The financial indicators used in this analysis were chosen based on their past use to measure state financial condition as well as because of the availability of data. Wang et al (2007) operationalized the cash, budget, long-run and service-level solvency
definitions introduced by Groves et al (1981). The authors use eleven financial indicators5 to construct four separate indices of financial condition: cash ratio, quick ratio, current ratio, operating ratio, surplus (deficit) per capita, net assets ratio, long-term liability ratio, long-term liability per capita, tax per capita, revenue per capita, and expenses per capita. Table 4.1 lists each financial indicator, its definition, the
interpretation of its value, and the fiscal stress index to which it contributes. The data used to create these financial indicators are available in the government-wide financial statements in state Comprehensive Annual Financial Reports (CAFRs).
As mentioned above and detailed in table 4.1, four indices of fiscal stress are created in this chapter: cash, budget, long-run, and service-level. These indices capture
5 Other financial ratios are proposed in the literature and are available using state government-wide
financial statements in CAFRs. Kamnikar et al (2006) proposes three measures to assess state financial condition: cash quick ratio (cash+cash equivalents+investments/current liabilities), debt to asset ratio (total liabilities/total assets), and continuing services ratio (unrestricted net assets/expenses). Chaney et al (2002b) list six financial ratios to measure local government financial condition including cash ratio, operating ratio, and long-term debt/total assets. In sum, multiple financial ratios exist and all measure some component of a government’s financial condition. The value of using those proposed by Wang et al (2007) is that these financial ratios are linked to each of the four dimensions of solvency. And, as explained later in this chapter, these financial ratios are internally and externally consistent measures of each dimension of financial condition examined here.
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both the financial condition of a state as well as its level of fiscal stress. The methodology for creating these indices draws from Wang et al (2007).
Table 4.1: Financial Indicators Used to Measure Fiscal Stress
ID Financial Indicator
Definition Meaning Dimension 1 Cash Ratio (Cash+Cash Equivalents+
Investments)/Current Liabilitiesa
Higher ratio indicates greater cash solvency
Cash 2 Quick Ratio (Cash+Cash Equivalents+
Investments +Receivables)/ Current Liabilities
Higher ratio indicates greater cash solvency
Cash
3 Current Ratio Current Assetsb/Current
Liabilities
Higher ratio indicates greater cash solvency
Cash 4 Operating
Ratio
Total Revenues/Total Expenses 1 or above indicates budget solvency Budget 5 Surplus (deficit) per capita Total Surpluses (Deficits)/Population
Positive indicates budget solvency
Budget
6 Net Asset Ratio
Restricted and Unrestricted Net Assets/Total Assets
Higher ratio indicates stronger long-run solvency Long-run 7 Long-term Liability Ratio Long-term (non-current) Liabilities/ Total Assets
Lower ratio indicates stronger long-run solvency Long-run 8 Long-term Liability per capita Long-term (non-current) Liabilities/ Population
Lower value indicates greater long-run solvency
Long-run
9 Tax per capita
Total Taxes/Population Higher value indicates lower service-level solvency
Service-level
10 Revenue per capita
Total Revenues/Population Higher value indicates lower service-level solvency
Service-level
11 Expenses per capita
Total Expenses/Population Higher value indicates lower service-level solvency
Service-level
Source: Wang et al (2007, 8-9)
aCurrent liabilities were classified for twenty-four states. Twenty-six states did not classify liabilities
as current or noncurrent for all eight years. Using the same method as Wang et al (2007) liabilities are assumed to be listed in order of maturity. Current liabilities as measured in this analysis do not include any liability items listed as or after noncurrent liabilities or long-term liabilities. Since states list different items as liabilities, the composition of current liabilities across states is not identical.
bCurrent assets were classified for twenty-four states. Twenty-six states did not classify assets as
current or noncurrent for all eight years. Using the same method as Wang et al (2007) assets are assumed to be listed in order of liquidity. In this analysis, current assets include assets listed before restricted or capital assets. Receivables include all items listed as receivable that are listed before restricted assets. Since states list different items as assets, the composition of current assets across states is not identical.
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Five of the financial indicators (Surplus per capita, Long-term liability per capita, Tax per capita, Revenues per capita, and Expenses per capita) are not presented as ratios and therefore, require adjustment due to yearly fluctuations in inflation. These financial indicators are deflated using the GDP price index. To ensure that the financial indicators are interpreted correctly when added together, five are transformed so that higher values denote higher solvency. This was done by taking the inverse of the original variable.6 All the financial indicators were standardized and converted to z scores. Each index was created as follows; the standardized financial indicators underlying each solvency index were added together and then averaged. The resulting score is the value for each index. All states for which data is available are included in the analysis.
4.3 Data
Data was collected from Comprehensive Annual Financial Reports (CAFRS) for all 50 states for fiscal years 2002 through 2009. With the exception of New York, all states had implemented GASB 34 by 2002 and therefore their CAFRS were prepared using the GASB 34 financial reporting model.7 Two financial statements in each CAFR – the Statement of Net Assets and the Statement of Activities – are the sources of
government-wide financial information. Information on how states report on their infrastructure assets was also collected from the CAFRs. Annual estimates of resident population by state for the years 2001 through 2009 was taken from the U.S. Census
6 Long-term liability ratio, long-term liability per capita, tax per capita, revenue per capita and expenses per
capita indicate a lower level of solvency the higher the value. The other six financial indicators indicate a higher-level solvency the higher the value. When aggregating these values and comparing between the different indexes, it is necessary that a higher value have the same meaning for all financial indicators. To ensure this, the inverse of the five ratios listed above are taken. By taking the inverse, a higher value on the five indicators listed also indicates a higher level of solvency.
7 GASB Statement No.34: Basic Financial Statements – and Management’s Discussion and Analysis – for
State and Local Governments required governments to report consolidated government-wide financial statements that use the full accrual accounting basis. This included the production of the Statement of Activities and Statement of Net Assets.
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Bureau, Population Division. Data on the economic growth within a state in one year is taken from the State Coincident Index published by the Federal Reserve Bank in
Philadelphia. The Bank generates and reports an indexed measure of economic growth in each state by month based on four economic indicators: nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average) (Crone 2006). Total personal income by state for the years 2001 through 2009 was collected from the U.S. Bureau of Economic Analysis, State Annual Personal Income tables. The general fund ending balance and total expenditures figures used to create the ending budget balance as a percent of total expenditures variable are consistently taken from the NASBO Fall Fiscal Survey of the States for the years 2002 through 2010.
4.4 Results