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Unsustainable drain on operating reserves for Greenway leaves no room for error

Updated: Dec 16, 2022

Operating reserves are unlikely to recover the $2+M drain until at least 2030.

With the posting of the proposed 2023 Kennett Township Budget, residents now realize that Kennett Township wants to hike property taxes by 20% in 2023. Few probably realize, however, that this hike masks a much larger proposal to draw more than $3,600,000 from its reserves to pay construction costs for the 1.4 mile Chandler Mill Trail (CMT) section of the struggling Kennett Greenway, effectively draining these reserves bone dry. Even Finance Director Amy Heinrich acknowledges that "Further prioritization or additional grants/funding sources will be needed to reduce draw on reserves"(p.25).

In this post, we dig deeper into the $2,000,000 Kennett proposes to drain from its operating reserve, 85% of which is for CMT, and the tremendous pressure that this may well place on Kennett’s budgeting through at least 2030. These expenses are summarized in Figure 1, with the focus of this post - on operating reserves - outlined in blue. As we detail below, this budget leaves little room for reserves to cover projected increases in expenses in key areas of operations totaling almost $1,500,000 in 2024 and 2025, at the expense of community operations and essential infrastructure. This is especially worrying given how vulnerable Kennett's revenue sources are to economic downturns, and the fact that operating expenses appear likely to rise at twice the rate of operating revenues.

This post complements existing posts detailing how other expenses that will drain Kennett's operating operating revenue will ensure that the tax hikes are permanent, and how Kennett proposes to draw more than $1.5M from open space funding to defray CMT costs, as well as a future post on the continued failure to adequately fund a capital reserve to ensure maintenance of key infrastructure. The sums listed in Figure 1 represent direct costs to Kennett taxpayers after state grant funding has been applied, and after other operating and capital expenses that have been budgeted are accounted for. In sum, even after its 20% tax hike, Kennett will have virtually no operating revenue (i.e., less than $16,000) available to pay for CMT after covering other expenses. That is why Kennett must “borrow” 99% of the cost of the Greenway from its operating, capital, and open space reserves.

So what is an operating reserve, and why do companies, governments and non-profits need one? This definition developed for non-profits applies to many organizations; an operating reserve is "an unrestricted fund balance set aside to stabilize an (organization's) finances by providing a cushion against unexpected events, losses of income, and large unbudgeted expenses". In fact, we can observe how each of these contingencies added up to at least $750,000 in 2022 by comparing the proposed to the actual 2022 budget.

  • Unexpected expenses: About $280,000 for the Police, and $40,000 in unexpected Fire/EMS expenses (see p.13).

  • Unbudgeted expenses: About $280,000 in administration expenses (most of which was due to the “ethics review” of concerns centered around the conflicts of interests of Township manager Eden Ratliff)

  • Loss of income: A $40,000 shortfall in revenues (see p. 4)

How much does a township need to ensure that it has the cash flow to cover all of its bills (see p. 25) while providing a cushion for these other contingencies? There is no hard and fast rule, but most organizations would consider an operating reserve comprising 3-4 months annual operating expenses to be the absolute minimum. With operating expenses of about $6.8M in 2023, Kennett should therefore keep at least $1.7M-$2.2M in an operating reserve. Given that Kennett needed to cover $750,000 of unplanned expenses and lost revenue in 2022, it appears extremely unwise to allow operating reserves to dip below the higher amount of $2.2M.

Kennett's "operating reserves" of $4.4M at the beginning of 2022 might appear healthy, but this is deceiving because Kennett has for years failed to set aside funds for capital expenses (discussed in a separate post) and projects like the Greenway. The result? Operating reserves are rapidly drained as portions of the Greenway are constructed, with Kennett drawing down $401,132, then $1,562,200, and finally $331,837 in 2023, 2024, and 2025 respectively. By the end of 2025, Kennett is left with an operating reserve of just $2,164,200, barely 28% of its annual operating expenses.

So why else should we be worried about Kennett's plan to draw operating reserves down to levels that many would agree are unacceptable?

  • About 2/3's of Kennett's revenue (Earned Income Taxes, Real Estate Transfer taxes, and grants) would be the first casualties of an economic downturn. Consider the difference in these three sources between 2020 during COVID (totaling about $3.5M) and one year later (totaling about $4.5M) as the recovery took shape. This plan leaves Kennett little room to deal with a recession

  • Kennett has already taken a hard look to cut expenses in key areas over the past several years. There are unlikely any easy cost reductions left.

But perhaps we should be most worried about projections that costs will increase at twice the rate as revenues in 2024 and 2025. Consider the figure below, including 6 of the key categories that together comprise about 80% of operating expenses (administration combines administration and Finance/HR expenses). We tracked actual budget expenses in these categories from 2020 through 2022, added the 2023 budget, and then used these data to project forward for 2024 and 2025.

This makes it clear that there is every reason to expect expenses to increase, at an average annual rate of 15%. In fact, the increase in costs for 2024 and 2025 alone add up to almost $1,500,000! This also reveals how support for key community partners and updates to the Township building has stagnated despite the evidence of increased need.

Will the revenues keep up, even without a recession? We do not think so. Using the same methods, we project that total revenues (about 90% of operating revenue) will increase by an average of 7% in 2024 and 2025 (we excluded grants because many of these are not for operations but for trails and infrastructure). Assuming that these trends continue, we can reasonably project an operating shortfall of about $400,000 in 2024 and again in 2025. And what recourse would Kennett have to make up this shortfall? Another 20% increase in property taxes would do the trick.... In this context, we think that drawing down on operating reserves will put Kennett in a precarious position, even before considering the backlog in infrastructure costs (discussed next).

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