget process, Full Council approves a series of Prudential Indicators that demonstrate that its activities are affordable, prudent and sustainable.
Investment Strategy - The primary principle governing the Council’s investment criteria is the security of its investments, although the yield or return on the investment is also a key consideration. After this main principle the Council will ensure:
As a result of the recent unsettled banking market, the Council had moved the majority of its deposits to the Government’s Debt Management Account Deposit Facility, an account guaranteed by the Government. Funds placed here are more secure than if they had been placed with a bank or building society, but the rate of interest offered is lower. Over the long-term, a continued loss of investment income due to lower interest rates is not sustainable and the Council therefore needed to look at where else it could safely invest. The Council’s counterparty list was also so restrictive that the Council had very few alternatives that could be considered. During 2009/10, therefore, a revised counterparty list was approved by Full Council. This has enabled the Council to look at other highly credit-rated institutions who may be able to offer higher rates of return whilst still providing security for the Council’s surplus funds.
The Audit Commission’s report ‘‘Risk and Return’ reminded councils that they should invest prudently and should primarily seek to safeguard public funds rather than maximise returns. Security and liquidity should therefore take priority over yield. This Council is diligent in ensuring that monies are only placed in secure and liquid investments and also uses a wide range of information, including, but not limited to, credit ratings, to ensure it is making informed investment decisions. It has well trained treasury officers and has recently undertaken treasury training for members. Treasury activity is also reported on a regular basis to senior management and members.
Borrowing – Active management of the Council’s debt portfolio is an important part of the treasury management function. Interest rates are predicted to fall further and therefore the Section 151 Officer will continue to ensure that these rates are closely monitored to ensure any advantages arising from restructuring the Council’s debt are obtained. The Council will need to undertake additional borrowing over the next few years as old debts are due to mature and will need to be repaid. A debt of £2m will mature on 30 June 2010, a further £3m matures 31 December 2011 and £2m on 31 December 2013. The Council will opt to take out borrowing to meet these debts when it is most advantageous to do so based on predicted interest rates.
There are a number of factors that could impact on the interest payable/investment income of the Council:
These risks have been mitigated by seeking professional advice on interest rate forecasts, carefully modelling the cash flow against anticipated financial forecasts and restricting investments only with those that have high credit ratings as set out in the Council’s Treasury Investment Strategy.
The assumptions made within this MTFP for treasury management related activities are:
Table 15
2010/11
£’000
2011/12
2012/13
2013/14
2014/15
Borrowing as at 31 March
28,003
27,999
Total Investments as at 31 March
7,000
Investment Income
195
Interest rate%
1.0%
2.0%
4.5%
Although the interest rate is predicted to increase over the medium term, there is no certainty around this and therefore it is considered prudent to keep the investment income budget at the current level.
With budgeted expenditure of over £70m and income targets of over £47m, just for the General Fund alone, it is fundamental to the financial standing of the Council that its budgets are realistic, affordable and meet its service requirements.
A number of different techniques have been employed to ensure that this Medium Term Financial Plan represents an affordable needs-based budget that is robust and able to be sustained over the medium term. Each of these are discussed in turn below:
Longer Planning Timeframes – With the advent of three-year financial settlements it was expected for it to be possible at last to draw together the impact of known future settlements and anticipated future budget pressures to enable the Medium Term Financial Plan to be modelled so as to identify the level of savings needed for a safe and sustainable budget requirement, thereby reducing the risk that future years’ aspirations will not be deliverable. However, contrary to expectations, the latest spending review has not been forthcoming and the settlement for 2011/12 is not expected to be known until the conclusion of the Spending Review 2009. There therefore remains considerable uncertainty about the period from 2011 onwards. The Pre-Budget Report suggests real term growth for public sector expenditure of only 0.8%. As the Government is committed to increasing NHS and schools funding in line with inflation and has promised that policing numbers will be maintained, it follows that funding for other areas will be cut. Therefore, for the purposes of this MTFP, there has been an assumption that formula grant will be cut by 3% each year from 2011/12 onwards.
The Planning Cycle: Develop, Review and Revise – The Budget and this Medium Term Financial Plan set out the expected levels of expenditure and income for the future. The estimates are arrived at through careful consideration of historic trends and actual expenditure levels and any factors which may have an impact in the future, such as known changes in legislation. It also requires a degree of estimation and assumption, such as to calculate the impact of a perceived increase or decrease in future demand as a result of demographic changes or patterns of behaviour that have a socio-economic impact. As time progresses the accuracy of the assumptions behind these figures will become clearer and in many cases will require the budgets within this MTFP to change if they are to continue to reflect the financial implications of delivering the Council’s aims and aspirations as set out in the Corporate Plan and other plans and strategies. Through the financial year the Council regularly monitors its financial performance against its budgets and will revise them where necessary, subject to remaining within the overall available funding envelope. By monitoring the actual expenditure against budget in this way, the budgets can be amended to best meet the actual needs of the Council, and provide a more suitable starting point for the next Medium Term Financial Plan.
Table 16
Shared services is no longer a feasible option.
Possible risk £2.5m - £3m
If shared services aren’t progressed, then a sizeable amount of budget savings factored into the medium term financial plan will not be able to be delivered. The likelihood of shared services not being progressed is also deemed to be high risk, as it relies on reaching consensus with four other councils (at member and officer level) and is dependent upon excellent project management being applied to be able to simultaneously merge a number of services across at least four councils, where currently all partners have different structures, policies and processes.
This is being mitigated by the close involvement of officers in the shared services projects and the long lead in time.
Bankruptcy of a major supplier or customer.
Possible risk £100k - £250k
This could result in having to pay twice for the same service if payments were made in advance, or see artificially inflated prices being charged if a replacement service needs to be obtained at very short notice.
One of the main customer risks is at the Port, which as the second largest municipal port in the country would suffer significantly in the event of a berth failure, or a problem with a regular operator.
The financial position of new contractors is vetted prior to entering into any large contracts. Managers are aware that they have a duty to work closely with key suppliers as part of contract management role, which would increase their chance of noticing any problems.
The options around the future operation arrangements for the Port are currently being reviewed, this will include consideration of measures to mitigate risks associated with service delivery failures or operator difficulties.
Repayment of Grant due to failure to meet qualifying criteria.
Possible risk £100k - £800k.
Grant may need to be repaid after the expenditure has already been committed. There may be no budgetary provision for the repayment.
Managers of grant funded schemes are aware of the need to comply with the terms of the grant. Problems have been experienced in the past where there has been a change of management and insufficient hand over. A new grant application protocol has now been developed to address this.
Unplanned major works to the Council’s property portfolio are required.
Possible risk £100k - £200k
The Council could be expected to fund major works at short notice and so additional revenue funding or prudential borrowing would be required.
This will be closely monitored to enable timely action to be taken.
Sums are lost as a result of an imprudent investment
Possible risk £0k - £1million
The world’s banking market is currently unstable. There is therefore a risk of a bank in which the Authority has invested collapsing.
The Council only invests with low risk organisations with high credit ratings and spreads its investment portfolio in accordance with its Treasury Investment Strategy.
An unfavourable outcome arises from any legal action taken against the Council Possible risk £100k - £250k
This could arise over a number of different grounds, including equal pay, discrimination and corporate manslaughter.
The Council may incur additional expenditure as a result of incorrect treatment of VAT.
Possible risk £100k - £250k.
Incorrect accounting for VAT could affect the Council’s partial exemption status, causing a reduction in the amount of VAT that could be reclaimed.
The Financial Services Section regularly reminds managers of the need to consult them on areas which represent the greatest risk. The Council has also entered into a contract with a firm of VAT specialists for the provision of VAT advice.
By assessing the risks in this way allows a financial estimate to be made of the total contingency that is needed to enable the Council to meet all of its financial obligations in the event of a major disaster. The financial risk assessment also considers the cash-flow requirements of the Council for both day-to-day activities, and those that may come out of its treasury management activities. Based on the financial risk assessment that was carried out as part of setting the Council’s 2010/11 Budget the required level of the General Reserve was deemed to be 10% of the net budget requirement. Therefore, the financial strategy will be to use reserves sparingly, and only when absolutely necessary and to replace them to restore the balance to 10% when possible.
As explained above, many of the figures contained within this Plan are based on estimates, which could prove to be inaccurate. In order to assess the impact of the use of poor estimates a top level sensitivity analysis has been carried out, using a 10% variance to indicate the impact of that level of error in the estimate. The outcome of this is shown in the table below.
Table 17
Area under consideration
Sensitivity of Estimates
The opening base budget
The opening base budget for both 2010/11 and 2011/12 is firm, as it is based on the budgets approved in February 2009 and 2010.
The base for 2012/13 could change, however this would be picked up as part of the preparation of the 2011/12 budget.
The pay estimates
A 10% change to the figure for pay increases that result from the pay award and increments would equate to £1.8million. However, such a large discrepancy would be unlikely as the pay budget is developed at a very detailed level (on a per post basis).
The main impact on the accuracy of the budgets for pay headings results from vacancy estimates which are impossible to predict.
The vacancy savings and post reduction estimates
For 2010/11 the vacancy abatement saving has been budgeted at £522.8k which is equivalent to approximately 20 posts. A variance of 2 posts equates to £50k. This will require a robust proactive approach to ensure that the savings that naturally arise due to staff turnover are retained. Based on experience in recent years, and considering the current staff turnover rate, this target is felt to be challenging but achievable.
The savings from posts that become redundant as a result of staffing reviews have been built into the budget based on assumptions as to when the postholders will leave.
Price Increases
In the main these are based on the terms of the contract. Inflation has been assumed at 1%. A 2% variance on this would equate to an increase in budget requirement of £486k.
Pension Increases
No provision has been made for an increase in pension contributions as there is currently an underspend against the budget provision which will be set aside in a reserve to meet any future overspends. The position will be reviewed again in a year’s time to ensure that adequate provision has been made.
Service Delivery Pressures
The estimates for service delivery pressures are best estimates. However, the demands on Council funding is continually moving. Therefore there is a chance that there will be greater demand than budgeted for. A 10% increase would account for £90k.
Volatile Budgets
A number of budgets are particularly volatile as they are dependent on how quickly the Council recovers from the impacts of the recession and on future interest rates. These budgets include interest payable, interest receivable and some income streams. Estimating these for budget purposes is made even more difficult due to the planned changes around structures, the uncertainty with regard to shared services and the possible need for prudential borrowing. If income levels return to those prior to the recession and interest rates return to their previous level of 4.5% by 2012/13, then potential revenue savings up to approximately £1.1m could be made. Due to the volatility of these budgets, this has not been reflected in the budget build but these budgets will be reviewed in 2011/12 when hopefully they can be predicted with more certainty.
Reduced Fees Income
The Council has suffered from reductions in income streams due to the recession. The budget assumes that these reductions will continue over the medium term, although in reality the income is likely to pick back up as the economy recovers.
The increased income targets
There is always a risk that increases in fees and charges reduce demand, which can have a detrimental impact on the budget. With £61k having been added into the budget for 2010/11 for increased income targets, a 10% reduction in achieving this would result in £6k. However, the impact of a reduction in demand isn’t necessarily limited to the achievement of the increase in income factored in; rather it can affect the achievement of the total income budget for any particular service. The increases proposed within the budget have been carefully calculated to match demand and to remain competitive where appropriate, but customer preference can’t always be anticipated, as a result the achievement of income targets will be monitored closely during the year.
Other savings estimates
The budget and Medium Term Financial Plan reflects the savings as a result of a number of efficiency measures and service reductions, which in some cases have been calculated based on indicative plans and in others on the conclusions of more firm contract negotiations. In order to maintain a balanced budget any under achievement of savings will be offset against emerging underspends in the first instance, but will require compensating savings otherwise. Service managers and the Council’s Management Team are aware of this and will review the achievement of them carefully over the year.
The level of general reserves which has been budgeted has been determined based on a financial risk assessment which considers the likelihood of the main risks facing the Council, and the possible financial implication should the risk happen. This has allowed an amount of general reserves to be used as part of the funding envelope for the General Fund Revenue Budget over the medium term, whilst still providing an adequate level of contingency for unanticipated events and cash flow purposes. The estimated position on general reserves at year end is that they will stand at 8.16% of the net revenue budget against the target of 10%. Every effort will be made to replenish these reserves to the recommended level at the earliest opportunity from in-year underspends.
Earmarked reserves are being used to enable funds provided for a specific purpose to be held until needed, and allows budgets that are needed on an irregular or periodic basis to be funded by setting aside an annual base budget at a fraction of the total cost. The funds held within earmarked reserves represent a one-off source of funding to meet planned expenditure. Their use is managed on a cash limited basis, and a shortage of reserved funds in year may be dealt with by re-phasing the expenditure, or by making use of emerging underspends.
The Government Grant
The Formula Grant settlement for 2011/12 (comprising Revenue Support Grant and National Non-Domestic Rates) has not yet been announced. There is therefore a strong likelihood of the amount differing to that budgeted. A prudent view has been taken of a cut of 3%, which should minimise the risk of the actual position being worse than anticipated. Were the cut to be as much as some commentators are suggesting of 8%, this would require additional savings over the 5 years of this MTFP of £2.24m.
Financial Services
E-mail:
accountancy@ thanet.gov.uk
Tel: 01843 577000