Policies on budget coverage and a balanced budget are not always clearly articulated, many governmental entities have adopted explicit policy guidelines for budget reserves. As a result of unforeseen events or in order to accumulate cash for future purposes, governmental entities establish reserve accounts in various funds and then earmark the cash for that purpose. The more common types of reserves are for:

  • Cash flow requirements
  • Revenue stabilization (rainy day)
  • Unforeseen contingencies
  • Equipment replacement
  • Repair of buildings or other improvements
  • Debt service

Cash Flow Requirements: Revenue inflow may not coincide with the outflow of payments, government entities must maintain sufficient cash on hand to satisfy cash flow needs. The amount of reserve for this purpose, called operating reserves, depends on the timing of tax payments, growth and assessed values.

For the general fund, one rule of thumb is that there should be adequate cash on hand to cover disbursements for sixty (60) days. A governmental entity should first examine its cash flow and the margin of protection required, and then specify in its budget policy the size of cash flow reserve it wishes to maintain.

Revenue Stabilization: Following the impact on local government by recessions over the past twenty years, many local governmental entities established revenue stabilization reserves, or rainy day accounts, maintained in the general fund, to provide resources when revenues decline because of an economic slowdown; IE gas and oil abatements, reduction in assessed values, reduction in specific ownership taxes, etc. While the timing of slowdowns and even recessions can be anticipated somewhat accurately, their severity and length are much more difficult to forecast. And their impact on local communities varies widely, depending on their cause and on the local economy’s link to the broader economic cycle. Example: gas and oil abatement will have a greater impact on Weld County local government than Larimer County local government.

While revenues fluctuate with the economy, expenditures usually display a countercyclical trend. During economic downturns, demand for government services increase. A revenue stabilization reserve enable governmental entities to insulate their spending and taxing policies from the vagaries of the economy

The appropriate size of the reserve depends on the stability of a government’s revenue stream and on its political resolve to protect against budget instability.

Two policy issues that governmental entities must resolve when creating revenue stabilization reserves are the size of the reserve and the way in which the reserve can be accessed. The appropriate size of the reserve depends on the stability of a government’s revenue stream and on its political resolve to protect against budget instability.

Most budget policies leave the question of when to access the reserve to the discretion of the governing body, on the recommendation of the Finance Director and Chief Executive Officer. Some governmental entities require a majority vote by their governing body (Council, Board of Directors, etc.) to transfer money from reserves to the operating budget. An alternative approach is to identify an economic indicator, such as a decline in the gross State product or an increase in regional unemployment. Whatever mechanism is used, the budget policy should specify the benchmark measure to “trigger point” for accessing the reserve.

Unforeseen Contingencies:
Governmental entities also establish reserves for unforeseen contingencies to provide funding in times of emergencies or disasters. In Colorado, the Tabor Amendment requires the governmental entity to maintain a restricted reserve (3% of the budget) in the event of an emergency or disaster. A contingency reserve provides a readily available pool of funding to ensure continuation of government operations during an emergency. Many governmental entities establish a separate contingency reserve in each major fund (operations, capital and debt service).
Equipment Replacement and Building Improvements:
Two other types of reserve that governmental entities use occasionally are for equipment replacement and building improvements. The advantage of an equipment replacement reserve is that money is available for purchasing operating equipment and vehicles as they become obsolete or unusable. A capital replacement plan provides a replacement schedule for vehicles and capital equipment.

Debt Service:
Governmental entities establish reserves for debt service payments, usually as a condition of a bond agreement. Debt Service is the annual or semiannual payment of principle and interest that is made on an outstanding indebtedness. The District’s bond indebtedness is paid through taxes levied on property.