5 Financial Forecasting & Fop

Financial Analysis, Forecasting and Planning Financial Analysis Financial Forecasting Financial Planning

“Analysing Financial Condition” “financial condition can be broadly defined as a LG’s ability to finance its services on a continuing basis. More specifically, financial condition refers to a LG’s 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

Evaluating Financial Condition – some basic truths  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

 Budget, balance sheet and other financial statements fails to provide multiyear perspective of emerging good or bad Financial Condition of LG

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 without 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 LG’s policy with specific financial plans to achieve a governing body’s longrange strategic goals  Develop a picture of the LG’s 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

Medium-term Long-term

Number 0-1 year of years

1-5 years

Use

Budgeting Strategic Policy analysis planning Fiscal impact of Physical and legislation economic Identify development financial trends planning Fiscal Capital impact investment analysis programming

Operating budget Cash management Monitor budget implementatio n

10+ years

Methods of Forecasting    

Expert or Best Judgment Trend Deterministic Econometric

Comparison of Forecasting Methods Method

Advantages

Expert or • Produces reasonably Best accurate forecasts. Judgment • Relatively low costs.

Disadvantages • Lack of an explicitly stated technique makes it difficult to determine what was right or wrong when analyzing the forecast methodology. • Dependence upon a single individual may hamper LG’s effectiveness if that person leaves the organization. • 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.

Comparison of Forecasting Methods Method Advantages Trend

Disadvantages

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

Comparison of Forecasting Methods Method

Advantages

Disadvantages

•Relies on fixed relationships Determinist •Simple to use. •Accurate for revenue and ic between inputs and activities. •Uses averages as a major variable in expenditure short and medium forecasts for variables not subject the forecast, making it less to changes in economic responsive to changes in the conditions. economy. •Useful for economically •Depends on assumptions usually determined variables over long based on experience. periods of time because changes in •Less likely to accurately forecast business cycles tend to cancel out revenues and expenditures in areas of and averages become more decline using the deterministic dependable. method •Accurate and suitable for forecasting growing areas. •Inexpensive.

Comparison of Forecasting Methods Method

Advantages

Disadvantages

•More costly. Econometr •Only methodology that lends itself to projecting revenues or expenditures based on •Requires a person trained in ic changes in the economy. economics and statistics to

•More accurate than other techniques develop the forecasting because, unlike the best judgment method, it equations. is based on behavioural relationships that can •Requires considerably more be measured and evaluated. time for data collection and •It (regression technique) is not limited to input for regression analysis. •More complex than the other forecasting in one direction like trend line techniques. alternatives and has more •Tests whether a relationship between potential for errors. variables is, in fact, statistically significant. •Considers multiple variables in making projections rather than the single variables in deterministic techniques.

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 name is self explanatory  It is an attempt to create synergy between operational and financial requirements  It inherently involves iteration process Financial Requirements of developing and running of operations

Preparation of a Financial Plan for Understanding Leading to of financial Leading to raising resources and their allocations feasibility, sustainability Leading to recasting of operational Plan of operations

The Financial & Operating Plan  Features of the FOP  Determines ULB’s 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 city’s 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 ULB’s 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/ 5cityDemandwith the Supply Gap recommended Analysis levels/ norms Estimates at the macro level, the gaps in service levels, which need to converted 6- be Project into projects Costing (MIP) Determines capital investments (based on unit costs) and associated O&M

77- FOP FOP Assumptions Assumptions Provides Provides for for entry entry of of the the assumptions for: assumptions for: ••projecting projecting the the income income && expenditure expenditure of of the the ULBULBcurrent currentitems items && new new items items due to CIP due to CIP ••funding funding pattern pattern for for the the CIP CIP and the debt terms. and the debt terms. 8Income & 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

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 Thank you And Wish you Happy Learning