Fund Balance and Reserve Policies
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.
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.
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.
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
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
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%.
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 that not only varies throughout the year, but also fluctuates from year to year based on the weather? 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.
- Do you have a buffer against economic downturns? If and when the local economy slows, will you be able to sustain most of your staffing and operations, or will you be forced to make layoffs and service cuts (which will have a further detrimental impact on the economy)? Consider establishing an economic stabilization reserve to help protect against these inevitable economic cycles. This is an important consideration for all jurisdictions, but especially for those entities or funds that rely heavily on sales taxes or other revenues that are highly sensitive to economic conditions.
- Will lenders, credit agencies, and others be evaluating your fund balance levels? For instance, entities that receive USDA loans may be subject to more stringent debt covenants as a result of insufficient reserves and/or inadequate financial policies to address fund balance. These covenants can potentially create ongoing compliance issues, such as annual federal single audits until the loan balance is below a specified level or additional reserve requirements for short-lived assets. Similarly, if you are considering issuing bonds, your fund balance policies or lack thereof will be one of the factors considered by credit rating agencies to help determine your agency’s creditworthiness, and inadequate fund balance policies could result in a reduced credit rating.
- If your fund balance/reserves are currently insufficient, how will you accumulate the desired amount, and how long will that take? Depending on your entity’s current financial condition, you might be able to reach your goals within a single year, or the process might take multiple years. Establish a clear plan for how you will build your fund balance levels (such as using one-time revenues) and the length of time you anticipate it will take to meet the policy level you have adopted.
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.
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).
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.
- Burien General Fund Reserve Levels Analysis (2016) – High-level summary of general fund reserve levels for comparable mid-sized cities in the Puget Sound region
- Bainbridge Island Budget Policies (rev. 2018) – see Section 6, Reserves
- DuPont Financial Policies (2021) – see Section XI, Reserve Policies; plus portion of Section II dealing with Water and Stormwater System Fund Balance and Maintenance of Minimum Reserve Levels
- Ferndale Financial Management Policies (2012) – see Reserve & Contingency Policy
- Issaquah Financial Management Policies (2022) – see Section 2 on Reserves and Fund Balance
- Leavenworth Financial Management Policies (2018) – see Reserve Fund Policies
- Mukilteo Fund Balance Reserve Policy (2019)
- Oak Harbor GASB Statement No. 54 Fund Balance Policy (2011)
- Redmond Fiscal Policy (2018) - see Section 8, Reserve Fund Policies
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.
- Best Practice: Fund Balance Guidelines for the General Fund – Background and recommendations for adopting a fund balance policy. The paper references GAAP accounting concepts, but it’s important to note that fund balance is applicable to both GAAP and cash basis entities.
- Best Practice: Working Capital Targets for Enterprises Funds – Discusses fund balance needed for enterprise funds (utility funds). Although written for GAAP accounting entities, the principles and recommendations are appropriate for cash basis enterprise funds.
- Best Practice: Using Cash Forecasts for Treasury and Operations Liquidity – Recommends that governments perform ongoing cash forecasting to ensure they have sufficient cash liquidity to meet disbursement requirements and limit idle cash
- Financial Policies (2012) – For-purchase publication provides a step-by-step approach to developing and implementing financial policies.
- WA State Auditor's Office Financial Intelligence Tool (FIT) – Displays annual financial report data for each local government, including changes in cash position, cash balance sufficiency, and enterprise sufficiency
- Governing Institute Guide to Financial Literacy Volume 2 (2015) – Information on managing your jurisdiction's financial health
Risk Assessment Tools
- 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