Financial Analysis: Training Manual

Financial
Analysis
Modernizing Financial Management for Hungarian Local Governments
2
TRAINING MANUAL
Contents
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Acknowledgments ........................................................................................................................... 1
Preface........................................................................................................................................... 2
How To Use This Manual ................................................................................................................. 3
Practical Guide............................................................................................................................. 3
Training Guide ............................................................................................................................. 3
Practical Guide ................................................................................................................................ 4
Overview..................................................................................................................................... 4
Objectives ................................................................................................................................... 4
Topic Definition ............................................................................................................................ 4
Benefits of Financial Analysis ....................................................................................................... 5
Financial Analysis in Hungary ....................................................................................................... 6
Budget Structuring........................................................................................................................ 6
Fiscal Indicators ......................................................................................................................... 12
Forecasting................................................................................................................................ 23
Summary of Key Points .............................................................................................................. 27
Glossary .................................................................................................................................... 28
Training Guide............................................................................................................................... 30
Training Outline.......................................................................................................................... 30
Slides ........................................................................................................................................ 30
Exercises .................................................................................................................................. 30
Bibliography............................................................................................................................... 41
Acknowledgments
The Urban Institute (UI), Washington, DC, and the Metropolitan Research Institute (MRI), Budapest,
developed these manuals with funding from the United States Agency for International Development
(USAID).
Several individuals contributed to the content of these manuals. Katharine Mark, UI Program Director in
Hungary, conceived the program and provided overall management with the assistance of her colleagues
Wendy Graham and Margaret Tabler. The program was based on the success of initial municipal budget
reform work with the city of Szolnok carried out by Philip Rosenberg. The training program itself was
developed and implemented by a team of U.S. and Hungarian trainers led by Philip Rosenberg and
József Hegedüs. Wendy Graham and Ritu Nayyar-Stone coproduced the training manuals. Wendy
Graham directed the development, and Ritu Nayyar-Stone edited all the drafts. Principal authors of the
manuals were Róbert Kovács, Mihály Lados, Ritu Nayyar-Stone, Monika Jáki, Katalin Pallai, and Philip
Rosenberg. Other individuals made contributions to specific topics: József Hegedüs, Andrea Tönkõ, Judit
Kálmán, József Kéri, Mária Kürthy, Erzsébet Krajsóczki, András Vigvári, Orsolya Sebõk, Harry Hatry,
Sharon Cooley, Scott Bryant, and Blue Wooldridge. Diane Ferguson provided substantive editing and
layout. Ágnes Magyari also assisted with layout and coordination of the printing. Jeffrey Stevenson Murer
designed the cover. Katalin Zsámboki, Gabriella Szabó, and Judit Hegedüs translated the manuals from
English into Hungarian and vice versa.
Principal Author: Róbert Kovács

Contributions by: Philip Rosenberg, József Hegedüs, András Vigvári
1
Preface
These manuals are based on a three-year training program, Modernizing Financial Management for
Hungarian Local Governments, sponsored by USAID from 1996 to 1999 and executed by UI and MRI.
The training consisted of six seminars each year, following the municipal budget cycle. The objective was
to train municipal officials to improve financial management in their municipality via financial analysis,
revenue alternatives, performance measurement, strategic planning, capital improvements programs, and
program budgeting. The program was interactive and used Hungarian local consultants. It was refined
annually based on feedback from municipal finance officers.
As a result of the program, thirty-five local governments have focused on improving financial
management practices and enhancing transparency. Many municipalities found it beneficial to attend
more than one series of seminars. Often municipalities sent larger teams to work in detail on reformed
budgets for specific sectors. The modernization brought about by program budgeting has greatly
improved municipal budgeting practices in Hungary.
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How To Use This Manual
This training manual, like other manuals in the series, can be used in many ways. It can be a guide for all
individuals involved in bringing about financial reform in a municipalitymayors, finance officers,
department heads, and your staff. It can also be a guide for trainers.
Practical Guide
The first part of the training manual is intended for self-instruction. You can also use it as a basis to
develop your own presentation on this topic. Throughout the practical guide you will find slide icons in the
left-hand margin. These show that the topic has a corresponding slide in the second part of the training
manual, which is the training guide.
Training Guide
The second part of the training manual can be used by finance managers to train staff prior to initiating
financial reform. Trainers can also use it in a training workshop for finance managers from different local
governments. This section contains a training agenda, slides, exercises (where applicable), and a
bibliography. You can either use the slides as they are, or you can enhance or change them based on
your experience. Trainers may wish to rearrange or modify the materials to meet the objectives of a
particular training situation.
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Practical Guide
Overview
Municipal officials need accurate, timely financial information to make good decisions and avoid
problems. This is particularly important when municipal needs are great and financial resources
are scarce. Financial analysis will assist municipal officials to gain an understanding of the
municipality’s fiscal situation and identify emerging trends of which they may be unaware. You
can use financial analysis to present the municipality’s strengths and weaknesses to the local
council, citizens, central government, and investors. This, in turn, will promote budget
transparency and enhance the municipality’s ability to borrow. Importantly, financial analysis
helps guide financial planning and the formulation of fiscal policy.
This training manual is designed for municipal staff who are directly involved in financial analysis,
including finance department staff and budgetary institution staff involved in preparing forecasts
and analyzing financial data. Municipal policymakers also will benefit.
This training manual presents the tools and techniques used by municipalities to perform financial
analysis. It consists of three modules that complement and build on each other. The first module
presents a structure for grouping and analyzing budget data. The second module presents fiscal
indicators, which are tools for evaluating the fiscal condition of a community. The third module
presents techniques for forecasting municipal revenues and expenditures.
Objectives
♦ Creating an analytic approach to the municipal budget.
♦ Developing skills for grouping budget data for specific purposes.
♦ Implementing the Budgetary and Creditworthiness Analysis Model (BCAM).
♦ E valuating the fiscal condition of a community.
♦ Learning methods and developing skills to calculate fiscal indicators.
♦ Understanding the value of charts and figures.
♦ Understanding forecasting techniques for municipal budgets.
♦ Identifying problems related to municipal budget forecasting.
Topic Definition
What Is Financial Analysis?

Financial analysis is a set of tools and techniques, including fiscal indicators and forecasting, that
allow you to measure the current fiscal condition of a government or business and predict trends
in its future fiscal condition. Financial analysis helps your municipality decide how much it can
afford to spend and how it will fund new priorities.
What Is a Good Budget Structure?

Before you apply financial analysis tools, it is important to structure your budget well so that it
highlights important information. A good budget structure groups data logically and breaks down
revenues and expenditures in a useful way.
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What Are Fiscal Indicators?
Fiscal indicators measure your municipality’s financial well-being. They give you quantified
information that helps you evaluate the fiscal condition of your municipality and compare your
current budget with that of previous years and other municipalities. (See the performance
measurement manual for information on indicators that measure the results and
accomplishments of programs.)
What Is Forecasting?
Forecasting is a tool for predicting the future fiscal condition of a municipality. Forecasting
projects future revenues and expenditures based on past trends and modified by specific
assumptions about the future. Forecasting can therefore assist you in budgeting, policymaking,
and planning for your community.
Benefits of Financial Analysis

Financial analysis benefits your municipality by:
♦ Linking municipal policy with specific financial plans to achieve long-range goals.
♦ Developing a vision of your municipality’s financial future and allowing you more time to
respond to adverse events.
♦ Helping your municipality to better meet its responsibilities toward its citizens.
♦ Increasing the number of alternative strategies and improving the quality of financial decision
making.
♦ Supporting borrowing and credit evaluation.
In addition to the above benefits, the tools and techniques for municipal financial analysis
presented herein will assist municipalities seeking to borrow funds. These techniques reflect the
approach a lender would take in evaluating municipal creditworthiness and debt carrying
capacity. Other institutions that interact with a municipality (such as central government
ministries) also require financial data that are complete and accurate. One of the most important
such institutions in Hungary is TÁKISZ (the administrative branch of the Ministry of Finance), to
which all municipalities are required to send their budget reports and financial and performance
data.
Financial analysis will help institutions and municipal officials answer the following questions:
♦ What is included in each budget item?
♦ How much has the amount allocated to the budget item increased or decreased each year?
♦ How has the budget item changed in importance relative to other budget items?
♦ What is the reason for any substantial change, either up or down, in the allocation for any
item?
♦ How does the municipality’s budget compare to other municipalities’ budgets?
♦ What changes can be expected in the future regarding any major budget item?
♦ What are the trends, positive and negative?
♦ What is the rationale for projections, including any expected changes?
♦ How accurate and certain are projected trends?
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Financial Analysis in Hungary
Financial analysis techniques are not generally used by local governments in Hungary. Municipal
budgets are simple documents responding to legal requirements and adjusting expenditures to
potential revenues. For Hungarian municipalities in general, the budget is more of an accounting
document than a policy statement on what the municipality wants to do. Most municipalities use
neither fiscal indicators nor forecasting to monitor services or to gain a financial perspective that
will help them plan their future. Some of them, in developing municipal strategies, do some
calculations, but not as a reason to start thinking about the future. Even when taking out a loan,
municipalities rarely make medium- or long-term financial projections.
Municipalities do produce various indicators that are required of them. One reason for this is their
obligations to collect data for national statistics or the central budget or to provide data when
applying for some central funds. Municipalities rarely use these data to better understand their
own situation; rather, they perceive the required development of indicators more as an extra
burden.
More recently, some Hungarian municipalities have participated in training on budgeting reform.
These municipalities are using fiscal indicators to improve their decision making, make their local
budgets more transparent, and improve their financial management in terms of using resources
more efficiently.
Budget Structuring
The budget is central to financial analysis and municipal management. It is the plan for keeping
your municipality solvent, including ensuring that proposed expenditures are balanced by
anticipated revenues, loans can be obtained and repaid, there are adequate reserves, municipal
priorities are established, and resources allocated. Furthermore, the budget must contain
comprehensive information on the financial position of your municipality. Therefore, it is essential
that you structure your budget so that it provides accurate, timely, and complete information.
A good budget structure contains separate estimates of capital and operating revenues and
expenditures. You must also distinguish between the planned budget and the actual quarterly
budget report, which demonstrates the performance of the municipality. Also, the budget changes
during the year. For example, in Hungary, you can only include investment grants in your budget
after the central government decides whether to award grants for your municipality’s proposals.
Steps in Structuring Your Budget
Step 1: Decide on Scope and Identify Data Sources.

The data sources that you choose affect the results of your financial analysis. Revenue and
expenditure data are constantly changing as revenues are collected and monies expended.
Because the budget changes during the year, you need to distinguish budget data by the period
they cover (prior year, budget forecast, mid-year, year-end).
Historical data are required for financial analysis since they provide a basis for projecting the
future. Actual revenue and expenditure data for the last five years are usually a minimum
requirement, but many Hungarian municipalities lack historical data covering five years. Where
data are not available, use the most exact estimates you have. You may have to use the data
contained in the budget, which are only estimates, or interim financial data based on quarterly
reports. Recognize the limitations that the lack of accurate data places on the quality of your
financial analysis. Then, begin to build a database by adding subsequent years’ data, and over
time you will develop a sound body of information.
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It is important to decide what scope of budget data to use depending on the aim of your analysis.
Highly specified information can be very attractive in theory; however, it may decrease the
efficiency of your analysis in practice. Therefore, it is important to first specify your goals and then
decide how much detail and what kind of data you will use.
Step 2: Structure Your Budget.

Budgets are separated into revenues and expenditures. Breaking down budget data into more
specific categories will enable you to review and evaluate them more easily. You should be sure
to define and describe each revenue source and expenditure category. Include data specific to
each category: number of customers/accounts, rates and bases of revenue source, collection
rates, and other related factors.
Break down revenues for analytic purposes as follows:

♦ Actual revenues collected by source (own source revenues, transfers, and central
government grants and subsidies);
♦ Capital revenues;
♦ Recurring discretionary revenues; and
♦ Nonrecurring/nondiscretionary revenues.
Break down expenditures for analytic purposes as follows:

♦ Actual expenditures by account, department, or program/activity;
♦ Description of account classification, department, or program/activity;
♦ Data specific to each expenditure (detailed sufficiently for analytic purposes);
♦ Recurring expenditures; and
♦ Capital investment expenditures.
Further categorization is possible, and the final categorization of the budget data depends on the
goals of your financial analysis and the information required by outside institutions. Municipalities
usually structure their data based on accounting and other related regulations. Financial analysis,
however, requires a different kind of structure, which should be harmonized with the goals of the
analysis.
You can break revenues and expenditures down by sectors if you are performing a sector
analysis. However, avoid forcing certain revenue items into a sector category; you need to treat
discretionary revenue items separately from nondiscretionary sector revenues because this
process may help you identify local priorities. You can then choose among alternative sources of
discretionary revenues based on your municipality’s goals and objectives.
The groups of revenues and expenditures presented above are broad categories. You can
consider the personal income tax revenue as an individual item; however, in most budgets it is
considered part of the broader category of transfers. Local tax revenues are comprised of the
aggregate amount of revenues raised from specific local taxes, and revenues from asset sales
contain income from sales of property and other assets. This item may be listed separately from
the revenues raised from the sales of other assets, that is the budget may list the sales of
material and non-material items separately, or it can distinguish between the revenues from
property sales and the sales of other material objects, for example. See Exhibits 1 and 2 for a
sample of detailed revenue and expenditure categories and breakdowns.
The Budgetary and Creditworthiness Analysis Model

One useful budget structure is the Budgetary and Creditworthiness Analysis Model (BCAM) for
Hungarian local governments. The BCAM a financial analysis model that you can use to make
budget forecasts, analyze trends, evaluate your municipality’s fiscal condition, determine funds
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available for capital investment, and assess creditworthiness. See Exhibit 3 for a sample BCAM
structure. (More detailed instructions on using the BCAM are contained in Balogh et al., 1999.)
The main advantage of the BCAM is that it summarizes the most important aspects of your
municipality’s finances in a few lines.
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Exhibit 1
Sample Breakdown of Revenue Categories (in HUF ‘000)
Curr.
Item 1994 1995 1996 1997 Year
Central operating transfers
Personal income tax
Personal income tax redistribution
Normative grants
Education
Culture
Sport
Health care
Social welfare
Other (i.e., communal services)
Centralized appropriations
Social Security transfers
Other operating transfers from the central government
Own current operating revenues
Revenues from municipal institutions
Duties
Other own revenues
Total local taxes
Business tax
Tax on plots
Tax on buildings
Communal tax
Tax on tourism
Car tax
Other operating revenues
Capital investment revenues
Central grants for capital investment
Targeted and addressed subsidies
Grants from Development Councils
Other central funds
Other central grants for capital investments
Local revenues for capital investment
Revenues from asset sales
Sale of properties
Sale of bonds
Revenues from asset use
Housing revenues
Commercial unit revenues
Interest revenues
Recovery on investments
Other revenues from asset use
Revenues from the citizens for capital investments
Reimbursement of value-added tax (VAT)
Other revenues (i.e., from other municipalities)
For operation
For capital investments
Loans
For operation
Residual balance from the previous year
Adjustments
TOTAL REVENUES
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Exhibit 2
Sample Breakdown of Expenditure Categories (in HUF ‘000)
Curr.
Item 1994 1995 1996 1997 Year
Operating expenditures
Administration
Health care
Education
Social welfare
Infrastructure
Other operating expenditures
Cash subsidies
Subsidies for enterprises
Capital investment and development expenditures
Administration
Health care
Education
Social welfare
Infrastructure
Other capital investment expenditures
Debt service
Interest payments
Debt amortization
For operation
For capital investment
Reserves
Adjustments
Closing cash balance
TOTAL EXPENDITURES
Out of current expenditures:
Salaries
Benefits for employees
Material expenditures
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Exhibit 3
Sample BCAM Table
Curr.
Item 1994 1995 1996 1997 Year
Total current revenues
Own current revenues
Central current revenues
Total current expenditures
Operating balance
Debt service
Net operating balance
Total capital revenues
Own capital revenues
Capital revenues from central funds
Capital investment expenditures
Investment balance deficit (+)/surplus (-)
Other revenues
Other expenditures
DEFICIT (+)/ SURPLUS (-)
Borrowing
Residual balance from previous year
CLOSING BALANCE
The BCAM separates municipal budgets into four parts:

♦ Operating (current) revenues;
♦ Operating (current) expenditures;
♦ Capital revenues; and
♦ Capital expenditures.
The difference between operating revenues and expenditures is the operating balance; the
difference between capital revenues and expenditures is the capital investment balance (also
called the capital deficit or surplus). The distinction between the operating and the investment
balance enables you to determine what resources your municipality has available for develop-
ment purposes after calculating all operating expenditures. It also shows whether your munici-
pality finances its operating costs by exhausting its assets. The operating and investment
balances together give the resource deficit or surplus (by considering the residual balance as
well). This gives a comprehensive picture of the fiscal condition of your municipality.
A cautionary note about separating revenues into operating and capital investment: operating
revenues include regular or current revenues, as opposed to investment resources. The latter are
composed of asset management and transaction-related revenues, interest, profit share, grants
received for a proposal, or resources received by the municipality for a specific development
project. Items that are difficult to categorize according to these rules require individual
consideration, or you can classify them under “other revenues” or “other expenditures.”
The BCAM clearly separates operating and investment balances and treats debt service
separately. The version presented here includes interest repayment and capital amortization in
the operating balance and introduces the concept of “net operating balance.” Loans reduce the
resource deficit.
The final structure of BCAM data depends on the objectives of the analysis. BCAM can serve as
a supplement to any kind of financial analysis and is particularly useful for presenting investment-
related analysis. You can break down the aggregated items of BCAM, especially revenues,
further if needed.
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Fiscal Indicators
What Does Fiscal Condition Mean?

This module presents tools for evaluating a municipality’s fiscal condition. Evaluating your
municipality’s fiscal condition means sorting through a variety of financial and other data (e.g.,
data on the national economy, local economy, population level and composition, local business
climate, character of local finances, changes in the local population) and identifying both positive
and negative trends.
Fiscal condition refers to both cash solvency (the municipality can pay its bills) and budgetary
solvency (the municipality generates enough revenues to meet its expenditures and not incur
deficits). In a broad sense, fiscal condition refers to a municipality’s ability in the long term to pay
for all the costs of doing business, including both expenditures that normally appear in each
annual operating budget and those that will appear in the future. In addition to cash solvency and
budgetary solvency, fiscal condition refers to:
♦ A municipality’s ability to maintain services and capital facilities. Can your municipality
continue to afford to pay for services it is currently providing? Aside from the basic services,
can the municipality maintain its capital facilities, such as streets and buildings? Can the
municipality continue to provide services at the level of quality required for the health, safety,
and welfare of the community and provide services that its citizens desire?
♦ A municipality’s ability to handle unexpected events. Does your municipality have the
financial ability to handle emergencies, withstand local and regional economic disruption, or
adjust for an eroding revenue base due to rapid inflation?
♦ A municipality’s ability to meet the demands of growth, decline, and change. Does your
municipality have the financial flexibility to meet the needs of growth, which will necessitate
an increase in the operating budget to provide necessary services? Can the municipality
withstand decline, which will leave fewer people and businesses to pay for services, fixed
costs, and infrastructure maintenance?
Benefits of Fiscal Indicators

Indicators represent a way to quantify changes and trends within the municipality. This will enable
better judgments about your municipality’s demographic and economic bases, as well as its
financial base. The quantified information that fiscal indicators provide helps you compare your
current budget with that of previous years and other municipalities. Examining a variety of
indicators, both internal and external, will give you a complete picture of your municipality’s fiscal
condition. Once the municipality’s fiscal condition is understood, you can focus the budget on
investments that will address the problems the municipality is facing and improve municipal
productivity.
Fiscal indicators allow municipal officials to focus on trends within their municipality. Trend
monitoring uses various economic, financial, and demographic indicators to monitor the fiscal
condition of the community. Fiscal indicators also focus attention on factors and trends over a
relatively long period of time, thus allowing municipal officials to see whether potential problems
are intensifying or improving. The process of developing fiscal indicators provides a framework for
assembling and analyzing information about a municipality on a regular basis.
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Other benefits of fiscal indicators are that they:
♦ Rely on existing and available data;
♦ Are designed for use by municipal staff;
♦ Do not require complicated techniques; and
♦ Incorporate benchmarks used by lenders to assess creditworthiness.
Fiscal indicators measure quantitative information. Because of this, they avoid the problem typical
of sector indicators, which is the quantification of qualitative information. Such quantification is
only possible within certain limits: you can measure the number of teachers per student in a
school or the rate of students continuing their studies at a higher level, but these indicators give
only a limited picture of the quality of education.
Types of Fiscal Indicators

Fiscal indicators, the primary tools for evaluating fiscal condition, can be categorized into three
groups:
Financial Indicators: measures that reflect the condition of the municipality’s finances, including:
♦ Revenues;
♦ Expenditures;
♦ Operating position;
♦ Debt structure;
♦ Unfunded liabilities; and
♦ Infrastructure condition.
Environmental Indicators: measures of the external influences on a municipality that may

create or reduce demands, and provide or diminish resources, including:
♦ Population;
♦ Community needs and resources;
♦ External economic conditions;
♦ Intergovernmental constraints;
♦ Natural disasters and emergencies; and
♦ Political culture.
Organizational Indicators: measures of the municipality’s response to changes in environmental

indicators and of the management practices and legislative policies that enable an appropriate
response to change. Some examples are:
♦ Institutionalization of a new emergency relief fund;
♦ Creation of new staff positions for liaison with the central government; and
♦ Creation of new mechanisms to gather citizen input.
Indicators measure trends over time. For example, revenues per capita measures changes in
revenues relative to changes in population size. As population increases, you might expect that
revenues and the need for services would increase proportionately, and therefore that the level of
per capita revenues would remain at least constant in real terms. If revenues per capita are in fact
decreasing, the government may be unable to maintain existing service levels unless it finds new
revenue sources or ways to save money.
Indicators can be either static or dynamic. Static indicators are based on data of a single year. If
you compare several years’ data, for example using the BCAM, the resulting indicators are
dynamic. Exhibit 4 is a sample of static and dynamic indicators.
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Steps in Developing Fiscal Indicators
Step 1: Select and Develop Significant Indicators. The usefulness of indicators increases
considerably if you approach them in a comprehensive way. This means that after considering
the purpose of your analysis, you should first outline your municipality’s problems and then define
indicators that treat them. A maximum of two indicators should be related to each key problem.
For example, if your municipality is undertaking a general financial evaluation, you can categorize
your budget into sectors and identify one or two characteristic indicators for each sector.
Select indicators that reflect the characteristics of your community. See Exhibit 5 for a listing of
indicators used by four Hungarian municipalities.
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Exhibit 4
Sample of Static and Dynamic Indicators
Explanation of Explanation of Dynamic
Static Indicators Static Indicators Dynamic Indicators Indicators
Revenues
Central sources Central resources/ Share of central resources Percentage change in Changes in the measure of
total revenues out of total resources central resources central resources
compared to the previous
year
Operation fund Operating revenues/ Measures whether the
total expenditures municipality is self-sustaining
Local taxes Local taxes/ total Proportion of local taxes—as
income one of the most important
resources—from income
Local taxes/ Average local government tax Percentage change in local Changes in the level of local
population burden of citizens taxes compared to the taxes
previous year
Local taxes paid by Percentage of local taxes
citizens/ all local paid by citizens from taxes of
taxes the local government
Asset Asset management/ Ratio of asset management
management total income in the municipal resources
Asset sales/ total Ratio of asset depletion in the Percentage change in Measure of asset depletion/
income municipal resources asset values compared to asset growth
the previous year
Asset management/ Efficiency of asset Change in asset Changes in asset
asset value management management/ percentage management efficiency
of asset value compared to
the previous year
Property sale/ Measure of property
Property value depletion
Expenditures
Operation Operating Ratio of operating Change in operating Changes in operating
expenditures/ total expenditures to total expenditures compared to expenditures
expenditures expenditures the previous year
Proportion of Total operational expenditure/
branches, office/ weight of expenditures in
total operational different branches
expenditures
Investments Investments/ total Weight of investments in total Percentage change in the Changes in funds spent on
expenditures expenditures investment base compared investment
to the previous year
Proportion of each Proportion of investment for
agency’s each agency
investment/ total
investment
Debt service Debt service/ total Proportion of resources Percentage change in debt Changes in debt burden
revenues reserved for debt service service compared to the
previous year
Debt service/ Debt service burden per
population capita
Liabilities Liabilities/ total Proportion of resources
revenues reserved for liabilities
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Exhibit 4 (cont’d)
Sample of Static and Dynamic Indicators
Explanation of Explanation of Dynamic
Static Indicators Static Indicators Dynamic Indicators Indicators
Balance
Balance Revenues - Result Percentage change in Changes in revenues
expenditures/ total revenues compared with changes in
revenues compared to the expenditures are the main
previous year indicator of the fiscal
Percentage change in condition of the municipality
total expenditures
compared to the
previous year
Loans Loans/ total Amount of debt of the Percentage change in Changes in the amount of
revenues municipality loans compared to the municipal debt
previous year
Loans/ population Amount of debt per capita
Reserves Reserves/ total Proportion of reserves
revenues compared to revenues
Environment
Municipal Number of Measure of the relative Percentage change in The increase of the size of
employees employees / number size of the municipal staff number of employees the municipal staff
of inhabitants compared to the
previous year
Population Number of Percentage change in
inhabitants the number of
inhabitants compared
Share of active
population
Unemployment rate
Income Local GDP / national Local income capacity Percentage change in This indicator shows in
GDP local GDP compared to some sense the
the previous year effectiveness and efficiency
of local policies
Income per capita Income conditions of Percentage change in
inhabitants have a direct income compared to
influence on the the previous year
municipality’s financial
situation
Inflation Inflation rate
Enterprises Number of new Expansion of the local Percentage change in
enterprises / number economy the number of new
of inhabitants enterprises compared
16
Exhibit 5
Selected Financial Indicators in Four Hungarian Municipalities
(in percent unless otherwise indicated)
Municipality 1 Municipality 2 Municipality 3 Municipality 4
Type of Indicator 1994 1997 1994 1997 1994 1997 1994 1997
Static Indicators
Revenues
Central transfers
Central transfers/net total revenues 92 59 67 67 59 49 62 50
Central op’g revenues/total op’g rev. 86 67 77 80 74 56 73 65
Central inv. grants/total inv. rev. 87 60 5 12 2 40 7 6
Operating revenues/operating exp. 103 124 111 117 100 125 110 117
Local tax
Local tax/net total revenues 1 10 0.2 2 5 10 6 7
Local tax/total population1 1 16 0.1 2 4 12 3 5
Expenditures
Op. exp.+ housing all./total exp. 65 59 76 76 78 60 82 69
Human-social welfare 86 73 76 74 95 95 61 77
Infrastructure inv./total investment 25 42 71 68 67 52 55 65
Balance
Total budget
Net total revenues 2 2,932 4,652 973 1,353 5,404 10,092 1,500 5,656
Net total rev./total population 89 141 59 83 69 129 48 78
Debts
Debts served/total assets 111 7 0.9 0.8 32 15 3 13
Background
Income: PIT per capita 19 35 13 24 28 58 17 36
Inflation 119 118 119 118 119 118 119 118
Dynamic Indicators3
Revenues
Change in central transfers 121 139 116 110 111 115 109 107
Change in local taxes 106 131 84 110 87 134 170 138
Expenditures
Change in operating expenditures 128 121 135 109 120 115 110 120
Change in investments 124 310 116 194 101 149 123 105
Balance indicators
Change in net total revenues 110 149 120 113 122 122 113 117
Background
Change in per capita income 120 129 134 129 121 123 122 128
1
1,000 forints per capita.
2
1,000 forints.
3
All dynamic indicators are calculated as a change over the previous year.
Step 2: Collect the Data and Calculate the Indicators. Use primary, reliable sources of data.
The most important feature of any data is its source. For example, you can calculate per capita
revenues based either on actual population data of your municipality or the permanent or
residential population data from the Central Statistical Office (CSO). The primary, reliable source
in this case is data from the CSO. Even though these data may have uncertainties, the CSO is
the official source. You should obtain information on gross domestic product (GDP) from the CSO
as well, while the daily source of exchange rate information should be the National Bank.
In many cases, however, the necessary data are only available from unreliable sources, if they
exist at all, and many times you will need to accept an estimate. In certain cases you will even
need to make your own estimate. This is better than not using any data at all. When you use
uncertain data, you should indicate their source and reliability.
Pay special attention to the unit of measurement. Are the data in percentages, thousands, or
millions? Failure to report the unit will affect correct interpretation of the data. Failure to
consistently use the same unit of measurement each year will also restrict your ability to compare
data and analyze trends in the future. If your objective is to compare data with that of another
local government, be sure to collect the data in the same unit of measurement.
17
Identify the fiscal period for which the data were collected. The budget data usually reflect the
year-end position. However, if you use a different period, this should be so noted, and you should
adjust any year-to-year comparisons accordingly.
Be aware that you must adjust indicators for inflation to reflect year-to-year comparisons in
constant forints. In graphing indicators, consider including two lines showing both current and
constant forints to demonstrate the impact of inflation. Hungary has experienced significant
inflation in the early 1990s, and even though the rate of inflation has slowed, its level will remain
significant in the future. Therefore, to compare budget data from different periods, you need to
compute the current data relative to constant data, or in the case of constant values, keep in mind
that they include inflation.
Use multiyear data. An evaluation of fiscal condition is most practical and useful if it focuses on
multiyear trends. Budgets usually show a comparison of last year, this year, and proposals for
next year. However, it is best to use three to five years of actual data for trend analysis. This will
indicate in what direction each indicator is moving and how fast.
Step 3: Analyze and Interpret the Indicators.

You should also analyze and interpret the fiscal indicators that you calculated. The primary tool
for analyzing indicators is trend analysis—examining each indicator over a period of three to five
years. This has several advantages: (1) it allows officials to determine how fast an indicator is
changing and in what direction; 2) it permits you to compare one trend to another; 3) it allows
comparison to other communities; and (4) it provides a database for effective budgeting and
capital planning.
Trend analysis involves the following steps:

1. Identify both favorable and unfavorable trends.
2. Determine when the unfavorable trend began. How fast is it changing? Is it getting better or
worse? How serious is the problem?
3. Consider mitigating circumstances, for these may neutralize an otherwise unfavorable trend.
For example, if per capita expenditures increase—which you may at first perceive as an
unfavorable trend—it could be mitigated by a proportionate rise in per capita revenues.
4. Identify the causes underlying unfavorable trends.
5. Determine reasons for favorable trends. You can use this information to explain positive
trends to citizens and to justify your borrowing needs to lending institutions.
6. Analyze each indicator in relation to other indicators. No single trend implies a good or bad
fiscal condition. It only points to a situation that should be examined more closely.
7. Compare your conditions to those of other local governments or to regional or national
trends.
8. Determine whether you should perform further analysis.
9. Apply your professional judgment.
Exhibit 6 shows static and dynamic indicators for the city of Szombathely. The analysis and
interpretation of the data are as follows. The indicators show a relatively high level of dependence
on central government revenues, principally because of the value of shared taxes (e.g., personal
income tax). Asset sale revenues (S7) are also an important part of local revenue sources. But a
high level of asset sales for a long period can signify a significant drain on local government
assets. The shares of local tax (S3) and asset management (S6) revenues in total revenues are
very low. In healthy conditions this should increase.
18
The level of operating expenditures relative to total expenditures (S10) is very high. This shows
the importance of the budget reform. The share of operating (S11) and investment (S13)
expenditures by sector shows local government priorities in the medium and long term. Many
local governments had to spend more on these sectors than initially estimated.
Dynamic indicators show the change in the relative share of local revenues. Local government
income from local taxes increased at a higher rate than inflation, which was 28.8 percent in 1995.
But it increased at a lower rate than central sources calculated with shared taxes (D1).
19
Exhibit 6
Sample of Static and Dynamic Indicators for the City of Szombathely, 1995
Static Indicators Value Dynamic Indicators Value
Revenues
Central sources1 S1 Central sources/ total revenues 33.9 / 47.6 D1 Change in central funds 109.0 / 152.7
compared to the previous year
Operation fund S2 Operating revenues/ operating 30.8
expenditures
Local taxes S3 Local taxes/ total revenues 4.8
S4 Local taxes/ population2 3,875 D2 Change in local taxes compared 136.8
S5 Local taxes paid by citizens/ all local taxes —
Asset S6 Asset management/ total revenues 1.6 D3 Change in asset values 104.8
management compared to the previous year
S7 Asset sales/ total revenues 21.2 D4 Change in asset management/ 103.5
asset values compared to the
previous year
S8 Asset management/ asset value 1.3
S9 Property sales/ Property values 17.3
Expenditures
Operation S10 Operating expenditures/ total 70.8 D5 Change in operating 123.8
expenditures expenditures compared to the
previous year
S11 Share of operating expenditures by sector/ total
operating expenditures
Mayor’s office 22.4
Health service 4.9
Education, culture, sports 57.0
Social security 9.6
Public services 6.1
Investment S12 Investment/ total expenditures 21.4 D6 Change in investment compared 103.6
S13 Share of investment by sector/ total investment
Mayor’s office 47.9
Health service 2.5
Education, culture, sports 10.1
Social security 1.1
Public services 38.3
Debt service S14 Debt service/ total revenues 7.6 D7 Change in debt service 102.1
S15 Debt service/ population2 6,141
Liabilities S16 Liabilities/ total revenues —
Balance
Balance S17 Revenues – expenditures/ revenues 1.2 D8 Change in total revenues 114.3
D9 Change in total expenditures 117.0
Loans S18 Loans/ total revenues 0.1 D10 Change in loans compared to 63.0
the previous year
S19 Loan amount/ population2 5,453
Reserves S20 Reserves/ total revenues —
20
Sample of Static and Dynamic Indicators for the City of Szombathely, 1995
Static Indicators Value Dynamic Indicators Value
Environment
Municipal S21 Number of employees / number of 3.2 D11 Change in the number of 101.5
employees inhabitants 3 employees compared to the
previous year
Population S22 Number of inhabitants 85,059 D12 Change in number of 99.9
inhabitants compared to the
previous year
S23 Share of active population —
S24 Unemployment rate 6.4
Income S25 Local GDP / national GDP — D13 Change in local GDP compared —
S26 Income per capita2,4 33,303 D14 Change in per capita income 175.1
Inflation D15 Inflation rate 128.3
Enterprises S27 Number of new enterprises / Number of 9.4 D16 Change in the number of new 65.6
inhabitants 3 enterprises compared to the
previous year
Notes:
1
The first value is calculated without shared taxes, and the second one with shared taxes.
2
Hungarian forint per capita.
3
Person per thousand inhabitants.
4
Income tax per capita is for 1994, and the change is calculated compared to 1993.
The changes in operating (D5) and investment (D6) expenditures from 1994 to 1995 show the
devaluation of both in real terms, but the extent of devaluation in the case of investment
expenditures is much higher. In general the increase in both total revenues (D8) and total
expenditures (D9) is below inflation. The loan burden on the local budget seems low and is
decreasing because of a conservative borrowing policy. The number of municipal employees
(S21) and the rate of increase in municipal employees (D11) is greater than the rate of increase
in the municipality’s population. This should be avoided even in a period of overall growth and
should be carefully monitored in the current environment.
Step 4: Present the Results. Present indicators in an understandable format. This means that
you should prepare charts, tables, or figures that summarize the indicators and illustrate
unfavorable trends. Exhibit 7 is a sample of different charts that you can use to present indicator
data.
There is a proverb that a picture is worth a thousand words. In any report you prepare, it is
important to find a good balance between numbers and charts, and contents and format. Charts
are very useful visual tools but may mislead inexperienced readers. For example, if you change
the starting point on a scale from 0 to 100, readers may interpret that the change was nominal, or
they may conclude the opposite. Bar diagrams are the most widely used figures, lines suggest a
continuous change, and pie charts are appropriate for presenting the share of a certain value
(income tax as a share of total revenues, for example).
21
Exhibit 7
Sample Charts
22
Forecasting
What is Forecasting?
Forecasting is a tool for predicting the future fiscal condition of a municipality. Forecasting
projects future revenues and expenditures based on past trends and modified by specific
assumptions about the future. The budget document and appropriately designed fiscal indicators
give a reliable picture of the current condition of the municipality. But you also need to produce
quantifiable information on future trends to assist you in budgeting, planning, and policymaking.
Budget structuring techniques are very sensitive to the goals of your analysis and possible use of
the results because you have the autonomy to set different parameters according to your ultimate
goal. Forecasting techniques are similarly sensitive, and you need to carefully specify your goals
to avoid unnecessarily increasing your workload.
Uses of Forecasting
You can use forecasting for the following purposes:
♦ Preparing the annual budget. In many ways the adopted budget is itself a forecast (for a
single year).
♦ Facilitating decision making. You can also use forecasting to make operational, project, and
strategic decisions.
♦ Marketing or “selling” municipal policy (e.g., to citizens, outside investors, or the central
government).
Types of Forecasting Techniques

The selection of a specific forecasting technique depends on the reliability of available data and
the requirements of your analysis. Forecasting for the short term and forecasting for the
intermediate or long term require different forecasting techniques. Forecasting may also differ
depending on its goal. For example, a normative forecast will help find solutions to a specific
problem, while an analytical forecast will describe expected changes in the social, economic, and
political environment. Budget analysts generally employ one or more of the following types of
models in projecting revenues/expenditures for budgetary (single year) or multiyear forecasting
purposes.
Expert Judgment. The key to the successful use of this technique is the “expert” who possesses
substantial knowledge and experience in the estimation of annual budget revenues. To produce
consistently successful forecasts, an expert must know the revenue system, the local economy,
and how to obtain additional information. Expert judgment is widely used in estimating annual
revenues, often in conjunction with trend analysis. Expert judgment and trend analysis are simple
and inexpensive forecasting methods that are ideal for certain revenues, such as the property tax.
The disadvantages associated with expert judgment are its dependence on the subjective views
of the expert and heavy reliance on one individual.
Trend Analysis. This technique relies on the assumption that revenues, for example, are a
function of time. One of the most common assumptions in trend analysis is that the annual
revenue growth rate in the future will be the same as that in the past. You can apply trend
analysis to all revenue sources, including business licenses, building permits, sales taxes, and
property tax. As mentioned above, trend analysis is often used in conjunction with expert
judgment to estimate budget revenues. A limitation of trend analysis is that it never predicts a
“turning point” in a revenue stream; rather, it predicts a continuation of the increases or decreases
previously experienced, regardless of any changes taking place in the economy. This can lead to
overestimating or underestimating revenue collections.
23
Deterministic Forecasting. This technique for revenue forecasting allows for variables other
than time by focusing on the rates and bases of revenues. For example, revenues from auto
registration fees are a function of the number of registered automobiles and the registration fee
per automobile. By projecting the number of automobiles registered in a municipality, you can
easily develop an estimate of automobile registration revenues. This approach is often criticized
as being too linear. It has many of the same flaws as the trend analysis and expert judgment
techniques.
Econometric Forecasting. This technique is much more complex than those described above.
Econometric forecasting relates historical revenues to economic and demographic variables,
which, in turn, link revenue estimates to anticipated fluctuations in those variables. In econometric
forecasting, you use several independent variables concurrently and systematically to produce
revenue estimates. Use of this technique enables “what if” analysis, which provides estimates of
the effect of alternative assumptions on outcomes. Despite its greater flexibility, this technique
has several weaknesses. It is very costly in terms of data needs, staff time, and expertise and
requires the use of computers. For the most part, this technique is used for multiyear revenue and
expenditure forecasting.
The scenario method is one of the most important ways to improve the reliability of any
forecasting technique. This method provides you with alternative forecasts according to the
different projections of certain information. In addition, you can produce more optimistic and
pessimistic predictions than the original forecasts and can design a strategy for the future
comparing the results of the three scenarios.
The significance of econometric models is that they take into account the impact of internal
factors and also help avoid the problem that key parameters of the model may not follow the
predicted path. In these cases you can apply the scenario method, which can forecast the
differences and enable you to compare the predictions and actual data. For example, a muni-
cipality may wish to construct a highway. If the municipality prepares the budget assuming a
certain date of construction and makes important decisions based on this prediction, and the work
is delayed or canceled, it may cause significant problems for the municipality. In extreme cases it
may cause the municipality to go bankrupt. In certain cases, particularly in the case of parameters
used in scenarios, estimates calculated on the basis of expert judgment need to be substituted for
the lack of reliable data. It is important to emphasize that expert estimates include more than just
random information. Expert estimates mobilize the knowledge of experts, often including specific
preliminary information on such things as future regulatory changes. These predictions may
become self-fulfilling prophecies in cases where they influence behavior.
Sample Trend Analysis

Trend analysis involves analyzing historical data (for at least three years), accounting for changes
in local revenue sources, identifying positive and negative economic conditions, adjusting for
inflation, and making careful judgments in analyzing the data. The first part of trend analysis—
analyzing historical data—follows these steps:
1. Identify and list each revenue source (e.g., property taxes, sales taxes). Analyze sources
separately because trends can vary by source.
2. Calculate the percentage change in revenues between each year.
3. Add the percentages for all years.
4. Divide the total by the number of percentage changes (e.g., for three years of historical data
there would be two percentage changes). This provides the average annual percentage
change for the period studied.
5. Multiply revenues for the current fiscal year by the average annual percentage change. Add
the result to current revenues to project revenues for the upcoming fiscal year.
24
6. Adjust the projected revenues for changes in inflation, population growth or decline, laws
impacting local revenues, and changes in economic activity.
The following example shows how you can use trend analysis to estimate the “business licenses”
revenue source. A review of financial records reveals the following:
Revenues from Business

Fiscal Year Licenses (in HUF ‘000)
1993 1,000
1994 1,200
1995 1,300
1996 1,500
1997 1,900
Current Year 2,100
Next Year ?
Estimated
Use the figures above to calculate the rate of change between each year’s collected revenues
from business licenses:
Rate of Change
(FY1994 – FY1993) = (1,200 – 1,000) = 0.20 or 20 percent
FY1993 1,000
(FY1995 – FY1994) = (1,300 – 1,200) = 0.08 or 8 percent

FY1994 1,200
(FY1996 – FY1995) = (1,500 – 1,300) = 0.15 or 15 percent

FY1995 1,300
(FY1997 – FY1996) = (1,900 – 1,500) = 0.26 or 26 percent

FY1996 1,500
(FY1998 – FY1997) = (2,100 – 1,900) = 0.10 or 10 percent

FY1997 1,900
Add up the rates of change and divide them by the number of changes over the period:
20% + 8% + 15% + 26% + 10% = 79% = 16%
5 changes 5
Apply the average rate of change to the revenues for the current year (FY1998) to estimate how
much revenues will increase for FY1999:
2,100 x 0.16 = 336
Adding this increase in revenues to the current year’s collections provides the estimated
revenues from business licenses for FY1999:
336 + 2,100 = 2,436 HUF (‘000) to be collected in FY1999
The basic analysis of historical data described above does not constitute a complete trend
analysis. In projecting revenues, take into account the following factors:
♦ Changes in the law that affect your municipality’s ability to collect the revenue source.
♦ The rate of delinquent taxes and fees (Are all revenues due to the municipality being
collected in a timely fashion? If not, what actions will correct this situation?).
♦ Unusual or seasonal changes in the revenue source (e.g., was a large, one-time revenue
received in the past?).
25
♦ Inflation’s effect on real growth.
♦ Special problems in collecting a particular revenue source.
In addition to local revenue projections, you can perform trend analysis to estimate the level of
central government transfers that your municipality is likely to receive. You must make
assumptions to obtain some projection of this critical revenue source even though it is difficult to
predict this major component of municipal revenues. As a starting point, you can base these
revenue projections on receipts from prior fiscal years, making adjustments for inflation and any
actions of the central government. After you complete the analysis, you should identify when
during the fiscal year each revenue source will be received and the amount to be collected. This
will serve as a revenue and cash flow plan. Once the fiscal year begins, you should monitor
actual revenue collections against this plan and make adjustments accordingly.
If your municipality does not have data on each revenue source, or if staff resources are limited,
you can perform trend analysis with total revenues. Keep in mind, however, that the result of such
an exercise is more an approximation than a projection.
Steps in Developing a Forecast
Step 1: Make Strategic Decisions.

Before beginning the forecasting process, you need to make some strategic decisions. First you
need to decide on the depth of the forecasting analysis and the forecasting technique that you will
use. You should also consider whether you would like to perform the forecasting based on current
prices or comparative prices and adjust the data for inflation accordingly. This decision strongly
influences the results of the estimates.
Step 2: Choose a Forecasting Technique and Develop Your Forecast.

The simplest method of forecasting is trend analysis, and you should use it if it satisfies the goal
of your analysis. You can apply this technique for the whole budget or for individual items of the
budget if more sensitive techniques are necessary for some items.
In developing forecasts you need to calculate the annual changes in each item. For every item
you need to calculate the average change for past years, and you need to multiply the previous
data by this average to obtain the forecast for the next year. For every year you need to multiply
the average index by the actual data of the previous year. Continue until you obtain the
projections for all items.
Step 3: Refine Your Forecast.

You can also refine your forecast and examine whether in specific years certain items
experienced significant changes that would justify the exclusion of those years (for example, the
first few years) from the calculation. You can calculate the average based on a period between
1993 and 1998 but also a period between 1996 and 1998 if justified. If you decrease the number
of years to calculate the average change without justifiable reasons, however, you may reduce
the credibility of your forecasting.
Concluding Points on Forecasting

As stated earlier, it is important to design your forecasting prior to beginning the calculation itself.
You need to decide on the goals and depth of the analysis and select the appropriate forecasting
technique. The technique you use should correspond to the reliability of your data. The
forecasting process produces different results depending on whether you use current prices or
comparative prices.
Your forecasting design, the budget data you use, and the technique you select determine the
accuracy of your results. The most useful forecasting techniques are those that combine
mathematical methods and nonquantifiable information provided by experts.
26
Summary of Key Points
♦ Financial analysis involves the use of tools and techniques, such as budget structuring, fiscal
indicators, and forecasting, to measure the fiscal condition of a municipality.
♦ Financial analysis links municipal policy with long-range goals, allows your municipality more
time to respond to adverse events, helps your municipality better meet its responsibilities,
improves the quality of financial decision making, and supports borrowing and credit
evaluation.
♦ Financial analysis techniques are generally not used in Hungary, but some Hungarian
municipalities have recently begun using fiscal indicators to make their local budgets more
transparent and to help them use resources more efficiently.
♦ The steps in budget structuring are to decide on the scope of your analysis, identify data
sources, and structure your budget.
♦ The Budgetary and Creditworthiness Analysis Model (BCAM) for Hungarian local
governments is one useful type of budget structure. Its main advantage is that it summarizes
the most important aspects of a municipality’s finances in a few lines.
♦ Fiscal indicators, the primary tools for evaluating fiscal condition, allow municipal officials to
focus on trends over a relatively long period of time and provide a framework for analyzing
information about a municipality on a regular basis.
♦ Fiscal indicators can be categorized as financial, environmental, or organizational indicators.
♦ The steps in developing fiscal indicators are to select and develop significant indicators,
collect the data, calculate the indicators, analyze and interpret the indicators, and present the
results.
♦ Forecasting is a tool for predicting the future fiscal condition of a municipality. You can use
forecasting to prepare the annual budget, facilitate decision making, or market municipal
policy.
♦ Common types of forecasting techniques are expert judgment, trend analysis, deterministic
forecasting, and econometric forecasting.
♦ The steps in developing a forecast are to make strategic decisions about the forecast, choose
a forecasting technique, and develop and refine your forecast.
27
Glossary
Asset Management Management of government-owned property that has monetary value.
Capital Amortization Paydown or reduction of debt borrowed for the provision of capital assets.
Capital Facility A fixed asset that has a certain useful life and minimum cost defined by the
municipality; examples include roads, bridges, and public buildings.
Capital Investment Balance (Capital Deficit/Surplus) Capital revenues minus capital

expenditures.
Capital Revenues/Capital Expenditures Revenues from capital projects/expenditures

(investments) made for capital improvement projects.
Debt Service Payment of interest and repayment of principal to holders of a government’s debt
instrument.
Deterministic Forecasting A method of forecasting that allows for variables other than time
(e.g., rates and bases of revenue sources).
Discretionary Revenues/Expenditures (vs. Nondiscretionary Revenues/Expenditures)

Discretionary revenues and expenditures are those that municipalities have the discretion to
collect or incur, respectively. Nondiscretionary revenues and expenditures are mandatory.
Econometric Forecasting A forecasting technique where the variable being forecast (dependent
variable) is a function of various economic and demographic variables that are independent of the
variable being forecast and may or may not affect it. For example, income (dependent variable) is
a function of age, education, and sex (independent variables).
Financial Analysis A set of tools and techniques that allow you to measure the current financial
condition of a government or business and predict trends in its future financial condition.
Fiscal Indicators A group of statistical values that indicate an organization’s fiscal performance.
Forecasting A tool for predicting future revenues and expenditures based on past trends and
modified by specific assumptions about the future.
Indicator Any of a group of statistical values that when taken together indicate the performance
of a project, organization, or group of people.
Net Operating Balance Operating balance (current revenues minus expenditures) minus debt
service.
Nonrecurring Revenues/Expenditures Nonrecurring revenues and expenditures are one-time

revenues or expenditures.
Normative/Analytical Forecast A normative forecast has a well-defined purpose, such as

budgeting, in contrast to an analytical forecast, for which the aim is to determine more general
expectations (e.g., for the municipal strategy). A normative forecast consists only of numbers,
which will form part of a document, while an analytical forecast can also include scenarios, for
example.
28
Normative Grants Targeted or nontargeted central government transfers to local governments to
improve service provision. They are calculated on the basis of existing capacities of local
governments to provide certain services to their citizens.
Operating (Current) Revenues/Expenditures Revenues from municipal institutions and local

taxes and fees. Expenditures of day-to-day operations, such as office supplies, maintenance of
equipment, and travel. Also known as operating and maintenance costs.
Operating Balance Operating revenues minus operating expenditures.
Own Source Revenues Revenues that are collected and retained at the local government level.
They do not include subsidies, transfers, or shared revenues.
Residual Balance Cash (or equity) left in an account that is carried over from one fiscal year to
the next.
Resource Deficit/Surplus The sum of the operating balance plus the capital investment balance.
Targeted and Addressed Subsidies Central government subsidies that support municipal
investments in priority areas. In targeted subsidies, the share of subsidyas a percentage of total
investment costis set in each specific target area. Addressed subsidies are discretionary
decisions and often provide nearly 100 percent financing.
Tax Collection Rate The rate at which a municipality collects the amount of tax levied.
“What If” Analysis A type of analysis that provides estimates of the effects of alternative
assumptions on outcomes.
29
Training Guide
Training Outline
♦ What is Budget Data?
♦ Revenues and Expenditures
♦ Categorizing Revenues and Expenditures
♦ Defining the BCAM
♦ The Application of BCAM
♦ What are Fiscal Indicators?
♦ Why are Indicators Useful?
♦ Types of Indicators
♦ Steps in Developing Indicators
♦ What Is Forecasting?
♦ Types and Uses of Forecasting
♦ Steps in Developing a Forecasting Technique
Slides
The slides can be found at the end of this training guide.
Exercises
The following exercises deal with structuring budget data, developing fiscal indicators, and using
forecasting techniques. Some of the exercises may take time; you should not plan on completing
them all at once.
Exercise on Budget Data
Prepare the BCAM table for your municipality based on the budget data, using the sample table
provided below. Describe some characteristic trends.
30
Exhibit 8
Sample BCAM Table
Curr.
Item 1994 1995 1996 1997 Year
Total current revenues
Own current revenues
Central current revenues
Total current expenditures
Operating balance
Debt service
Net operating balance
Total capital revenues
Own capital revenues
Capital revenues from central funds
Capital investment expenditures
Investment balance deficit (+)/surplus (-)
Other revenues
Other expenditures
DEFICIT (+)/ SURPLUS (-)
Borrowing
Residual balance from previous year
CLOSING BALANCE
Exercise on Fiscal Indicators
Design and calculate some characteristic budget indicators for your municipality. Use data from
the budget and also data from other sources and calculate the indicators on the basis of current
prices and comparative prices. Describe your municipality’s fiscal condition on the basis of the
results.
Smithville: the Use and Evaluation of Fiscal Indicators
From Valente, Carl F., and Maureen Godsey Valente, "City of Smithville," 1980. Reprinted with
permission of the International City/County Management Association, 777 North Capitol Street,
NE, Suite 500, Washington, DC 20002. All rights reserved.
The Financial Situation in Smithville

Number of the population 15,000
Current annual budget HUF 1 billion
Number of employees 127
The major local tax revenue Property tax
The major central transfers Shared taxes, normative grants, targeted
subsidies
Smithville is a suburb of a large metropolis; its population has been growing since 1970 at about
2 to 3 percent. Except for a small group of low-income people who live in the southern part, the
municipality is mainly inhabited by middle-income and richer people. Civil organizations are well
organized in the municipality, and up until now they supported the municipal leaders. Recently,
these groups have begun to put pressure on the municipality to increase police protection and
expenditures on road maintenance.
The main revenue source of Smithville is the property tax: 35 percent of the property tax revenue
comes from nonresidential and 65 percent from residential properties. Until the mid-1970s, the
number of commercial properties increased quite quickly; however, since then the increase has
stagnated. After the planned property valuation (the first in the past seven years), the property
owners will need to contribute more to the revenues. Housing consists of generally old buildings,
maintained quite well by the owners. The large number of vacant land parcels in the downtown is
in the hands of the municipality as well. In the previous years the municipality sold some of the
31
land to construction companies. Due to the economic decline in the region, however, the plots
remained vacant.
Most of the public services are delivered by the municipality, except for education and electricity,
which are provided by the county. The municipal employees established a trade union, and since
then they have fought successfully for a considerable salary increase and the provision of
additional benefits. Although their income does not exceed that of the employees in other
municipalities, they have considerably more benefits. Their pension is provided by the central
government.
Under the Capital Improvement Program, the municipality is currently extending the sewer
system and is paving a road 4 kilometers long. In addition, several public buildings are being
renovated to decrease energy consumption. Smithville is also constructing a sewage treatment
plant to ensure that the quality of water meet standards. The total annual debt service (the actual
yearly capital and interest payments) amounts to 13 percent of the operating costs this year.
The municipality operated relatively well in the past ten years and created a HUF 500 million
reserve fund. Last year the municipality had to use HUF 80 million to balance the budget, and it
planned to use HUF 18 million this year. As the closing of the fiscal year is approaching, József
Kovács, head of the Finance Department, thinks that the municipality should obtain HUF 70
million from its reserves to balance the budget because the tax revenues lagged behind the
planned revenues. Both property tax and user fee revenues are lower than expected. The
reserves will be 332 million at the end of the year.
József Kovács has already realized that one of the problems is in the Finance Department. As the
tax administration procedures are underdeveloped, Smithville does not collect all the tax
revenues due. Furthermore, owing to the lack of accurate data, the municipality overestimated
the expected revenues in previous years.
József Kovács and his colleagues have just started planning next year’s budget. For the sake of
increasing the reserves to their original amount and to balance out the effects of the inflation,
József Kovács decided to propose an increase in the property tax rate for the first time in six
years. In addition, he plans to propose several restrictions in service delivery. After unofficial
discussions with municipal leaders, József Kovács feels that his proposals will face strong
objection from the citizens. However, he also feels that it is high time to manage the financial
matters of the municipality more strictly. József has four months until the submission of the
budget to the municipal council. When the next fiscal year starts, he would like to start preparing
the long-term financial plan of the municipality, and he has assigned his deputy to this task as
well.
József thinks that he will need a lot of information to be able to prepare his budget proposal and
the long-term financial plan. His deputy prepared graphs of selected indicators as a preliminary
report on the financial condition of Smithville (see Exhibit 9).
Questions for Group Discussion:

Let’s suppose that the head of the Finance Department employs you as a financial consultant.
1. List three indicators (from Exhibit 9) that show immediate problems in Smithville. Explain the
underlying negative trends. If possible, please use indicators and information used in the case
study for your justification.
32
Indicators that show immediate problems:
Name of the indicator Quantity of the indicator Justification
1. _____________ ____________ ________________________

________________________
________________________
2. _____________ ____________ ________________________
________________________
________________________
3. _____________ ____________ ________________________
________________________
________________________
2. List three indicators (from Exhibit 9) whose trends need to change if Smithville is to achieve
financial stability. Explain the underlying negative trends of the indicators. If possible, please use
indicators and information used in the case study for your justification.
Problematic indicators in the long term:
1. _____________ ____________ ________________________

________________________
________________________
2. _____________ ____________ ________________________
________________________
________________________
3. _____________ ____________ ________________________
________________________
________________________
3. József Kovács feels that he needs more information on Smithville. Due to the limited time
available, he can only calculate three more indicators. What additional fiscal indicators would you
recommend for József? Why? See Exhibit 10, where you can find a list of all possible indicators.
Additional necessary information:
1. _____________ ____________ ________________________

________________________
________________________
2. _____________ ____________ ________________________
________________________
________________________
3. _____________ ____________ ________________________
________________________
________________________
33
Exhibit 9
A City of Smithville—Selected Indicators
34
35
36
Exhibit 10
Summary of Indicator Formulas
No. Name of the Indicator Formula
1. Revenues Per Capita Net Operating Revenues Adjusted for Inflation
Population
2. Restricted Revenues Restricted Operating Revenues
Operating Revenues
3. Central Transfers Central Operating Transfers
Gross Operating Revenues
4. Flexible Tax Revenues (revenues Flexible Operating Revenues
controlled by the municipality) Operating Revenues
*5. One-Time Revenues One-Time Operating Revenues
Operating Revenues
*6. Property Tax Revenues Property Tax Revenues Adjusted for Inflation
*7. Uncollected Property Taxes Uncollected Property Taxes
Net Property Tax Levy
8. User Fees for Services User Fee Revenues
Expenditures for Related Services
9. Income Deficit Income Deficit
Operating Revenues
*10. Expenditures Per Capita Operating Expenditures Adjusted for Inflation
Population
11. Employees Per Capita Number of Employees
Population
*12. Regular Expenditures Regular Expenditures
Operating Expenditures
*13. Benefits Expenditures for Benefits
Wages and Salaries
*14. Operating Balance Operating Deficit
Operating Revenues
15. Operating Deficit of Municipal Profits or Losses Adjusted for Inflation
Institutions
*16. Reserves Share of Reserves Not Earmarked
Operating Revenues
*17. Liquidity Cash and Short-Term Investments
Current Liabilities
18. Current Liabilities Current Liabilities
Operating Revenues
*19. Long-Term Loans Outstanding Long-Term Loans
Maximum Permitted Value of Long-Term Loans
20. Debt Service Debt Service
Operating Revenues
37
Summary of Indicator Formulas
21. Maintenance Expenditures for Maintenance of Fixed Assets
Value of Fixed Assets
22. Accumulated Expenditures Accumulated Expenditures
Operating Expenditures
23. Depreciation Depreciation
Investment Cost of Amortizing Fixed Assets
24. Population Population
25. Median Age Median Age of the Population
26. Personal Income Personal Income Adjusted for Inflation
Population
27. Families Living on Social Welfare Families Living on Social Welfare
Number of Families in Thousands
*28. Property Value Change in Property Value
Property Value the Previous Year
29. Housing Investment Market Price of New Properties
Total Market Value of Properties
30. The Rate of Vacant Apartments The Rate of Vacant Apartments
31. Active Population Unemployment Rate
Number of Jobs
32. Business Activity Retail Sales
Number of Community Enterprises
Gross Business Income
Value of Commercial Properties
Size of Built Up Properties (in hectares)
*Indicators developed by Smithville.
Exercise on Forecasting
Prepare a forecast of the budget data of your own municipality using trend analysis and the
sample tables provided (Exhibits 11 and 12). Give predictions for two years and estimate all the
revenues and expenditures in comparative and current prices as well. Interpret the results
together with the results of exercises 1 and 2 in this training guide.
38
Exhibit 11
Sample Breakdown of Revenue Categories (in HUF ‘000)
Curr.
Item 1994 1995 1996 1997 Year
Central operating transfers
Personal income tax
Personal income tax redistribution
Normative grants
Education
Culture
Sport
Health care
Social welfare
Other (i.e., communal services)
Centralized appropriations
Social Security transfers
Other operating transfers from the central government
Own current operating revenues
Revenues from municipal institutions
Duties
Other own revenues
Total local taxes
Business tax
Tax on plots
Tax on buildings
Communal tax
Tax on tourism
Car tax
Other operating revenues
Capital investment revenues
Central grants for capital investment
Targeted and addressed subsidies
Grants from Development Councils
Other central funds
Other central grants for capital investments
Local revenues for capital investment
Revenues from asset sales
Sale of properties
Sale of bonds
Revenues from asset use
Housing revenues
Commercial unit revenues
Interest revenues
Recovery on investments
Other revenues from asset use
Revenues from the citizens for capital investments
Reimbursement of value-added tax (VAT)
Other revenues (i.e., from other municipalities)
For operation
Loans
For operation
Adjustments
TOTAL REVENUES
39
Exhibit 12
Sample Breakdown of Expenditure Categories (in HUF ‘000)
Curr.
Item 1994 1995 1996 1997 Year
Administration
Health care
Education
Social welfare
Infrastructure
Cash subsidies
Subsidies for enterprises
Capital investment and development expenditures
Administration
Health care
Education
Social welfare
Infrastructure
Other capital investment expenditures
Debt service
Interest payments
Debt amortization
For operation
For capital investment
Reserves
Adjustments
Closing cash balance
TOTAL EXPENDITURES
Out of current expenditures:
Salaries
Benefits for employees
Material expenditures
40
Bibliography
(All documents listed below are available in Hungarian through the Metropolitan Research
Institute, Budapest, and the Hungarian Finance Officers Association.)
Balogh, Ádám, Róbert Kovács, and Jószef Hegedüs. Budgetary and Creditworthiness Analysis
Model for Hungarian Local Governments. Developed under an Urban Institute contract with
the United States Agency for International Development. April 1999.
Hatry, Harry, Louis Blair, Donald Fisk, and Wayne Kimmel. “Improving on Crystal Ball Gazing:
The Basic Elements of Program Analysis.” Chap. 3 in Program Analysis for State and Local
Governments. Washington DC: The Urban Institute Press, 1988.
Hatry, Harry, Louis Blair, Donald Fisk, and Wayne Kimmel. “Putting Program Analysis to Work.”
Chap. 2 in Program Analysis for State and Local Governments. Washington DC: The Urban
Institute Press, 1988.
Poister, Theodore H. “Productivity Monitoring: Systems, Indicators, and Analysis.” Chap. 10 in

Public Productivity Handbook, edited by Marc Holzer. New York: Marcel Dekker, Inc., 1992.
Rosenberg, Philip. “Estimate Revenues.” Working paper. Prepared for the Modernizing Financial
Management for Hungarian Local Governments Program, United States Agency for
International Development. October 1996.
Valente, Carl F., and Maureen Godsey Valente. "City of Smithville." Washington, DC:
International City/County Management Association, 1980.
Vigvári, András. “A Possible Method for Government Financial Capacity Analysis and Forecast
(The CLF Method).” Working paper. Prepared for the Modernizing Financial Management for
Hungarian Local Governments Program, United States Agency for International
Development. November 1998.
41

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Financial

Principal Author: Róbert Kovács

What Is Financial Analysis?

What Is a Good Budget Structure?

Benefits of Financial Analysis

Steps in Structuring Your Budget

Step 1: Decide on Scope and Identify Data Sources.

Step 2: Structure Your Budget.

Break down revenues for analytic purposes as follows:

Break down expenditures for analytic purposes as follows:

The Budgetary and Creditworthiness Analysis Model

The BCAM separates municipal budgets into four parts:

What Does Fiscal Condition Mean?

Benefits of Fiscal Indicators

Types of Fiscal Indicators

Environmental Indicators: measures of the external influences on a municipality that may

Organizational Indicators: measures of the municipality’s response to changes in environmental

Step 3: Analyze and Interpret the Indicators.

Trend analysis involves the following steps:

Types of Forecasting Techniques

Sample Trend Analysis

Revenues from Business

(FY1995 – FY1994) = (1,300 – 1,200) = 0.08 or 8 percent

(FY1996 – FY1995) = (1,500 – 1,300) = 0.15 or 15 percent

(FY1997 – FY1996) = (1,900 – 1,500) = 0.26 or 26 percent

(FY1998 – FY1997) = (2,100 – 1,900) = 0.10 or 10 percent

Steps in Developing a Forecast

Step 1: Make Strategic Decisions.

Step 2: Choose a Forecasting Technique and Develop Your Forecast.

Step 3: Refine Your Forecast.

Concluding Points on Forecasting

Capital Investment Balance (Capital Deficit/Surplus) Capital revenues minus capital

Capital Revenues/Capital Expenditures Revenues from capital projects/expenditures

Discretionary Revenues/Expenditures (vs. Nondiscretionary Revenues/Expenditures)

Nonrecurring Revenues/Expenditures Nonrecurring revenues and expenditures are one-time

Normative/Analytical Forecast A normative forecast has a well-defined purpose, such as

Operating (Current) Revenues/Expenditures Revenues from municipal institutions and local

Operating Balance Operating revenues minus operating expenditures.

Exercise on Fiscal Indicators

The Financial Situation in Smithville

Questions for Group Discussion:

Name of the indicator Quantity of the indicator Justification

1. _____________ ____________ ________________________

Name of the indicator Quantity of the indicator Justification

1. _____________ ____________ ________________________

Name of the indicator Quantity of the indicator Justification

1. _____________ ____________ ________________________

Poister, Theodore H. “Productivity Monitoring: Systems, Indicators, and Analysis.” Chap. 10 in

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1. _ ____________

1. _ ____________

1. _ ____________