This paper proposes a classification model of the financial reporting of Italian Local Governments (ILGs) and a grid of indicators supporting financial analysts in their solvency ratings. Due to their increased financial autonomy, ILGs increasingly need to resort to various forms of borrowing. However, the Basel II agreement requires financial institutions to carry out a thorough assessment of the creditworthiness of all potential borrowers, including ILGs. After reviewing the main criteria adopted by rating agencies for their analyses, this paper focuses on the assessment of the financial situation and debt position of ILGs. Such entities use a ‘financial’ accounting system based on commitment and ascertainment, to which the cash flow analysis model provided by IPSAS cannot be applied. The proposed classification model and the relevant grid of indicators were applied to the ILGs, differing in size but located in the same area, in order to test whether these tools could provide a thorough assessment of the financial situation of any LG. Finally, the study proposes an equation to define the maximum degree of indebtedness for an LG, in compliance with the limits set by the current regulations in Italy.

Over the last few years, the degree of financial autonomy enjoyed by Italian Local Governments (ILGs) has considerably increased, partly due to the 2001 Constitutional Reform. Consequently, ILGs have gained access to a wide range of financing possibilities, such as credit securitization, financial leasing, interest rate swaps, and bonds covering investment expenditure. Meanwhile, the International Capital Framework issued by the Basel Committee (known as Basel II) requires that the banking system carries out more thorough credit risk assessment1. Being entitled to levy taxes, ILGs are like sovereign entities and are therefore subject to credit risk assessment. Yet the accounting system they currently use, which is based on financial accounting, does not allow to directly calculate appropriate credit rating indicators. In this socioeconomic scenario, ILGs are increasingly pressed to disclose their financial situation, not only to provide financiers with substantive information about their economic and financial standing, but also to be accountable to their citizens for the decisions taken.

Given these premises, the purpose of this study is to test whether the financial statement of ILGs, as it is set out by the current regulations, can provide an accurate assessment of their debt capacity and particularly of their solvency rating. The paper then proposes a cash flow analysis model and a grid of indicators to complement the information provided in the Financial Report.

The paper is organized as follows: Section 2 presents the scenario in which ILGs currently operate and seeks to identify the parties to whom ILG managers should be accountable to. Section 3 raises considerations about the informative ability of financial reporting for the purposes of financial analysis, and Section 4 reviews the criteria adopted by credit rating agencies and provides the initial observations concerning the usefulness and comprehensiveness of financial reporting when it comes to assessing the solvency and creditworthiness of an ILG. Section 5 proposes a cash flow model and a grid of indicators to assess the financial equilibrium of ILGs; the model and the grid are then used to analyze the Financial Report of three ILGs. The last section discusses whether it is possible to give a credit rating based on a financial accounting system, and finally, the conclusion is offered with some implications for further research.

Financial Risk Management Journal, Discounted Cash Flow, DCF, Net Present Value, NPV, DCF Techniques, Monte-Carlo Simulation Method, Cyprus Telecommunications Authority, CYTA, Information Technology, IT, Methodological Issues, Cash Flow, Weighted Average Cost of Capital, WACC, Decision Making.