Fundamentals of Municipal Finances

Introduction

With the upcoming 2016 local government elections, it is appropriate to review the scope of local government. This inquiry can apply just as equally to local government, national government and any other organisation or institution that is accountable to the public or a board. As electioneering intensifies, the contestation around service delivery will become more apparent and pressing. 

Municipalities have been plagued by allegations of maladministration, poor financial management and internal factions that have limited their ability to fulfil their functions and obligations. This review allows us to put into context the policy wishes and fiscal opportunities and constraints of those campaigning for a seat at the table.    

Municipal Finances

Municipal finances consist of a range of systems which establish how funds are to be spent and ensure they are spent for the purposes for which they were allocated.  They ensure that funds are spent within the realm of the law; thereby promoting public accountability. The system as a whole is regulated by the Municipal Finance Management Act (MFMA).

Good financial management practices are therefore crucial for the delivery of goods and services. A sound understanding of the fundamental components of municipal finances described below is essential to ensure the sustainability of municipal governance. 

1. Budgetary Process

The budgetary process is the most common and recognisable financial system. The municipal budget is a spending plan that indicates how available funds will be used to deliver goods and services.  It is an expression of how political goals will be achieved, and it can be used to evaluate the performance of the municipality. It is the driving instrument of policy and governance in a municipality and helps all municipalities make informed decisions. 

The budgetary process is complex and begins with policy guidance and direction from the municipal council. Here the council stipulates its policy goals for the coming year.  Thereafter the budgetary process continues with five, well defined, stages: 

• The first stage of the budgetary cycle is the preparation of initial requests for funds from each department. This should include a narrative description of specific projects covered under a budget request and how the spending plan relates to the overall goals and objectives of the council.
• The second stage involves the submission of budgetary requests to the municipal manager. The municipal manager is responsible for compiling, combining and coordinating all requests for funds.  A key element in this stage is the development of revenue and expenditure estimates for the coming year. This sets the financial parameters within which the manager must operate.  Given these constraints priorities are set among competing demands for funds, leading to a budget that is presented to the budget committee of the municipal council. 
• The third stage is the adoption of the budget by the council. To increase accountability the public is invited to comment on the proposed budget prior to council approval. As the legislative and executive authority, the municipal council votes on the budget and has the final say on spending. 
• The fourth stage of the budget cycle involves the implementation and monitoring of the budget throughout the fiscal year. This involves reviewing expenditure and ensuring it is consistent with the directives of the council, as well as making sure budgets are not overspent. Monitoring actual performance against the original budget can help detect problems early and allow for corrective action. 
• The fifth stage is the auditing of municipal financial records. Financial audits are designed to detect problems in the system of internal financial control, detect failure to comply with accounting principles and standards or with reporting requirements set out by government, and detect misappropriation of funds.  

The budgetary process is continuous. It should clearly identify the municipality’s service priorities. The budgetary process is the foundation on which all other elements of municipal finances are built. 

2. Capital Planning

The budgetary process described above deals with the operating expenditure for the fiscal year. However, all municipalities face major costs that have a multi-year impact on the finances of the municipality. These items usually have a high acquisition cost but also have an economic life of multiple years. Capital planning sets out plans to acquire or rehabilitate long-term assets such as buildings, roads, and water and sewerage pipes. 

A capital improvement plan is a methodical process by which all the capital needs of the municipality are identified, prioritised and scheduled for acquisition. The capital budget is an important financial management tool.  It informs the municipality and the public about the need for capital expenditure and facilitates decisions with respect to future capital spending. 

The plan schedules the acquisition of capital items three or more years into the future to ensure they are least disruptive to any given annual budget. The plan also considers the affordability of such items. The greatest value of the capital improvement plan is that it helps the municipality plan for its largest acquisitions in a sensible and prudent manner, allowing the municipality to deliver on an Integrated Development Plan.   

3. Consumer Debt and Revenue Management

Municipal consumer debt refers to outstanding settlement of property rates, fees for services and various other municipal charges.  The payment of these items provides the main source of income for municipalities, and non-payment affects their financial viability. 

It is therefore essential that municipalities manage and improve revenue collection to ensure financial and economical stability and sustainability. Efforts need to be made to maximise income through proper revenue collection management, improved revenue collection to guarantee cash flow, and to ensure effective functioning of systems, processes and procedures.  The lack of proper systems and capacity can cripple the cash position of the municipality and potentially threaten its ability to deliver services. 

4. Procurement

The procurement function consists of the purchase of goods and services. The main goal of this function is to ensure that quality goods and services are procured at the lowest possible price. The essential elements of procurement include setting standards and specifications, soliciting quotations and analysing them, awarding bids, receiving goods and services, and paying for them. This function can be performed either on a centralised or decentralised basis. 

Municipal government procurement processes are complex, comprehensive and subject to several pieces of legislation. Municipal procurement processes and procedures differ at various levels of expenditure:

• petty cash can be used for purchases/ projects under R2 000; 
• at least three quotes are needed from the preferred provider database for projects/ purchases under R10 000; 
• three written quotes from the preferred provider database are required for purchases/ projects under R30 000; 
• projects/ purchases between R30 000 – R1 million require written quotes, the application of the Preferential Procurement Policy Framework Act, and 7 days advertisement in local newspapers; 
• the competitive bidding process is used for projects/ purchases over R1 million; and 
• for projects greater than R10 million the competitive bidding process is used plus 30 days must be allowed for public advertisement, and bidding must be open for at least 30 days.  

Consistent procurement processes that are competitive and fair are vital in ensuring public money is not wasted or misspent.

5. Financial Reporting and Auditing

Financial reports are a valuable tool for monitoring the finances of a municipality. Information provided by financial reports illustrates to the public how funds were collected and spent. They also allow the public to compare actual financial performance with intentions and expectations of the budget as originally envisaged and voted. Managing and monitoring financial activities play a key role in a municipality’s ability to improve service delivery and minimise wasted resources. 

The basis for meaningful financial reporting is a good accounting system which consists of general ledgers, general journals and detailed subsidiary ledgers. Key to this is maintaining and keeping records up to date. Having systems in place for accounting and auditing ensures municipalities have sufficient revenue to meet their expenditure responsibilities; are transparent and prudent about the state of public finances; and can account for sources and allocation of revenues. 

Financial audits are designed to detect problems in the system:

• by providing assurance that the financial statements are free from misstatements;
• by reporting on the usefulness and reliability of the information;
• by reporting on material non-compliance with key legislation; and
• by identifying key internal control deficiencies. 

Financial audits by themselves do not address the efficient (or otherwise) use of resources or the achievement of performance standards. Performance audits can be conducted to determine whether resources have been procured economically and are used effectively and efficiently – examining areas of waste and mismanagement to provide suggestions on how a municipality can improve efficiency in its operations.  

The Auditor-General publishes a Municipal Finance Management Act General Report every year, in which financial and performance aspects of the local authorities are set out. 

The level and sophistication of the fiscal components should not be defined by the size of the municipality. All municipalities should be able to define and develop financial systems appropriate to their needs as guided by existing policy and legislation. 

Conclusion

The budgetary process is central to good governance whether at the local, provincial or national level. At the local level it becomes manifestly important that sound financial processes are in place. Most people in South Africa live in urban areas, and there exist structures and systems which need to be clearly articulated, understood and defended. Above all, the process must be transparent, and the holders of power - whether they be administrative or political - must be accountable.   

Anele Mtwesi
Researcher
anele@hsf.org.za