Finance Unpacked is a series of animated explainer videos to provide councillors and officers with an understanding of some of the key concepts within local government finance and audit.
The videos can be used to support learning and development for those new in role or as a refresher on key topics. It will be of particular relevance as a resource for new councillor induction programmes.
What are the differences between revenue and capital expenditure and income?
A council’s outgoings in any given year are split between revenue expenditure and capital expenditure.
Councils need to demonstrate a clear separation between capital and revenue expenditure in their financial reporting. Understanding why these two types of expenditure are different is vital for managing council finances effectively. Let’s look at them in a bit more detail.
Revenue expenditure is the council’s day-to-day expenditure. It includes salaries, running costs like utility bills, payments to contractors for the delivery of services, such as social care, and provision for repaying debts. As a rule of thumb, if expenditure is budgeted for and spent within one year, then it’s known as revenue expenditure.
Normally, revenue expenditure can only be funded through revenue income. Revenue income includes revenue grants provided by central government; business rates and council tax; charges for services, like parking fees or client social care contributions; and income from investments.
Capital expenditure is money spent on purchasing new assets – such as land, buildings or vehicles – or on improving existing council assets, for example, refurbishing existing buildings. As a rule of thumb, if money is spent on something that will provide benefit over more than a year, then it is capital expenditure.
Capital expenditure can be funded in various ways: through capital grants; through proceeds from the sale of other assets, known as ‘capital receipts’; through borrowing; or from developer contributions (that is, money paid by developers to improve local infrastructure). Capital expenditure can also be financed by revenue income.
However, councils are generally not allowed to use any capital income to fund their revenue expenditure. For example, a council could purchase new land using revenue income such as council tax, but selling land and using the proceeds to pay an officer’s salary would not be allowed.
To watch more, visit local.gov.uk/finance-unpacked
Local funding: Understanding council tax and business rates
A large part of council revenue comes from locally sourced funding such as council tax and business rates. It’s a complex system but vital for financing local services.
The Valuation Office Agency determines the property valuations, which are used in setting council tax and business rates.
Council tax valuations are set at 1991 levels, while business rate valuations are reviewed at regular intervals, decided by central government. Council tax is levied on residential properties, which are grouped into valuation bands from A to H.
A local authority’s basic rate of council tax must be agreed by 11 March each year with full council approval required. All council tax revenue is retained locally.
Since the 2011 Localism Act, authorities cannot raise council tax beyond government-set thresholds without holding a public referendum.* There are exemptions and discounts for some council taxpayers, such as single occupants, students, and those on low-incomes. Some council tax schemes are set nationally while others are decided locally.
The proportion of overall revenue raised from council tax varies from one local authority to another, partly depending on the make-up of properties in a local area.
Bodies who don’t collect their council tax revenue directly are referred to as ‘precepting authorities’. Authorities who collect council tax on behalf of themselves and for the precepting authorities, are referred to as ‘billing authorities’. These include district, metropolitan, and unitary councils.
Business rates are the other major source of locally collected revenue. They apply to commercial properties, with the rate set centrally by government as a multiplier applied to property’s rateable value.
Some properties – such as charities or small businesses – qualify for reliefs. Some relief schemes are set nationally, while others are agreed locally.
In most areas half of business rate revenue is retained locally, with the other half passing to central government for redistribution through grants. However due to variations in relative resources and ‘needs’ between authorities, a mechanism of tariffs and top-ups is then applied by central government to redistribute the local share of business rates across councils to make the system fairer.
Under the ‘Business Rates Retention’ scheme introduced in 2013 councils are also allowed to retain a proportion of any new income above an agreed baseline.
To watch more, visit local.gov.uk/finance-unpacked
[*The Government may give specific councils special dispensation to increase council tax above the ‘standard’ threshold in any given year if there are exceptional circumstances.]
How do government grants work?
Grants from central government are an important source of income to most councils.
Each council’s budget will have a different balance between grant funding and other sources of income, such as council tax and business rates. That balance is affected by local policy decisions, among other factors.
Government grants fall into two categories: Revenue grants are used to cover the day-to-day costs of local services, such as the delivery of services and contract payments. Capital grants are provided for long-term investments. They’re often ‘one-off’ grants awarded for specific projects, for example, building roads, schools, or other public buildings.
The distribution of grants across councils is usually determined by central government. The way it’s calculated may depend on factors such as local population size, assessed local needs, and current government policy. Certain grants – often for capital projects – are allocated based on bids made by councils.
Grants may be ring-fenced, such as the Public Health Grant, or the Dedicated Schools Grant, meaning that the funds must be used for specific purposes and may have to be returned if not fully spent. In cases where grants are not ring-fenced, the council has flexibility in how they decide to spend the funds.
The Local Government Financial Settlement normally sets out the major grant allocations to enable councils to set their budgets for the year ahead. Some grants may be announced separately, outside of the settlement process.
To watch more, visit local.gov.uk/finance-unpacked
How are local government budgets set and monitored?
A council's financial year runs from 1 April to 31 March. A council must consider and approve its budget for the financial year ahead prior to 11 March. As part of this process, the council will also set the level of council tax for the next financial year.
The budget is proposed to the council by the executive or relevant committee, often after scrutiny by other committees.
It’s a legal requirement for the revenue budget to be ‘balanced’, which means that all budgeted spend must be funded. The Chief Finance Officer has statutory responsibility to report on the robustness of the budget process and the adequacy of financial reserves.
The budget will also set out the council’s capital spending plans.
There is a requirement to produce a separate annual capital strategy and treasury management strategy, which link to the cash requirements of the budget and set the council’s limits on borrowing.
It’s good practice for councils to approve a medium-term financial plan covering a period of three-to-five years ahead. This planning is important to ensure long-term financial sustainability.
Throughout the financial year, the council’s executive or relevant committee should receive regular budget monitoring reports. These reports will set out how actual spend compares to budgeted spend, explain any variations, and recommend mitigating actions if required.
At the end of each financial year, a comprehensive set of financial statements will be produced to ensure public accountability for the use of public money. These statements are produced in accordance with international accounting standards and other relevant professional guidance, so they look different to the financial monitoring information provided throughout the year.
The financial statements also include other supporting information, such as a narrative statement, which provides context to the numbers.
To watch more, visit local.gov.uk/finance-unpacked
Why are reserves and balances in local government important?
Any council funds which aren’t allocated for short-term spending are known as reserves and balances. They’re a particularly important tool in managing council finances, because councils are not allowed to borrow to balance their revenue budgets.
In a similar way to a household savings account, reserves can only be spent once, so councils need to have clear policies in place for approval of any reserve spending.
As part of every annual budget cycle, the Chief Finance Officer must review all reserves and balances, and make sure they’re at appropriate levels.
Reserves can be called on to balance a budget in any given year. However, this can be a sign of financial distress, as it’s not usually sustainable over the longer-term. Use of reserves to balance the budget should, therefore, be considered carefully before approval.
Reserves can be split into three main categories: unallocated reserves, or general balances, can help to smooth uneven cash flows, and act as contingency funds to cover the impact of unexpected events. There’s no legislation dictating what proportion of a council’s budget needs to be held as a general working balance. The level is recommended by the Chief Finance Officer, and should reflect the level of financial risk that the council faces. Smaller authorities may hold a higher percentage of general balances compared to their net revenue budget.
Earmarked reserves are funds set aside by an authority for specific purposes, such as to mitigate known risks, or to build up funds for planned future expenditure, for example vehicle replacement. Earmarked reserves must always have their purpose clearly described.
Some councils also hold reserves on behalf of their schools, or for public health. These can only be spent on the specific services they are assigned for by government and are examples of what are known as ring-fenced reserves. Some reserves are unusable as they are ring-fenced by accounting practice or statute and do not represent cash available to spend on general services, for example the pension reserve.
To watch more, visit local.gov.uk/finance-unpacked
Understanding the legal framework for local government finances
It’s important to understand the legal framework that governs a local authority’s financial affairs. Here are the key pieces of legislation you should be aware of.
The Local Government Act 1972
Section 151 of this Act says that "every local authority must ensure the proper administration of their financial affairs". It also requires that a specific named officer has overall responsibility for the administration of those affairs.
That’s why the Chief Finance Officer of a local authority is sometimes known as the ‘Section 151 officer’.
The Local Government Finance Act 1992
This Act gave councils the ability to raise council tax and business rates locally, although central government still regulates these at a national level.
The Local Government Finance Act 2003
This Act allows councils to borrow money, placing trust in local government’s ability to manage its own financial affairs. It’s supported by the ‘Prudential Framework’, which helps a council to determine how much borrowing is prudent and affordable locally.
The Localism Act 2011
This Act introduced a council tax increase ‘cap’, which is set by central government every year. A council can only exceed a certain percentage increase in council tax by holding a local referendum.*
To encourage innovation, the Act also granted a ‘general power of competence’, which gives councils the legal capacity to do anything that’s not specifically prohibited in other legislation.
Accounts and Audit Regulations 2015
These regulations include the requirement for every council to prepare annual financial statements in accordance with proper accounting practices, which should include a narrative statement commenting on the council’s financial performance.
An Annual Governance Statement, which summarises the governance arrangements of the council, must also be published every year.
Councils have a responsibility to open their annual financial statements for a period of public consultation before they’re approved by full council or a delegated committee.
Councils also have a duty to publish their final annual financial statements, along with any external audit opinion on these, by a specified date, or provide an explanation if they are not able to do so.
To watch more, visit local.gov.uk/finance-unpacked
[*The Government may give specific councils special dispensation to increase council tax above the ‘standard’ threshold in any given year if there are exceptional circumstances.]
What does 'financial sustainability' mean in local government?
For any council, financial sustainability is of the utmost importance. Put simply, it means being able to continue to pay for the delivery of essential services over the longer-term.
Some of the key elements needed to underpin financial sustainability are: a balanced revenue budget for the year ahead, without relying on one-off reserves, and sufficient reserves and balances to safeguard against future financial risks.
Other key elements are a medium-term financial strategy covering a period of three to five years – which links to the council’s priorities, and considers external factors such as inflation, government funding and demographic changes – and regular financial reporting, scrutinised by officers and councillors, with a commitment to taking mitigating actions early, to address any overspends.
It is also important to demonstrate a commitment to achieving ‘best value’ by continuously improving the efficiency and effectiveness of council services, and identifying where savings could be made; and to undertake a regular review of all available income streams, including fees and charges; and ensure strong and transparent financial governance arrangements are in place.
There are several roles that are key to ensuring ongoing financial sustainability: The Chief Finance Officer has a legal duty to ensure a balanced budget is set, advise the council on a suitable level of reserves and balances, and report on any financial risks.
The Audit Committee must review the council’s financial statements, supervise risk management arrangements, and ensure that sound internal controls are in place.
External auditors provide an independent opinion on the financial statements and review the value for money achieved by the council in its provision of services. If they believe a council’s financial position is unsustainable, they must report this.
And it’s important to remember that the ultimate responsibility for ensuring financial sustainability rests with all councillors, as part of Full Council.
To watch more, visit local.gov.uk/finance-unpacked
What does 'value for money' mean in local government?
Achieving good value for money is crucial in any council. It means, simply, delivering the intended outcomes through the optimal use of resources. It’s not just about minimising cost. It’s ensuring economy, efficiency, and effectiveness.
Economy means looking at the cost of providing services – are resources being secured at the lowest possible price?
Efficiency means looking at productivity - are resources being converted into the required services in an effective way?
Effectiveness means looking at the impact of the service - how well does it achieve the required outputs and objectives?
Under the 1999 Local Government Act, local authorities have a legal duty to deliver best value. This means that a council must have arrangements in place to secure continuous improvement - particularly in the key areas of delivering a balanced budget, providing statutory services, and securing value for money in all spending decisions.
Local authorities must have appropriate internal controls in place to support the achievement of best value. And all councils have a responsibility to report on these arrangements, as part of their Annual Governance Statement. Auditors also have a responsibility to report on the arrangements to secure value for money that are in place. If external auditors identify any significant weaknesses in these arrangements, they must report these and make recommendations for improvement.
Any significant weaknesses will be reported by exception within their Auditor’s Annual Report.
To watch more, visit local.gov.uk/finance-unpacked
What are the roles and responsibilities of internal and external audit?
Council finances and governance arrangements are complex and by law must be subject to independent review by internal audit and external audit.
Internal audit
A council may have its own internal audit department or use a private audit firm to deliver its internal audit services.
Internal audit’s role is to provide assurance to councillors and officers that the council’s internal control processes and procedures operate in an effective and efficient manner.
The head of internal audit will report regularly to the council’s Audit Committee. This will include agreeing a risk-based annual audit plan at the start of the year, reporting regular progress reports against the plan during the year, and delivering an annual audit opinion at year-end.
Internal audit’s detailed audit findings and recommendations will be shared and discussed with the responsible officers, before being reported to the audit committee.
External audit
A council must procure its own external auditor. This may be done as part of a joint exercise through a central body.
The responsibilities of external audit are to: give an opinion on whether the council’s annual financial statements provide a true and fair view of the council’s finances; give an opinion on whether the council has made proper arrangements for securing economy, efficiency and effectiveness in its use of resources; give electors the opportunity to raise questions about the council’s accounts and consider and decide upon objections received in relation to the accounts; if required, apply to the court for a declaration that an item in the accounts is contrary to the law.
As part of this work, the external auditors must satisfy themselves that the council’s governance and internal control systems are sound. Senior representatives of the external auditors should regularly attend the council’s Audit Committee and will share their audit plan as well as their audit opinion, findings and recommendations in the form of an annual audit letter.
To watch more, visit local.gov.uk/finance-unpacked
What are the roles and responsibilities of the Audit Committee?
An Audit Committee may be known by a few different names, but its job always remains the same – to provide independent assurance to the council. Assurance on the adequacy of the risk management framework, the internal control environment; and the integrity of financial reporting.
The Audit Committee plays an important role in setting the tone of governance throughout the council. If the committee has concerns, they have the power to make recommendations to councillors, or officers.
To ensure compliance, it’s the job of the Audit Committee to oversee internal and external audits, reviewing plans and reports to ensure sound internal controls are in place; and ensure that the council has a comprehensive set of procedures and rules, such as financial regulations and risk management policies.
It is also the job of the audit committee to approve the annual financial statements, which the council must prepare in compliance with relevant statutory guidance and professional codes of practice; and review and scrutinise the annual governance statement. This is a statement that is signed by the Leader of the council and the Chief Executive. It summarises the outcome of a review of the effectiveness of the council's governance arrangements, and includes an action plan for any improvements that are judged to be needed.
An Audit Committee usually includes a mix of councillors and independent members. Because a lot of the work of the committee is technical and complex, independent members can have an important role to play in helping to consider governance issues in detail.
The Chief Finance Officer will also often offer briefings on the financial statements to aid interpretation for committee members.
To watch more, visit local.gov.uk/finance-unpacked
What is a Housing Revenue Account (HRA)?
Many district, unitary, or metropolitan councils directly provide housing in their local area, making them local housing authorities.
Any local housing authority that owns 200 or more dwellings is required to manage their finances through a Housing Revenue Account, often referred to as the HRA.
The HRA is used to record expenditure and income related to running a council’s own housing stock and related services and facilities.
The main items of expenditure will include housing management and maintenance costs, major repairs, loan charges, and depreciation costs.
The main sources of income include the rents and service charges paid by tenants. Council tax and business rates are not used for HRA funding.
Legislation prescribes how HRAs must be managed.
An HRA is a specific ring-fenced account for transactions relating to local authority housing within an authority’s General Fund which is used to finance other council services. This ring-fencing means that it’s illegal for a council to subsidise any of its general fund activity from its HRA, or vice-versa.
Most HRAs have their own capital programme, which reflect the specific maintenance and development responsibilities of the council as a domestic landlord. The HRA capital programme is financed separately, but any borrowing must be in line with the Prudential Code, to ensure it is prudent and affordable, as would be the case for General Fund borrowing.
A council’s annual Financial Statements will include a separate HRA account if appropriate, which shows the annual cost of providing housing services. It’s important to be aware that the core financial statements include both General Fund and HRA transactions.
The statements will also include several notes detailing financial and non-financial information relating to the HRA, for example, the number and types of dwellings making up the housing stock, their value, and the current level of rent arrears.
To watch more, visit local.gov.uk/finance-unpacked
