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Fund Balance and Reserve Policies

This page provides guidance to help local governments in Washington State develop and adopt fund balance and reserve policies, including key questions to consider and sample policies.

It is part of MRSC’s Financial Management Policies and Resources project, funded through a partnership with the State Auditor’s Office Performance Center.

What is Fund Balance?

Fund balance is an accounting term to describe the difference between a fund’s assets and liabilities.

For “cash basis” entities (the majority of local governments in Washington), fund balance represents the net cash after all revenues have been deposited and all expenses have been paid. Just like your checkbook at home at the end of the month, it represents how much cash you have in the fund.

For GAAP accounting and reporting entities, fund balance describes the net position of local government funds. There is a distinction made between governmental fund and business-type activities when calculating net position (see BARS, GAAP, Net Position, and Statement of Net Position), but it is intended to measure financial resources currently available.

One of the primary reasons for establishing a policy for fund balance is to provide sufficient cash flow to meet operating needs. Local government revenues are often cyclical in nature. For example, many jurisdictions depend primarily on property tax revenues. This revenue is due from property owners twice a year on April 30 and October 31. Similarly, a water utility fund might receive a significant portion of its revenues during the summer irrigation and watering season. But these entities must meet their financial obligations year-round, which would be difficult, if not impossible, without maintaining a certain minimum fund balance.

There are varying philosophies of how much is enough or whether you could potentially have too much in fund balance and/or reserves. There is also the discussion of what types of reserves are needed to provide financial stability for the short-term and what reserves may be needed in the future. This page focuses on those types of policy considerations, rather than accounting and reporting requirements.

What are Reserves?

The terms “reserves” and “fund balance” are often used interchangeably, which can be confusing to the layperson. For the purposes of developing a financial policy that addresses reserves, the distinction should be made within the scope and purpose component of the policy. Whether you define fund balance as a “general operating reserve” or simply “general operating fund balance” will be determined by the needs of your jurisdiction.

Typically when local government is discussing the need for reserves, it’s in the context of future outlays for capital, or liability accruals such as employee buy-outs. Other areas of consideration are emergencies and the inevitable unforeseen event that would trigger a fiscal hardship. It is essential to clearly define the intended use for each reserve and/or fund balance that your entity establishes.

Key Components of Fund Balance and Reserve Policies

A fund balance and reserve policy establishes minimum levels for designated funds to ensure stable service delivery, meet future needs, and protect against financial instability. There are fewer components to a fund balance and/or reserve policy than other more complex financial policies. At a minimum, your policies should include:

  • Scope and purpose
  • Appropriate fund balance level
  • Use and replenishment of funds

Scope and Purpose

The scope and purpose should clearly identify which funds are included and what purpose the fund balance/reserves are intended for. The funds that your entity decides to include may vary widely from those selected by your peers.

The selected funds should represent major operating funds of your local government, and at a minimum each one of them should have a fund balance that meets cash flow needs.

Key questions to consider:

  • Which funds are your major operating funds? You should establish minimum fund balances for all of these funds. At a minimum, the GFOA recommended best practice is for the general (current expense) fund and the enterprise funds (utility funds such as water, sewer, and storm drainage).
  • Is there an interdependence between funds that would drain resources from the general fund or enterprise funds? For example, the street fund is typically dependent upon the general fund for operating income, so consider that when establishing the fund balance for the general fund.
  • What types of reserves should be included? When considering which types of reserves your entity should establish, it’s important to define the problem or potential problem that could trigger a fiscal crisis. Fiscal crisis will often trigger policy creation, but the objective of reserve and fund balance policies is to minimize the potential financial crisis as well as provide financial stability to the funds. Some of the most common reserves are:
    • Contingency Reserves
    • Rainy Day Funds
    • Emergency Reserves
    • Current and Future Capital Needs Reserve
    • Liability Reserves for compensated absences, pension, post-employment benefits (OPEB), unemployment

Appropriate Fund Balance Level

The question of an appropriate level of fund balance is always a difficult one to answer. Each government has its own unique set of circumstances. Establishing an appropriate level of fund balance to meet the demands of the fund during periods of the year when revenues are not available is vitally important to the fiscal health of the fund.

Key questions to consider:

  • Is your jurisdiction dependent on cyclical or volatile revenue sources? For instance, are you heavily dependent on property tax revenues, which are due April 30 and October 31? Is your utility dependent upon seasonal consumption? Do state shared revenues, which can be unpredictable and are not guaranteed in the future, contribute significantly to a program or service? Is your tax base heavily dependent upon one industry or one or two major employers?
  • Do your enterprise funds (utilities) have debt service requirements? Do the debt service payments have a significant impact on the cash flow needs of the utility? Are all of the debt payments due at the same time of the year? Should the utility increase its reserve or fund balance to minimize the impacts of debt payments?
  • Are your enterprise funds (utilities) dependent upon a small number of customers that represent a large portion of the cash flow? For instance, if one of your customers represents a significant portion of the income and then goes out of business, it will create a problem with cash flow, especially if there is a heavy debt load.
  • Do your utility billing cycles create cash flow concerns? For example, if your utilities collect payments every two months, or if your water utility only reads meters once a year, that may impact your cash flow, especially for smaller jurisdictions.
  • Are you vulnerable to natural disasters such as earthquakes, wildfires, landslides, or flooding? If so, you should set aside a certain amount of money to prepare for and protect against future risks.

Depending upon the answers to some of these questions you may need to set your fund balance a bit higher. The GFOA best practice recommendation has changed to consider the many variables of local government, but at a minimum the fund balance for the general fund should be no less than what will meet the average cash flow needs of your entity (GFOA Best Practice, Cash Flow Analysis). This is typically no less than two months of operating expenditures for the general fund and 45 days for the enterprise (utility) funds. However, this recommendation is for operating costs and does not consider impacts of debt. For cash basis entities where debt service is frequently paid from the operating funds, consideration should be given to timing of these debt payments.

For examples of general fund reserve levels, see:

Use and Replenishment of Funds

Your policy should clearly state when reserves should be used, how the reserves will be replenished (and how quickly), and what happens when fund balances or reserves drop below the designated levels. Defining these conditions and triggers will help minimize possible interpretation issues later on.

Key questions to consider:

  • When can reserves be used? Contingencies, “rainy days,” and emergencies mean different things to different people, so they should all be clearly defined. When is it raining, what is the trigger for a contingency, and what counts as an emergency?
  • How will reserves and fund balance be replenished once they’re used? Describe the strategy for repayment (resources potentially to be used, one-time revenues, or other considerations) and define the time period. Replenishment is usually within 1 to 3 years, but that can be difficult if the use of funds was due to an extreme event such as a natural disaster or severe economic decline. Identify possible scenarios and set your policy considerations accordingly.

Reporting Requirements

This page focuses on the policy considerations of how much a jurisdiction needs in its fund balance and/or reserves, rather than accounting and reporting procedures. The complexities of reporting the various types of reserves and fund balances are addressed within the SAO BARS manuals. GAAP reporting entities must be mindful of the requirements of GASB 54, while cash entities have specific guidance in BARS under the heading of Reserved and Unreserved Cash and Investments.

Examples of Fund Balance/Reserve Policies

Below are some examples of financial policies that include fund balance and reserve levels. Each entity has evaluated and adopted policies to meet their specific needs. These examples focus primarily on small and mid-sized jurisdictions.

Recommended Resources

Below are some useful resources from the Government Finance Officers Association (GFOA) and other sources to help you develop fund balance/reserve policies. While the GFOA resources are primarily oriented towards GAAP entities, the discussions also provide valuable information that can be used by smaller “cash basis” entities.

Last Modified: June 05, 2018