K NYSNA MUNICIPALITY...Prepared by INCA Portfolio Managers 9 | P a g e ECONOMY The service-related sectors are the main contributors to the local economy. Trade remained the dominant

Prepared by INCA Portfolio Managers

March 2020

KNYSNA MUNICIPALITY

Long Term Financial Plan – Update 2020

Prepared by INCA Portfolio Managers 2 | P a g e

REPORT OVERVIEW – INTRODUCTION AND BACKGROUND

The Knysna Municipality appointed INCA Portfolio Managers in 2017 to prepare a Long-Term Financial Plan (LTFP). The output of the assignment was a report

entitled Knysna Municipality Long Term Financial Plan: 2017 – 2026; November 2017. The report was updated in March 2019 with the latest information. This

2020 Update aims to update the LTFP based on the latest available information and report on the findings.

The objective of a Long-Term Financial Plan is to recommend strategies and policies that will maximise the probability of the municipality’s financial sustainability

into the future. This is achieved by predicting future cash flows and affordable capital expenditure based on the municipality’s historic performance and the

environment in which it operates.

A summary of the demographic-, economic- and household infrastructure perspective was updated with the latest available information as published by iHS

Global Insight. The historic financial analysis was updated with the information captured in the municipality’s audited financial statements of 30 June 2019.

IPM’s Long Term Financial Model was populated and run with this latest information, and the outcome thereof is reported herein. The model was re-calibrated

against the municipality’s MTREF (adjustment budget) for the 3 years from 2019/20 to 2021/22.

Unlike the original assignment, no renewed analysis of the Asset Register, review of municipal documents (viz. IDP, Master Plans, etc.) and conversations with

management were undertaken. The conclusions reached in this report are complimentary to the recommendations made previously.

The contents of this report entail the following:

1 Planning Process

2 Updated Perspectives (Demographic, Economic, Household Infrastructure)

3 Updated Historic Financial Assessment

4 Long Term Financial Model Outcomes

5 Future Revenues

6 Affordable Future Capital Investment

7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


KEY FINDINGS AND CONCLUSIONS DRAWN FROM THE 2020 LTFP UPDATE

• The local annual GVA growth rate has deteriorated from 1.9% in 2012 to 0% in 2019, this compares adversely with the high population growth rate of

2.2% for 2018 and a 28% household formation in the past 10 years.

• Tourism is a key sector for Knysna with a total spend of R 2.30 billion in 2018 which equates to more than 46.5% of the local GVA

• The latest data reflects a decrease in unemployment rate to 18.7% with Trade Sector being the largest provider of employment followed by Finance,

Community Services and Construction.

• The general financial position of Knysna has deteriorated during the 2018/19 financial year mainly caused by:

o A deteriorating liquidity ratio of 1.25:1 (0.98 when debtors older than 30days are excluded)

o Water distribution losses of 26.68%

o Collection rate below the minimum acceptable norm of 95%

o Fast increasing unspent conditional grants and creditors balances

o Insufficient Cash generated from operations of -R 2.36 million, decreasing from a deficit of R 0.10 million at FY2018.

• This resulted in Knysna at FYE2019 not having sufficient unencumbered cash and cash equivalents to cover the liquidity recommended, and a shortfall

of R 177.75 million is reflected.

• Given the importance of the tourism sector for the Knysna economy and the current uncertainty of the extent of the negative impact of COVID-19 on

this sector, cost containment should receive even more attention as this is within the control of the municipality.

• The financial deterioration during the past two financial years necessitate a specific Financial Stabilization and Recovery Plan.

• Liquidity needs to be safe guarded and it is strongly recommended that expenditure savings that contribute at least R10 million p.a. to the cash flow

is needed in combination with an average 1% additional revenue increase from rates and taxes.

• Debt collection and credit control needs to receive special monitoring to increase the collection rate to 95%.

• Capital Expenditure need to be prioritized and correctly funded with a bias towards well managed external borrowing with a loan tenure of 15 years.


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


PROCESS

The diagram below illustrates the steps in the process that were followed in

drafting the LTFP and the steps taken during this 2020 “LTFP Update”:

FIGURE 1: PLANNING PROCESS

The long term financial model was populated with the latest information of

Knysna and used to make a base case financial forecast of the future

financial performance, financial position and cash flow of the municipality.

The diagram below illustrates the outline of the model.

FIGURE 2: FINANCIAL MODEL FRAMEWORK

The model methodology remains the same and the capital budget as

presented in the MTREF was utilised and forecasts of an affordable future

capex were made.


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


DEMOGRAPHY

Knysna’s current Population is 79 693 (2018). After Bitou, Knysna has the

second highest population growth rate (2.2%) of the seven municipalities in

the Eden District, slightly higher than the Western Cape (2.0%) and higher

that the National growth rates (1.5%). The movement of people from the

Eastern Cape to the Western Cape is the main contributor to the higher

population growth rate of Bitou and Knysna in the Eden district.

GRAPH 1: POPULATION

The average per capita income of Knysna compares well with the other

municipalities in the district: Mossel Bay: R 99 290; Hessequa: R 86 635;

Knysna: R 80 904: George: R 77 874; Bitou: R 61 876; Oudtshoorn: R 56 852

and Kannaland: R 50 056

The average household income for Knysna is R 255 368 p.a. (R 21 280 p.m),

that is 24.7% more than the national average household income of R 204 679

p.a. Graph 2, hereunder, is a reflection of the household income distribution

per income bracket for Knysna. The highest concentration (12.1%) falls within

the R 192 000 – R 360 000 bracket. Households that earn less that R 30 000

p.a. and who are dependent on the fiscus for grants represents 15.0%. Of

specific importance is the fact that 70.8% of all households earn an income of

less than R 192 000p.a. or R 16 000 p.m. The extent to which these

households could be levied by the municipality in the future will have to be

carefully considered.

GRAPH 2: DISTRIBUTION OF HOUSEHOLD INCOME

-

50 000

100 000

150 000

200 000

250 000

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kannaland Hessequa Mossel Bay GeorgeOudtshoorn Bitou Knysna

-

500

1 000

1 500

2 000

2 500

3 000

3 500


Unlike a classical population pyramid, the Age Profile illustrates

proportionally fewer people younger than 25 years of age but the age groups

between 25 and 44 years have a proportionally higher representation. This

population profile reflects the high number of people in their economic active

age group and the result of the high number of job seekers currently in and

moving to Knysna.

GRAPH 3: AGE PROFILE

Positive to note is that Knysna Unemployment Rate (18.7%) reflects a

decreasing trend since 2012 and became the second lowest of the seven

municipalities in the Eden District and lower than the Provincial (Western

Cape) and National rate of 20.3% and 27.4% respectively.

GRAPH 4: UNEMPLOYMENT RATE

6 000 4 000 2 000 0 2 000 4 000 6 000

00 - 04 Years05 - 09 Years10 - 14 Years15 - 19 Years20 - 24 Years25 - 29 Years30 - 34 Years35 - 39 Years40 - 44 Years45 - 49 Years50 - 54 Years55 - 59 Years60 - 64 Years65 - 69 Years70 - 74 Years

75+ Years

Male Female

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Kannaland Hessequa Mossel Bay GeorgeOudtshoorn Bitou Knysna


ECONOMY The service-related sectors are the main contributors to the local economy.

Trade remained the dominant Economic Sector with 22.1% of the output in

2018, followed by Finance (20.8%) and Community services (18.9%).

Together these three subsectors comprise 61.8% of economic output. The

services sector not only contributes significantly to the economy but is also

the main provider of employment.

GRAPH 5: ECONOMIC SECTORS

The proportional contributions of key economic sectors reflect the structure of

the economy. The Proportional growth experienced in the Finance and

Trade Sectors, and significant decrease in Agriculture since 2009 is a

reflection of structural changes in the economy.

GVA growth rate deteriorated from 1.9% in 2012 to 0% in 2018, this compares

adversely to the population growth rate of 2.2% during the same period.

Important to note is the decrease in the Manufacturing sector’s contributions.

TABLE 1: PROPORTIONAL GROWTH OF ECONOMIC SECTORS

Sector 2009 2018

1 Agriculture 6.5% 4.8%

2 Mining 0.1% 0.1%

3 Manufacturing 13.1% 12.6%

4 Electricity 1.8% 1.1%

5 Construction 11.5% 11.2%

6 Trade 21.3% 22.1%

7 Transport 7.9% 8.3%

8 Finance 19.3% 20.8%

9 Community services 18.4% 18.9%

5%

0%

13%1%

11%

22%8%

21%

19%

Agriculture

Mining

Manufacturing

Electricity

Construction

Trade

Transport

Finance

Community Services


The analysis of the employment figures reveals the following:

➢ The Trade sector is the largest Employer with 23.2% of Total

Employment;

➢ Finance, Community Services, Construction, Household and

Manufacturing contribute 17.4%, 16.1%, 12.4%, 10.4% and 9.7%

respectively.

Total employment reflects a significant improvement (58.7%) since 2010. At

the end of 2018 the officially registered number of workers came to 31 935

people.

GRAPH 6: EMPLOYMENT

Tourism Spend in 2018 amounted to R 2.30 billion which equates to a high

46.5% of GVA (Current Prices). Knysna has the highest tourism spend of the

seven municipalities in the Eden District. It will be correct to describe Knysna

as a tourist town and the activities in the services sectors and the number of

job opportunities are directly related to the ability of Knysna to maintain its

tourist attraction.

GRAPH 7 reflects the increasing trend of Tourism Spend since 2009, although

it decreased in 2018 to R 2.30 billion. The importance of tourism as the

economic backbone of Knysna cannot be overemphasized.

GRAPH 7: TOURISM SPEND

-

10 000

20 000

30 000

40 000

-

2 000

4 000

6 000

8 000

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018T

ota

l E

mp

loym

en

t

Em

plo

ym

en

t in

Ea

ch

Se

cto

r

Agriculture Mining ManufacturingElectricity Construction TradeTransport Finance Community ServicesHouseholds Total

-

500 000

1 000 000

1 500 000

2 000 000

2 500 000

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018


HOUSEHOLD INFRASTRUCTURE

The Infrastructure Index of 0.88 is on par with that of the Province (0.89) and

the District (0.90) and higher than the National average of 0.75. The high

population growth and household formation in recent times have, however,

increased the demand for household infrastructure services.

GRAPH 8: INFRASTRUCTURE INDEX

Between 2009 and 2018 the growth in Household Formation was 28%,

which was the second highest of all seven municipalities in the district. In

absolute numbers, the growth of households in Knysna during the period

is estimated 5 552.

GRAPH 9: HOUSEHOLD FORMATION

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Knysna Eden Western Cape South Africa

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Kannaland Hessequa Mossel Bay George Oudtshoorn Bitou Knysna

Local Municipalities Eden Western Cape South Africa


Table 2 hereunder is a reflection of the level of key household service delivery in Knysna compared to that in other municipalities in the Eden District. Knysna compared

well with the average of household service delivery in the District, with the exception of Sanitation that lags 2% behind the district average. The outperformance in refuse

removal is mainly due to the relative higher population density of Knysna compared to the other municipalities.

TABLE 2: HOUSEHOLD INFRASTRUCTURE PROVISION

Infrastructure Eden DM % Knysna %

Above RDP Level

Sanitation 182 245 94.7% 23 511 92.7%

Water 188 798 98.1% 24 836 97.9%

Electricity 185 297 96.3% 24 322 95.9%

Refuse Removal 174 743 90.8% 24 225 95.5%

Below RDP Level or None

Sanitation 10 183 5.3% 1 848 7.3%

Water 3 630 1.9% 523 2.1%

Electricity 7 131 3.7% 1 037 4.1%

Refuse Removal 17 685 9.2% 1 134 4.5%

Total No. of Households 192 428 100.0% 25 359 100.0%


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


FINANCIAL POSITION

Liability Management

GRAPH 10: LONG TERM LIABILITIES: INTEREST BEARING VS NON-INTEREST

BEARING

The new external loans taken up during the current year amounting to R60.24

million contributed to the increase of Total Long Term Liabilities from R 157,0

million at FYE2018 to R 199,0 million at FYE2019.

The gearing ratio increased by 2 percent from last year to 22% as at FYE2019.

This ratio is still below the maximum norm of 45%; suggested by National

Treasury. The negative debt service cover ratio of -0.07 implies that Knysna

did not generate sufficient cash from operations during FY2019 to service the

current debt levels. Debt affordability will be further analysed in chapter 5

(Affordable Future Capital Investment)

Non Interest bearing liabilities are also a significant fragment of Knysna’s

balance sheet and amounted to R 109.70 million. This total includes provisions

for Employee Benefit Obligations and Landfill sites.

Liquidity Management

GRAPH 11: LIQUIDITY RATIOS

GRAPH 12: CURRENT LIABILITIES

-

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Short Term Provisions LT Liabilities (Non-Interest Bearing)

LT Liabilities (Interest Bearing) Short Term Portion of Loans

Total Interest Bearing Liabilities

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2012 2013 2014 2015 2016 2017 2018 2019

Current Assets : Current Liabilities

Current Assets (less Debtors > 30 Days) : Current Liabilties

-

50.0

100.0

150.0

200.0

250.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Creditors Consumer Deposits

Unspent Conditional Grants ST Portion of Loans

Short Term Provisions Overdraft


The management of Knysna’s liquidity has come under pressure; especially in

the past 2 years. Although current assets still exceeded current liabilities, it is

concerning to note a declining trend; from a liquidity ratio of 1.68:1 in FY2017

to 1.25:1 in FY2019. Should all debtors older than 30 days be excluded, this

ratio falls to 0.98:1, confirming the potential liquidity risk that Knysna faces in

the future.

The current annual growth in current assets was R23.17 million (9%) against

a higher increase of current liabilities of R 56.07 million (34%).

GRAPH 13: CURRENT ASSETS

Creditors constitute 51% of the municipality’s total current liabilities and has

increased by R21.07 million (23%) in the reporting period. The effect of fast

increasing creditors balance will be higher cash outflows in the next financial

period if the municipality continues to maintain the 30-day repayment period

prescribed by the MFMA.

The increase in current liabilities was also influenced by the growth in unspent

conditional grants as at 30 June 2019. This liability should always be cash

backed.

Debtors Management

Gross consumer debtors grew by 14% (R 34.35 million) while Billed Revenue

increased by R 13.30 million (2%). The provision for doubtful debts of R 155.83

million (an increase of R 16.25 million or 12%) covers only 80% of consumer

debtors older than 90 days (R 194.52 million) as opposed to the 100% cover

suggested by National Treasury.

GRAPH 14: GROSS CONSUMER DEBTORS VS NET CONSUMER DEBTORS

The Net Debtor Days ratio, which refers to the average number of days

required for a Municipality to receive payment from its Consumers for bills

issued to them for services was at a high of 71 days in FY2019 as compared

to National Treasury’s prescribed industry norm of 30 days. This is an

indication that a significant amount of potential cash is tied up in consumer

debtors and therefore, timeous and effective collection of outstanding debt will

improve revenue and cash flow management.

-

50.0

100.0

150.0

200.0

250.0

300.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Short Term Investments Current Cash

Net Consumer Debtors Other Debtors

Inventories Total Cash and Cash Equivalents

-

50.0

100.0

150.0

200.0

250.0

300.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Gross Consumer DebtorsTotal Provision for Bad DebtsNet Consumer Debtors


GRAPH 15: CONSUMER DEBTORS AGE ANALYSIS

The composition of Knysna’s age analysis of consumer debtors reflects a

negative trend of consistent increases of debtors older than 90 days,

especially in the past 2 years. 72% of gross consumer debtors were older than

90 days at FYE2019.

The collection/payment ratio improved to 94% at FYE2019 from 91% at

FYE2018. This growth is commendable and should be continued in the next

financial period. It remains imperative that the municipality strives to improve

its collection rate to at least a minimum of 95% to support the cash generation

ability of the municipality in future.

FINANCIAL PERFORMANCE Surplus/Deficit

GRAPH 16: ANALYSIS OF SURPLUS

Both Total operating Income and Total Operating Expenditure reflected

significant growths of 16% and 15% respectively, during FY2019. The small

variance between operating income and expenditure growths did not leave

much room for profitability as only a Total Operating Surplus of R 1.2 million

was posted in FY2019.

Revenue Management

Total operating income (excluding capital grants) for FY2019 was

R 898.90 million, compared to R 777.83 million in FY2018.

Concerning to note is that Property Rates income, which is the municipality’s

second largest income generator, increased by less than 1% against a higher

CPI growth. Property Rates is also the largest outstanding debtor type.

Income from Electricity Services and Equitable Share increased by R 119.62

million and R 7.50 million, respectively, and a decrease of R 1.63 million was

recorded in water revenue.

-

50.0

100.0

150.0

200.0

250.0

300.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Current 31 - 60 Days 61 - 90 Days Older than 90 Days (200.0)

(150.0)

(100.0)

(50.0)

-

50.0

100.0

150.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Total Accounting Surplus Total Operating Surplus(excl Capital Grants)

Cash Generated by Operations(excl Capital Grants)


GRAPH 17: CONTRIBUTION PER INCOME SOURCE

GRAPH 18: CONTRIBUTION PER EXPENDITURE ITEM

Expenditure Management

Total operating expenses for FY2019 were R 893.98 million, compared to

R 774.75 million in FY2018. Staff cost continued to be the municipality’s

greatest expenditure item and increased by R12.24 million (5%) during the

year, while Electricity bulk purchases increased by R14.61 million to R 169.55

million.

GRAPH 19: INTEREST RECEIVED VS INTEREST PAID

Interest paid on external loans continued to exceed Interest Received from

cash and investment during the year due to the additional borrowings in

FY2019 and a decrease in cash balances.

The electricity distribution losses decreased to 7.73% and remained within the

recommended benchmark that ranges between 7% and 10%.

The water distribution losses decreased to 26.63% and remained on the higher

end of the 15% to 30% benchmark prescribed by National Treasury.

-

200.0

400.0

600.0

800.0

1 000.0

-

50.0

100.0

150.0

200.0

250.0

300.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Operating Income Property RatesElectricity Services Water ServicesEquitable Share Conditional Operating GrantsInterest Received

-

200.0

400.0

600.0

800.0

1 000.0

-

50.0

100.0

150.0

200.0

250.0

300.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Operating Expenses Staff CostElectricity Services Water ServicesRepairs and Maintenance DepreciationInterest Expense

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Interest Received Interest Paid


CASH FLOW

Cash Generated from Operations

After deducting Capital Grants, Knysna is left with a negative Cash generated

from operations/ Cash utilised by operations balance of -R 2.36 million. This is

a continuation of a negative trend that started in FY2018.

GRAPH 20: CASH GENERATED FROM OPERATIONS / OWN SOURCE REVENUE

GRAPH 21: WORKING CAPITAL

The management of changes in working capital yielded positive results, with a

net inflow of R 12.5 million. However, this can be mainly attributable to the

increase in creditors. The increase in creditors may signify that Knysna is

taking longer than 30 days to settle payments due. Proper and effective

controls should be put in place to ensure prompt payments.

(40.0)

(30.0)

(20.0)

(10.0)

-

10.0

20.0

30.0

40.0

50.0

2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Change in Debtors Change in CreditorsChange in Inventories Change in Working Capital

-2%

0%

2%

4%

6%

8%

10%

12%

(100.0)

-

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Cash Generated from Operations Own Source Revenue

Cash Generated from Operations /Own Source Revenue (%)


Capital Expenditure and Funding Mix

GRAPH 22: ANNUAL CAPITAL FUNDING MIX

The increased Capital Expenditure of R 148.5 million at FYE2019 was funded

through a mix of Capital Grants (R 103 million) and External Borrowings

(R 60.2 million).

Knysna achieved a positive Capex implication indicator ratio of 99% at

FYE2019. The annual growth of capex in the past 4 years is positive,

regardless of the increase in unspent conditional grants.

Minimum Liquidity Requirements

GRAPH 23: MINIMUM LIQUIDITY REQUIRED

Knysna has continued to drift further away from holding sufficient

unencumbered cash and cash equivalents to cover minimum liquidity

requirements. The unencumbered cash and cash equivalents of R 59.9

million at FYE2019 was R 117.5 million short of the minimum liquidity required

(including one month’s operational expenditure) of R 177.36 million. The cash

coverage decreased from 0.5 in FY2018 to 0.3 in FY2019.

The capital replacement reserve of Knysna increased from R 40.5 million as

at FYE2018 to R 45.5 million as at FYE2019 and was not cash backed.

-

50.0

100.0

150.0

200.0

2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Unspent Conditional Grants Short Term Provisions

Funds, Reserves & Trust Funds(Cash Backed)

Working Capital Provision(1 Month's Opex)

Unencumbered Cash

(40.0)

(20.0)

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

2012 2013 2014 2015 2016 2017 2018 2019

Mil

lio

ns

Capital Grants Financing

Sale of Fixed Assets Cash Reserves and Funds

Capital Expenditure


TABLE 3: MINIMUM LIQUIDITY LEVELS

2012 2013 2014 2015 2016 2017 2018 2019

Unspent Conditional Grants

2,1 1,3 10,0 11,4 8,3 4,9 10,3 32,6

Short Term Provisions

18,8 21,6 21,3 22,5 23,5 26,4 31,7 38,9

Funds, Reserves & Trust Funds (Cash Backed)

4,7 3,6 - 25,0 5,0 38,9 40,5 45,5

Total

25,6 26,6 31,3 58,9 36,8 70,2 82,5 117,0

Unencumbered Cash

47,5 37,8 9,8 51,6 65,7 97,8 68,8 59,9

Cash Coverage Ratio (excl Working Capital)

1,9 1,4 0,3 0,9 1,8 1,4 0,8 0,5

Working Capital Provision (1 Month's Opex)

42,4 36,6 41,5 41,4 48,2 52,1 53,6 60,4

Cash Coverage Ratio (incl Working Capital)

0,7 0,6 0,1 0,5 0,8 0,8 0,5 0,3

Minimum Liquidity Required

68,0 63,2 72,8 100,3 85,0 122,3 136,1 177,4

Cash Surplus/(Shortfall)

(20,5) (25,4) (63,1) (48,7) (19,3) (24,5) (67,3) (117,5)


IPM SHADOW CREDIT SCORE

Knysna LM was assessed for an IPM shadow credit score, to provide information to

management and to council as to the current risk rating that municipality may

receive from external lenders, which will determine Knysna’s cost of funding. Any

improvements to the shadow credit rating over time will result in more affordable

lending rates.

Based on the 2019 performance of Knysna LM, the IPM credit model reflects a score

of 5.9 which would have been classified as A+ to A- investment grade due to

satisfactory scoring on financial performance, institutional capacity and

infrastructure service delivery. However, the Municipality scored a non-investment

grade level of high BBB+ to BBB- on a national ratings scale mainly due to the

qualified audit opinion, which means that Knysna may struggle to access external

borrowing at affordable rates.

The results obtained from the assessment, per module, are presented below:

TABLE 4: IPM CREDIT MODEL OUTCOMES

Modules 2019 (5)

Financial 2,9 Institutional 3,0 Socio-Economic 2,0 Infrastructure 4,0 Environmental 4,2

Total

The institutional capacity rating emphasises the need to maintain strong governance

and compliance with relevant legislations. The Auditor General findings have a

significant impact on the investment grade of the municipality and should be

addressed as a matter of urgency.

Other areas of improvement that can help Knysna achieve an investment grade

rating include further improvement in collection, effective expenditure management

and an improved liquidity position. Socio-Economic factors including a positive rate

of GVA growth in relation to population growth rate will also assist but might be

outside of the direct influence of the municipality.

Household infrastructure remains strong, which also impacts positively on the

municipality’s ability to be environmentally sensitive and sustainable.


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


LONG TERM FINANCIAL MODEL OUTCOMES

Current MTREF Scenario

During the past year Knysna Municipality has seen a deterioration of its financial

performance and financial position, specifically as far as it relates to its liquidity

position. From initial discussions with executive management, it is clear that the

municipality is considering the necessary measures to address this deterioration and

improve the financial performance of the municipality to such an extent that it is

considered financially sustainable over the longer term. It is expected that this focus

on financial improvement should be reflected in the MTREF of the municipality.

GRAPH 24: CURRENT MTREF SCENARIO – SURPLUS ANALYSIS

Based on the analysis of the MTREF, it appears that the financial woes of the

municipality continue over the short to medium term, with liquidity levels

deteriorating to such an extent that the municipality depletes its cash resources by

the end of FY2020 and thereafter the liquidity position continue to worsen. This

means that the municipality will not be able to service its operating expenditure and

the days payable will increase significantly due to non-payment, in an attempt to

remain cash positive. Such a scenario is financially unsustainable.

GRAPH 25: CURRENT MTREF SCENARIO – CASH BALANCE TO MINIMUM LIQUIDITY

LEVELS

It is therefore imperative that the municipality reviews its MTREF budget and make

the necessary adjustments to remain viable. The municipality significantly increased

its capital investment in recent years and has also budgeted high levels of capital

investment over the MTREF period. The anticipated total capital investment up to

FY2021/22 (R 608 million) appears to be relatively reliant on own cash resources

(R 298 million or 49.0%). The graphs indicate that this will result in a cash shortfall.

Due to the liquidity constraints faced by the municipality and to address the depletion

of cash, the level of capital expenditure and associated funding mix need to be

reconsidered. An unbalanced funding mix favouring capital grants and external

borrowing will preserve own cash resources.

-120-100

-80-60-40-20

020406080

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

R m

illio

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Total Accounting Surplus

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GRAPH 26: CURRENT MTREF SCENARIO – CAPITAL FUNDING MIX

Adjusted MTREF Capex and Funding Mix Scenario

By addressing the level of capital investment and its associated funding mix, by

decreasing capital expenditure and increasing reliance on external borrowings over

the MTREF period, much better liquidity results are obtained - as can be seen in the

graphs below.

The MTREF currently proposes the following capital investment:

TABLE 5: 3-YEAR MTREF FUNDING MIX R’000

R’000 Total 2019/20 2020/21 2021/22

Loans 172 773 87 188 52 063 33 522

Cash 298 078 100 850 110 505 86 723

Grants 137 249 75 741 29 928 31 580

Contributions 0 0 0 0

Total 608 100 263 779 192 496 151 825

The capital investment was adjusted in the model and is recommended as follows:

TABLE 6: PROPOSED 3-YEAR MTREF FUNDING MIX R’000

R’000 Total 2019/20 2020/21 2021/22

Loans 217 188 87 188 65 000 65 000

Cash 74 342 70 850 72 3 420

Grants 137 249 75 741 29 928 31 580

Contributions 0 0 0 0

Total 428 779 233 779 95 000 100 000

These adjustments to the capital programme result in the preservation of own cash

resources and an improved liquidity position, albeit still not sufficient to cover

minimum liquidity requirements and with further deterioration of cash resources in

the latter years of the forecast period.

GRAPH 27: ADJ MTREF CAPEX & FUNDING MIX SCENARIO – CASH BALANCE TO

MINIMUM LIQUIDITY LEVELS

Under this scenario, operational surpluses remain too low, gearing levels remain

within the maximum acceptable benchmark, but the debt service to total expense

ratio exceeds the maximum acceptable norm over the forecast period.

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Public & Developers' Contributions Capital Expenditure

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GRAPH 28: ADJ MTREF CAPEX & FUNDING MIX SCENARIO – SURPLUS ANALYSIS

GRAPH 29: ADJ MTREF CAPEX & FUNDING MIX SCENARIO – NEW BORROWING

GRAPH 30: ADJ MTREF CAPEX & FUNDING MIX SCENARIO – GEARING

GRAPH 31: ADJ MTREF CAPEX & FUNDING MIX SCENARIO – DEBT SERVICE TO

TOTAL EXPENSE RATIO

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R million 87 65 65 68 72 75 79 83 87 91

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Debt Service to Total Expense Ratio: Forecast

Debt Service to Total Expense Ratio: Benchmark


Other Adjustments Scenario

The decrease in gearing levels and increase in debt service requirements towards

the latter years of the previous scenario indicate an opportunity for Knysna to benefit

from longer loan tenors. A longer loan tenor will reduce annual repayments, while

marginally increasing the outstanding debt balance year-on-year. Furthermore, the

previous scenario indicated a need for higher levels of profitability.

Based on the historic assessment, and the indication that Knysna Municipality still

has an ability to increase rates or tariffs, a 1% higher increase (bringing the annual

increase to CPI+1%) in rates was modelled with an increased loan tenor of 12 years

(compared to 10 years in the previous scenario).

Keeping all other assumptions and inputs constant, the results indicate an improved

financial performance and financial position, which for the purposes of this report is

considered the optimal scenario. The outcomes of this optimal scenario (base case

scenario) is further analysed in the next chapters of this report.


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


MUNICIPAL REVENUE RISK INDICATOR (MRRI) = “HIGH”

GRAPH 32: ECONOMIC RISK COMPONENT OF MRRI

The latest iHS Global Insight update of the Knysna economy reveals a continuation

of sluggish economic growth, similar to most other local municipalities in the

country, averaging only 0.5% p.a over the last five years. A Tress Index of 45

suggests that the Knysna economy is relatively well diversified, but the consistently

low economic growth has impacted negatively on the economic risk indicator. The

Economic Risk component of the MRRI produces a risk assessment for Knysna

of “High”.

The unemployment rate of Knysna at 18.7% is relatively low, considering the

national official unemployment rate of 27.4%. The percentage of households

earning less than R 30 000 p.a. is 14.6%, and these factors combine to return a

Household Ability to Pay Risk component of the MRRI of “Medium to High”.

The overall MRRI is considered to be “High”.

GRAPH 33: HOUSEHOLD ABILITY TO PAY RISK COMPONENT OF MRRI

GRAPH 34: REAL REVENUES PER CAPITA VS REAL GVA PER CAPITA

Kannaland

HessequaMossel Bay

George

OudtshoornBitou

Knysna

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10.00

20.00

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GVA Growth Rate


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Mossel Bay

George

Oudtshoorn

Bitou

Knysna

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Unemployment Rate


2009

2010

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20132014

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2016

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2018

2019

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Ln (Real GVA p. capita)


The graphs indicate the effect of a sluggish economy with low GVA growth, whereby

the municipality is annually extracting higher levels of real revenue from households,

while the real GVA per household is decreasing. This amounts to more pressure on

households to service its municipal bill, which may result in reduced collection rates

and/or social unrest. This trend is not sustainable over the longer term and economic

growth is imperative to the municipality’s longer-term financial sustainability. This

pressure may also limit the municipality’s ability to increase rates and tariffs

exponentially in future.

A comparison of the Average Household Bill for the Middle Income- and Affordable

Range of a selected number of municipalities in the Western Cape (extracted from

Budget Table SA14), based on the 2019/20 tariffs reveals that Knysna’s current

household bill is still well below the mean of the sample and tariff increases can still

be considered an effective way to increase revenue in the short term, but it should

be limited over the longer term.

GRAPH 35: AVERAGE MONTHLY HOUSEHOLD BILL (R)

Based on the results obtained, Knysna will need to grow its economic base by

providing a conducive environment for economic growth and thereby increasing

economic wealth, as opposed to trying to extract revenue from excessive tariff

increases. It is also important for Knysna to analyse its current tariff structure to

ensue cost reflective tariffs that are financially sustainable on a functional level.

MUNICIPAL REVENUES

GRAPH 36: REVENUE AND EXPENDITURE

The optimal scenario estimates over the 10-year forecast period indicate that Future

Nominal Revenue (including all grants) is growing at an average rate of 7.2% p.a.,

while Future Nominal Expenditure is growing at a rate of 7.1%. The growth in

revenue includes (i) tariff increases (ii) increased sales and (iii) additional revenue

sources. To maintain this margin between sales growth and expenditure growth

(which is critical for financial sustainability) the municipality needs to be financially

prudent and apply strong financial governance to avoid irregular, unauthorised,

wasteful and fruitless expenditure.

The Real GVA per Capita and the Real Revenue per Capita is expected to decline

until 2023/2024, with an improvement noticed thereafter. Local GVA growth is

critical to expand the municipality’s revenue base in order to extract revenue for the

municipality.

Notwithstanding the cash generated from operations, the municipality continues to

generate operating deficits over the entire forecast period. This is not financially

sustainable and should be addressed.

0.00500.00

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GRAPH 37: PROJECTED REAL GVA AND REVENUES PER CAPITA

GRAPH 38: ANALYSIS OF SURPLUS

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1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


CAPEX AFFORDABILITY AND FUNDING

The total capex demand was determined during the preparation of the LTFP in 2018,

but is expected to have changed since then. However, for purposes of this report the

affordability is of more concern and not so much the demand.

Total 10-year Capex Demand (2018) = R 7 353 million

Total 10-year Capex Affordability = R 1 425 million

The capex demand still exceeds the capex affordability. The capex affordability was

updated in FY2018, however, it needs to be stressed that the capex demand

estimates were based on the desk top estimates undertaken in 2017, which included

an analysis of the asset registers and IPM’s estimates of new capital investments.

These estimates need to be revised pursuant to updated master plans.

10-YEAR CAPITAL FUNDING MIX The 10-year capital funding mix is presented in the table below:

TABLE 7: CAPITAL FUNDING MIX

Source Rm %

Public & Developers' Contributions 0 0%

Capital Grants 405 28%

Financing 737 52%

Cash Reserves and Funds 283 20%

Capital Expenditure 1 425 100%

The capital funding mix reflects the MTREF budget for the first 3 years decreasing

from R 234.8 million in FY2020 to R 105.0 million in FY2023, after which an increase

in capital expenditure is possible at an average annual growth rate of 10%. Due to

the prevailing national fiscal constraint and the liquidity constraints faced by the

municipality, less reliance is placed on grant funding or own cash resources in future.

GRAPH 39: DISTRIBUTION OF FUTURE FUNDING

LIQUIDITY AND CAPITAL REPLACEMENT RESERVE

The maintenance of a sufficient level of liquidity remains key to financial sustainability

over the longer term. For purposes of this report the minimum required liquidity level

caters for unspent conditional grants, reserves, short term provisions, and 1 month’s

working capital. The municipality’s liquidity will only reach the minimum required

liquidity levels in 2025.

From 2025, the excess liquidity allows for the funding of a capital replacement

reserve. It will be prudent for the municipality to maintain a cash reserve for this

purpose as part of the minimum liquidity requirements.

The maintenance of sufficient liquidity buffer will also improve the municipality’s

credit rating and will result in lower cost of financing.

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Financing Capital Grants

Public & Developers' Contributions Capital Expenditure


GRAPH 40: BANK BALANCE VS MINIMUM LIQUIDITY REQUIREMENTS

GRAPH 41: ESTIMATE OF FUTURE EXTERNAL FINANCING

GRAPH 42: GEARING

GRAPH 43: DEBT SERVICE TO TOTAL EXPENSE RATIO

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2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

R million 87 65 65 68 60 65 71 78 85 92

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Debt Service to Total Expense Ratio: Forecast

Debt Service to Total Expense Ratio: Benchmark


GEARING

National Treasury recommends a maximum gearing ratio of 45% and a debt service

to total expense ratio of 6% - 8%. In our view, considering the size and operating

environment of Knysna Municipality, the recommended levels for Knysna should be

at a maximum gearing of 30% and debt service to total expense ratio of 7.5%.

The total forecast external borrowing comes to R 736 million, at an average of R 73.6

million per annum. Even at this level of borrowing, assuming an average loan tenor

of 13 years and an expected interest rate of approximately 6% over CPI, Knysna

Municipality will remain at or below the maximum recommended levels for the entire

forecast period.

This level of borrowing, as indicated in the model, will preserve liquidity and improve

Knysna Municipality’s long term financial sustainability.


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


SCENARIOS

Considering our analysis of the proposed MTREF budget and the risks identified as

part of this update, the following scenarios were run, against the optimal scenario

(base case scenario) presented in this report, to indicate the potential outcomes,

and assist the municipality in its strategic decision-making and to serve as an input

to the budget for FY2021:

i) Collection Rate Changes

a. A positive scenario, indicating the positive impact that an increase

of 1% in collection rate will have on the financial performance of the

municipality. Notwithstanding the tough economic environment and

higher level of municipal revenue risk identified, this realistic 1%

improvement can be achieved through concerted efforts by the

municipality to increase its efficiency in collecting monies due and

by applying strict credit control policies without fear or favour.

b. A negative scenario, indicating the negative impact that a decrease

of 1% in collection rate will have on the financial performance of the

municipality. In light of the higher level of municipal revenue risk

identified, this scenario is considered possible The scenario seeks

to highlight the importance of maintaining the high collection rate

and of enforcement of strict credit control policies to support

financial sustainability.

ii) Profitability Changes

a. A positive scenario, indicating the positive long-term impact on

Knysna’s financial performance, should a R 10 million permanent

improvement in profitability be realised in FY2021, through an

increase in cash revenues, a decrease in cash expenditure, or a

combination of both. The municipality should consider its MTREF

budget and reassess the possibility of realising such an

improvement without compromising on its service delivery and/or

maintenance of its productive asset base.

b. A negative scenario, indicating the negative long-term impact on

Knysna’s financial performance, should a R 10 million permanent

deterioration in profitability be realised in FY2021, through a

decrease in cash revenues, an increase in cash expenditure, or a

combination of both. Should management not exercise prudency in

its budget preparation, implementation and monitoring, such a

deterioration in profitability is likely, which can have a detrimental

impact on its financial sustainability. Any unfunded mandates,

unproductive spending, irregular, unauthorised, fruitless and

wasteful expenditure should be avoided.

SCENARIO 1: COLLECTION RATE CHANGES

The Knysna financial model remains sensitive to any changes in the collection rate.

Should the municipality be successful in improving its collection rate by a mere 1%,

while everything else remains constant, the municipality can look forward to the

following outcomes:

• A cash balance of R 356 million at the end of the forecast period, an increase

of R 123 million over the optimal base case. This additional cash resources,

which is R 147.5 million in excess of the forecast minimum liquidity

requirements, can be utilised to increase capital investment programme,

allocate to the Capital Replacement Reserve or maintain as additional

liquidity buffer to absorb unforeseen external financial shocks.

• In light of the higher level of liquidity, also evidenced in the higher liquidity

ratio of 1.4:1, Knysna can expect lower cost of funding of its external

borrowings.

• Improved profitability as a result of increases in interest from its cash and

investment balances.


GRAPH 44: SCENARIO 1: COLLECTION RATE +1% - SURPLUS ANALYSIS

GRAPH 45: SCENARIO 1: COLLECTION RATE +1% - BANK BALANCE VS MINIMUM

LIQUIDITY REQUIREMENTS

GRAPH 46: SCENARIO 1: COLLECTION RATE +1% - CURRENT ASSETS TO CURRENT

LIABILITIES

Should the collection rate, however, come under pressure and deteriorate by a mere

1%, keeping all other assumptions and inputs constant, the opposite adverse impact

is noted. Under this scenario:

• The cash balance at the end of the forecast period, at R 108.4 million, will

fall short of the minimum liquidity requirements.

• The cost of external borrowing is expected to be higher, considering the

weaker liquidity position evidenced in a low liquidity ratio of 0.8:1 (below the

minimum recommended norm of 1:1).

• In order to maintain its minimum liquidity levels, Knysna will have to reduce

its capital investment programme, specifically as far as the utilisation of its

own cash resources is concerned. These lower levels of investment will

have a negative impact on growth in the municipal area, which will also

impact profitability over the longer term.

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GRAPH 47: SCENARIO 1: COLLECTION RATE -1% - BANK BALANCE VS MINIMUM


GRAPH 48: SCENARIO 1: COLLECTION RATE -1% - CURRENT ASSETS TO CURRENT

LIABILITIES

SCENARIO 2: PROFITABILITY CHANGES

Considering Knysna’s low levels of profitability in recent years and the need for

Knysna to realise operating profits to remain financially sustainable, the financial

model was updated to reflect the effect of a R 10 million permanent improvement in

profitability in FY2021 by increasing cash revenue, decreasing cash expenditure or

a combination of both. Should the MTREF budget be adjusted realistically to achieve

this improvement, the municipality can look forward to the following outcomes:

• A cash balance of R 368 million at the end of the forecast period, an

increase of R 136 million over the optimal base case. This additional cash

resources, which is R 160.1 million in excess of the forecast minimum

liquidity requirements, can be utilised to increase capital investment

programme, allocate to the Capital Replacement Reserve or maintain as

additional liquidity buffer to absorb unforeseen external financial shocks.

• In light of the higher level of liquidity, also evidenced in the higher liquidity

ratio of 1.4:1, Knysna can expect lower cost of funding of its external

borrowings.

• Improved profitability as a result of increases in interest from its cash and

investment balances.

This scenario reflects very similar outcomes to the collection rate improvement

scenario, which highlights the importance of both these metrics. Should the

municipality be successful in realising both the R10 million improvement in

profitability and the 1% improvement in collection rate, the impact would be much

more meaningful.

These two factors remain key to Knysna’s financial improvement and needs to be

strategically considered by the municipality and its Council, to align its policy choices

to the improvement of these metrics, to support longer term financial sustainability.

This should serve as input to the MTREF budget process for 2020/2021.

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GRAPH 49: SCENARIO 2: PROFITABILITY +R10M - BANK BALANCE VS MINIMUM


GRAPH 50: SCENARIO 2: PROFITABILITY +R10M - CURRENT ASSETS TO CURRENT

LIABILITIES

On the other hand, should the municipality’s profitability come under pressure and

deteriorate by R 10 million in FY2021, the municipality will suffer the following

consequences:

• The cash balance at the end of the forecast period, at R 97.1 million, will fall

short of the minimum liquidity requirements.

• The cost of external borrowing is expected to be higher, considering the

weaker liquidity position evidenced in a low liquidity ratio of 0.7:1 (below the

minimum recommended norm of 1:1).

• In order to maintain its minimum liquidity levels, Knysna will have to reduce

its capital investment programme, specifically as far as the utilisation of its

own cash resources is concerned. These lower levels of investment will

have a negative impact on growth in the municipal area, which will further

negatively impact on profitability over the longer term.

GRAPH 51: SCENARIO 2: PROFITABILITY -R10M - BANK BALANCE VS MINIMUM


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1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


FORECAST RATIOS

The Base Case predicted ratios are presented below. Although the model is not programmed to measure the ratios as required by National Treasury in all instances, it

does provide comfort that the municipality is sustainable in future - on condition that it operates within the assumed benchmarks set in the financial plan.

TABLE 8: OUTCOME OF FUTURE RATIO ANALYSIS

N.T. NORM 2020 2021 2023 2025 2027 2029 COMMENTS

FINANCIAL POSITION

ASSET MANAGEMENT

R29 Capital Expenditure / Total Expenditure

10% - 20% 19.0% 8.5% 8.4% 8.8% 9.2% 9.5%

Capex is below the proposed benchmark of between 10% and 20% of Total Expenditure, for most of the period, but improves over time as the liquidity position of Knysna strengthen towards the latter years of the forecast period.

DEBTORS MANAGEMENT

R4 Gross Consumer Debtors Growth 12.2% 9.3% 6.8% 6.9% 7.1% 7.2% The collection rate in Knysna fell behind due to the effects of the fire, but must improve again for the LTFP to be sustainable. All efforts must be put in place to ensure that a payment ratio of 95% is achieved.

R5 Payment Ratio / Collection Rate 95% 93.1% 94.0% 95.0% 95.0% 95.0% 95.0%

LIQUIDITY MANAGEMENT

R49 Cash Coverage Ratio (excl Working Capital)

0.5 : 1 0.7 : 1 1.8 : 1 2.3 : 1 2.6 : 1 2.8 : 1 Liquidity has deteriorated since the last update and the available cash is not sufficient to cover minimum liquidity requirements. This position, however, improves towards the latter years of the forecast period.

R50 Cash Coverage Ratio (incl Working Capital)

0.3 : 1 0.4 : 1 0.8 : 1 1 : 1 1.1 : 1 1.1 : 1

R51 Cash Surplus / Shortfall on Minimum Liquidity Requirements

-R 116.0 m -R 91.5 m -R 24.0 m R 1.7 m R 15.9 m R 21.8 m

R1 Liquidity Ratio (Current Assets : Current Liabilities)

1:1.5 - 1:2.0

0.9 : 1 0.9 : 1 1.1 : 1 1.1 : 1 1.1 : 1 1.1 : 1

LIABILITY MANAGEMENT

R45 Debt Service as % of Total Operating Expenditure

6% - 8% 5.6% 6.0% 6.7% 7.0% 7.3% 7.3% The municipality has scope to increase its borrowings as demonstrated by the gearing ratio of up to 29.3% and a debt service cover ratio of up to 7.3% in 2029. However, for Knysna to receive credit it must demonstrate financial discipline and manage its liquidity more prudently.

R6 Total Debt (Borrowings) / Operating Revenue

45% 26.7% 29.3% 31.8% 31.3% 30.2% 29.3%

R7 Repayment Capacity Ratio 2.29 11.15 5.90 6.10 5.71 5.55

R46 Debt Service Cover Ratio (Cash Generated by Operations / Debt Service)

2.6 : 1 1 : 1 1.4 : 1 1.3 : 1 1.3 : 1 1.3 : 1


N.T. NORM 2020 2021 2023 2025 2027 2029 COMMENTS

SUSTAINABILITY

Net Financial Liabilities Ratio < 60% 38.7% 39.2% 35.6% 33.3% 31.7% 31.0% The Operating Surplus Ratio improves during the forecast period.

Operating Surplus Ratio 0% - 10% -2.2% 0.4% 2.4% 2.3% 2.6% 2.7%

Asset Sustainability Ratio > 90% 123.3% 36.5% 33.7% 37.3% 40.7% 43.8%

FINANCIAL PERFORMANCE

EFFICIENCY

R42 Net Operating Surplus / Total Operating Revenue

>= 0% -2.2% 0.4% 2.4% 2.3% 2.6% 2.7% The electricity surplus is maintained at 29.3% over the entire forecast period.

R43 Electricity Surplus / Total Electricity Revenue

0% - 15% 29.3% 29.3% 29.3% 29.3% 29.3% 29.3%

REVENUE MANAGEMENT 100.0%

R8 Increase in Billed Income p.a. (R'm) R 84.0 m R 58.5 m R 57.9 m R 67.9 m R 80.6 m R 96.2 m Billed income is above the assumed inflation rate due to an increase in quantities of services sold as well as increase in tariffs. The national fiscal constraints will necessitate that the municipality strengthens its ability to generate cash from own revenue.

R9 % Increase in Billed Income p.a. CPI 14.3% 8.7% 7.4% 7.5% 7.7% 7.9%

R12 Operating Revenue Growth % CPI 9.9% 4.9% 7.2% 7.5% 7.7% 7.9%

R47 Cash Generated by Operations / Own Revenue

17.9% 7.2% 10.9% 10.6% 10.8% 10.8%

R48 Cash Generated by Operations / Total Operating Revenue

14.7% 6.0% 9.2% 9.0% 9.1% 9.1%

EXPENDITURE MANAGEMENT

R30 Contribution per Expenditure Item: Staff Cost (Salaries, Wages and Allowances)

25% - 40% 24.5% 28.6% 29.1% 28.6% 28.2% 27.8% Employee related costs are at the lower end of

the proposed norm although increasing over time and Contracted Services as a % of Total Expenditure has increased to level well above the norm. This needs to be addressed.

Contribution per Expenditure Item: Contracted Services

2% - 5% 16.9% 12.5% 12.5% 12.4% 12.2% 12.0%

GRANT DEPENDENCY

R10 Total Grants / Total Revenue 23.9% 18.4% 17.6% 17.5% 17.3% 17.2% The municipality’s dependence on transfers from other spheres of government is never entirely eliminated. It is however essential to try and reduce such dependence in future.

R11 Own Source Revenue to Total Operating Revenue

82.0% 84.0% 84.5% 84.7% 84.8% 85.0%

Capital Grants to Total Capital Expenditure

32.4% 31.5% 28.6% 27.4% 26.5% 25.9%


1 Planning Process




5 Future Revenues


7 Scenario Analysis

8 Ratio Analysis

9 Conclusions


OUTCOME OF THE INDEPENDENT FINANCIAL ASSESSMENT

Knysna’s overall financial performance in FY2019 continued to weaken, but the

municipality remained in a profitable position. The profitable position was

demonstrated by an Accounting Surplus of R 51.0 million, which decreased from

R 71.0 million in the previous year.

When capital grants are excluded, the municipality breaks even with a total

operating surplus of only R 1.2 million, compared to a surplus of R 4.6 million in

2018. This was mainly a result of the increase in Total Operating Revenue of

R 121.07 million (16%) against an increase in Total Operating Expenditure of

R 119.23 million (15%).

Knysna was still not able to generate cash from operations on exclusion of

conditional grants. However, it is positive to note that an improved debtor’s

collection rate of 94% was achieved, from a low rate of 91% the previous year.

With new external loan liabilities of R 60.24 million taken up during the year, the

gearing ratio was still manageable at 22% (compared to 20% in the previous year).

The negative debt service cover ratio of -0.07 raises debt affordability concerns

since cash generated becomes negative on exclusion of conditional grants.

Since Knysna did not generate enough surplus cash to invest in capital expenditure

for the year, the capital expenditure programme of R 148.51 million in FY2019 (an

increase of R 22.39 million or 18% from FY2018) was funded mainly by a mix of

capital grants (R 103 million or 59%), external borrowings (R 60.24 million or 41%).

Cash and Cash Equivalents decreased by R 8.17 million (10%). Current liabilities

increased by R 56.07 million primarily due to increases in unspent conditional grants

(R 22.27 million), and Creditors (R 21.07 million).

The movements in current assets and current liabilities resulted in a decrease of

the liquidity ratio of Knysna LM from 1.53:1 in FY2018 to 1.25:1 in FY2019. The

liquidity ratio is lower at 0.98:1 on exclusion of debtors older than 30 days.

The unencumbered cash and investments balance of R 59.85 million (FYE2018:

R 68.76 million) was insufficient to cover minimum liquidity required comprising of

Short term provisions (R 38.9 million), cash backed funds and reserves (R 45.5

million), unspent conditional grants (R 32.6 million), and the 1 months Opex

provision (R 60.04 million); resulting in a cash shortfall of R 117.5 million at year

end.

Capital replacement reserve of Knysna increased from R 40.5 million as at

FYE2018 to R 45.5 million as at FYE2019. It is a prudent approach to earmark

available cash for asset replacement in future.

STRENGTHS

• Ability to post increasing Accounting surpluses;

• Acceptable levels of gearing (22%), implies that the current level of

borrowings is not excessive.

• Positive budget implementation indicator of 99%;

WEAKNESSES

• Decreasing cash and investment balances;

• Weakening liquidity position;

• Negative cash generated from operations for the last 2 years

• R117.5 million shortfall to reach the minimum liquidity requirements for the

year;

• Increased balance of unspent conditional grants and creditors at year end.


OUTCOME OF THE FUTURE FORECASTS

The deterioration of Knysna’s financial position, specifically the liquidity position of

the municipality, necessitates immediate and drastic actions by management to

avoid a total depletion of cash resources.

The current MTREF paints a grim picture with liquidity levels forecast to continue its

decline. Should the MTREF of Knysna materialise the municipality will soon find

itself in a position where it will be unable to settle its creditors as and when it is due.

This will increase days payable and the municipality will find itself in a dire financial

situation, which is clearly not financially sustainable.

To avoid this situation, management will need to review its MTREF and take the

following corrective actions (as proven by the long-term financial model outcomes):

• The capital investment programme needs to be decreased to more

affordable levels from the current R 608.1 million to R 428.8 million over the

current and next two financial years;

• The capital funding mix should be strategically unbalanced to favour capital

grants and external borrowings over the utilisation of own cash resources,

thereby preserving cash and maintaining liquidity levels; and

• The rates tariffs need to be adjusted by not less than 1% per annum more

than currently proposed’

In addition to these corrective measures in the MTREF, Knysna needs to ensure

sound financial policies and corresponding actions that will ensure that:

• A collection rate of 95% is achieved and maintained; and

• Loan tenors are increased to an average of 13 years on all new borrowing

by the municipality (which means that a significant portion of the loans need

to have a loan tenor of 15 years or longer).

Should Knysna be successful in the implementation of the above recommendations,

the municipality can look forward to short term stabilisation of the financial situation

and slow improvement thereof over the medium to longer term.

This will enable Knysna Municipality to grow its capital investment programme by

10% year-on-year from FY2024 to reach a total capital investment of R 1.425 billion

over the ten-year forecast period. The cash and cash equivalents will reach the

minimum liquidity levels by FY2025.

The scenarios clearly indicate that an accelerated financial improvement is possible

should the municipality be able to:

• Increase collection rate to levels above 95%; or

• Improve real profitability once-off and permanently by R 10 million per

annum, by either increasing revenues, decreasing expenditure or a

combination of both; or

• Improve the collection rate in addition to an improvement in profitability,

which will result in an even stronger financial recovery with much better

results.

Throughout this period of financial stabilisation and recovery it is, however,

extremely important to maintain financial discipline and prudency, since any

decrease in profitability or drop in collection rate will be detrimental to the

municipality’s efforts in turning its financial situation around.

In the financial management of the municipality, management needs to take the

following considerations into account:

• The current household bill is still comparable to, and in most cases lower

than, the municipality’s peers in the Western Cape.

• Future rates and tariffs need to be cost-reflective and financially sustainable

on a functional level, which should be supported by thorough tariff

modelling, to avoid a profit margin squeeze (or reduction) on the main

municipal services or an over-reliance on the profits of any individual

service.

• The consistent year-on-year low economic growth in the region in recent

years is starting to impact negatively on the economic base of the

municipality, which is showing signs of erosion.


• As the municipality continues to extract higher levels of real revenue from

this eroding economic based, the households are under increased pressure

to service it municipal bill.

• The municipality will still be able to increase rates and tariffs in excess of

CPI in the short term, but should the low economic growth continue in the

foreseeable future, the municipality will have limited ability to increase

revenue with exponential increases in tariffs.

• It is therefore imperative that the municipality implement and action its

financial improvement strategy in the short term and that the municipality

create a conducive environment to stimulate and enable economic growth.

• It is also important to maintain or improve the other important municipal

financial metrics (i.e. technical losses on electricity and water) over the

forecast period, to avoid any abnormal or unnecessary profit and/or cash

leakage.

• The forecast ratio analysis contained in this report should guide the

municipality and provide management an indication as to the ratios that

need to be achieved annually to maintain its financial improvement and

longer-term financial sustainability.

• The municipality needs to achieve an unqualified audit opinion year-on-year,

as this is an important consideration for lenders, which can negatively

impact on availability of external financing and/or increase the cost of such

financing to the municipality.

• The long term financial plan should be adopted and updated annually to

maintain its relevance and provide the municipality with guidance and input

into its annual strategic decision making processes and budgets.


ANNEXURE 1: ROJECTED FINANCIAL STATEMENTS

j

Municipal Financial Model - Knysna

Statement of Financial Performance

Model year 1 2 3 4 5 6 7 8 9 10

Financial year (30 June) 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

R thousands

Revenue

Property rates 229 279 246 663 265 262 285 214 306 934 330 635 356 519 384 801 415 693 449 391

Service Charges 437 387 478 134 513 658 551 596 592 022 635 768 683 289 735 083 791 663 853 530

Rental of facilities and equipment 5 441 5 822 5 795 5 768 6 202 6 672 7 183 7 739 8 347 9 010

Interest earned - external investments 7 752 6 392 7 111 9 859 12 867 15 022 17 204 19 381 21 700 24 058

Interest earned - outstanding debtors 14 559 15 578 16 591 17 670 15 723 17 141 18 745 20 544 22 543 24 744

Dividends received – – – – – – – – – –

Fines, penalties and forfeits 84 708 90 637 96 529 102 803 110 537 118 912 128 012 137 930 148 759 160 589

Licences and permits 1 664 1 780 1 896 2 020 2 176 2 356 2 560 2 786 3 033 3 299

Agency services 3 000 3 213 3 438 3 679 3 955 4 255 4 581 4 935 5 323 5 746

T ransfers and subsidies (operating) 175 211 163 531 171 434 181 215 193 516 206 826 221 284 237 036 254 227 272 998

Other revenue 8 116 8 683 9 247 9 847 10 588 11 390 12 262 13 212 14 250 15 383

Gain on disposal of PPE 6 000 500 500 – – – – – – –

Revaluation on investment property gain / (loss) – – – – – – – – – –

Total revenue before Capital Grants 973 117 1 020 934 1 091 461 1 169 670 1 254 519 1 348 977 1 451 638 1 563 448 1 685 539 1 818 750

Capital Grants 75 741 29 928 31 580 30 000 32 299 34 842 37 660 40 791 44 273 48 148

Public & developers contributions – – – – – – – – – –

Total Revenue after Capital Grants 1 048 858 1 050 862 1 123 041 1 199 670 1 286 819 1 383 818 1 489 297 1 604 239 1 729 812 1 866 898

Operating expenditure

Employee related costs 290 384 307 327 328 509 351 150 374 396 399 662 427 239 457 426 490 525 526 836

Remuneration of councillors 9 982 10 681 11 375 12 114 12 794 13 530 14 328 15 197 16 145 17 179

Debt impairment 106 326 107 324 106 923 114 229 122 782 132 052 142 131 153 119 165 118 178 227

Depreciation and asset impairment 34 907 41 057 42 714 44 505 46 417 48 612 51 113 53 945 57 135 60 712

Finance charges 29 653 34 478 39 268 44 287 47 865 51 824 55 960 60 123 65 000 70 149

Bulk purchases 199 678 221 906 239 975 259 323 280 206 302 871 327 557 354 534 384 079 416 474

Other Materials 26 734 74 874 74 764 78 854 86 336 94 574 103 669 113 735 124 895 137 275

Contracted services 207 702 139 408 146 538 155 389 168 823 179 452 191 184 204 139 218 446 234 235

T ransfers and subsidies 5 317 3 985 4 032 4 079 4 386 4 718 5 079 5 473 5 902 6 372

Other expenditure 82 911 74 973 74 953 76 960 83 128 89 362 96 141 103 535 111 613 120 442

Loss on disposal of PPE 674 715 757 798 898 1 015 1 154 1 318 1 512 1 744

Total Expenditure 994 268 1 016 727 1 069 808 1 141 687 1 228 032 1 317 672 1 415 556 1 522 544 1 640 371 1 769 643

Suplus/ (Shortfall) for the year 54 590 34 135 53 233 57 983 58 787 66 146 73 742 81 695 89 441 97 254



Statement of Financial Position

Model year 1 2 3 4 5 6 7 8 9 10


R thousands

Non-current assets: 1 463 038 1 520 776 1 582 223 1 647 319 1 721 513 1 805 651 1 900 670 2 007 608 2 127 612 2 261 950

Property, plant and equipment 1 328 704 1 382 647 1 439 933 1 500 428 1 569 512 1 647 950 1 736 592 1 836 377 1 948 346 2 073 648

Intangible assets 136 136 136 136 136 136 136 136 136 136

Investment properties 76 755 76 755 76 755 76 755 76 755 76 755 76 755 76 755 76 755 76 755

Investments 37 948 41 743 45 904 50 505 55 616 61 316 67 693 74 845 82 880 91 916

Long-term receivables – – – – – – – – – –

Other non-current assets 19 495 19 495 19 495 19 495 19 495 19 495 19 495 19 495 19 495 19 495

Current assets: 207 281 221 686 259 513 300 203 325 465 348 428 368 773 388 967 407 688 426 782

Inventories 22 530 30 790 30 764 32 016 34 821 37 795 41 057 44 645 48 598 52 956

T rade and other receivables 141 459 141 459 141 459 141 459 141 459 141 459 141 459 141 459 141 459 141 459

Cash & Short term investments 43 293 49 436 87 290 126 727 149 185 169 174 186 257 202 863 217 631 232 368

TOTAL ASSETS 1 670 319 1 742 461 1 841 736 1 947 521 2 046 978 2 154 079 2 269 443 2 396 575 2 535 300 2 688 732

Municipal Funds: 1 086 098 1 120 234 1 173 467 1 231 450 1 290 237 1 356 383 1 430 124 1 511 819 1 601 260 1 698 515

Housing development fund & Other Cash Backed Reserves – – – – – – – – – –

Reserves (Not Cash Backed) 45 500 45 500 45 500 45 500 45 500 45 500 45 500 45 500 45 500 45 500

Accumulated surplus 1 040 598 1 074 734 1 127 967 1 185 950 1 244 737 1 310 883 1 384 624 1 466 319 1 555 760 1 653 015

Non-current liabilities: 343 775 380 922 413 668 446 479 465 951 484 153 504 007 525 309 550 862 587 418

Long-term liabilities (Interest Bearing) 234 079 271 226 303 972 336 783 356 254 374 456 394 310 415 612 441 166 477 722

Non-current provisions 109 696 109 696 109 696 109 696 109 696 109 696 109 696 109 696 109 696 109 696

Current liabilities: 240 445 241 305 254 600 269 592 290 791 313 543 335 312 359 446 383 177 402 799

Consumer deposits 13 905 14 930 15 994 17 089 18 217 19 382 20 583 21 825 23 109 24 438

Provisions 38 872 38 872 38 872 38 872 38 872 38 872 38 872 38 872 38 872 38 872

T rade and other payables 161 482 159 650 167 480 178 191 193 173 208 092 224 424 242 350 262 054 283 727

Bank overdraft – – – – – – – – – –

Current portion of interest bearing liabilities 26 186 27 853 32 254 35 439 40 529 47 198 51 432 56 400 59 141 55 762

TOTAL MUNICIPAL FUNDS AND LIABILTIES 1 670 319 1 742 461 1 841 735 1 947 521 2 046 978 2 154 079 2 269 443 2 396 574 2 535 299 2 688 732



Cash Flow Statement

Model year 1 2 3 4 5 6 7 8 9 10


R thousands

Cash flows from Operating Activities

Suplus/Deficit for the year including Capital Grants 54 590 34 135 53 233 57 983 58 787 66 146 73 742 81 695 89 441 97 254

Suplus/Deficit for the year excluding Capital Grants & Contributions (21 151) 4 207 21 653 27 983 26 487 31 305 36 082 40 904 45 168 49 106

Capital Grants & Contributions 75 741 29 928 31 580 30 000 32 299 34 842 37 660 40 791 44 273 48 148

Adjustments for non-cash items:

Depreciation, amortisation and impairment loss 34 907 41 057 42 714 44 505 46 417 48 612 51 113 53 945 57 135 60 712

Revaluation on investment property (gain) / loss – – – – – – – – – –

Increase / (Release from) current provisions & non-interest bearing liabilities – – – – – – – – – –

Increase / (Release from) other non-current provisions & non-interest bearing liabilities – – – – – – – – – –

(Increase) / Release from non-current interest bearing assets (3 450) (3 795) (4 161) (4 601) (5 111) (5 700) (6 377) (7 152) (8 035) (9 036)

Capitalised interest – – – – – – – – – –

Operating surplus before working capital changes: 86 047 71 397 91 786 97 887 100 092 109 058 118 478 128 488 138 541 148 930

Change in W/C Investment 57 074 (10 092) 7 857 9 459 12 177 11 945 13 071 14 338 15 752 17 315

(Increase)/decrease in inventories (12 239) (8 261) 27 (1 253) (2 805) (2 974) (3 262) (3 588) (3 953) (4 358)

(Increase)/decrease accounts receivable 53 259 – – – – – – – – –

Increase/(decrease) in trade payables 16 054 (1 832) 7 830 10 711 14 982 14 918 16 333 17 925 19 705 21 673

Net cash flow from Operating activities 143 121 61 305 99 643 107 346 112 269 121 003 131 548 142 825 154 292 166 245

Cash flows from Investing Activities

Capital expenditure (233 779) (95 000) (100 000) (105 000) (115 500) (127 050) (139 755) (153 731) (169 104) (186 014)

Decrease/(Increase) in non-current receivables – – – – – – – – – –

(Additions) / Disposals of investment property – – – – – – – – – –

Net cash flow from Investing activities (233 779) (95 000) (100 000) (105 000) (115 500) (127 050) (139 755) (153 731) (169 104) (186 014)

Cash flows from Financing Activities

New loans raised 87 188 65 000 65 000 68 250 60 000 65 400 71 286 77 702 84 695 92 317

Loans repaid (25 927) (26 186) (27 853) (32 254) (35 439) (40 529) (47 198) (51 432) (56 400) (59 141)

(Decrease) / Increase in consumer deposits 981 1 025 1 064 1 095 1 128 1 165 1 202 1 241 1 284 1 329

Net cash flow from Financing activities 62 242 39 838 38 211 37 091 25 689 26 036 25 290 27 511 29 579 34 505

Change in Cash (28 416) 6 144 37 854 39 437 22 457 19 989 17 083 16 606 14 768 14 736

Cash/(Overdraft), Beginning 71 709 43 293 49 436 87 290 126 727 149 185 169 174 186 257 202 863 217 631

Cash/(Overdraft), Ending 43 293 49 436 87 290 126 727 149 185 169 174 186 257 202 863 217 631 232 368

Prepared by INCA Portfolio Managers

Tel: +27 [0]11 202 2210

Fax: +27 [0]11 202 2231

Unit F14, Pinewood Square

Pinewood Office Park

33 Riley Road

Woodmead

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