Jul 11, 2019 in Exploratory
Analysis of Revenues and Revenue Sources
- It is becoming increasingly apparent that the financial stability of Houston leaves much to be desired. A current debt of the city is $13 billion, while the forecasted investments are $3 billion only. However, the Controller’s Office has found several opportunities to save $450 million without the prolongation of the debt’s life (Green, 2014, p. i). The Audit Division, which is part of the Controller’s Division, managed to calculate $7 billion of additional savings (Green, 2014, p. i). Needless to say, Houston seems to almost cover its current debt, but numerous issues have to be addressed. Adverse economic conditions may worsen the ability of the city to cover the debt so that the government takes certain risks concerning the total coverage of the debt. On the contrary, the city obtains “deep and diverse” economy, which is why a certain sector should be selected for a proactive promotion. That will stabilize the economy and let the city cover the debt. However, the bottom line of a break-even margin for governmental revenues and expenditures is relatively distant from the current debt of the city. The difference between expenditures and governmental charges is negative, but it is not considerable. Budgetary cushion of the city is 262, 274/ (2, 089, 298 + 42) = 0. 125. Therefore, the city needs to deploy some cost-effective economic model; otherwise Houston will not cover its debt. The other solution can be based on a large investment so that a diverse economy is a particular advantage in this situation.
- In spite of the fact that Houston was claimed to have a “sizeable, profound, and diverse economy,” it possess two sources of prominent revenues (Green, 2014, p. iii). The first source of income that belongs to governmental revenues is the segment of public works. This sector was the most charged one within the fiscal year, but according expenditures exceeded the income. As for business incomes, the entire complex of business-type activities also presents a source of meaningful income. However, the situation with total revenues is the same since expenses also exceeded the income. In regard to this, the major sources of income for the city are evidently weak, which is why Houston does not have any specific sector for proactive reliance. Ronald C. Green has mentioned that Houston obtains diversified economy, but its effectiveness is dramatically low. This particular case clearly demonstrates circumstances in which the diverse economy is not an advantage. The city has to find its most efficient segment and align all its investments in accordance with its objectives; otherwise the city economy will be not optimized because of the current debt. To the largest extent, Houston may need to create a new economic diversity so that it has to start with one particular activity that will be potentially beneficial.
- As it has become apparent, the city relies heavily on governmental activities, while business-type activities are minor even though they comprise nearly the same income as the public work sector. In regard to the current state of the city, it has to place emphasis on business-type activities as long as that will give Houston an opportunity to initiate competitiveness in the local markets and regulate the transparency of business. In other words, business-type activities are currently more profit-generating than governmental segments, which is why the city needs to reinvest in the governmentally owned business. By the end of the fiscal year 2014, the combined utility system gathered $953,408 of charges, which presents the largest profit within the segment of business-type activities (Green, 2014, p.16). The combined utility system should acquire re-investment in order to gain competitiveness with the rest of the segments. Generally speaking, Houston needs a prominent industry to create a competitive environment and alignment of the entire economy in accordance with the objectives of the major activity. As a result, that will start covering the related expenditures since budgeting of each segment will be adjusted to the overall strategic planning. In simple terms, the government needs to leverage its correlation between long-term debt and equity. Thus, equity is a determining factor concerning reduction of the debt. The correlation can be calculated as follows: 13, 000, 000, 000 / 83, 269 = 156120.
- With regard to the percentage of the covered total expenditures of governmental activities, total revenues were able to cover approximately 19% only. Total expenditures of governmental activities are $2,768,417, while overall charges for these activities were $545,470 (Green, 2014, p.16). Needless to say, such a drastic difference has to be eliminated by means of a more flexible model of economy. Since the government is unable to increase prices for more substantial charges, expenditures should be considerably reduced. Hence, implementation of cost-effective solutions is a vital procedure for Houston as its debt will keep growing within several years. Again, the emphasis has to be placed on business-type units because the coverage of expenditures is almost positive, which is why this segment is relatively resistant to adverse economic conditions. Re-investment in business-type activities is particularly reasonable in this case as they have a pre-existing profit-generating factor. In other words, the primary governmental activities are directed to serve public needs, while business-type units work for making certain profits in terms of governmental management. As a result, the city will be able to use its net profits for covering the primary governmental expenditures or invest them in cutting-edge and cost-effective models of municipal economy. However, liquidity of the budget can be limited so that is has to be determined by following total ratio: 329, 207/167, 334 = 1. 97
- In spite of the fact that business-type activities were admitted to be the most effective, convention and entertainment facilities occur to be the most unprofitable. The difference between expenditures and charges is substantial; so, this segment presents an obvious gap for business-type activities. Therefore, it deserves particular attention because of the risks that it tends to expose in the nearest future. Convention and entertainment facilities are an indispensable component of publically accessible facilities, but its pricing can be increased. The facilities do not belong to a group of facilities that present vital importance to a community, which is why a relative change in prices can be possible. However, price elevation is insufficient for addressing the problem. The facilities should follow the same cost-effective model that the primary governmental activities were expected to implement. Convention and entertainment facilities are also a profit-generating element of business-type activities, but some managerial approach is required for leveraging its expenditures (Green, 2014, p.16). Overall, it has become increasingly difficult to ignore the fact that Houston needs a business-based approach to addressing its problems with economy. The city obtains a sufficient business-type base; so, the success depends totally on a reasonable management and investments. The government is expected to determine its operating margin so that it will be able to perform in terms of a certain framework. The margin can be measured as 39, 555 /(2755 + 42) = 14. 141.
Analysis of Debt Burden
- The overall tendency of long-term effects of debt demonstrates a relative progress. In fact, net profit did not change considerably within several years since the coverage of debt was producing its effect. At the same time, the government managed to find several ways to amortize expenses so that certain bonuses to a regular net income can be observed even though they are not substantial. Hence, the government succeeded in leveraging debt so that it is not likely to increase in the nearest future (Green, 2014, p.ii). Special attention should be paid to the fact that demographic changes positively reflected on the charging system of almost all governmental as well as business-type activities. In such a way, a public health unit started demonstrating particular benefits even though the demand on healthcare drastically increased within several years. Regarding these points, it is possible to assume that the future trend will be more adjusted to the financial capacity of citizens as well as the government. The city finds various ways to limit growth of the debt; so, the general obligation to the current debt tends to weaken. Still, extents of the debt burden can be measured: 13, 000, 000, 000 /137, 692 = 94413. 6.
- Unfortunately, Houston does not obtain sufficient economic capacity for gaining the short-term reduction of debt. However, the government managed to implement certain solutions regarding debt leveraging, but they tend to produce their full effect in the future in the long run. Therefore, the matter of economic growth is out of the question. Still, some levels of the short-term operating debt can be observed, but their short-term effect is strong; so, the government has to rely on some other ways to reduce the current debt. That is why the government needs to find some solutions in proprietary funds. This financial perspective of Houston demonstrates relative stability even though it also contributes to the debt growth. The government needs to align all possibilities to reduce the debt so that it can be addressed in complex. Such an approach will direct the government toward a meaningful short-term level of operating the debt. The total net position is equal to $10,725,141, and it is a particularly positive tendency since the government already managed to amortize certain expenditures, especially in the healthcare unit (Green, 2014, p.35). The same method can be also applied to other cost-demanding units.
- Speaking about quasi-debts and contingent liabilities, securities lending collateral should be indicated. As a matter of fact, the government was preserving the budget from further growth of the debt, and such a preventive measure was taken. However, securities lending collateral liability is a contingent liability in this particular case. This liability occurs in a financial statement on a regular basis, but its significance is evident for that fiscal year. To be more specific, securities lending collateral is $319,456, while accounts payable are $101,252 (Green, 2014, p.34). The difference between these liabilities is obvious, and securities lending collateral should have been maximally $202,504. In other words, the current securities lending collateral is not justified even though the government is experiencing certain financial hardships. As for the rest of quasi-debts, their level does not demonstrate a positive tendency, but an extreme decline cannot be also forecasted, which is why a relative stability can be admitted. This period should be utilized by the government for making drastic changes in advancing in debt reduction and alignment of the primary governmental as well as business-type activities. The government has the advantage of excessive securities lending liability; so, it is able to take certain risks for intensification of the debt reduction. In addition, indication of tax collection efficiency may be needed in order to forecast outcomes of the debt reduction. The effectiveness can be measured throughout 30, 110/ 2755 = 10. 9
- As the annual report suggests, risky investments in the form of derivatives can be observed. The report admits that risks associated with derivative disclosure are a result of the counterparty effect of risks (Green, 2014, p.64). Under these circumstances, obligation is not feasible for current investments; so, the risk probability grows accordingly. However, credit risks are comparatively low, which is why derivative disclosure is stronger. That implies the fact that obligation is not risky for the government and derivative will produce the intended effect on the financial statement of Houston. Since the risks are adequately disclosed, the type of investment is well-justified. As it has been already mentioned, the government managed to leverage its debt, and it needs more capacity for short-term debt reduction. Derivatives are a sufficiently reasonable type of investment as long as the risks are minimal, and the investments will cover at least minor percentage of total liabilities for the next fiscal year. Furthermore, the choice of investments did not have any justified alternatives; so, investments in the form of derivatives were explicit to the government, especially in terms of low risk probability.
- As for demographic and economic factors, a certain revival can be admitted since the overall capacity to pay taxes increased in comparison with past years. It can be explained by the fact that businessmen are particularly interested in supporting the government since it provides flexible policies and framework for a natural competition within markets. However, the small and medium sectors of business are still unaddressed because of a variety of requirements to a business start-up. That is why a common tendency witnesses a decrease in business licenses for small and medium entrepreneurship. Proactive franchising and impact of social media made existence of small businesses dramatically weak in terms of market competition.
Potential “Red Flags” or Warning Signs
- The overall decline in revenues is explicit throughout the entire annual report as expenditures evidently exceeded charges. Since the majority of activities are primary governmental, they are not particularly aimed at generating profits. Therefore, the main cause of revenue decline is based on ineffective management of costs rather than a low demand on the governmental activities. It is hard to argue that the natural need for certain facilities can be modified by a specific behavior of the government; otherwise the related activities would be strictly commercial. In addition, the fact of debt burden should not be omitted since all extra earnings are directed to reduce the current debt of the city. The decline in revenues is a ‘red flag’ for Houston for several years; so, external factors such as economic fluctuations, which are not dramatically dangerous for the city economy, are not a reason for revenue decline. Therefore, a certain problem is implied in the economic governance since the same mistake can be traced within numerous annual reports of Houston. The government has to review its model of economy because the current system will not resist adverse economic circumstances. The city is able to forecast its shortcoming performance by measurement a quick ratio that is based on a correlation between current liabilities and cash available. Hence, 1, 094, 897 / 167, 334 = 6. 54.
- a) Concerning the collection of levies in 2014, a distinct growth can be admitted. In comparison with 2013, the reported fiscal year managed to exceed minimal 92% of levy collection. The total levy collection is $1,078,378,000 for 2014, while 2013 was remarked with $980,338,000 only (Green, 2014, p.225). Hence, a considerable growth of collections is evident.
- b) The report outlines that property taxes are equal to 77% of the entire revenue of the city; so, a legal tax limit is not exceeded. In this particular case, such evidence is not positive as the rest of the taxations are ineffective (Green, 2014, p.ix). However, the presence of the current debt effects redirects tax revenues to coverage of the current debt.
- c) On the contrary, the decline of tax collection cannot be observed within the past two or three years. Such a paradox can be explained by the growth of business sector and current debt of the city. What is more important, the tax-supported debt was equal to 2.03%, while the factual difference between the debt and tax revenues is substantial (Green, 2014, p.ix). It can be explained by the fact that the government found multiple ways to leverage the growth of the debt and amortize certain expenditures.
- As it has been mentioned many times, expenditures are growing considerably faster than revenues. To the greatest extent, this evidence can be regarded as the most distinct sign of warning to the government of Houston. The city does not generate much profit since all the operational income is used for coverage of expenditures. However, the tendency has changed for better within several fiscal years, but the economy of the city is still under threat of being affected by even minor fluctuations. The city possesses a meaningful business capacity; therefore, Houston is recommended to generate profits via business-type activities. To the greatest extent, a drastic difference between expenditures and revenues is a fundamental factor of economic decline in Houston. The government should reconsider its approach to governance of the local economy since changes in transactions are fairly weak for influencing the situation. That is why it is an evident ‘red flag’ as long as the city government practices a vulnerable model of economy. What is more important, the government is attempting to find solutions in the other aspects of the economy because such a tendency can be observed within several fiscal years.
- a) General fund deficit can be observed within a couple of past years. However, it is not the result of insufficient investments since current investments are expected to be $3 billion (Green, 2014, p.i). The fiscal year 2014 can be marked with the growing deficit of funds, especially fiduciary ones. It can be explained by the fact that the city economy is not self-sufficient, which is why funding as obligation keeps growing to representatives that hold responsibility of funding the government. Since they are unable to cover their private expenditures, fiduciary funds are insufficient. Moreover, that can be an additional reason for a substantial difference between expenditures and revenues.
- b) General fund balance is not less than 5% since total general fund revenues are $2,068,690, while fund expenditures are $1,898,258 (Green, 2014, p.113). Hence, the balance of general funds is the following: 2,068,690 - 1,898,258 = 170,472. Therefore, the percentage of the balance is 100% multiplied by 170,472 and divided by 2,068,690, which equals approximately 8%. This evidence is positive for the city funds, but the growth of fund deficit is reflected on a low liquidity of the funds since they are utilized for coverage of deficit and fiduciary obligations.
- Reliance on non-recurring as well as special items of funding is obviously weak since additional items are not frequent. Therefore, the government does not rely on them heavily because they do not guarantee stability in the long run. As for the short-term debts and transactions, the government optimized several transactions so that it is able to leverage the debt. Non-recurring items are not helpful in this case. Therefore, the city does not face the most devastating decline as long as it is able to provide a minimal profit margin for limiting its current debt and amortizing expenditures. Reliance on special and non-recurring items does not have to be regarded as evidence of threat. Economy that is able to generate profits from temporal items is highly productive, and its stability is implied. In terms of governmental accounting, reliance on non-recurring items is strongly prohibited as it presupposes extreme risks. Therefore, the use of additional items implies economic stability of the city. Taking these points into account, the absence of economic stability in Houston is explicit; so, the absence of reliance on additional items is regarded as a financial weakness of the government. Still, it is not a warning sign for the city.
- a) The current debt is the main problem of the city finance; so, certain ‘red flags’ regarding the debt can be expected. However, Houston managed to cope with recent hardships and even make short-term balance positive. Operating revenue is $452,107, while the short-term debt is $180,000; it is evidently more than 5% of operating revenue (Green, 2014, p.16).
- b) In fact, the short-term debt stayed approximately the same for a couple of previous years; so, the government succeeded in leveraging the growth of the debt. Still, the economy is vulnerable as it cannot resist the adverse economic environment.
- c) Returning to the subject of operating revenue, it is important to note that debt service extremely exceeds 20% of operating revenue. This is a particularly negative tendency since this type of debt thwarts the government from leveraging its current liabilities; therefore the growth of the debt is likely in the future.
- d) Surprisingly, the debt per capita ratio does not exceed 50% of the same ratio four years ago; governmental leveraging can be proved with these data. However, certain changes can be observed, but they are not considerable, which is why this aspect does not demonstrate any signs of warning.
- The government managed to cope with its pension obligations even though it was equal to $3.218 billion in total for three pension programs (Green, 2014, p.xi). Growth of unfunded liabilities is the matter of the demographic factor: the government cannot control it by standard governance of the city finances. Therefore, the government just plans coverage of its unfunded obligations with the priority to pensions and any other liabilities related to support of socially insecure population. Increase in unfunded liabilities cannot witness any warning signs, while absence of capacity to cover these liabilities is an evident ‘red flag.’ One may argue that unfunded liabilities limit the government’s capacity to cover the debt. It is certainly true since coverage of unfunded liabilities requires substantial expenditures, which is why the government cannot focus its entire operating income on reduction of the current debt. Overall, unfunded liabilities do not present any information concerning negative tendencies since this factor is strictly demographic and does not depend on the governmental decision-making. Simultaneously, growth of unfunded liabilities prevents the government from a proactive reduction of the current debt as the government has limited capacities regarding liquidity of the finances. The government needs to compare its preplanned outcomes with a current situation via measurement of program service ratio: 2, 755/2, 768 = 0. 99.
- Deferral of needed capital plant is equal to $166,241, which is a fairly reasonable inflow of resources in comparison to revenues in primary governmental as well as business-type activities (Green, 2014, p.15). The government reasonably uses expenditures on the resources required for capital plants; therefore, the problem of a drastic difference between expenditures and charges becomes more specified. As a matter of fact, poor management of human resources and coverage of governmental and business-type liabilities lead to excessive expenditures. In addition, risk management at governmental as well as business level is also evidently poor since the growth of expenditures in terms of sufficient deferral inflows is not natural. It is necessary to note that most of deferral inflows are comprised of governmental activities, while the business-type unit does not require substantial resources. Consequently, the need for proactive funding of the business-type unit is proved by such a low inflow of resources that is equal to $3,577 (Green, 2014, p.16). All in all, this aspect of the city financial statements does not provide in-depth information concerning specific threats or signs of warning because it demonstrates internal transformation of finances. Namely, a certain amount was taken from the balance and transformed into deferral inflows that are presented in a dollar equivalent.
- Decrease in value of taxable properties is evident within the fiscal year, but it should not be regarded as a negative phenomenon. First of all, taxes for properties were increased sufficiently; therefore, the government is able to cover a certain percentage of the expenditures and leverage the current debt. Provided that the value of taxable properties decreased because of intensive spreading of such units, it is not a ‘red flag’ for Houston. It can be explained by the fact that the government still has a source of taxes that can be used for coverage of the city liabilities. As for the retail business, it contributed 91.69% of the entire revenue of the local business, which is why any decrease in its value cannot be observed (Green, 2014, p.264). What is more, disposable personal income remains at approximately the same level; consequently, the value of the private sector does not demonstrate any evidence of negative tendency. Besides, a significant contribution of retail business to the total revenues indicates an apparent need to re-invest in business-type activities since they are highly profit-generating. That will reduce the short-term debt and provide the government with an alternative model of governance for the city economy.
- The city received a standard federal fund equal to $500,000 since the current debt of the city complies with all existing policies and considered to be manageable (Green, 2014, p.i). It is certainly true that additional funds from the side of federal or state government are not needed. Again, the federal government implies the fact that economic decline of Houston is a managerial problem, which is why any additional funds will worsen the situation since the liabilities of the city will grow accordingly. Needless to say, absence of support from the federal and state government makes decision-making of the local government more risky, but decrease in federal or state support should be regarded as a relative independence of the city economy. As a matter of fact, Houston is able to manage its economic decline without any external help. Since the debt is manageable and complies with related legal requirements, there are no reasons for admitting that decrease in federal or state support is a distinct evidence of threat. Although the revenues are negative, they are sufficient for leverage of the current debt. The city does not face a complete economic decline as long as its debt can be leveraged and the government is able to manage the situation.
- The unemployment rates were decreased within the previous fiscal year. At the beginning of the fiscal year 2013, unpaid claims mounted to $294,052. By the end of the fiscal year 2013, the claims fell to $138,598 (Green, 2014, p.102). As for the fiscal year 2014, it began with $138,598 claims and ended with $176,350 (Green, 2014, p.102). Therefore, increase in unemployment cannot be admitted in comparison with the previous fiscal year. It increased within the fiscal year 2014, but such growth is not considerable, which is why current unemployment rates cannot present any ‘red flags.’ The report admits that the city paid all claims as they were settled so that the current debt is not increased with this type of liabilities. Still, the following fiscal year will start with higher unemployment, which is why the long-term trend should be addressed; otherwise unemployment rates can potentially grow, especially in terms of increasing expenditures on governmental activities. As a consequence, many employees from governmentally-funded sectors face a risk to become unemployed; for this reason, the government has to address that issue in the future. Eventually, the city has a sufficient capacity to address this problem because experience of the past and current fiscal years demonstrates a financial feasibility of the issue.
- Unusual climatic conditions as well as environmental disasters were not observed to an extent that may require additional expenditures. Therefore, the city did not spend substantial costs on such events. What is more, the government has a sufficient capacity to address such cases; consequently, the potential damage of environmental accidents will be restored without much harm to the budget of Houston. In other words, the government does not tend to economize on prevention of the consequences of environmental disasters. Therefore, this perspective does not show any signs of warning.
- Eventually, ineffective management should be recognized as a potentially most significant ‘red flag’ of the city finances. As it has been already indicated, the debt of Houston was caused by a substantial difference between expenditures and charges in the primary governmental activities. Since this unit cannot commercialize its performance, an evident problem with management is apparent. It is possible to assume that the government invests excessive funds in the primary governmental unit; therefore, expenditures are higher than charges a priori. Without doubt, the government preserves the unit from ineffective performance, but such a strategy increases the overall debt of Houston. Since this scenario is an assumption only, other mistakes in management are also possible. Anyway, the government is recommended to change its model of management and deploy more sophisticated means of risk management. As it has been mentioned, budgetary cushion is 262, 274/ (2, 089, 298 + 42) = 0. 125 so that the current government has to consider that. Dysfunctional and unstable political circumstances cannot influence the situation because the observed tendency can be traced within several years, which is why any external impacts are excluded from the list of potential causes. The government needs to conduct a general analysis of its performance as the problem may occur to be far more complicated than mistakes in management and governance. Also, the government is supposed to make major investments in business-type activities as they are evidently profitable for Houston.