FINANCE

Sound management

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Sound financial management is key to fixing municipal finances, writes Corné Oberholzer, Deloitte’s municipal finance specialist, following the company’s latest report concerning local government.

The poor state of municipal finances is now a well-documented phenomenon. In the 2010/2011 financial year, for example, the Auditor-General of South Africa (AGSA) found that only 13 of 283 municipalities achieved a clean audit.

There are many factors that contribute to achieving a clean audit, starting with political will from a leadership core that can be held accountable, but also a sense of ownership by all departmental staff, especially senior staff and managers.

But the most important ingredient is sound financial management and it requires the deployment of suitably skilled people at the right places, and a continuous building of internal capacity rather than a reliance on external parties such as consultants.

A lack of proper financial management leads to most of the problems identified by the AGSA as the nature and causes of qualified audits. Chief among these is the need to make adjustments to annual financial statements during the audit process. This means municipalities rely on auditing firms to identify errors and omissions.

Other problems include a failure to comply to acceptable accounting standards, an incomplete fixed asset register and a failure to reconcile the ledger with underlying supporting schedules.

But the biggest direct threat to the viability of a municipality is a failure to collect and adequately measure revenue. Another is having accounting officers fail to take reasonable steps to prevent irregular, wasteful or fruitless expenditure.

The AGSA identifies more than a dozen basic internal controls that are required to support sound financial management and corporate governance. These range from proper record keeping and reconciliation controls to regular and accurate reporting, compliance with the legislative framework, effective leadership culture and oversight responsibility as well sound human resource and IT management.Effective financial management is critical to any organisation.

In the context of local government, a lack of sound financial management will have a direct adverse impact on service delivery, as there is a strong correlation between sound financial management and effective service delivery.

To support service delivery and provide the necessary accountability, municipalities should create and maintain authentic, reliable and usable records. These are essential to help ensure a clean audit. Ideally, an integrated electronic document management system should be used.

The next crucial area of focus should be timeous and regular reporting. Financial activities need to be reported daily, weekly, monthly and quarterly depending on their scale and frequency. This allows for better preparation for audit.The principles of reporting (transparency, accountability and stewardship) should underlie the preparation and presentation of financial statements that are required to give a true and fair view of the financial position and performance of a municipality.

The Municipal Finance Management Act (MFMA) and reporting guidelines add to the onus of quality and relevance of financial reporting. They emphasise the importance of preparing regular, accurate and complete financial and performance reports that are supported and evidenced by reliable information.

Finally, provincial government needs to put in place governance and oversight functions over municipalities to monitor and report on progress made by municipalities to resolve challenges. Where such systems exist, they need to be used effectively.Equally important is the need to align service delivery, performance management and reporting.

The framework for municipalities to improve financial management, governance and ultimately service delivery is in place. What municipalities require is guidance through partnerships to help them implement the framework, and to use that opportunity to build their own capacity.

The technical and complex nature of financial management may require a municipality to partner with a consultant. But when they do, municipalities, or government in general, must build skills transfer as an element of the service level agreement to ensure that the municipality is left with requisite capacity at the end of the contract period.

Reporting

As for financial management, sound corporate governance requires greater corporate responsibility and the conduct of business within acceptable ethical standards. Transparency and accountability in reporting and disclosure of information, both operational and financial, are internationally accepted to be vital to the practice of good corporate governance.

The principles of reporting (transparency, accountability and stewardship) should underlie the preparation and presentation of financial statements that are required to give a true and fair view of the financial position and performance of a municipality. Financial reporting should support good corporate governance through external and internal reporting. The MFMA and reporting guidelines add to the onus of quality and relevance of financial reporting.

They emphasise the importance of preparing regular, accurate and complete financial and performance reports that are supported and evidenced by reliable information. It is critically important that these reports are reviewed and monitored for compliance in line with the applicable laws and regulations.

According to Deloitte’s Municipal Clean Audit Efficiency Series report, municipalities must also endeavour to produce reliable monthly/quarterly financial statements. These statements must be reviewed and monitored by the leadership in the municipality. Reliable financial statements and reports will support better decision making, ultimately impacting service delivery. Further, the preparation of monthly/quarterly financial statements will ensure that shortcomings are identified and addressed timeously, thus facilitating better audit outcomes at year-end.

“In our experience, there is a critical skills and capacity shortage for the preparation of GRAP-compliant financial statements. Municipalities are too reliant on consultants in this regard. It is suggested that each municipality should develop a clear strategy to build the required in-house capacity to deal with all aspects of financial management and reporting. Appropriate recruitment and skills development strategies must be developed.

“It is also critical that leadership monitor compliance with laws and regulations. For this purpose, reviewing and monitoring mechanisms such as checklists or dashboards need to be developed to ensure compliance. The MFMA also requires a range of reports to be prepared for different purposes by the municipal manager and/or the executive mayor or committee at regular intervals,” according to the report.

An increasing focus of the AG is on the auditing of performance information, an area which poses significant challenges for many municipalities, from the setting of appropriate predetermined objectives through to presenting evidence of achieving these.

The performance information process must begin when policies are developed and must continue through each of the planning, budgeting, implementation and reporting stages.

If monitoring and reporting processes and systems are not set up initially, municipalities will struggle to provide accurate and complete audit evidence for actual achievements. Integration with the municipality’s performance management system is therefore critical.

The report further suggests that formal controls over IT systems must be developed and implemented to ensure relevant and accurate management information is available, and that valuable data is protected. Municipalities must further ensure information is accurate and complete in relation to its source documentation.

This will ensure appropriate audit evidence is available to support reported performance information. A proper disaster recovery framework must also be in place as part of sound governance.

Effective cash management

The most common symptom of the going concern uncertainties identified at the 74 municipalities was a net liability position, which 38 municipalities reported, thereby indirectly declaring technical insolvency.
Poor working capital management and net cash deficits were also common symptoms of these municipalities. According to the Deloitte report, these outcomes are due to the fact that municipalities are struggling with effective cash management practices. While the reasons for this may vary from municipality to municipality, they include:

  • The lack of a clear, comprehensive policy on cash management and a realistic cash management plan;
  • Inadequate planning, budgeting and monitoring of operational and capital expenditure;
  • Inadequate planning, budgeting and monitoring of cash flows;
  • Inadequate collections and payment processes;
  • Budgets not being adjusted adequately to compensate for under-collections;
  • The lack of a well-defined investment strategy resulting in entities failing to invest idle cash in high return, low risk assets, and consequently not being able to generate additional income.

The bigger picture

Broader reasons for inadequate cash management across local government entities may include:

  • Shortage of financial management skills within the South African public sector;
  • Deficiency of accountability and oversight from senior officials;
  • Inappropriate and/or uncommitted leadership; and
  • Inefficient internal controls required to support, among others, sound financial management and corporate governance principles.

“In our view, effective cash management requires municipal management to take appropriate actions to maintain adequate levels of cash for operational and capital requirements and to invest idle cash, thereby allowing the entity to benefit from the related investment returns.

“Such practices also benefit communities, as incremental investment income can then be used to offset escalating costs without any additional burden being imposed on taxpayers. Furthermore, it ensures that capacity for service delivery to communities is maximised.

“In conjunction with sound controls and procedures around documentation, communication, and the monitoring of cash, we consider the following three activities to be vital for an effective cash management practice,” the report concludes.

Corné Oberholzer

 

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