Critique of Valley Hi Surplus Justification Model

I asked for the Excel spreadsheet on which the Valley Hi Nursing Home financial projections presented to the McHenry County Board last Tuesday were based.

After some hesitation, County officials sent the spreadsheet, but with the cells protected.

The cover email from Deputy Administrator Scott Hartman follows:

Attached please find the Valley Hi financial model with the assumption identified.

Valley Hi spreadsheet provided by McHenry County.

Valley Hi spreadsheet provided by McHenry County.

Valley Hi spreadsheet 11-6-15 assumptions
Valley Hi Spreadsheet 11-6-15 Revenues + ExpendituresPlease note that after Tuesday’s presentation, I created a second version (Scenario Graph 2) that pulls the capital and depreciation out of the total expenditure calculation and factors it in separately in the fund balance reserve calculation.

While this does not change the fund balance reserve picture, it does reduce the 12 month operational reserve amount and smooths this line out.

In addition, I created a third scenario calculator that takes depreciation completely out of the equation (tab named ‘Scenario graph (3) – no dep’).

Under this model at the current bed mix and ongoing $2.25M levy, there is a slight increase in the fund balance for the first few years then the fund balance declines due to deficit operations coupled with capital projects.

Interestingly, this holds true at the current bed mix (80 Medicaid / 20 private / 20 Medicare/ 8 undesignated) and case mix scenario 5 (increase Medicaid by 5, reduce private pay by 5).

If other case mixes that are primarily Medicaid are run, the fund balance draws down each successive year.

Fortunately, Lakewood bond analyst Steve Willson is used to getting protected financial documents and knows how to access the formulas used.

Steve Willson’s Analysis

Valley Hi Deputy Administrator Scott Hartman put together a series of slides showing the projected decline in the fund balance at Valley Hi over time.

At that time, no explanation of the assumptions underlying the slides was presented. This made it impossible to challenge the accuracy of the projections.

Mr. Hartman subsequently provided the following spreadsheet with the financial projections that underly his graphics. The Valley Hi financial projection table is shown below:

Valley Hi Willson 1 11-15-15

Note that in this financial “projection”, fees and charges for service remain flat, with no adjustment for inflation.

The notes to the spreadsheet state that personnel expenditures are projected to increase 3.5% annually.  However, they actually shoot up 8.7% in 2015 without explanation.  Increasing this expense sharply in the first year affects all the later years significantly.

Other expenses increase 2.8% annually.

Capital outlay suddenly jumps from $40,000 in 2014 to $424,000 in 2015 to $1.2 million in 2016.  They then drop, but in 2021 and beyond, they suddenly jump to $1 million a year again, without explanation.

Surely major capital expenditures are subject to board approval and cannot simply be projected without evidence of need.


The bottom line is that if you make a model in which you assume revenues remain flat and expenditures shoot up sharply, of course you will show a deficit.

The point of such an exercise is, however, to DOCUMENT such projections, not simply to present graphs without explanation, and then to present spreadsheets with no evidence to support the inputs.


Now let us turn to the second issue, the proper size of the fund balance.

Steve Willson

Steve Willson

Valley Hi asserts that it “needs” a 12 month operational reserve and a $6 million capital and indemnity reserve.

So far this has been pure assertion, meaning no proof has been provided.

However, as the Illinois Supreme Court opined in 1955:

“The authority to levy a tax for building purposes is intended to provide for the needs of the ensuing year and not to provide a fund for possible future needs.”

To understand the proper size of the fund balance, it is necessary to understand what it is and why it exists.

What is a fund balance?

A fund balance is nothing more than excess tax collections, that is, the accumulation, over the years, of annual surpluses.

But it is not the purpose of governments to run continuous surpluses.

To do so is to over tax.

In a perfect world, governments would levy the exact amount they need and incur neither a surplus nor a deficit each year. In the real world, there is some unknown variability in both the timing and amount of revenues and expenditures.

So governments will in some years achieve surpluses and then, purposely, incur deficits to draw down the surplus.

Thus, over many years, the aggregate revenues will very closely equal the aggregate expenditures.

All the time the government will maintain a reasonable fund balance.

So what is a reasonable fund balance?

Understanding what a fund balance is leads directly to the objective method for determining the proper size for a fund balance.

As the purpose of the fund balance is to provide seasonal liquidity plus a modest margin for variability, the objective method for determining how large a fund balance is to determine the larges deficit incurred during the year, that is, the largest difference, on any given day, between revenues and expenditures.

To this is added a modest amount for safety’s sake.

Valley Hi Nursing Home fund's cash on hand from FY 2006 through FY 2016 (projected).

Valley Hi Nursing Home fund’s cash on hand from FY 2006 through FY 2016 (projected).

Even this amount can be reduced if it is determined that a seasonal line of credit is cheaper than allowing money to lie fallow for much of the year.

So a proper analysis examines the average difference during the year.

It should be noted that Moody’s Investors Service believes that a fund balance of 8.5% (one month’s expenditures) is sufficient for most governments.

And please note that Moody’s is watching out for lenders, not taxpayers.

Most governments, including municipal utilities, maintain modest fund balances, in keeping with what Moody’s deems sufficient.

Most governments determine the proper fund balance using the method described above.

As most of Valley Hi’s operating revenues are collected on a monthly basis, and most of its expenses are paid on a monthly or bi­weekly basis, and as for many years operating revenues at Valley Hi were approximately equal to expenditures, the proper fund balance should equal a small fraction of one year’s expenditures.

Valley Hi should provide the data necessary for the exact calculation.


Finally, as is often the case, answers beget questions.

Valley Hi has put forth the proposition that it is facing substantial deficits in future years because of reductions in Medicare and Medicaid.

But their own historical figures, plus their own projection for fiscal year 2015 and their budget for fiscal year 2016 refute that contention.

Please look at the table below:

Cash flow for the Valley Hi Nursing Home.

Cash flow for the Valley Hi Nursing Home.

This table shows revenues and expenditures at Valley Hi since fiscal 2012. It includes the projection for the current fiscal year, which will end November 30, and the budget for fiscal 2016.

All of these figures are taken from official County budget documents.

Note that intergovernmental revenue actually INCREASES in both fiscal years 2015 and 2016.

This is contrary to the statements that decreases in revenue from Medicare and Medicaid will be the cause of operating deficits at Valley Hi.

Note further that after years of increases, fees and charges suddenly turn down sharply in fiscal 2015 and 2016.

In other words, Valley Hi has suddenly become much worse at collecting fees from residents.

And, of course, any reduction in collections from residents of Valley Hi must be made up from property taxes.

These figures not only rebut the statements that future budget problems stem from reductions in revenues from the state, but they raise the question as to why Valley Hi is suddenly unable to collect as much as it has in prior years.

It should be noted as well that the figures used in Valley Hi’s projections differ significantly from official figures in their budget documents, and without explanation= 


Critique of Valley Hi Surplus Justification Model — 2 Comments

  1. What doesn’t make sense to me is the inclusion of Depreciation expense in the forecast of future fund balance.

    Depreciation is a non-cash charge amortizing the cost of a capital expenditure over the useful life of that asset.

    I know in school district financial reporting, depreciation does not affect fund balance.

    Rather, fund balance is reduced immediately, at the time the capital expenditure is made.

    This analysis is essentially double-counting.

    It reduces fund balance when the capital expenditure is made and then a second time through the recognition of depreciation expense over time.

    The $513k in annual depreciation expense needs to be removed from this analysis, which means the 2023 fund balance is actually $4 million higher than presented.

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