Local Government Cash Position (Liquidity) and Cash Forecasting    

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Benjamin Effinger
June 7, 2024

Importance of Cash Position/Liquidity

When we talk about cash position or liquidity within local government, we are talking about the importance of ensuring that the government agency has sufficient operating liquidity by estimating the available cash deposits, expected inflows and required disbursements within any given period. This is critical for government agencies of all levels from the smallest of municipal budgets to the largest of municipal operations—no matter the size—the availability of cash matters greatly. According to the GFOA Best Practices of Using Cash Forecasts for Treasury and Operations Liquidity, common forms of inflow consist of tax receipts (sales, transient occupancy, property, etc.), bond proceeds, utility payment received, grant revenue, miscellaneous revenue from imposed fees and penalties and maturities and interest revenue from investment securities. Outflows, commonly referred to as disbursements, represent any anticipated payment obligations, such as debt services, employee payroll and benefits, payments to vendors for goods and services and the purchase and roll-over of investment securities.

Agencies must also account for non-repetitive receipts and payments that will impact the cash position and short term forecast for cashflow needs. Examples of these may include proceeds from bond issuance, capital expenditures or expected legal settlements. The most relatable recent example for many government agencies is the receipts of American Rescue Plan funds, signed into law in March 2021, which provided an equitable economic recovery from the devastating economic effects of the COVID-19 pandemic. These funds were often received by many agencies on short notice, which accounted for large one-time payments, and agencies needed to shift their cash position and liquidity forecast to account for the one-time funds of a substantial amount. If an agency did not account for the funds accordingly, it may leave the funds idle, which may significantly impact both short- and long-term investment returns.

The cash forecast analysis is intended to measure and assess a local government agency’s ability to meet its liquidity needs. Consequences of not knowing or understanding your agency’s cash position may result in an increased need for short-term cash borrowing and/or premature liquidation of long-term investments prior to maturity to manage cash shortages. These types of events can negatively impact your agency’s credit rating, increasing interest rates on both short- and long-term borrowing. City and County administrators need to be aware of and understand these consequences to avoid the negative impacts of an inaccurate or ineffective cash forecast analysis.

Cashflow Forecasting

It is critical for local government agencies to know how much cash they have on hand, when that cash is available and for how long that cash will be available. All of these factors influence how the agency will invest their excess cash, for how long they will invest and how much cash they need to keep on hand for immediate liquidity needs to meet fiscal obligations. The size and scope of the agency will dictate the cash forecasting methods and models that the agency elects to use to manage their cashflow needs.

Let’s look at the benefits of an effective cash forecast:

• An effective cash forecast can help an agency accurately identify idle cash and make the best decisions, both short- and long-term for their investments needs.
• An effective cash forecast can help an agency account for cash deficiencies and strategize their borrowing of cash—which they will want to access at the most advantageous rates (the forecast helps to eliminate emergency borrowing which typically comes at a much higher rate).
• An effective cash forecast can help an agency improve their rating agency confidence thought accuracy and proven ability to forecast (this affords the agency the ability to access lower interest rates on cash borrowing).
• An effective cash forecast can help an agency identify potential budgetary issues—such as revenue shortfalls or excess disbursements (that should appear as anomalies in the cash forecast and spark inquiry).

Cash Forecasting Models

Local government agencies need to have a cash forecasting model that meets the needs of their agency. Cash forecasting is not a one-size-fits-all type of situation and as stated—the size and scope of the agency dictates the methods and models that should considered to best meet their fiscal needs. Basic cash forecasting models are very simplistic and can be represented by the following equation: Beginning Cash + Revenues – Expenditures = Excess Cash available for Investment. This type of forecast model may be good for very small municipalities that do not have complex revenue and expenditure streams to consider.

Many agencies (small to mid-sized) utilize a Moving Average Model, which is a little more involved than the basic cash forecasting model. The moving average model evaluates recent history (typically the most recent past three months) and the informed average is use to project the cash forecast for the upcoming month. This model is reliable, however must be evaluated for reasonableness. Agencies must look at the period of time being averaged and analyze for anomalies (large or unexpected revenues or disbursements that could skew the informed average).

Lager agencies may struggle to utilize basic cash forecasting models or the moving average model because their specific needs are greater than these models can meet. Larger agencies may need to consider more complex models to account for their specific needs such as exponential, smoothing, dynamic regression and regression analysis. Specifically, in Los Angeles County, where our treasury pool is greater than $50 billion, we utilize a smoothing model. Smoothing models are employed to iron out the volatility inherent in cash flow data, rendering a more digestible and actionable forecast. This allows the agency to focus on more recent past trends instead of more distant past trends to inform their cash forecast. Smoothing can also account for the ups and downs of the market, where “good” periods can help balance out “bad” periods—hence “smoothing” out the forecast.

Importance of Cash Position Future Calendars

It is important for treasury managers and agencies to understand their cash flow through several time-based units of measure. This is where cash position future calendars come into play for local government agencies. It is not uncommon for agencies to forecast a next-day, next-month and next-year cash flow forecast calendar. These calendars are living documents, which need to be updated as the agency learns of new incoming funds or shortfalls to accurately project the cash position. The accuracy of the future cash forecast calendars are very important, as these calendars are used to inform future investment decisions such as duration (short-, mid- and long-term) of investments and drive the maturity dates of each investment to meet the liquidity needs of the agency.

Conclusion

Agencies must understand the importance of their cash position and liquidity to ensure that they can effectively and efficiently operate. Understanding their cash position and accurately employing cash forecasting models to project future cash needs ensures that the agency can maintain necessary liquidity and if they need to borrow, they are borrowing at favorable rates through predictable needs, and not on short notice. Effective cash management builds the reputation of the agency and improves overall confidence in the local government agency, which is responsible to the constituents within the jurisdiction that it services. An agency must know its cash position and do everything in its power to ensure that its cash position is advantageous to support the agency’s needs at any moment.

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