Five states have general funds with negative fund balances: Illinois, Kansas, Wisconsin, West Virginia and Connecticut. This must not be good from a credit perspective, but what does it really mean? The simple answer is that under modified accrual accounting standards, short-term liabilities are larger than short-term assets. This is usually caused by expenses and other uses outstripping revenues and other sources over time. These five states all still have positive cash balances in their general fund. Cash may be the more appropriate measure of liquidity for a state with zero-or-lower fund balance. But the mere fact that a state or local government had operations that led to a negative fund balance is a credit concern.

Relationship between fund balance and cash

The cash and investments reported in a state’s general fund are highly correlated with the total fund balance. This makes sense. Many of the non-cash assets like receivables are often roughly in line with short term liabilities like payables. Long-term liabilities such as pension obligations do not show up in the general fund statement under GASB standards. The chart below shows the correlation.

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Illinois’ worsening negative fund balance

Illinois provides an example of a state with a general fund balance digging a deeper hole. The total balance as of year-end 2016 was -23.6% of general fund expenses, down from -16.5% in 2014. Overall the fund balance fell $2.9 billion. But over that same period, cash and investments increased $673 million. The causes of the falling fund balance were largely an increase in payables of $1.7 billion and an increase in amounts due to other funds, also of $1.7 billion. Expenses and other uses were greater than revenues and other sources in 2015 and 2016. Illinois’s balance sheet story fits with the ongoing news reports of unpaid bills.

California leaves the negative fund balance club

California’s general fund balance climbed out of negative territory in fiscal year 2016. The balance is now 0.3% of expenses, up from -7.8% in 2014. How did California achieve this? On the balance sheet, it was largely driven by a decrease in liabilities. The fund balance grew $7.8 billion between 2014 and 2016. $5.4 billion of that growth is from a reduction in “due to other funds” and another $2.1 billion is from a similar reduction in “interfund payables”. Cash grew only $987 million. Much of the resources gained in the general fund during this period of increasing revenue were used to pay back short term obligations.

Measuring liquidity

The general fund balance is still a good measure of financial cushion. And governments provide additional information on the availability of the fund balance by categorizing it as nonspendable, committed, etc. For cash and investments, often unrestricted and restricted are not specified. For states and local governments with very low or negative fund balances, looking at cash and investments provides another measure of the actual liquidity available. But the mere fact that a government let short-term liabilities outstrip short-term assets is a cause for concern.