xxxi barriers in successfully analyzing t he financial st at ement s of local governm ent s. The first barrier is
t he lack of w idely accept ed financial rat ios and t he second barrier is t he fact t hat since such rat ios do not exist neit her are t her e nat ionw ide nor ms against w hich t o com pare t he rat ios for a
part icular local governm ent s. The obst acles of conduct ing financial rat io analysis in public sect or can be solved by
underst anding t he nat ur e of financial rat ios implement at ion in local government s as indicat ed by Cohen 2008 w ho st at ed t hat financial rat ios implement at ion in local governm ent s ar e not as
st raight f orw ard as t he privat e sect or. The evaluat ion of public sect or ent it ies’ financial condit ion involves judgm ent s about t he int erplay of complex social, organizat ional and financial fact ors. In
general t er ms, economy, geography and demographi cs const it ut e major component s of a local governm ent f inancial condit ion as t hey ar e det er mining fact ors of a government s’ abilit y t o m eet
it s f inancial and service obligat ion. Thus, as t he charact erist ics of t he com munit y ar e expect ed t o have an impact on t he act ivit y
of local government s, t he use of macroeconomics t ype paramet ers as moderat ors w hen assessing t he perfor mance of public sect or ent it ies is a com monly employed f eat ur e in public sect or
ef ficiency st udies as conduct ed by At hanassopulos and Triant is 1998 and Cohen 2008. At hanassopulos and Triant is 1998 have analyzed t he efficiency of 172 large Gr eek local
governm ent s for t he year 1996 on t he basis of cash-basis account ing dat a. They concluded t hat t he most efficient local governm ent s w ere t hose t hat had higher t ax bases, incom e levels and
public invest m ent share on t ot al expendit ure.
1. Financial ratio selection
The financial rat ios developed in t his research ar e based on financial rat ios used by Cohen 2008 w it h several modificat ions adjust ed w it h Indonesian cont ext . The financial rat ios ar e
xxxii profit abilit y rat ios, liquidit y rat ios, capit al st ruct ur e rat ios, and perfor mance rat ios. Cohen 2008
st at ed t hat t he f inancial rat ios select ion is based on privat e sect or and public sect or lit erat ur e such as ICM A 2003, Berne 1992, Ant hony and Young 2003, and Finkler 2005. M oreover, t he
select ed rat ios aim at achieving balanced r epr esent at i on of t he four broad cat egori es of f inancial rat ios w it hin t he analysis f ramew ork Cohen, 2008.
a. Profit abilit y rat ios
In privat e sect or, one of t he most difficult at t ribut e of a fir m t o concept ualize and t o measur e is profit abilit y. Ross et al. 2005 st at ed t hat t he pr ofit abilit y rat ios cont ain t w o
draw backs. The first draw back is t hat many business opport unit ies involve sacrificing curr ent profit for fut ure profit s and possibly t he business w ill produce low init ial profit s. Thus, current
profit s can be a poor r ef lect ion of t rue f ut ur e profit abilit y. The second draw back is t hat t hey ignore risk.
Profit abilit y in public sect or is measured by comparing surplus or deficit on local governm ent ’s budget w it h equit y, t ot al asset s and local government original r evenue. Thus, prof it
like usually know n in privat e sect or is replaced by budget surplus or deficit . Even t hough profit abilit y is not a primary goal in t he public sect or, t he exist ence of a r easonable surplus is
necessar y in or der f or a municipalit y t o have enough funds t o finance it s long-t erm invest m ent Cohen, 2008.
In Indonesia, budget surplus or deficit is ruled under The Governm ent Rule Number 58 Year 2005 about Local Governm ent Financial M anagement . The Rule st at es t hat ever y local
governm ent can not exceed t he deficit limit based on minist er of f inance’s decr ee. M eanw hile, local gover nm ent s can use budget surplus t o pay debt s, est ablish reser ve fund and finance social
securit y program. Thus, The Rule indicat es t hat r easonable surplus is favorable because local
xxxiii governm ent can use surplus t o pay debt s, est ablish reser ve fund and finance social securit y
program. On t he cont rar y, deficit is less favorable because local governm ent has t o r eimburse t he deficit w it h several resources as st at ed by Governm ent Rule Number 58 Year 2005 w hich consist
of posit ive value of budget calculat ion dif fer ence from previous year, reimbursed reser ved fund, asset auct ion and debt .
The pr ofit abilit y rat ios used in t his research consist of ret urn on equit y rat io ROE, r et urn on asset s rat io ROA and profit margin rat io PM . The profit abilit y rat ios ar e included in t his
research because t hey provide a reflect ion of eff iciency in t he use of resources Cohen, 2008. b. Short -t er m solvency
Rat ios of shor t -t erm solvency measur e t he abilit y of t he fir m t o m eet r ecurring f inancial obligat ions Ross et al. 2005. The ent it y should have a good rat io in t his t erm t o avoid f inancial
dist ress. In cont ext of local governm ent , t he short -t erm solvency indicat or show s local governm ent abilit y t o sust ain a st rong financial posit ion Cohen, 2008.
The financial obligat ion of local governm ent s in Indonesia is ruled under Government Rule Number 54 Year 2005 about Local Government Debt . The Rule enables local governm ent s t o issue
bonds in order t o cope w it h financial difficulties. How ever, The Rule rest rict s local govern ment s t o involve in debt by r equiring ever y local governm ent meet several crit eria as st at ed by Sect ion 11
and 12 successively. Sut aryo 2009 invest igat ed t he r elevance of Indonesian local gover nment s f inancial
st at em ent s st at ed in financial rat ios t o financial dist ress and found t hat informat ion cont ent in local governm ent financial report has r elevant value t o Indonesian local governm ent ’s f inancial
dist ress. Cohen 2008 invest igat ed fact ors influencing financial performance in Greek
xxxiv municipalit ies and f ound t hat f inancial perf or mance t hat elaborat ed w it h several financial rat ios
including current rat io is influenced by macroeconomic fact ors. The m ost w idely used m easur es of account ing liquidit y are current rat io and quick rat io
Ross et al, 2005. How ever, t he short t er m solvency used her e is only t he curr ent rat io since t he quick rat io is not applicable because t he pr esence of invent or ies t hat only suit able for privat e
sect or. c.
Capit al st ruct ure rat io Capit al st ruct ur e rat ios show how t he ent it y is being f inanced. The f inancing sour ce comes
from t w o sources; liabilit y and equit y. The t w o common rat ios for capit al st ruct ur e rat ios ar e debt t o equit y rat ios and debt t o t ot al asset r at io.
This resear ch w ill incorporat e t he debt t o equit y rat io and t he long t erm deb t o t ot al asset s rat io. The higher t he value of debt t o equit y r at io, t he gr eat er t he local governm ent s’ leverage
and t hus t he great er t he ext ent t o w hich it ut ilizes debt funds t o supplem ent int ernal equit y funds Cohen, 2008.
d. Perf ormance rat io
The per for mance rat ios in t his research w ill relat e w it h t he r evenues. In Indonesian cont ext , based on t he Law Number 33 Year 2004, t he r evenue can be divided int o t hr ee t ypes; m unicipal
original revenue, count erbalance funds and ot her r evenues. The rat ios ar e divided int o t hr ee rat ios: asset s t urnover rat io, operat ing r evenue t o t ot al revenues and operat ing r evenue t o
xxxv operat ing expense. Based on t he law , operat ing revenue is represent ed by local governm ent
original revenue. The asset s t urnover rat io repr esent s t he efficiency use of asset s in generat ing t he municipal
original revenue. The operat ing r evenue t o t ot al revenues show s t he degr ee independency of local governm ent s from t he cent ral governm ent subsidies. Operat ing revenue t o operat ing
expenses rat io show s t he abilit y of Local governm ent original revenue in f inancing t he operat ing expenses.
C. Exogenous Fact or Select ion
