Report 2004-117 Summary - December 2004

City of Richmond:

Poor Spending Decisions and Weak Monitoring of Its Finances Caused Its Financial Decline and Hinder Its Ability to Recover

HIGHLIGHTS

Our review found that the city of Richmond's (city) financial health deteriorated because it:

  • Significantly increased employee salaries and retirement benefits without ensuring it would have adequate funds to pay for them.
  • Agreed to increase some salaries to exceed those of other cities without knowing what the amounts would be and without limiting the increases.
  • Underestimated how much it would spend out of its general fund, sometimes intentionally, and delayed making spending reductions.
  • Relied on inaccurate reports to monitor and adjust the budget.

Since March 2004 the city has taken steps to improve its financial health and how it monitors its finances.

RESULTS IN BRIEF

In reviewing its midyear progress for fiscal year 2003-04, the city of Richmond (city) announced in March 2004 that during the previous fiscal year, several funds had greater outflows than inflows and some funds had large negative cash amounts. Most significantly, during fiscal year 2002-03, expenditures exceeded revenues by $14.5 million in the city's general fund—its main operating fund—and the fund had an $8.3 million negative cash amount as of June 30, 2003.

The imbalance between the city's inflows and outflows was largely caused by its failure to control spending. Although the city expected to increase revenues to make up for the increased spending, its expectations for swift revenue increases were overly optimistic and did not materialize. Personnel costs represent the largest portion of the city's spending and contributed significantly to the city's increased costs, the result of salary increases ranging from 16 percent to 27 percent for most employees between 2000 and 2003. The city also enhanced its employees' retirement benefits, thereby increasing its obligation to the retirement system; in some cases, retirement benefit costs exceed 30 percent of what it pays employees in salaries. The city council believed that the increases were necessary to be competitive with other cities and to attract and retain qualified employees. However, it agreed to increase some salaries to exceed those of other cities without knowing what the amounts would be and without setting limits on the increases. Additionally, the city council enhanced retirement benefits, knowing that the benefits would be a significant expense and without having set aside funds to prepare for the increases.

Although the intent of the city council's decisions was to improve services to the public, the effect appears to have backfired. In fact, because the city's costs increased rapidly while its revenues did not, the city has laid off 250 of its staff since March 2003, drastically cut funds to some of its programs, and diminished its reserves. To improve its financial outlook, the city's revenues must not only align but also exceed its expenditures to make up for past deficits and rebuild its resources, a direction the city has been heading with recent revenue increases and cost reductions.

The city's budget preparation and monitoring processes were disjointed and therefore did not identify that the city council's decisions would cause a deficit in fiscal years 2002-03 and 2003-04. Consequently, the city council did not make decisions to reduce spending until after the city had spent more money than it could afford. The city's budget process failed in part because the city significantly underestimated what it would spend on personnel, bond payments, and insurance during fiscal year 2002-03. Additionally, the city deliberately underbudgeted certain expenditures to balance its fiscal year 2003-04 budget.

The finance department's quarterly and midyear reports, which it provides to the city council to monitor the budget, should have indicated what the budgets did not: that the city's outflows would exceed its inflows. However, the reports from the finance department for fiscal year 2002-03 did not disclose that information. Instead, the updated spending estimates the finance department reported to the city council incorrectly showed that the city could afford the increases using reserve funds. The department's calculations of the city's general-fund reserves were incorrect, mostly because they did not include all outflows, such as transfers from the general fund to other funds. The quarterly and midyear reports also did not show other indicators of the city's financial troubles, such as the cash position of the city's individual funds and losses in other funds, including its workers' compensation and general insurance funds. As a result, the city council was not fully aware of the city's serious financial predicament until the city released its audited financial statements. The financial statements disclosed losses and negative cash amounts nearly one year after the end of the 2002-03 fiscal year, at which point the city began taking corrective action. Although the city has taken steps to improve its monitoring procedures, to some extent the problems continued throughout fiscal year 2003-04.

Since the city discovered its financial deterioration, it has taken steps to improve its financial health and how it monitors the finances of the city. Specifically, in March 2004, the city published a corrective action plan to eliminate negative cash amounts and reduce costs by June 30, 2004, while the city implemented longer term solutions, such as increasing the sales tax and renegotiating certain benefits with its six employee unions. Additionally, in September 2004, the interim city manager issued an assessment that enumerated specific tasks needed to strenghten the city's fiscal and organizational structure. The tasks in this assessment include having departments submit monthly reviews of their budgets and ensuring the city completes its financial statements by the end of the calendar year. However, it is too soon to tell whether the actions the city has already taken and plans to take in the future will be sufficient to restore its financial health.

RECOMMENDATIONS

To ensure that the city has sufficient funds to meet its operating costs and does not spend more than it can afford, Richmond should do the following:

  • When negotiating agreements with its employee unions, consistently analyze salary and benefit increases to determine the long- and short-term effects the increases will have on the city's budget.
  • Cease raising salaries based on amounts outside the city's control. If the city chooses to continue to base its salaries on those of other cities, it should ensure that its agreements with employee unions include limits to the amounts the city will raise the salaries.

To reestablish the value of the budget as an essential planning tool, Richmond should budget for all likely expenditures and not knowingly adopt budgets that reflect inaccurate estimates of expenditures or revenues. If the city needs to reduce expenditures to balance the budget, it should promptly take cost-cutting measures.

To improve the quality of the financial information that the city council uses to make budget changes during the year, the city's finance department should take the following steps:

  • Monitor the amount of reserves the city has during the year, using a method that includes all inflows and outflows.
  • Include information on the status of other city funds, not just the general fund, in its quarterly and midyear reports.

AGENCY COMMENTS

The city is in general agreement with the recommendations and facts in the report.


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