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Illinois School Board Journal
May/June 2004
'Watch lists' to profiles: How Illinois reviews school district finance
by Brad Colwell
Brad Colwell is an associate professor, Department of Education Administration and Higher Education, and director of graduate studies at Southern Illinois University, Carbondale.
It is that time of year again - time when the Illinois State Board of Education (ISBE) announces the financial condition of the 893 local school districts in Illinois. Still commonly referred to as the "Financial Watch List," the system of financial accountability that started in 1981 has evolved, and in 2002 ISBE adopted a new system of financial accountability - the Financial Profile System.
Reviewing the evolution of the Financial Watch system and exploring the new Financial Profile System will help school board members and superintendents know how these lists are generated and what each designation means.
History of financial review
Currently, the state has a two-tiered approach to monitor the financial condition of local Illinois school districts: the Financial Profile System and the more serious process of certifying a district to be "in financial difficulty" pursuant to Article 1A-8 of the School Code. However, it has not always been that way. A brief review of the origin of the state's involvement is helpful to clarify how Illinois derived its present system of financial oversight.
In 1981, the state officially became involved in the review of school district finances. It was then that the Illinois General Assembly enacted a law granting the state board the power to monitor the financial health of all public school districts as well as certify districts "in financial difficulty" in accordance with the School Code. (See "What constitutes 'in financial difficulty'?" on page 33f)
In 1985, ISBE started sending letters notifying a school district of potential financial difficulty if its Operating Fund balances-to-revenue ratio was minus-10 percent or lower. The state board offered technical assistance to those districts in hopes of avoiding being certified as "in financial difficulty."
Three years later, in an attempt to heighten district accountability, ISBE started providing the media a list of school districts whose Operating Fund balances-to-revenues ratio was plus-5 percent or less (based on the previous year's Annual Financial Report). This published list of school districts was formally termed the "Financial Watch List."
During that same year, ISBE certified 16 school districts as being "in financial difficulty" according to Section 1A-8. Over the next few years, however, it became apparent that only using one indicator (Operating Fund balance-to-revenue ratio) was not a perfect model for identifying schools with financial hardship.
Adjusting the system
In 1996, ISBE attempted to address the weaknesses of the Financial Watch List when it adopted the Financial Assurance and Accountability System (FAAS). This system provided an expanded framework to analyze, review and monitor all school districts' finances and to alert district officials of potential financial problems. Like the previous system, the FAAS continued to use the same single indicator - fund balance-to-revenue ratio - to determine whether a school district was in a critical financial situation.
Five fund balances from the previous year's annual financial report were included in the calculation: Educational, Operations & Maintenance, Transportation, IMRF and Working Cash funds. (The IMRF fund was removed from the calculation in 2001.) Depending on the resulting fund balance-to-revenue ratio, ISBE classified every Illinois school district into one of the following five levels of financial classification, or "bands":
1. Financial Recognition: ratio greater than plus-10 percent.
2. Financial Technical Assistance: ratio between 0 to plus-10 percent.
3. Financial Watch List: ratio less than 0 percent, or those districts that issued teacher's order (bonds) in three of the last five years, issued second-year tax anticipation warrants/notes, or did not annually submit the AFR to ISBE in a timely manner.
4. Financial Certification: those districts on the Financial Watch List are evaluated for Financial Certification under Section 1A-8 if: the district appeared on the Financial Watch List for two or more years and had a current-year ratio of minus-10 percent or less, issued teacher's order (bonds) in three of the last five years, issued second-year tax anticipation warrants/notes, and carried an operating fund balance of minus-20 percent or less.
5. Financial Oversight Panel: those districts that met the criteria for Financial Certification and petitioned for Emergency Financial Assistance or failed to comply with its approved plan.
Additionally, the FAAS expanded the state's role in monitoring school district finances as well as providing technical assistance to those districts in need.
Current system
Starting in 2003, the state board adopted the present system to assess school districts' financial health: the Financial Profile System. This measurement replaced the FAAS with a comprehensive methodology to more accurately portray school district finances and assess school districts in danger of financial difficulty. Specifically, the Financial Profile System increased the number of indicators ISBE reviews from one to five, keeping the fund balance-to-revenue indicator and adding four others:
• Fund balance-to-revenue ratio
This is the previous indicator carried over from the old FAAS system. It is the result of dividing the ending fund balances by the revenues for the four operating funds (Education, Operations & Maintenance, Transportation and Working Cash funds). Further, any district with a negative IMRF/FICA fund balance will be deducted from the total balance of the four operating funds. This indicator comprises 35 percent of the composite score.
• Expenditure-to-revenue ratio
This indicator determines a district's expenditure for each dollar it receives. It is calculated by dividing the total expenditures for the Educational, Operations & Maintenance, Transportation and Working Cash funds by the revenues for each of those funds. If there is deficit spending, there will be a review of the fund balances to determine whether the district has adequate fund balances to sustain their operation. This will minimize being penalized for one-time expenditures, such as construction projects. This indicator comprises 35 percent of the composite score.
• Days cash on hand
This indicator projects the number of days a district could meet its operating expenditures without receiving additional revenue. It is calculated by obtaining the average expenditures per day of the Educational, Operations & Maintenance, Transportation and Working Cash funds, then the total cash and investments for these same funds are divided by the average expenditures per day. This indicator comprises 10 percent of the composite score.
• Percent of short-term borrowing remaining
This indicator measures the total short-term borrowing allowed by law minus the percent of tax anticipation warrants outstanding. It is computed by taking the sum of unpaid Tax Anticipation Warrants and dividing it by 85 percent of the Equalized Assessed Valuation (EAV), multiplied by the sum of the tax rates for the Educational, Operations & Maintenance and Transportation funds. This indicator comprises 10 percent of the composite score.
• Percent of long-term debt margin remaining
This indicator evaluates the long-term debt for major expenditures, such as new construction. This figure is determined by multiplying the district's EAV by its maximum general obligation debt limitation, minus any outstanding long-term debt. This indicator comprises 10 percent of the composite score.
For each indicator, the state board reviews the data from every school district and determines the range of scores. Once the range is established for each of the five indicators, each district's score for that indicator is weighted on a four-point scale [1.0 (low) to 4.0 (high)]. The sum of the weighted scores for the five indicators determines the school district's overall (composite) score.
Under the Financial Profile System, a school district will be placed in one of four categories based on its composite score. These four designations are listed in numerical order from lowest to highest risk of financial difficulty:
1. Financial recognition: The rating for a composite score between 4.0 and 3.54. This is the highest possible rating and involves minimal or no review by the state board unless it is requested by the school district.
2. Financial review: The rating for a composite score between 3.08 and 3.53. This next highest category involves limited ISBE review, including monitoring for downward financial trends. ISBE also will review the budget adopted for the next school year.
3. Financial early warning: The rating for a composite score between 3.07 and 2.62. A district with this classification will be monitored carefully by ISBE, including assistance regarding cash flow analysis and financial projections. In addition, ISBE will review the district to see if it meets the criteria listed in Section 1A-8 to be certified "in financial difficulty" and possibly qualify for a Financial Oversight Panel.
4. Financial Watch: The rating for a composite score between 2.61 and 1.00. This means the district has a high risk of financial hardship. ISBE will closely monitor a district receiving this classification and will provide technical assistance that includes enrollment projections, cash flow analysis, and guidance with budgeting and personnel issues. The state board also will review these districts to see if they meet the criteria listed in Section 1A-8 to be certified "in financial difficulty" and possibly qualify for a Financial Oversight Panel.
Based on FY 2003 AFR data, the March 2004 Profile data released by ISBE indicated that 156 Illinois school districts were placed on the Financial Watch category, the most dire of the four financial categories. This category increased by 69 school districts from the 2003 Financial Profile. Moreover, the 296 school districts in the bottom two classifications comprise 33 percent of all Illinois school districts, up 8 percent from the 2003 report, while the best category (financial recognition) experienced a decrease of 75 school districts (8 percent decline).
What constitutes 'in financial difficulty'?
The Illinois General Assembly gave the Illinois State Board of Education the power to certify that a school district is "in financial difficulty"(105 ILCS 5/1A-8). According to the law, a school district may be certified to be "in financial difficulty" if any of the following conditions existed:
ISBE will monitor each district to measure compliance with their approved plan. In addition, the state board may also request financial data and make recommendations to ensure compliance with the plan. If ISBE determines that a district has failed to comply with its financial plan, that board may rescind approval of the plan and appoint a Financial Oversight Panel (105 ILCS 5/1B).