Protagonistas de la información.

The data set which was analysed and used to determine financial trends for local governments throughout Australia was based on a sample of 100 of the 720 local

governments that currently exist in Australia. The sample group of councils were stratified on a pro-rata basis to reflect both the number of councils in each:

• ACLG category, and

• proportion of each ACLG within each jurisdiction.

These sample councils covered all sub-categories within each council group, which, as defined by DOTARS, are classified as extra small, small, medium, large and very large. This pro-rata council sample was developed in order to ensure a fair and representative sample was obtained encompassing all councils from which conclusions could be drawn. Conclusions were based on an overall average of the 100 councils and averages of council categories.

It should be noted that data for Rural Significant Growth (RSG) councils is not considered statistically significant as the pro-rata construction of the sample resulted in the inclusion of only one RSG council. Therefore the resultant conclusions should not be heavily relied on. As a result, all KPIs adopted that are a measure of percentage of councils within a category operating at a given level have been removed. This is because they result in an indicator of either 0% or 100%, which is misleading.

All councils in Australia are required to adhere to national public accounting standards. The financial statements produced in accordance with the accounting standards and published in the annual report for each council were used to determine trend analysis and financial sustainability.

This information, however, was sometimes difficult to source for all councils, particularly very small and/or remote councils due to copies of annual reports not being publicly available on council websites. All states provided a summary of revenue and expense data for each council in 2004-05, with the exception of NSW for which 2003-04 data was used. The availability of asset and liability information was mixed between jurisdictions, with no information available for some councils.

As identified earlier a key limitation with the data is the mixed consistency and accuracy of councils’ measurement and recording of capital expenditure and renewals. An

example of a common inconsistency is the recording of say, a road reseal as an expense based on the premise that the entire road is one bundled asset, as opposed to

capitalising the reseal based on the assumption that the road is segmented into the seal, road base, land, road curb, signs and lighting. Where a council pursues the first

approach the book value of the asset remains unchanged with no capital upgrades recorded, whilst the second approach would change the value of the asset and be recorded as capital renewal. These two different approaches to recording the same road reseal emphasises the importance of prudent asset management practices and the need to move to a nationally consistent set of accounts.

Due to data availability constraints and differences in reporting between jurisdictions, the financial indicators considered in this study are relatively simple vis-à-vis the indicators used in the NSW, WA and SA state inquiries led by Access. We also note that PwC uses more sophisticated indicators (eg restricted current ratio, the ratio of outstanding rates and debt service ratio) to assess viability in our process of completing formal financial audits of a number of councils each year. Whilst both this PwC study and the Access approach factor in R2R funding into sustainability evaluations, the Access analysis excludes other capital grants or SPPs, which Access set aside to avoid overstating the revenues available for recurrent operations. However, PwC has retained all capital grants within operating position analysis due to some data sets not separating out grant by type, as well as a view that capital grants are an ongoing and important revenue source for councils. To exclude other capital grants from the financial sustainability analysis could potentially overstate the extent to which councils are unsustainable – assuming capital grants remain an ongoing funding tool for governments.

The SA Inquiry noted that financial sustainability relates to the long-term financial

performance and position of a particular council, rather than to the finances of a sector in aggregate. Hence assessing the sustainability of the local government sector in

aggregate is less relevant than examining the percentage of councils with sustainability problems.

The PwC financial KPI analysis in Table 4.1 uses four indicators, which are:

• Operating surplus (deficit) – is total operating revenue less total operating

expenses. It is an indicator of a council’s ability to meet its operating expenses with its operating revenue stream. The analysis uses a benchmark operating deficit of 10% of total revenue as councils with deficits larger than this are spending well beyond its revenue base and potentially at risk of sustainability problems.

• Interest coverage – Interest coverage is determined as earnings before interest and tax (EBIT) divided by borrowing costs and it measures a council’s ability to pay interest on its outstanding debt. We have used an interest coverage benchmark of 3 which provides a generally guide to delineate a financially sustainable level of borrowing. An interest coverage value below 3 indicates that a council may have problems in repaying debt and associated interest.

• Sustainability ratio or capital expenditure divided by depreciation. This ratio is a measure of the net increase or decrease in the asset base. Results over 1.0 indicate that its overall asset base is increasing, or being replenished, at a rate above the consumption of assets whilst results under 1 indicate a declining asset base and potential sustainability risks. Council sustainability ratio results need to be interpreted with care due to factors such as infrequent as well as inconsistent asset revaluations and depreciation approaches.

• Current ratio (or current assets divided by current liabilities) is a measure of ability to meet short-term debt obligations. We have used a benchmark value of 1 for the current ratio with councils at below 1 being more at risk of liquidity problems.

Analysis of financial sustainability of local government 99

• Rates coverage (total rates revenue as a proportion of total expenses) is a measure of a council’s ability to cover its costs through its own tax revenue. A benchmark result of 40% was selected as a point that measures adequate self-funding, with results below 40% indicating a greater dependence on other revenue streams such as grants, and hence more risk of sustainability issues.

Analysis of financial sustainability of local government 100 • examples of unsustainability at the individual council level, if finances of most councils are sustainable over the long term, or

• examples of sustainable finances at the individual council level, if most councils have a sustainability problem.

Table 4.1 summarises the financial results from the survey of the financial viability of 100 councils across the seven council categories. A full

explanation and definition of these financial key performance indicators (KPI) can be found in Appendix B.

Table 4.1: Summary of financial indicators of ACLG Financial Sustainability Summary KPIs DOTARS category % Councils with Interest Coverage <3 (EBIT/borrowing costs) Median Operating Surplus as a % of Total Revenue % Councils with Deficit greater than 10% of Total Revenue Median Sustainability Ratio (capex/ depreciation) % Councils with Sustainability Ratio <1 Median current ratio (current assets/current liab.) % of councils with current ratio <1 Median rates coverage (%) (rates as a % of total expenses) % of councils with rates coverage <0.4

Urban capital city 40.0 5.0 28.6 2.0 8.0 4.5 14.3 55.8 0.0

Urban regional 41.7 4.2 16.7 1.3 0.0 2.8 9.1 66.5 16.7

Urban fringe 37.5 14.1 12.5 2.1 16.7 3.4 25.0 62.5 0.0

Urban development 41.7 7.6 8.3 1.6 0.0 1.0 50.0 65.2 0.0

Rural remote 28.6 10.3 18.8 2.3 8.3 2.6 12.5 25.4 87.5

Rural agricultural 32.6 11.7 15.9 1.7 0.0 2.6 20.5 42.4 54.5

Rural significant growth n/a -8.0 n/a 2.4 n/a 2.4 n/a 47.5 n/a

Average 35.8 10.0 16.0 1.8 8.0 2.6 21.4 47.9 40.4

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The results above indicate:

• Approximately 30-40% of councils have an interest coverage ratio (EBIT/interest) of less than 3. A ratio of 3 generally represents a threshold above which credit risk becomes less significant. For those with a ratio of less than 3, a large unexpected event with adverse cashflow implications could potentially place pressure on ability to meet interest payments.

• Councils have a median operating surplus of 10% of total revenue. However, some 16% of councils have an operating deficit of over 10% of revenue. Such councils have a tendency to defer renewals expenditure, which creates a risk of developing maintenance backlogs.

• The median sustainability ratio (capex/depreciation) in this sample was 1.8, with 8% of councils with a sustainability ratio (capex/depreciation) of less than 1. A ratio of less than 1 indicates that the capital being consumed in an accounting sense exceeds the capital being replaced into the asset base.

• Councils have a median current ratio (current assets/current liabilities) of 2.6, however 21% are less than 1. The ratio of 1 is a key threshold for testing liquidity issues. In particular the urban fringe, urban development, rural remote, and rural agricultural categories all have potential liquidity problems with between 12% and 50% less than 1.

• Councils across the nation typically have 48% of costs covered by rates, ranging from 25 to 66%. Of some concern is the fact that 87% and 54% of rural remote and rural agricultural councils respectively have rates covering less than 40% of costs. Where rates are less than 40% of council revenue, there is an indication that own- source revenue generating capacity is constrained and that the council is likely to have a degree of dependence on grants from other levels of government.

Whilst the majority of councils have indicator results at an acceptable level, there are councils within each category results operating at unsustainable levels. In particular, the higher proportion of the rural agricultural, rural remote and, to a lesser extent, the urban fringe categories are at greater risk of financial sustainability challenges.