CapitalSources of Public Funding and Debt
There are several mechanisms through which city councils, states andfederal governments and other public entities solicit funds forinfrastructural development. This includes developments such asroads, schools, electricity, hospitals, water lines, seweragefacilities and airports amongst others. The decision on the mostappropriate source of funds and debt for public entities is a majorone, and it requires critical consideration of the various sources.The main sources include general obligation and revenue bonds,certificates of obligation, contractual obligation, commercial paper,capital leases, and notes payable. This paper seeks to provide acomprehensive discussion on each of these sources.
One of the main sources of funds and debt especially formunicipalities is general obligations and revenue bonds. While somescholars provide that one of these two is better than the other, willbe evident in this section that neither of the two types is betterthan the other. General obligation bonds (GOs) refer to debtinstruments that are issued by federal and state governments in theirattempt to raise funds for public works (Greenwood & Scharfstein,2013). They are backed the issuer’s “full faith and credit” andthis makes them unique from other sources of funds. The implicationof backing them with full faith and credit is that the municipalityfully commits its resources to their payment. On the other hand,revenue bonds refer to municipal bonds that are supported by revenuefrom the specific projects. Unlike the GOs, revenue bonds are securedby a specific source of revenue like the name suggests.
Certificate of obligation (COs) can be described in the simplestterms as an emergency debt. It is a form of emergency debt that iseasily available to public governing bodies in case of an emergencythat is too urgent to allow for a voter referendum. They areperceived to be very essential for the continuity of the civilsociety especially when they are used for the intended purpose. Overthe years, however, the purpose of the certificate of obligation hascontinually been abused with most of the local councils using it tosource funds for non-emergency purposes. Going by the fact that it isused for emergency purposes, the bond is issued by the city councilswithout voter approval. The appropriateness of its use in aparticular situation can only been assessed after the situation hasbeen resolved but not before. Voters disapprove the use of COs forsituations that are beyond the scope of public calamity.
Contractual obligation as a source of funds for public entitiesrefers to an agreement between the public entity and the fundprovider to meet the terms of the contract. A contractual obligationis legally binding which implies that either of the parties can suethe other for failure to adhere to their obligations as provided inthe terms of the contract. Once the public entity such as the citycouncil, state and federal government enters into a contractualagreement with another party, it has a legal, financial obligationthat it must make failure to which the other party is obliged to sueit (Newberry, 2015). Any good state or federal government budgetshould point out the contractual obligations that it has to make. Themain contractual obligations include operating lease obligations,capital purchase obligations, and long-term debt obligations.
In addition to the sources of funds and debts for public entities isa commercial paper. It is a short-term debt instrument which isunsecured mainly issued by corporations to finance accountreceivables. Besides, public entities also use them to financeinventories and other short-term liabilities. It is offered at adiscount, and the maturity date is considered to be no longer than270 days. The fact that it is not secured implies that it is notbacked by any form of collateral. The discount offered by publicentities is, therefore, intended to make the offer more attractivesince there are few buyers who are interested with the paper(Weygandt et al., 2011). The fact that it does not have acollateral insinuates that for public organizations to easily findbuyers, their creditworthiness, as well as the debt rating, should beconsiderably high. One of the major benefits of commercial paper isthe fact that it is a cost-effective means of financing. Thecommercial paper is, however, highly unreliable in times of greatfinancial crisis.
Capital lease refers to a debt source that is a lease where thelessor finances the leased assets as well as the provisioning processto the lessee, and all other rights of ownership are transferred tothe latter for a specified period. The use of the leased asset istemporary and, therefore, a capital lease falls under the category ofdebt funding. A capital lease is the most appropriate for items ofconsiderably high value that are required for a short period. Byextension, the ownership of the asset may be transferred to thelessee at the end of the lease period. Among the main benefits ofleasing include the fact that it solves provides an option forurgently needed capital items and prevents public entities fromowning assets that will be used for a considerably short period,temporarily, seasonally or sporadically.
Notes payable refer to debts that exist in written forms. A publicentity’s option to request a bank loan to finance its activities isan example of the utilization of the notes payable option. Notespayables are short term sources of funds, and they are categorizedunder current liabilities. In rare cases, they are considered aslong-term sources of funds. They may be in the form of an overdueinvoice, extended payment, and borrowed cash (McKinney, 2015). Inother words, it is a written promissory note to the company due toits debt to another. The public entity pays interest to thefinancier. Also, any interest owed for the period that the debt hasbeen outstanding is accrued. The main advantages of notes payable ascompared to other forms are the fact that the lender is only paidinterest with no ownership. Besides, it has less paperwork.
To wrap things up, there are various capital sources of publicfunding and debt. Their appropriateness as sources of finance for acertain public project is, to a large extent, dependent on the natureof the project itself as well as government tenets (Newberry, 2015).While some sources are appropriate for the short term, others areappropriate for long-term financing purposes. The capital sources ofpublic funding and debt analyzed in this discussion include generalobligation and revenue bonds, certificates of obligation, contractualobligation, commercial paper, capital leases, and notes payable.Public entities should consider the pros and cons for each of them ascompared to the situation at hand and finally choose the mostappropriate source to finance their project.
Greenwood, R., & Scharfstein, D. (2013). The growth of finance.The Journal of Economic Perspectives, 27(2), 3-28.
McKinney, J. B. (2015). Effective financial management in publicand nonprofit agencies. ABC-CLIO.
Newberry, S. (2015). Public sector reforms and sovereign debtmanagement: Capital market development as strategy? CriticalPerspectives on Accounting, 27, 101-117.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2011). Managerialaccounting: tools for business decision making. John Wiley &Sons.