2. Financial statements

In the municipal environment, results are measured by financial performance. Without money, all efforts will be useless. In South Africa, municipalities are required to generate 94% of their income themselves.

Financial performance is, therefore, of the utmost importance. The quality of life of the community can only be improved by creating new infrastructure: new roads, water and electricity connections, sewage disposal works, parks and recreational facilities. The ability of a municipality to create infrastructure depends on its ability to attract new capital (ability to borrow), which depends on its financial performance. Investors therefore analyse the financial statements of municipalities to forecast their future borrowing prospects. During the December 1997 Project Viability survey, questions regarding the financial statements were included for the first time.

Of the 393 municipalities that responded, 59 were unable to provide either their balance sheets or income and expenditure statements. Of the remaining 334 local authorities, 184, or 55 %, either did not balance or included unacceptable data and required follow-up to adjust. These errors were not confined to the smaller and medium sized local authorities, but also emanated from certain major local authorities.

The inability of municipalities to produce their balance sheets timeously is a reflection of the level of financial management experienced at municipal level. There are exceptions where major in- and unbundling have taken place in certain metropolitan areas. These exceptions are, however, not reflective of the rest of the country. During the last two years, more than 375 management audits have been conducted in the various provinces. These analysis also included revisions of the financial statements. I personally have attended more than 50 of these audits myself. From the data collected, it is quite clear that very few treasurers in this country understand their financial statements. They know very little about ratios and do not understand how to link their cash resources to funds and provisions. After these findings become known, the Department of Constitutional Development, in conjunction with the National Training Board, developed a refresher course for senior financial officers and chief executive officers.

Only 555 municipal officials found it necessary to attend, while most of the officials from the major centres chose to stay away. The financial institutions find it difficult to establish the risk associated with long-term borrowing if municipalities cannot produce financial statements.
Municipalities expect to borrow, but none produce data to prove their creditworthiness. The inability of municipalities producing their financial statements timeously indicates that they do not meet the following criteria:

• Resources and information management.
• Processes and administrative systems.
• Leadership.
• Policies and strategies.
• People management.
• Business results.

Due to a lack of financial statements, a few other Project Viability returns are going to be examined to gauge the overall financial situation.

2.1 Outstanding debtors
The ability of municipalities to collect amounts due for service charges and rates is fundamental to stability and viability and solving cashflow difficulties and has therefore been tracked by the Department of Constitutional Development since October 1996.

The following table and graph reflect the outstanding debtors of the core group1 of municipalities:

The steady increase in debtors reflects the inability of municipalities to deal with the pervasively high level of non-payment. This increase is due to the number of accounts in arrears, insufficient contributions for bad debts or lack of credit control policies and support measures to assist indigents. It is also indicative of the ineffectiveness of the measures applied in municipalities to collect outstanding debtors. It has become an acceptable practice for municipalities to give extensions of up to five years for payment of recurring service charges, without a dedicated finance source to cover these arrears. In the process, all the funds, reserves and provisions of municipalities have been depleted. This does not inhibit treasurers from recommending to their councils that these funds, reserves and provisions be used as finance sources for capital projects. A fundamental principle in debt collecting is not to give extension to recurring debts.

The Department of Constitutional Development is currently drafting a new credit control policy and enabling legislation to improve on current practices. Considering that the debtors situation has now reached critical proportions, it appears, however, that the National Minister will have to speed up the process by promulgating regulations as an interim measure.

The level of outstanding debtors is also reflective of the level of political interference in debt collection. During the June 1998 survey, 40% of municipalities indicated that they were being restricted in the application of normal credit control procedures. Since June 1997, outstanding debtors have increased by R2 billion (from R7,3 billion to R9,3 billion). This is substantially in excess of the combined results of any price escalations and growth in the municipal income basis. Punitive action against defaulting debtors is a logical process if accompanied by a proper customer service and a support programme for the indigent.

The unacceptable high level of outstanding debtors can be further demonstrated by the following schedule and graph reflecting the actual level of debtors as a percentage of rates and service charges (turnover).

Debtors outstanding Authorithies responding continously

If the level of outstanding debtors were to decrease from the unacceptable level of 33% (17 weeks) of rates and service charges income to the norm of 11% to 15% (6 to 8 weeks), R1,9 billion to R2,3 billion currently unnecessarily tied up in debtors would be released. This massive amount could be better invested in, for example, infrastructure programmes.



_{2.2 Debtors collection activity}
The following tables reflect the number of electricity disconnections and reconnections since the amalgamation of municipalities:

Although the number of disconnections has steadily increased over time, the vast difference between disconnections and reconnections either indicates that consumers are going without electricity or are reconnecting cut supplies themselves. In some parts of our country, illegal reconnections have become an industry and are reflective of the level of civil disobedience that municipalities need to deal with.

The inability of municipalities to collect outstanding debtors indicates that they do not meet the following criteria:

• Policy and strategy.
• Customer and market focus.
• Customer satisfaction.
• Business results.
• Liquidity.

2.3 Creditors outstanding
The following table reflects the situation with regard to major creditors outstanding:

It appears that municipalities are using their creditors as a bank to finance their working capital requirements. The unacceptable high level of arrears for bulk purchases of water and electricity are typical examples of the cashflow difficulties.
The inability of municipalities to pay their creditors indicates that they do not meet the following criteria:

• Resources and information management.
• Supplier and partnership proficiency.
• Business results.

2.4 Cash and investments
The following table and graph reflects the cash and investment situation of the core group of municipalities:

Cash & Investments

Although the cash and investments of municipalities have improved over the last two years, the figures also include long-term borrowing not yet spent on capital projects. From a national perspective, the overall situation indicates insufficient cash and investments to cover the outstanding debtors, especially considering that the Durban Corporation holds R3,5 billion of all cash and investments.

2.5 Liquidity

The above-mentioned tables reflect three of the main elements determining the overall liquidity of municipalities, which can be expressed as the ratio between current assets and current liabilities2.

Liquidity simply means the ability of a municipality to meet its debts as and when they fall due, i.e. its ability of a municipality to meet its short-term obligations. Failure to do this will result in the total failure of the municipality, as it will be forced into liquidation.

Liquidity therefore means having either sufficient cash or lines of credit available to meet commitments as they arise. While income is vital for the future health of a municipality, access to cash or credit is often more important. It has happened that profitable companies had to go into liquidation because of a lack of cash.

Liquidity is also a matter of degree. A slight lack of liquidity may prevent a municipality from availing itself of favourable cash or quantity discounts and from taking advantage of opportunities as they arise. A more serious lack of liquidity may place a municipality in the position of being unable to pay its current liabilities as they fall due. This may result in the deterioration of supplier relationships, or the sale of investments or other fixed assets or, in a worst case scenario, insolvency. There are already approximately 80 municipalities in South Africa that cannot pay their staff’s monthly salaries. These municipalities cannot obtain any further short-term credit from financial institutions. Liquidity, supported by the activity ratios3 of the main elements of net current assets, is the most important ratio used by financial institutions to evaluate creditworthiness. The other two are the gearing4 and profitability5 ratios.

2 Current assets = debtors, cash, stock and short-term portion of long-term debtors.
Current liabilities = creditors, bank overdrafts and short-term portion of long-term liabilities.
3 Turnover rate of debtors, creditors and stock.
4 Ratio of own funds to external funds.
5 Profit as a percentage of turnover.