Download GOOD GOVERNMENT NEEDS A BALANCE SHEET

GOOD
GOVERNMENT
NEEDS A
BALANCE SHEET
Imagine managing your business
without a balance sheet. How would
you do it? More importantly, would it
be a good idea? Martin Wheatcroft
looks at one organisation that does...
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JUNE 2015 FINANCE & MANAGEMENT
GOVERNMENT ACCOUNTING
mall businesses do not need to worry
about their balance sheets too much
(micro-businesses with a turnover of less
than £632,000 do not need to report using a
balance sheet). But as a business grows, the ability
to analyse financial effectiveness, apart from
receipts and payments, becomes too important to
ignore. The balance sheet is needed both as a tool
for managing assets and liabilities and part of the
measurement of financial performance. Revenue,
expenditure, cash, assets, liabilities, equity… all are
part of the three-dimensional way that we look at
how a business is performing.
But would it be a good idea to manage your
business without a balance sheet? Well, as it
happens, there is one major organisation in the UK
that operates in just this way, and with income of
£650bn for the financial year recently ended, it
definitely does not fall within the definition of a
micro-business. Perhaps it might be worth looking
at how that body – the UK government – does it.
That is not to say that it does not have a balance
sheet of sorts. In March this year the UK
government published its fifth official balance
sheet, for 31 March 2014, as part of its Whole of
Government Accounts (WGA) project to prepare
financial statements in accordance with GAAP.
“The government’s aims in making the
commitment to WGA were to provide improved
data for fiscal planning, to increase transparency
and to improve accountability to parliament” a
government statement proclaimed in March 2015.
But, as you might guess from the fact that it took
the government just under a year to produce
these accounts, they are not what it uses to
manage its operations.
That privilege is reserved for the National
Accounts (essentially cash accounting), within
which three primary measures of financial
performance – the current deficit, the total deficit
and the national debt – are the main focus.
S
THE FISCAL MANDATE
With the National Accounts targets are set not in
terms of a level of accounting profit or loss, or net
assets or liabilities, but in terms of borrowing and
debt. This is understandable given the very
significant amount of debt currently sitting on the
government’s books, and with borrowing averaging
close to £100bn a year over the past decade.
The government’s principal financial target or
‘fiscal mandate’, a legal requirement following a
vote by parliament in December 2014, is to balance
the structural current deficit over a three-year
FINANCE & MANAGEMENT JUNE 2015
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THE MISSING TARGETS
Given the challenging financial situation
facing the country, it is unsurprising that
the immediate priority of getting
borrowing under control will continue to
be a hot political topic. But what happens
once immediate borrowing is down to
more manageable levels? Is there anything
more sophisticated than just spending
between 35% and 37% of GDP a year on
public services?
Perhaps this is the point to look at the
government’s balance sheet (see tables,
right), even if it is a year or so out of date.
Because when you do so, it is clear that
solving a short-term cash flow problem
will not be sufficient to resolve all our
financial problems.
Yes, if annual borrowing comes down
then the national debt may start to be
‘inflated away’, but debt made up less
than half of the £3.2trn of total liabilities
reported at 31 March 2014.
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SUMMARY UK GOVERNMENT ‘WHOLE OF GOVERNMENT ACCOUNTS’
FOR THE YEAR ENDED 31 MARCH 2014
Revenue and expenditure
£bn
Balance sheet
£bn
Revenue
649
Property, plant and equipment
763
Operating expenditure
(718)
Other assets and investments
574
Operating loss
(69)
Public sector pensions
(1,302)
Net finance costs
(79)
Debt and bank deposits
(1,451)
Net asset disposals and revaluations
(1)
Other liabilities
(436)
Accounting deficit for the year
(149)
Net liabilities
(1,852)
Cash flow statement
£bn
Comprehensive loss /
£bn
movements in financial position
Operating loss
(69)
Accounting deficit for the year
(149)
Add back: non-cash transactions
41
Property and other revaluations
11
Changes in working capital
(11)
Investment gains
9
Operating cash outflow
(39)
Actuarial losses
(84)
Capital expenditure and investments
(55)
Comprehensive loss for the year
(213)
Cash outflow before financing
(94)
Other movements
(11)
Net cash inflow from borrowing
100
Change in financial position
(224)
Net interest and other financing
(5)
Opening net liabilities
(1,628)
Net change in cash in the year
1
Closing net liabilities
(1,852)
RECONCILIATIONS BETWEEN NATIONAL ACCOUNTS AND WHOLE OF GOVERNMENT
ACCOUNTS FOR THE YEAR ENDED 31 MARCH 2014
Deficit
£bn
Debt and net liabilities
£bn
(1,523)
Total deficit
(99)
Gross debt excluding nationalised banks
Add back: net public sector investment
26
Cash and financial assets
121
Current deficit
(73)
Public sector net debt
(1,402)
Asset related charges
(29)
Property, plant and equipment
763
Provision increases
(10)
Provisions
(142)
Pensions
(49)
Pensions
(1,302)
Other
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Other assets and liabilities (net)
231
Accounting deficit for the year
(149)
Net liabilities
(1,852)
It is clear that solving
a short-term cash flow
problem will not be
sufficient to resolve all
our financial problems
After debt, the number that stands out
is the £1.3trn in pension obligations at
31 March 2014. With a long-standing policy
of operating unfunded public service
pensions (the Local Government Pension
Scheme is one of the only funded public
service pension schemes), the government
is using current contributions to cover
current payments and topping this up with
taxpayers’ money on an annual basis. The
net present value of this liability, however,
implies, depending on your perspective,
one of the following: £1.3trn in lower
JUNE 2015 FINANCE & MANAGEMENT
TABLE SOURCE: HM GOVERNMENT, MARCH 2015
period. This is a complicated way of
saying that annual borrowing needs to be
reduced to below £30bn a year by 2017/18.
With forecast economic growth likely to
generate in the region of £26bn a year in
higher income, this implies cuts in annual
spending and/or tax rises to collect the
£32bn a year needed to comply with the
fiscal mandate.
The second key target, which is for debt
to be falling as a proportion of GDP,
means that borrowing needs to be lower
than the offsetting ‘inflating away’ of debt
that is caused by the combination of
inflation and economic growth. Based on
current forecasts for the economy, this is
equivalent to a target for borrowing to be
below 3% of GDP, or about £55bn a year at
the moment. So if the fiscal mandate
is achieved, this second target should
easily be met.
The new government is likely to start
increasing spending again as soon as it has
met its short-term targets, whether to
reduce borrowing to below the amount
needed to fund infrastructure spending or
to run a cash surplus. There is agreement
that spending should increase in line with
growth in the economy after that point
has been reached.
GOVERNMENT ACCOUNTING
spending elsewhere, higher taxes or
significant changes in the benefits of
the schemes.
The government is not completely
unaware of this problem, and has been
taking limited action to reduce the value
of pension entitlements and increase the
employee and employer contributions, to
the financial detriment of police officers,
teachers, health workers, members of the
armed forces and other civil servants. But
the £126bn accounting gain in 2010/11
from changing the inflation rate used to
index public sector pensions from RPI to
CPI, reducing the value of future pension
payments, did not need much explanation
in the Budget at the time because it did
not appear in the National Accounts.
Similarly, further planned reductions in
pension entitlements this year are also
unlikely to feature as part of the discourse
on the public finances as we will not see
the accounting impact until long after the
relevant financial year is over.
You may have views on whether the
reductions in public servants’ pension
entitlements are a good or bad idea and
whether they are necessary or not for the
health of the public finances. But why did
we get into the position where we couldn’t
keep promises made to employees? Did
the government and parliament not notice
this liability building up over the past 50
years? Perhaps they did, but without a
formal balance sheet until recently, and
Ministers who manage the National Accounts: economic
secretary Harriet Baldwin; financial secretary to the
Treasury David Gauke; George Osborne; Exchequer
secretary Damian Hinds; chief secretary to the Treasury
Greg Hands; commercial secretary Jim O’Neill
FINANCE & MANAGEMENT JUNE 2015
DEBTS AND DEFICITS
Provisional numbers reported for the
financial year ended 31 March 2015
comprised government income of
£649bn less government spending of
£707bn to give a current deficit of
£58bn. Taking away the public sector
net investment of £30bn results in a
borrowing requirement of £88bn, £2bn
lower than the forecast at the time of
the 2015 Budget. Public sector net debt
was provisionally reported at £1,484bn,
£5bn higher than forecast.
most accounting for pensions on a cash
basis, it is only as pension payments for
retired employees have started to
significantly exceed the contributions of
current employees, and the departments
they work for, that the squeeze on public
services has grown so great that
government has been driven to act.
The plan was for continually increasing
tax revenues from economic growth to
cover these payments; what could have
gone wrong?
This cash pressure will grow over the
next few years as the government
workforce reduces in size, leaving an
ever-smaller number of public servants
over which to spread the pension costs of
previous generations of workers. This is
much worse than the pressure that many
large companies found themselves under
before they curtailed pension benefits in
the private sector. They at least had assets
in their pension plans delivering strong
financial returns to partially offset the
impact of their staff living longer in
retirement; outside of local government
there are no such assets to cushion the
blow to public sector finances.
Of course, pensions are not the only
asset or liability in the balance sheet that
needs active management. There are
£142bn in provisions for such costs as
nuclear decommissioning and clinical
negligence that need to be funded. There
is £62bn in military equipment and
supplies that needs to be utilised
effectively. And there are £79bn in student
loans that need to be collected, not to
mention the £234bn in obligations for
leases and private finance initiatives
disclosed in the notes to the accounts.
This is why we all need to ask our
politicians what financial targets they
should be setting for the balance sheet,
now that we have one. Is the policy of not
funding government pension obligations
sustainable? If national debt should be
falling as a proportion of GDP from its
peak of 80%, should there also be a target
for liabilities in total, currently equal to
about 180% of GDP?
In business, we all know that
effective financial management means
focusing on the balance sheet just as
vigorously as we manage the income
statement and cash flow. It is time
policymakers saw that too.
Martin Wheatcroft
FCA is managing
director of Pendan
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