The value of stress testing your budget – a case study for decision-making

The COVID-19 pandemic continues to evolve as a dynamic situation for local governments. Strictly from a budgetary perspective, the global health crisis and subsequent economic shock will certainly cause strain, but how much? This is a question that can only be fully answered in hindsight, but governments do have access to tools that can provide valuable insights about what to expect and to enable response planning. And, while many have commented on the importance of cash flow modeling, less attention has been given to the critical linkage of cash flow modeling and operational decision-making.

One city in Kansas conducted a “stress test” on their general fund budget. Stress testing is a highly valuable output of cash flow modeling tools. To account for uncertainties in the available data, the city developed three possible economic scenarios: a “V”-shaped, a “U”-shaped, and an “L”-shaped recovery from the present economic and fiscal shock. These scenarios represent a quick economic recovery, a slower recovery and a failed recovery, respectively.

The city considered how these scenarios would impact each of their revenue streams as well as the demand for services. They then quantified the additional expenditures and tallied the estimated lost revenue from their baseline economic model through 2024. The city considered what budget adjustments they had available to them: staffing and service levels, potential expansion of more viable revenue sources and available cash reserves, among many others. They also considered how difficult it would be to implement these adjustments operationally, legally and politically.

Using this scenario-based approach, the city was able to judge whether their general fund budget was able to withstand certain economic shocks. The chart below demonstrates the budget solutions available to the city versus the additional expenditures and lost revenue, labeled collectively as “value at risk” over the coming five-year period.