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Chapter 3
FINANCIAL MANAGEMENT

This chapter reviews the financial management functions of Morgan Independent School District (MISD) in the following sections:

A. Financial Management
Part 1
Part 2
B. Purchasing
C. Asset and Risk Management

A. FINANCIAL MANAGEMENT (PART 1)

Public school funding comes from federal, state and local sources. Property tax revenues provide local funding. For 2001-02, public school funding for all entities in Texas amounted to about $34.4 billion. Public school districts' operations funds totaled about $26 billion of this amount. In 2001-02, the average Texas school district generated 53 percent of its funding from local tax and other local and intermediate sources, 43.6 percent from state funds and 3.4 percent from federal sources.

Because school districts rely on property taxes as their local revenue source, property tax revenues vary widely across the state as property values or wealth varies. To offset this local variation, the state provides funding to districts in inverse relation to district wealth: school districts with higher property wealth receive less state funding than low-wealth school districts. Exhibit 3-1 shows that MISD received the majority of its funding from 1998-99 to 2002-03 from the state. This is the result of the district's low property wealth.

Exhibit 3-1
MISD Total Budgeted Revenues - All Funds
1998-99 through 2002-03
Revenues 1998-99 1999-2000 2000-01 2001-02 2002-03
Local Tax 27.2% 32.7% 32.0% 38.4% 34.7%
Other Local & Intermediate 1.6% 1.8% 1.5% 6.6% 2.2%
State 60.2% 60.1% 62.5% 50.3% 57.5%
Federal 11.0% 5.3% 4.1% 4.6% 5.6%
Total Budgeted Revenues $1,308,228 $1,243,874 $1,378,221 $1,303,601 $1,562,785
Enrollment 159 150 145 153 159
Source: TEA, Academic Excellence Indicator System (AEIS), 1998-99 through 2001-02 and Public Education Information Management System (PEIMS), 2002-03.

Between 1998-99 and 2000-01, MISD reported enrollment figures to TEA that were higher than the district's actual enrollment. This caused TEA to distribute more money to MISD than it was entitled to in each of those years. MISD used the extra funding to cover cost overruns on their new cafeteria. TEA chose to recapture the entire overpayment amount of $342,254 in fall 2001. TEA calculated that MISD should receive $736,548 in state funding in 2001-02. After TEA subtracted the overpayment, MISD received $394,294 from the state. The district obtained a loan of $175,000 from Meridian State Bank to help cover 2001-02 expenses.

For 2002-03, the district expects $754,759 from the state. As of June 2003, TEA had paid MISD $559,732. The district will receive the remaining payments before September 10, 2003. Exhibit 3-2 compares MISD's sources of revenue to its selected peer districts and the statewide average. Although MISD receives slightly more state funding than the state average, it almost matches state funding received by two peer districts. One peer district, Megargel, receives less state funds; Penelope ISD receives a much higher percentage of state funding.

Exhibit 3-2
Total Budgeted Revenues Comparison - All Funds
MISD, Peer Districts and the State
2002-03
  Penelope Megargel Prairie Lea McDade MISD Cranfills Gap State
Local and Intermediate 13.7% 45.7% 38.2% 38.0% 36.9% 49.3% 56.2%
State 82.2% 49.9% 57.4% 59.4% 57.5% 50.7% 40.4%
Federal 4.1% 4.3% 4.4% 2.6% 5.6% 0.0% 3.5%
Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Source: TEA, PEIMS, 2002-03.
Note: Totals may not add to 100 percent due to rounding.

MISD receives local revenue from property taxes. As rural districts, MISD and its peers derive most of their taxable property from land and only a small percentage from taxes on businesses. This is a sharp departure from the state average. Exhibit 3-3 compares local revenue sources of MISD, its peer districts and the state average for 2001-02. Business and residential properties are more significant sources of revenue to the state average. Taxes on land properties are the largest source of local revenue for MISD and its peer districts.

Exhibit 3-3
Taxable Value by Category
2001-02
Source Cranfills Gap Penelope Megargel McDade MISD Prairie Lea State
Business 11.4% 11.1% 17.9% 15.0% 10.7% 13.2% 37.9%
Residential 11.5% 26.6% 15.2% 29.6% 44.0% 20.5% 50.3%
Land 76.3% 59.6% 50.3% 49.6% 44.6% 29.2% 6.7%
Oil and Gas 0.0% 0.0% 16.4% 0.0% 0.0% 34.4% 4.0%
Other 0.8% 2.7% 0.3% 5.8% 0.7% 2.8% 1.0%
Source: TEA, AEIS, 2001-02.

Federal funds represent the smallest portion of the three major revenue sources for the state's public schools. Federal agencies appropriate most federal funds for specific programs or to provide service to a specific group of students. Federal revenue is received by the district directly from the federal government or distributed by TEA or other state entities for programs such as career and technology education, programs for educationally disadvantaged children (Education Consolidation and Improvement Act, and Elementary and Secondary Education Act), food service programs and other federal programs.

Exhibit 3-4 compares the district's total actual expenditures by function for 1999-2000 through 2001-02 and budgeted expenditures for 2002-03 to the state average. The district's budgeted expenditures for 2002-03 for instruction is 42.1 percent compared to the state average of 50.8 percent.

Exhibit 3-4
MISD and State Total Expenditures by Function
1999-2000 through 2002-03
Function 1999-2000
Actual		 2000-01
Actual		 2001-02
Actual		 2002-03
Budgeted		 2002-03
Budgeted Percent of Total		 2002-03
State Budgeted		 2002-03
State Budgeted Percent of Total
Instruction $679,496 $660,135 $645,283 $655,520 45.7% $15,258,107,372 50.8%
Instructional-Related Services $10,360 $2,003 $2,488 $3,000 0.2% $815,176,913 2.7%
Instructional Leadership $0 $0 $0 $0 0.0% $360,073,948 1.2%
School Leadership $69,779 $75,284 $69,533 $80,635 5.6% $1,588,708,640 5.3%
Support Services-Student $14,149 $1,950 $1,947 $1,899 0.1% $1,204,538,130 4.0%
Student Transportation $36,176 $36,676 $26,525 $25,504 1.8% $788,729,993 2.6%
Food Services $104,393 $84,635 $88,425 $99,116 6.9% $1,470,996,886 4.9%
Co-curricular/ Extracurricular Activities $33,550 $36,170 $34,870 $36,694 2.6% $682,584,402 2.3%
Central Administration $134,741 $144,157 $139,875 $150,424 10.5% $1,090,220,713 3.6%
Plant Maintenance and Operations $86,220 $101,120 $113,463 $128,750 9.0% $2,995,707,896 10.0%
Security and Monitoring Services $500 $500 $500 $500 0.0% $181,806,687 0.6%
Data Processing Services $0 $0 $0 $0 0.0% $348,481,432 1.2%
Other (*) $114,738 $116,550 $65,000 $252,685 17.6% $3,269,293,923 10.9%
Total Expenditures $1,284,102 $1,259,180 $1,187,909 $1,434,727 100.0% $30,054,426,935 100.0%
Source: TEA, AEIS, 1999-2000 through 2001-02 and PEIMS, 2002-03.
*Includes any operating expenditures not listed above and all non-operational expenditures such as debt service, capital outlay and community and parental involvement services.

Exhibit 3-5 shows key financial data for MISD's general fund on a comparative basis with state and peer districts.

Exhibit 3-5
Comparative Profile of Financial Performance - General Fund
MISD, Peer Districts and State
2001-02
District Total
Revenues
per Student		 Total
Expenditures
per Student		 Instructional
Expenditures
per Student		 Student
to Employee
Ratio		 Student
to Teacher
Ratio
Megargel $11,524 $11,881 $6,992 3.48 6.2
Cranfills Gap $8,746 $8,541 $5,034 4.21 7.2
MISD $8,520 $7,764 $4,218 4.96 9.5
Penelope $8,467 $8,082 $4,655 5.13 9.4
McDade $7,915 $7,555 $4,215 5.71 11.3
Prairie Lea $6,465 $3,159 $226 7.03 13.5
State $6,769 $6,913 $3,611 7.40 14.7
Source: TEA, AEIS, 2001-02.

When compared to its peer districts, MISD ranks in the middle in terms of revenue received and expenditures. The district is above the state average in instructional expenditures but among its peer group, only McDade and Prairie Lea spend less then MISD. The district's ratio of students to employees and of students to teachers is low in comparison to the state average and the majority of its peers.

The district's superintendent manages MISD's financial duties. A public accounting firm in Cleburne performs the district's monthly bookkeeping. The superintendent personally approves all purchases and expenditures for the district and makes all deposits of district cash. The accounting firm uses budgetary accounting software sold by John W. Anderson & Associates to perform payroll functions and print operating checks.

FINDING

The district contracts with an accounting firm to provide bookkeeping services to save money. Twice each month, the superintendent compiles all invoices. The superintendent reviews the invoices for accuracy and then writes the account code to which the expense should be charged on the invoice. The superintendent drives 30 minutes to the Cleburne accounting firm to deliver the bills the district will pay that period. The accounting firm prepares checks to pay the bills and has them ready for the superintendent to pick up in two or three days. After receiving the checks, the superintendent reviews them for accuracy. Since the district requires two signatures on the check, the superintendent and his secretary sign each check. The secretary then mails the checks and files the supporting documentation by month.

The accounting firm issues the district's payroll checks every month. All employees are salaried so no timesheets are required for payroll processing purposes. The superintendent picks up the checks from the accounting firm and distributes them. Because of the district's small size and the limited number of employees, the superintendent's secretary tracks vacation and sick time manually. The accounting firm prepares all payroll reports; the superintendent signs and submits these reports. The accounting firm mails tax deposits to the district's bank for submission to the IRS.

The accounting firm charges the district $850 per month ($10,200 a year) to provide these services. A qualified, full-time bookkeeper could cost the district $24,000 to $36,000 annually.

COMMENDATION

The district saves money by contracting with an accounting firm to perform bookkeeping services.

FINDING

MISD does not have a general fund balance management policy. Cost overruns on the district's new cafeteria in 1998-99 depleted the district's fund balance. School districts establish and maintain fund balances, or reserve balances, to function similarly to a savings account. Fund balances serve as a source of funds in case of an emergency, a source of cash when revenues are low or a place to build up savings to make large purchases not affordable within a single year.

The district intended to pay for the cafeteria without issuing bonds by using a capital-acquisition program loan of $290,000 and $259,000 from the general fund. The cafeteria project cost more than expected because the district added to its construction plans as the project progressed. The district borrowed $300,000 from Bosque County Bank to pay for the additional costs. During this time, the district was receiving more funds from the state than was due as a result of erroneous enrollment projections. The additional construction costs on the cafeteria project forced the district to use up its fund balance and the excess payments received from the state.

In 2001-02, TEA reduced state funding payments to MISD to compensate for the overpayments of the previous three years. This left the district with a negative fund balance of $150,912. MISD began experiencing severe cash flow problems. The district was forced to take out two loans from Bosque County Bank. Exhibit 3-6 shows the district's general fund balance from 1998-99 through 2001-02.

Exhibit 3-6
MISD General Fund Balance
1998-99 through 2001-02
General Fund Balance
Source: MISD Annual Financial Reports, 1998-99 through 2001-02.

A review of the district policy manual revealed no guidelines or policies defining the district's desired general fund balance or acceptable uses for the fund balance. There are also no policies defining the reports that board members should receive to ensure that the general fund balance is not being used to fund normal district operating expenditures. No monthly reports are provided to the board showing the ending fund balance based on actual receipts and expenditures to date and the annual budget reports to the board do not discuss what the fund balance will be at the end of the year if the presented budget is approved or if a budgeted capital project is built. If reports had been provided to the board when decisions were made on how to finance the cafeteria project, it might have highlighted that the fund balance would be completely depleted and possibly go negative if any cost overruns were experienced.

TEA's FASRG provides a formula to calculate a district's optimum general fund balance. The FASRG formula suggests that districts maintain a fund balance equal to the estimated amount to cover cash flow deficits in the general fund for the fall in the following fiscal year plus the estimated average monthly cash disbursements of the general fund for the nine months following the fiscal year. Appendix 3 in TEA's Financial Accounting and Reporting module contains the "Optimum Fund Balance Calculation Schedule" and the "Instructions for Completion of Optimum Fund Balance Schedule for the General Fund." The fund balance and cash flow calculation worksheets were prepared by the external auditors as a schedule in the district's 1999-2000 through 2001-02 financial reports. The schedules show that the district's general fund balance is $284,670 below the balance recommended by TEA, as detailed in Exhibit 3-7.

Exhibit 3-7
MISD General Fund Balance Compared to TEA's
Proposed Optimum Fund Balance
1999-2000 through 2001-02
  1999-2000 2000-01 2001-02 2002-03
General Fund Deficit ($84,795) ($84,402) ($154,670) $68,000*
Less: General Fund Optimum Fund Balance Calculation $110,000 $120,000 $130,000 $130,000
Excess (Deficit) Undesignated Unreserved General Fund Balance ($194,795) ($204,402) ($284,670) ($62,000)
Source: MISD Audited Financial Reports, 1999-2000 through 2001-02. * Superintendent's estimate.

According to the superintendent, the district has already paid off the Bosque County Bank loans. He expects MISD's general fund balance to be a positive $68,000 at the end of 2003 because the money earmarked for loan repayment is now available and because district enrollment increased slightly.

An attorney general's opinion from 1942 indicates that state entities should not have a deficit fund balance. TEA takes the position that school districts should not pay for district operations from a subsequent fiscal year's tax levy. Expenditures may exceed revenues in the general fund during a fiscal year if there is sufficient fund balance to maintain a positive balance in the general fund. TEA expects districts to demonstrate sound discretion in all matters involving financial management.

The 77th Legislature (2001) enacted Senate Bill 218 creating an accountability rating system to measure how well Texas school districts are handling their finances. To comply with this mandate, TEA established the School Financial Integrity Rating System of Texas (School FIRST). In 2002-03, the School FIRST rating system will issue preliminary and final paper reports to each district and the Regional Education Service Center that serves it. When the rating system is fully implemented in

2003-04, each school board will publish an annual report that describes the district's financial management performance.

School FIRST seeks to improve school districts' financial management. The rating system assesses the quality of financial management in Texas public schools and measures the extent to which financial resources are directly used for instruction purposes. When the rating system is in place, school district ratings will be publicly available.

Ratings are based on the numerical scores expressed as the number of "No" answers on 21 indicators. Answering "no" to as few as one or two of the 21 questions could cause a district to receive a low rating. Exhibit 3-8 explains the School FIRST scoring system.

Exhibit 3-8
School FIRST
Rating Criteria
Rating Score (Number of "No" Answers)
Superior Achievement 0-2
Above Standard Achievement 3-4
Standard Achievement 5-6
Substandard Achievement 7 points, OR "No" to one of the five critical criteria indicators
Suspended - Data Quality Serious data quality issues
Source: TEA, School FIRST.

In addition, failure to meet the criteria for one of three critical indicators, or both of two additional criteria, will result in a Substandard Achievement rating. Exhibit 3-9 details these five critical indicators.

Exhibit 3-9
School FIRST
Critical Criteria Indicators
Criteria
Number		 Criteria
Description		 Result of a
"No" answer
1 Was total fund balance less reserved fund balance greater than zero in the general fund? Automatic Substandard Rating
2 Were there NO disclosures in the annual financial report and/or other sources of information concerning default on bonded indebtedness obligations? Automatic Substandard Rating
3 Was the annual financial report filed within one month after the deadline depending on the district's fiscal year end? Automatic Substandard Rating
4 Was there an unqualified opinion in the annual financial report? 4 AND 5
Automatic Substandard Rating
5 Did the annual financial report NOT disclose any instance(s) of material weakness in internal controls? 4 AND 5
Automatic Substandard Rating
Source: TEA, School FIRST.

TEA prepared drafts of School FIRST reports using 2000-01 financial data. MISD would have earned a Substandard Achievement rating that year because it answered "no" to Criteria Numbers 1 and 3 of Exhibit 3-9. TEA plans to sanction districts that earn a Substandard Achievement rating and impose additional sanctions on districts that have data quality issues. Sanctions could result in TEA assigning a financial monitor or master, or starting an accreditation investigation.

Successful school districts' board members effectively manage a school district's financial resources by having a thorough understanding of the district's financial condition. These districts require every agenda item for expenditure to contain a fiscal impact analysis. By understanding the impact their decision could have on the financial position of the district, board members can make choices to protect or increase the fund balance.

Recommendation 21:

Establish a policy for management of the general fund balance and provide reports to the board.

This policy should establish goals concerning what the district's optimum general fund balance should be at all times. The policy should provide the superintendent with clear directions as to how to increase revenues or decrease expenditures in order to meet the district's fund balance goals. It should also require that every agenda item for expenditure contain a fiscal impact statement.

The policy should ensure that the board is kept informed about the status of the general fund balance. In every board packet, the superintendent should include a summary of the beginning fund balance, the revenues received during the month, the month's expenditures, ending fund balance and a projection of the year-end fund balance. The board's report should explain any significant events that have had a major impact on the fund balance during that month. This will ensure that the board and district administration remain aware of the district's financial position.

IMPLEMENTATION STRATEGIES AND TIMELINE
1. The superintendent drafts a general fund balance management policy. September 2003
2. The superintendent presents the policy to the board for approval. November 2003
3. The board approves the policy and directs the superintendent to implement it. December 2003
4. The superintendent or his designee develops the required reports to submit to the board on a monthly basis and ensures fiscal impact statements are added to each agenda item. January 2004
and Ongoing

FISCAL IMPACT

This recommendation can be implemented with existing resources.

Financial Management - Part 2