Part 7: Analysis of the audited financial statements

7.1
In this Part, we discuss our analysis of what the audited financial statements can tell us about the financial health of central government entities and their ability to deliver on their objectives.

7.2
The analysis used information presented in the financial statements of the parent entity to better understand the adequacy and alignment of the entities' financial resources – a fundamental component in the ability of public entities to deliver on their objectives.

7.3
We carried out this analysis for all CRIs and all government departments. For Crown entities, we excluded DHBs and schools because they will be the subject of forthcoming separate reports that will feature a similar analysis of their financial statements. We included the largest of the remaining Crown entities (about 70% of those remaining). Because of the nature of their activities, we have also excluded entities whose activities have a significant financial services element (such as the Accident Compensation Corporation, the Reserve Bank of New Zealand, and the New Zealand Superannuation Fund).

Overview of government expenditure

7.4
Public entities have been operating in an environment of financial constraint for a number of years, particularly since the global financial crisis in 2008. The growth in total operating revenue and in operating and capital spending has slowed significantly since 2007. In recent years, these amounts have actually declined.

7.5
These trends have meant that the need for financial restraint has changed not only the way that entities are working (doing more with less) but also the structure of central government activities.

The financial health of central government entities

7.6
Our analysis covered the main groups of central government entities (Crown entities, government departments, and CRIs). We have analysed data from seven years of audited financial statements.

7.7
To consider the financial health of the entities, we assessed the:

• ability to operate as planned. This relates to the stability of entities' services. We examined the relationship between planned expenditure and actual expenditure for operational and capital spending. We also examined the likelihood of entities spending more than they receive;
• ability to manage uncertainty. This relates to the resilience of entities' services. We examined the ability of entities to cover their current liabilities and adjust their operations in times of change; and
• ability to invest for the future. This relates to the sustainability of entities' services. We examined the general level of expenditure on capital assets and the level of total liabilities the entity is responsible for.

7.8
Figure 21 summarises the accounting relationships we analysed to better understand the financial health of public entities.

Figure 21
Accounting relationships examined to better understand the financial health of public entities

Ability to operate as planned (stable services)	Ability to manage uncertainty (resilient services)	Ability to invest for the future (sustainable services)
Variance of operational spending from budget	Current assets to current liabilities. (working capital)	Spending on capital compared to depreciation
Variance of capital spending from budget	Ongoing or fixed operating expenses* and total operating expenses	Total liabilities to total assets
Net operating cash flow (excluding depreciation and amortisation) to total cash flow received

* By ongoing or fixed operating expenses, we mean employee benefits, interest, depreciation, and amortisation.

7.9
We use our analysis to better understand how the adequacy and alignment of financial resources can affect the risk posed to the different types of entities' ability to operate as planned, manage uncertainty, and invest for the future.

7.10
Generalisations need to be made in collecting and analysing the data from financial statements, similar to the generalisations required for any large and complex data set. The findings drawn from our analysis are of a general nature and can be used to identify matters or trends that might require further investigation.

7.11
The rest of this Part considers each of the three "abilities" and what our analysis shows about the financial health of the three groups of entities. We have used "traffic light" colours to help convey our assessment of relative risk.

The ability to operate as planned

Are entities over-forecasting or under-forecasting their operational spending?

7.12
The difference between budgeted and actual operational spending has been consistently small for most entities within all three groups. As Figure 22 shows, CRIs and government departments have improved their forecasting accuracy in recent years.

Figure 22
Over or under percentage difference between entities' budgeted and actual operational spending, by type of central government entity, 2006/07 to 2012/13

7.13
These small variances of less than 10% suggest a low or very low risk that entities will not be able to operate as planned in their day-to-day operations. Factors contributing to this could include good short-term forecasting procedures and/or a tighter monitoring environment.

Are entities over-forecasting or under-forecasting their capital spending?

7.14
The difference between budgeted and actual capital spending has been consistently large for most entities within all three groups (see Figure 23).

Figure 23
Over or under percentage difference between entities' budgeted and actual capital spending, by type of central government entity, 2006/07 to 2012/13

7.15
These large variances, mostly greater than 20%, suggest a high risk that entities will not be able to operate as planned in their capital-related activities. Factors contributing to the over-budgeting (or under-spending) on capital assets could include poor short-term forecasting, inadequate monitoring, and/or a generally uncertain capital project environment.

Are entities spending more than they receive on their operations?

7.16
In most instances, the difference between what is received and what is spent on entities' operations has ranged from a 5% surplus to a 2% deficit (excluding depreciation and amortisation funding received). Figure 24 shows that CRIs and government departments are slightly more likely to spend more than they receive on their operations than they were in earlier years. The pattern for Crown entities has not changed.

7.17
In Figure 24, 0% would mean that operational spending is equal to operational revenue, and negative amounts indicate spending more than what is received.²⁴

Figure 24
Proportion of entities' net operating cash flow to cash flow received, by type of central government entity, 2006/07 to 2012/13

7.18
Our findings showed that Crown entities have had only small differences between what they receive and what they spend. The results for CRIs and government departments could indicate generally tighter budgetary controls and monitoring environments. Overall, this suggests a low to moderate risk of entities not being able to operate as planned with little held back as reserves. However, we also note that, for most years, about 8% of central government entities showed cash flow operating deficits of more than 10%.

7.19
Overall, the financial statements show that central government entities' ability to operate as planned is supported by good operational planning and forecasting. Net operating cash flows appear to be managed appropriately without generating large surpluses, but some entities have significant deficits.

7.20
For all three groups, capital planning and forecasting needs to improve. The consistent over-budgeting suggests that there is scope for improvement in longer-term financial management practices. This aligns with the findings in our 2012 report on financial management, where we found that public entities were focused on providing (short-term) financial control budget management and external reporting. There was a need for stronger strategic financial management, including enhancing the quality, analysis, and usability of financial information to better understand financial performance.²⁵

The ability to manage uncertainty

Could entities find it difficult to cover their current liabilities, with current assets, if needed?

7.21
Figure 25 shows that, for all three groups, levels of current assets are mostly sufficient to cover current liabilities if required. In Figure 25, 100% means that the value of current assets equals the value of current liabilities.

Figure 25
Percentage of entities' current assets to their current liabilities, by type of central government entity, 2006/07 to 2012/13

7.22
For all three groups, our findings suggest a low risk that levels of current liabilities could be onerous in times of uncertainty. This is a positive indication of the ability of entities within these three groups to manage uncertainty. We also note that Crown entities and CRIs have shown some improvements in the past seven years.

Could entities find it difficult to adjust operations in times of change?

7.23
Where entities have a high proportion of non-discretionary (ongoing or fixed) expenses (employee benefits, interest, depreciation and amortisation), the ability to adjust and adapt in times of change can be limited. Figure 26 shows that, for all three groups, the average proportion of ongoing or fixed costs is between 30% and 70% of total expenses. In Figure 26, 100% would mean that all expenses are ongoing or fixed.

Figure 26
Proportion of entities' current operational expenses that are ongoing or fixed, by type of central government entity, 2006/07 to 2012/13

7.24
Our findings suggest a low to moderate level of risk that entities' ability to manage uncertainty could be adversely affected by these levels of ongoing or fixed costs.

7.25
Overall, the financial statements indicate that, in all three groups, levels of current assets, current liabilities, and fixed costs are not onerous, and would not adversely affect the entities' ability to manage uncertainty in times of change.

The ability to invest for the future

Are entities investing in their assets adequately?

7.26
Maintaining the operational capacity of assets is fundamental to the long-term sustainability of public services. Comparing an entity's capital expenditure to what accounting estimates suggest is reasonable (for example, to cover depreciation) is one way of understanding the adequacy of investment in an entity's capital assets.

7.27
The percentages shown in Figure 27 suggest some under-investment in capital assets for Crown entities and government departments (because their spending on capital is not quite equal to, or above, the amount set aside for depreciation). The investment in capital assets for CRIs appears adequate. In Figure 27, 100% means that levels of capital expenditure are equal to depreciation estimates.

Figure 27
Percentage difference between entities' capital spending and their depreciation estimates, by type of central government entity, 2006/07 to 2012/13

Note: We would expect a result of more than 100% because capital expenditure also includes spending on new assets.

7.28
Our analysis suggests that, for Crown entities and government departments, there is a moderate risk that these levels of capital investment could be inadequate to maintain operational capacity in the longer term. Although CRIs' investment appears adequate, variability in all three groups was high, with a significant proportion of very high risk and very low risk entities.

Are total liabilities becoming onerous?

7.29
Too many liabilities can reduce future funding options and distract management from a focus on the long-term assets of the entity. The percentages in Figure 28 suggest that, in all three groups, there is a low risk that the level of liabilities could adversely affect entities' ability to invest for the future.

7.30
In Figure 28, 100% would mean that total liabilities are equal in value to total assets.

Figure 28
Proportion of total liabilities to total assets, by type of central government entity, 2006/07 to 2012/13

7.31
Overall, the financial statements indicate that, in all three groups, levels of total liabilities and capital investment should not adversely affect the ability of entities to invest for the future. However, further work is needed to understand the levels of capital investment for Crown entities and government departments.

Our conclusions

7.32
Overall, our analysis of financial statements shows that the planning and alignment of financial resources in CRIs, government departments, and Crown entities are sufficient to support stable, resilient, and sustainable services. Crown entities and government departments show the greatest level of consistency over time, which could be due to the stability of their operating environments and/or the ongoing consequences for CRIs resulting from the 2010 taskforce review.

7.33
Our analysis of financial statements indicates that there are risks in the forecasting and management of capital expenditure.

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24: We excluded depreciation and amortisation because the associated revenue is related to capital.

25: Controller and Auditor-General (2012), Reviewing financial management in central government, Wellington.

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