Chapter 4 of the Local Government: Municipal Finance Management Act No. 56 OF 2003 (MFMA), in detail, addresses the processes and procedures of municipal budgets. The Municipal Budget and Reporting Regulations (MBRR) were promulgated on 17 April 2009 and further elaborate on specifically defined procedures that need to be followed in preparing a municipal budget.
The object of these Regulations is to secure sound and sustainable management of the budget and reporting practices of municipalities and municipal entities by establishing uniform norms and standards and other requirements for ensuring transparency, accountability and appropriate lines of responsibility in the budgeting and reporting processes of these institutions and other relevant matters as required by the MFMA.
Two key concepts to consider when preparing a budget are:
1. The budget must be funded according to MFMA section 18; and
2. The budget must be credible.
REQUIREMENTS OF A FUNDED BUDGET
The MFMA and the MBRR are very specific in how the budget must be funded. Section 18 of the MFMA determine as follows:
18. (1) An annual budget may only be funded from –
- realistically anticipated revenues to be collected;
- cash-backed accumulated funds from previous years’ surpluses not commit ted for other purposes; and
- borrowed funds, but only for the capital budget referred to in section 17(2).
(2) Revenue projections in the budget must be realistic, taking into account –
- projected revenue for the current year based on collection levels to date; and
- actual revenue collected in previous f inancial years.
Achievement of this requirement in totality effectively means that the Council has ‘balanced’ its budget by ensuring that budgeted outflows will be offset by a combination of planned inflows.
Unfortunately, many municipalities, when struggling to balance their budget, overstate or inflate revenue projections. Alternatively, many municipalities inflate collection rates, either to reflect a budgeted surplus or, on the surface, to show that excess expenditure requirements are adequately covered by revenues to be collected. Hence, the revenue estimates are seldom underpinned by realistic or realisable revenue assumptions, resulting in municipalities being unable to collect this revenue and, therefore, finding themselves in cash flow difficulties. Should such situations arise, municipalities must adjust expenditure downwards to ensure that there is sufficient cash to meet these commitments.
Thus, a budget that “looks” funded may not be funded. According to section 18 of the MFMA , expenditure may only be funded by realistically anticipated revenue to be collected. Furthermore, the definition of a credible budget refers specifically to revenue and expenditure projections that are consistent with current and past performance and supported by documented evidence of future assumptions.
The result of inflating budgeted revenue and/or collection rates on budgeted revenue is that the expenditure budgeted for is incurred, but the revenue budgeted for does not realise. That is why many South African municipalities are in dire financial constraints.
The results of inflating revenue and collection rates are devastating. As mentioned above, expenditure is incurred according to budgeted results, but due to inflating the revenue and/or collection rates, the actual cash inflow will be much less than budgeted for. The tables below demonstrate the accumulative effect of inflating collection rates in the budgeted results:
Whenever it becomes evident that the budgeted revenue will not be collected, section 28(2)(a) of the MFMA determines that an adjustment budget must be prepared to adjust the revenue and expenditure estimates downwards. Please be aware that for all other instances of preparing an adjustment budget, the MFMA stipulates that an adjustment budget may be prepared to adjust the budgeted amounts, but if it becomes clear that anticipated revenue will not be collected, the municipality must do an adjustment budget to adjust estimates downwards.
Municipalities may have previously included in their financial governance an objective of ‘balancing the budget ’. Under old budget formats, a ‘balanced’ income generated approach was a key objective, and this assisted in ensuring that outflows were matched by inflows, provided revenue collections were realistic. However, GRAP compliant budgets necessitate that budget ‘balancing’ be much more comprehensive.
New budgeting and accounting formats demand that the budgeted Statement of Financial Performance (Income Statement), the Budgeted Statement of Financial Position (Balance Sheet) and the Budgeted Statement of Cash Flows must be considered simultaneously to ensure effective financial management and sustainability.
The promulgation of the mSCOA Regulations and the accompanying circulars issued in terms of the MFMA , the MBRR and mSCOA, demanded a changed management approach in the preparation of municipal budgets. The budget must indicate exactly which funding sources are funding operating and capital expenditure. The National Treasury, through validation of budget data strings, can determine whether the available funding from a specific funding source is sufficient to cover the expenditure that is estimated to be funded from that funding source. Municipalities are forced to budget accurately to ensure the budget passes validation.
Although this might ensure that municipalities are careful to ensure that budgeted revenue and expenditure per funding source balance, it might have a negative impact on the credibility of the budget. Municipalities will, at all costs, ensure that the funding sources balance, but in the process, disregard some requirements essential for a credible budget.
REQUIREMENTS OF A CREDIBLE BUDGET
Circular 28, issued by National Treasury on 12 December 2005, defines a credible budget as follows:
Amongst other things, a credible budget is a budget that:
- Funds only activities consistent with the revised IDP and vice versa ensuring the IDP is realistically achievable given the financial constraints of the municipality;
- Is achievable in terms of agreed service delivery and performance targets;
- Contains revenue and expenditure projections that are consistent with current and past performance and supported by documented evidence of future assumptions;
- Does not jeopardise the financial viability of the municipality (ensures that the financial position is maintained within generally accepted prudential limits and that obligations can be met in the short-, medium- and long-term); and
- Provides managers with appropriate levels of delegation sufficient to meet their financial management responsibilities.
Excluded from the requirements above is the setting of tariffs. For any budget to be credible, the setting of accurate tariffs is essential.
Section 74(2) of the Local Government: Municipal Systems Act no 32 of 2000 stipulates that cost reflective tariffs that enable municipalities to recover the full cost of rendering a specific service must be set. Budget Circular No. 122 of 9 December 2022 stipulates that the setting of cost-reflective tariffs forms the basis of compiling a credible budget.
Unfortunately, one of the most neglected areas in municipal budgeting is the determination of tariffs. Municipalities of ten just add a percentage to the current year’s tariffs without considering the costs of rendering a specific service. Considering the third criterion for a credible budget that stipulates that future assumptions must be supported by documented evidence, it is clear that much more consideration must be given to the determination of tariffs.
A budget sets out certain service delivery levels and associated financial implications. Therefore, the community should realistically expect to receive these promised service delivery levels and understand the associated financial implications. Major underspending due to under collection of revenue or poor planning is a clear example of a budget that is not credible and unrealistic. Furthermore, budgets tabled for consultation at least 90 days prior to the start of the budget year should already be credible and reasonably close to the final approved budget.
A budget may, at face value, seem to be funded, but when considering all prescribed measures, it is not a true reflection of the actual results consistent with current and past performance, and it is not supported by documented evidence of future assumptions. Thus, a budget may be “funded” without being credible.
A budget is not credible if it jeopardises the financial viability of the municipality (does not ensure that the financial position is maintained within generally accepted prudential limits and that obligations can be met in the short-, medium- and long-term).
To meet short-, medium– and long-term obligations, the municipality must also ensure that infrastructure is kept in a condition that the expectations of consumers can be met. One indicator to test if a budget is credible measures the investment in asset renewal as a percentage of depreciation. This ratio measures the extent to which municipalities are replacing their assets in relation to the use (consumption) thereof.
Municipalities’ allocations for renewal and upgrading of existing assets represent 76.6 percent of depreciation in 2021/22 and increase to 80.4 per cent by 2023/24, while the ideal ratio should be 100 percent (refer to the consolidated A9 schedule). This indicates that municipalities are consuming their assets at a higher rate than what they are providing for renewal/upgrading. The impact of this under-provision will result in failing infrastructure performance due to obsolescence.
Ideally, there should be a correlation between investment in renewal and upgrading of existing assets and repairs and maintenance. For example, a municipality that invests significantly in the renewal and upgrading of existing assets to ensure that they are in a good condition will spend less on repairs and maintenance. However, this is not the case in most municipalities.
Municipalities are not adequately providing for repairs and maintenance while they are not prioritising renewal and upgrading of existing assets. This is evident in the reported service delivery failures due to ageing infrastructure and lack of maintenance. Therefore, investment in existing infrastructure and repairs and maintenance must be informed by the condition of the assets regardless of the provided norms. Some infrastructure assets have deteriorated to the extent that spending 40 per cent of capital expenditure on the renewal and upgrading of existing infrastructure is not sufficient to ensure sustainable service delivery. Furthermore, the condition of other assets has deteriorated beyond repairs and maintenance and requires replacement.
Local government must consider asset management a strategic spending priority, and municipalities must aggressively reprioritise non-priority spending to current economic infrastructure.
A budget cannot be regarded as credible if it does not support the maintenance, upgrading and renewal of existing infrastructure, as it will not allow the municipality to meet its future commitments towards consumers and ratepayers. A municipal budget, however, is considered to be funded if the projected cash to be collected is sufficient to cover the budgeted commitments. There are no defined prescriptions as to what should be included in the budgeted expenditure. Although the budget schedules measure spending on infrastructure upgrading and renewal and repairs and maintenance against depreciation and the carrying value of assets, it does not determine a budget as unfunded if it does not meet the required norms.
For a budget to be credible, the revenue projections must be based on calculated tariffs that support all functions and requirements of the municipality. Depreciation, for example, is included in municipal financial accounting to ensure that tariffs levied do not only ensure that normal activities are funded but also that the maintenance of infrastructure assets is possible to ensure that the municipality can render services and keep on rendering services in terms of its mandate.
All municipalities strive to table a funded budget, but unfortunately, a funded budget does not necessarily mean a credible budget. A budget can only be funded and credible if it ensures the financial sustainability of the municipality and ensures the sustainability of service delivery for the short-, medium- and long term.