Section 114 is a term that is becoming a frequent watchword in the world of local government finance as several local authorities threaten to invoke this power following the impact of the Covid-19 pandemic on their finances.
Local authorities are required by law to have a balanced budget but what is meant by ‘balanced’?
This is not defined anywhere in law but would most probably, in the eyes of an accountant, involve delivering a financial plan where expenditure will equal income over the short- and medium-term.
So, what would lead a Chief Financial Officer (CFO) to consider that the budget was not balanced?
In the current climate most certainly increased uncertainty leading to budget overspends that will reduce reserves to unacceptably low levels, or in extreme cases where the authority starts to demonstrate the characteristics of an insolvent organisation as it fears that it may be unable to pay creditors and other commitments and no longer be considered a going concern.
It is unlikely that the latter of these two examples would ever occur but reserves falling to lower than prudent levels is a distinct possibility, especially when income streams are being stressed. Reduced fees and charges, rent void periods on commercial property portfolios, increased non-payment of local taxes will all have an impact on the financial resilience of a local authority and cause many CFOs sleepless nights.
So, what can be done if the CFO considers that the authority may be getting into financial difficulty?
Within the Local Government Finance Act 1988, Section 114 (3) states that: “The chief finance officer of a relevant authority shall make a report under this section if it appears to him that the expenditure of the authority incurred (including expenditure it proposes to incur) in a financial year is likely to exceed the resources (including sums borrowed) available to it to meet that expenditure”.
To reach this point would suggest that the authority has failed to take notice of previous warnings from the CFO about the financial risks to the authority and/or the Council has failed to appreciate the seriousness of the budgetary position. It may even be the case that the CFO has failed to warn of the risks, but this is unlikely. The s114 process normally occurs over a lengthy period of time but the impact of Covid-19 has hastened the process and budgets that are only months old are being re-evaluated.
What is important to note is that it is not the Council that issues the notice, it is the CFO and the issuing of a 114 notice is therefore not for the faint hearted and is a potentially career limiting action. It is also damaging for the authority as it will impact the external view of that organisation by its peers and other external bodies so whilst s114 notices are often threatened they are rarely ever actioned, but times are different now and we may see a raft of 114 notices once the Covid dust has settled.
As mentioned, a 114 notice is normally only given in the gravest of circumstances and once issued the Council (namely its Members) has 21 days to consider a response. The 114 notice bans all new expenditure, except for that relating to the safeguarding of vulnerable people and the provision of statutory services. So effectively during the three-week period spending and other financial activity is suspended placing the organisation in a period of financial uncertainty.
Whilst traditional spending reviews focus on a line by line budget analysis and changes to methods of service delivery there may be opportunities to look in detail at the bigger picture including the balance sheet position of the authority, capital financing costs including MRP and interest costs (both for current commitments and future capital plans) and the returns on sums invested to help contribute to an overall improved financial position. These areas should not be overlooked during the 114 process and at Arlingclose we have assisted our clients in making considerable savings in these areas which could prove beneficial as part of the overall financial review.
Whatever action is taken It is hoped that the organisation will be able to agree on a spending and saving programme, and that a balanced budget can be put forward. If it still cannot make the budget balance then the authority will be required to call in its external auditors, who must try again to find a way to set viable budget. At this point, central government will get more heavily involved but it is unlikely they will provide the answers that the Council is looking for so the future for the organisation could remain uncertain for some time to come.