This page provides detailed 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 Policies Tool Kit, created in partnership with the State Auditor’s Office Center for Government Innovation.
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 Manual, Net Position, section 4.2.8, and Statement of Net Position, section 4.2.2), 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, economic downturns, 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.
Appropriate Fund Balance Level
The question of an appropriate level of fund balance is always a difficult one to answer. 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, Using Cash Forecasts for Treasury and Operations Liquidity).
This is typically no less than 60 days or two months (about 16.5%-16.7%) of operating expenditures for the general fund and 45 days (about 12.3%) 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.
Each government has its own unique set of circumstances and may require different thresholds. Even within the same governmental entity, different funds may require different levels of fund balance due to differences in cash flow or risk.
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. Depending upon the answers to some of the questions below, you may need to adjust your fund balance levels a bit higher or consider adding reserve funds for fiscal concerns unique to your entity.
In the Recommended Resources section at the end of this page, there are some useful risk assessment tools that can help jurisdictions better assess their risks. Using analytical tools such as these, which can run the gamut from relatively basic qualitative assessments that even small local governments can use to more advanced statistical models used by larger jurisdictions, can be very helpful, especially considering that research cited by GFOA has found that human judgment alone typically underestimates risks by about 50%.
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.
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 Beginning and Ending Cash and Investments Classifications (section 3.1.8).
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 assess your jurisdiction's financial risks and develop appropriate 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.
General Resources
Risk Assessment Tools
- GFOA:
- General Fund Reserve Calculation Worksheet – Downloadable Excel spreadsheet with allows you to qualitatively assess your jurisdiction's risks (no financial data needed) and turn them into a risk score with corresponding recommendations for target reserve levels. See individual tabs for extreme events, revenue stability, growth, etc.
- Colorado Springs: A Risk-Based Analysis of General Fund Reserve Requirements (2013) – GFOA case study, conducted at request of city officials, details the city's primary and secondary risk factors to develop appropriate reserve levels; can be used as an example by jurisdictions attempting a similar analysis.
- ProbabilityManagement.org – Nonprofit organization cited by GFOA as a good resource that makes it easier for jurisdictions to perform advanced risk assessment modeling using Excel