N.C. Local Government Finance Policy Manual

3.0 Introduction

Fund balance is one of the most important indicators of a local government’s financial condition and its ability to sustain operations over time. It reflects the cumulative results of past revenues, expenditures, and budget decisions, and it provides the cushion that allows a government to meet cash flow needs, respond to emergencies, invest in capital projects, and take advantage of opportunities without compromising stability. A strong fund balance is also a key factor in credit ratings, public confidence, and a unit’s ability to secure favorable loan terms. Lenders and rating agencies often evaluate fund balance levels to gauge a unit’s overall financial health and capacity to repay debt.

This chapter explains both the purposes of maintaining an adequate fund balance and the methods used to measure it. Local governments in North Carolina rely on fund balance for more than day-to-day operations—it is a critical tool for financial resilience and long-term planning. Understanding how fund balance is calculated, reported, and evaluated helps governing boards and finance officers make informed decisions, comply with legal requirements, and communicate clearly with the public, lenders, and oversight bodies.

The sections that follow begin with the primary reasons for maintaining fund balance. They then explain the three main calculation methods—statutory, GAAP, and LGC—each of which serves a distinct purpose. The statutory calculation focuses on legal limits for appropriating fund balance in the annual budget ordinance. The GAAP (Generally Accepted Accounting Principles) presentation follows national accounting standards to ensure transparency and comparability. The LGC (Local Government Commission) calculation uses audited GAAP data to benchmark financial condition and identify potential risks. Together, these perspectives provide a complete picture of a government’s fiscal position and capacity to deliver services effectively.

3.1 Reasons for Fund Balance

Cash Flow 
The primary reason to maintain a healthy general fund balance is to manage cash flow. In North Carolina, the fiscal year runs from July 1 to June 30. [G.S. 159-8(b)] Property taxes are the general fund’s main revenue source, but most are not collected until January, even though they are billed in the summer and due in early September. Taxpayers can pay any time before the January deadline without penalties or interest. As a result, a local government must operate for several months—covering payroll, vendor payments, and other expenses—before receiving the bulk of its revenue. Sufficient fund balance ensures the government can meet these obligations without borrowing.

Emergencies 
A second reason is to prepare for emergencies, such as natural disasters that disrupt essential services. While state and federal disaster aid is often available, it typically arrives after the fact. Local governments must have cash reserves to restore services immediately, repair damaged infrastructure, and stabilize the community. The ability to respond quickly protects both residents and the local tax base.states that the budget ordinance of a local unit shall cover a fiscal year beginning July 1 and ending June 30. While there may be initiatives for taxpayers to pay according to the due date in September or shortly thereafter (discount rates, federal tax laws, etc.), a significant portion of the property taxes are not collected until the beginning of January. Paying before the deadline in January still allows taxpayers to avoid interest and penalties on this fundamental revenue source of local units in North Carolina. Local units must have healthy fund balances to cash flow payroll and accounts payable for the first six months of operations while waiting for their cash accounts to be replenished from the collection of property taxes.

Pay-as-You-Go Financing The third reason is to support capital projects without relying solely on debt. Local governments regularly invest in infrastructure, facilities, and equipment, often guided by a capital improvement program. Using cash reserves to fund part of these projects—pay-as-you-go financing—reduces borrowing costs and can improve credit ratings. G.S. 159-18 allows the use of separate capital reserve funds to accumulate cash for this purpose. Credit rating agencies view a balanced approach between debt and cash financing as a sign of strong financial management.

Balancing the Budget The fourth reason is to balance the annual budget ordinance, as required by G.S. 159-8. A budget is balanced when estimated revenues plus any appropriated fund balance equal total appropriations. While a unit may use fund balance to balance its budget, state law limits how much can be appropriated for this purpose. Section 3.3 explains the statutory calculation.

Other Uses Healthy fund balance also provides flexibility to respond to opportunities or unexpected needs, such as providing local match funds for a grant or investing in an economic development project. Local governments may invest cash reserves under G.S. 159-30 to generate income, which can then be used to support the budget.

3.2 Understanding the Purpose of Different Fund Balance Calculations

To manage fund balance effectively, local governments must understand that different laws, accounting standards, and oversight practices define and measure fund balance in different ways, each designed for a specific purpose. No single calculation can answer every question about a government’s financial position, so finance officers and governing boards must know when and why to use each. Local governments use three main fund balance calculations:

1. Statutory calculation for budget appropriation – Required by G.S. 159-8 to determine the legal maximum fund balance that can be appropriated in the annual budget ordinance.

2. GAAP presentation – Established by the Governmental Accounting Standards Board (GASB) to standardize the reporting of fund balance in audited financial statements.

3. LGC calculation– Used by the Local Government Commission to assess financial condition, identify trends, and compare units with similar expenditure levels.

The statutory calculation is prepared during budget development and focuses on compliance with legal limits. The GAAP presentation is part of annual audited financial statements and is designed for transparency, comparability, and accountability to stakeholders. The LGC calculation relies on audited GAAP data but applies its own formula to create a consistent benchmark for evaluating fiscal health across local governments. Together, these approaches provide elected officials, finance staff, and auditors with complementary perspectives—legal, accounting, and analytical—on the government’s financial position.

3.3 Statutory Calculation of Available Fund Balance for Budget Appropriation

North Carolina law requires local governments to adopt a balanced budget each fiscal year. [G.S. 159-8(a)]. If appropriations exceed estimated revenues, the governing board may use fund balance to make up the difference. However, state law limits the amount of fund balance that is legally available for this purpose.

Under G.S. 159-8(a), the maximum amount of fund balance that may be appropriated to balance the budget equals cash and investments minus liabilities minus encumbrances minus deferred revenues from cash receipts. This figure is based on the fund’s position as of June 30, before the new fiscal year begins, not on final audited figures. Budget or finance officers typically calculate it during budget preparation to determine the legal maximum available for appropriation. Although the actual fund balance will fluctuate during the year, the legal maximum remains fixed for the budget year.

The first part of the equation is the sum of cash and investments, stated on the balance sheet of the general fund. Cash and investments include restricted amounts. Liabilities are amounts owed to vendors, other organizations, or other funds within the government. Encumbrances are commitments for goods or services, such as outstanding purchase orders, at year-end. Deferred revenues from cash receipts are payments received before they are legally due, such as prepaid property taxes, which cannot be recognized as revenue until the following fiscal year.

After calculating the available fund balance, the result is divided by the sum of general fund expenditures and transfers out from the prior fiscal year to produce the fund balance percentage. Local governments often compare this percentage to their policy threshold to ensure they maintain a safe reserve level. Setting the threshold typically involves comparing to the average percentage for similar-sized governments and adjusting for unique circumstances. Expressing the measure as a percentage allows for trend analysis and benchmarking over time.

3.4 GAAP Financial Presentation of Fund Balance

The budgetary definition of fund balance differs from the financial reporting definition used under GAAP, as established by the Governmental Accounting Standards Board (GASB) in GASB Statement No. 54, Fund Balance Reporting and Governmental Fund Type Definitions. GAAP classifies fund balance into five categories, which must be evaluated in order:

• Nonspendable
• Restricted
• Committed
• Assigned
• Unassigned

3.4.1 Nonspendable Fund Balance

Nonspendable fund balance represents a portion of fund balance that is either not in a spendable form or is legally required to remain intact. The most common portions of fund balance that are not in a spendable form would be inventory or prepaid assets remaining at the end of the fiscal year. These occur most commonly in the general fund. Amounts legally required to remain intact include endowments or the principal amount of a permanent fund. While uncommon for governmental funds, long-term notes or receivables and property held for resale would also be part of nonspendable fund balance (assuming the proceeds of the collection of the receivables or of the property sale have not been deemed to be restricted, committed, or assigned).

3.4.2 Restricted Fund Balance

In governmental GAAP, the term restricted indicates a limitation imposed by an external party or imposed by law. Examples of external restrictions could include but are not limited to, grants, donations, or debt covenants. Impositions by law most commonly include statutory requirements, constitutional provisions, or enabling legislation (an example of the latter would be a tax or charge authorized by the citizenry). While many of the elements of restricted fund balance may be in a spendable form, the use is limited by the external party or law.

A unique element of restricted fund balance in North Carolina is stabilization by state statute. This calculation is made at the end of the fiscal year and reflects the amount of fund balance that, by state statute, is not available for appropriation. The amount is determined as follows:

Total fund balance – (minus) Available fund balance (see Section 3.2) – (minus) Nonspendable fund balance = (equals) Stabilization by state statute reported as part of restricted fund balance

3.4.3 Committed Fund Balance

Committed fund balance represents the portion of fund balance “set aside” by formal action of the governing board for specific purposes, which is typically defined as the adoption of an ordinance in North Carolina. The action may only be taken by the governing board and must occur before the end of the fiscal year. However, the final amount may not be determined until after the end of the fiscal year. These commitments remain binding until the resources are used for their intended purpose or the governing board takes an equivalent formal action to remove the commitment.

3.4.4 Assigned Fund Balance

Assigned fund balance is intended to represent less formal fund balance designations for specific purposes. Assignments may be determined at any time before the external financial statements are issued. For the general fund, assigning fund balance for these purposes may occur by formal or informal action of the governing board. Alternatively, the governing board may confer the authority to determine assignments, if any, on management. In contrast to committed fund balance, limited or no action is taken to remove an assignment. If the assignment was created formally by the governing board, formal action is required to modify or remove the assignment if such action is taken during the same fiscal year. Otherwise, the assignment automatically lapses at the end of the fiscal year. In any situation, assignments may not create or increase a negative unassigned amount.

It should be noted that the way assignments are reported slightly differs for the other governmental fund types (i.e., special revenue, debt service, capital projects, permanent). Each of these fund types have very specific definitions and purposes. Thus, once nonspendable, restricted, and committed amounts are determined for each of these funds, if any positive amount is remaining, it is automatically assigned to the purpose of that fund type. If what remains is a negative amount, it would be reported as unassigned fund balance.

3.4.5 Unassigned Fund Balance

For the general fund, after the previous categories of fund balance are evaluated and identified, as applicable, the unassigned amount is determined. Whatever amount remains (positive or negative) would be reported as unassigned. However, the negative amount would lessen or eliminate the assigned amount. If there is still a negative unassigned amount after the assigned amount is eliminated, then it would be reported as such.

3.5 LGC Calculation of Available Fund Balance

Each year, local governments must submit audited financial statements to the LGC by December 31. The LGC focuses heavily on the general fund’s fund balance percentage as a key measure of fiscal health. Its calculation differs from the statutory method in Section 3.3 because it uses the GAAP categories from the audited financial statements and subtracts both nonspendable amounts and the restricted “stabilization by state statute” amount from total fund balance before dividing by total general fund expenditures and transfers out. Although the approach is different, the results are usually similar.

The LGC uses this calculation mainly for trend analysis and benchmarking. Instead of grouping local governments by population size, the LGC groups them by average general fund expenditures. Units that fall below 50 percent of the group average fund balance percentage are in the bottom quartile. A unit that stays in the bottom quartile for three consecutive years, with a declining percentage, is at risk of being placed on the Unit Assistance List (UAL). [Chapter 1: Introduction to the Local Government Budget and Fiscal Control Act has additional information on the UAL.] To avoid fiscal distress, the LGC encourages units to adopt and annually review a formal fund balance policy, maintain strong reserves, avoid unnecessary transfers from the general fund to enterprise funds, and comply with the preaudit requirement in G.S. 159-28. These practices help safeguard financial stability and support long-term sustainability.

3.6 Drafting a Fund Balance Policy

A written fund balance policy provides a clear framework for how a local government will manage its reserves. It establishes expectations for governing boards, staff, and the public, and it creates consistency in financial decision-making over time. Rating agencies and lenders often view the existence of a formal policy as a sign of strong fiscal governance.

An effective fund balance policy should:

• State the Purpose – Explain why maintaining fund balance is important for the unit’s financial stability, creditworthiness, and ability to deliver services.
• Define the Target Level – Specify a minimum reserve goal, often expressed as a percentage of prior-year general fund expenditures and transfers out. The target should be based on factors such as cash flow needs, historical revenue volatility, and service obligations.
• Describe How the Target Will Be Maintained – Outline strategies for building reserves (e.g., conservative revenue estimates, budget savings, one-time revenues) and the process for restoring fund balance if it falls below the minimum target.
• Identify Allowable Uses – Describe when and how fund balance may be appropriated, including conditions for using reserves for emergencies, capital projects, or to balance the budget. Clarify that statutory limits on available fund balance for budget appropriation still apply.
• Set Replenishment Requirements – If reserves are drawn down, state how and within what timeframe the balance will be replenished.
• Address Monitoring and Reporting – Require regular reporting to the governing board on fund balance levels, comparisons to policy targets, and explanations for significant changes.
• Include Review and Update Provisions – Commit to reviewing the policy periodically to ensure it remains relevant to the unit’s financial and operational circumstances.

Sample fund balance policies are available under Sample Ordinances and Policies in the Resource List at the end of this publication. Reviewing these examples can help a unit tailor its policy to its specific needs while incorporating best practices.

3.7 Conclusion

Fund balance is more than an accounting figure. It is a measure of financial resilience, operational stability, and public trust. Maintaining healthy reserves allows a local government to navigate the uneven timing of revenues, respond to emergencies without delay, invest in community priorities, and meet statutory requirements for a balanced budget. Understanding the three calculation methods—statutory, GAAP, and LGC—ensures that governing boards and finance officers can view fund balance through multiple lenses: legal compliance, transparent reporting, and comparative analysis. Each serves a distinct purpose, but together they provide the information needed to protect a unit’s fiscal health. By adopting clear fund balance policies, monitoring levels against both internal goals and external benchmarks, and making prudent budgetary decisions, local governments can sustain strong financial positions that inspire confidence among residents, partners, lenders, and rating agencies.