Q. What is a "Fund Balance"?
A. Although the term is used to describe a number of things, a fund balance is the difference between assets and liabilities.  When assets are greater than liabilities, the balance is positive.  Fund balance includes items such as money due but not received - including, for example, delayed subsidy payments from the State.

Q.  When revenues exceed expenditures, is this a Fund Balance?
A.   No.  When revenues exceed expenditures the result is termed an operating surplus, which becomes one part of the fund balance.

Q.  Is Fund Balance equal to cash and investments?
A .  No.  Cash and investments are part of a fund balance.  Other parts of a fund balance include amounts owed to the district, cash value of inventory and, other assets.

Q.  Why is a Fund Balance needed?
A.   Just as an individual or family should maintain a savings account for unforeseen expenses or emergencies, so, too, school districts should have funds in reserve to pay for emergency repairs or unexpected interruptions in revenues - such as a layoff at a major factory which suddenly affects tax collections.  Fund balance can also be used to offset year-to-year variations in local or state cash flow, such as a delay in subsidy payment from the State.  In addition, fund balances enable districts to generate investment income which, in turn, helps to keep tax rates lower.
     A November 1990 research bulletin by the Government Finance Officers Association recommended that an unreserved fund balance be retained to guard against an economic downturn.  It also advised that a fund balance is necessary to meet emergency situations, which could include: uninsured loss, major repairs to heating systems, and replacement of damaged educational equipment prior to scheduled change. 

Q.  What is the benefit of maintaining a Fund Balance?
A.   In addition to the ability to generate interest income, a fund balance benefit occurs when a bond issue is required.  Credit ratings of school districts and other public entities can be affected directly by the level of their fund balances; those with little or no money in reserve are considered to be higher risks and their ratings - along with their cost of borrowing, suffer accordingly.

Q.  What is an appropriate Fund Balance?
A .  There is no simple answer to this question.  The circumstances of a school district have a lot to do with the preferred size of its fund balance.  For example, where the local economy and tax base are weak, when the district budget relies heavily on state and federal sources of funding which can change or be delayed without notice, or when the district is carrying a sizeable debt burden, a higher fund balance may be appropriate.  There are, of course, many other legitimate reasons to hold funds in reserve.  School officials may build a fund balance over time, with the intention of using the money for a renovation project or another one-time expense.  In those instances, districts, in essence, pay themselves over time rather than borrowing and repaying a bank with interest.

Q.  Are there formal guidelines or standards for a Fund Balance?
A.   Guidelines that exist offer three different methods.  One relies on a formula where a predetermined number of months (usually one to three months) of operating expenditures are used.  The other is used by the three major bond rating agencies - Moody's, Standard & Poor's, and Fitch.  The rating agencies recommend between 5% and 10% of current period operating expenditures (budget). Section 688 of the school code says that when the fund balance exceeds between 8 and 12% of expenditures, depending on the size of the budget, the district must consume any fund balance in excess of 8% prior to increasing taxes.

Q.  If necessary, is all of a fund balance available for use?
A.   A fund balance can be divided into three parts called restricted, designated and unrestricted – undesignated fund balance.  A restricted fund balance is earmarked for a special purpose, such as pre-payments, and inventory or other liability.  A designated fund balance, is an amount that has been specifically set aside by the School Board for some future action such as to permit phase in of increased retirement costs, increases in health insurance premiums or any other purpose the board deems appropriate. An unrestricted fund balance is available for use.  The rating agency or formula calculation should be applied only to unrestricted fund balance. In the case of the School Code provision (Section 688) the limitation applies only to the unrestricted – undesignated fund balance in the general fund.

Q.  Should there be a formal policy concerning fund balance?
A.   Yes.  The board should adopt the standard that best suits the district.

Q.  If a fund balance exceeds the established guidelines or board policy, how should the funds be used?
A.   If the unreserved fund balance exceeds the standards set for the district, the excess funds could be used.  Use should be limited to one-time expenditures such as capital equipment, vehicle replacement or any other nonrecurring expenses.  An alternative use of excess fund balance is to transfer the balance to capital reserve for future building repairs. Additionally, the excess funds could be designated for some specific future use as determined by the board. Because the use of a fund balance is equal to one-time revenue, the expenditure should be a one-time expenditure.

Q.  When negotiating union contracts, is it damaging to maintain a fund balance?
A .  No.  While it may appear to be a problem, a fact-finding report (November 1991) stated, "A school board should not be penalized for efficiency in operation and the development of a strong financial position by being required to grant wage increases in excess of other districts that are not as fortunate.  Taxpayer money does not have to be spent just because it is available."
     A final observation:  In a 1991 survey, PSBA also asked school districts what percentage of their annual budgets the postponed June 3, 1991, basic subsidy payments represented. Of the nearly 200 districts responding, the average was 4.6%.  Said another way, most school districts would not have been able to cover expenses normally paid by the delayed June subsidy payments if fund balances of less than 5% had been in effect. 

For questions or comments please contact David W. Davare, Ph.D., Director of Research Services, e-mail dave.davare@psba.org or by phone (717) 506-2450 ext. 3372.