New London - In response to a budget crunch that may leave the city about $4 million in the hole by the end of the current fiscal year, the city's finance director has established a weekly "financial working group" and will meet with a representative of the state Office of Policy and Management.

"We really want to be able for the finance department to provide good financial information data in a timely fashion,'' said Jeffrey H. Smith, the interim finance director who began working for the city in August.

"We're not in jeopardy of the state taking over, but if we can't pay our bills, the state will be interested," said Smith, who also will meet with the City Council's Finance Committee at 6 p.m. Monday.

In a press conference Friday night, Mayor Daryl Justin Finizio announced that the city could be facing a $12 million budget gap. But the shortfall, which spans three fiscal years, is actually closer to $6 million.

If the city is forced to raid the $6 million fund balance - an emergency reserve meant to cover unanticipated expenditures - to cover a possible $4.3 million projected deficit in the current year's budget and a $1.3 million deficit in the 2010-11 budget, taxpayers might have to come up with nearly $6 million to replenish the fund balance in the 2012-13 budgeting process.

The city's 2012-13 budget is $81,862,570, about half of which covers the school budget.

In a memo sent to the mayor last week, Smith outlined the possible deficits.

"It does not overstate the case to say New London is on an unsustainable financial path which can only be solved by increasing revenues, decreasing expenditures or some combination of both,'' he wrote. "Regardless of the decisions the city makes they will not come without some level of pain."

In an interview Wednesday, Smith reviewed some of the budget figures and explained that the numbers for the current year are estimates and that "predicting the future is hardly an exact science." But he said he believes the estimates are reasonable.

The city is facing a three-tier problem, Smith said - cash flow, a deficit and restoring the fund balance.

In the budget for the current year, which ends June 30, some revenues were overestimated. The amount of taxes collected were overestimated by $790,000 and interest earnings were overestimated by $640,000. On the other hand, Smith said, grant money will cover another shortfall of $250,000 in the special revenue account.

Debt service - the amount of interest the city pays on its loans - was underestimated by about $500,000. The Public Works Department appears to be underfunded by about $700,000, the law department by about $115,000. The shortage in the law account is to cover claims, Smith said.

The city fire department also needs an additional $142,000, but Smith said the department comes in over budget every year because of staffing issues and overtime.

In the upcoming 2012-13 budget, which has not yet been presented, if the City Council sticks to a policy it adopted in 1993, which recommends a fund balance of 8.3 percent of the budget, the city would need another roughly $6 million.

Ways to address the budget crunch include sending out supplemental tax bills and selling off city property.

On Friday Finizio announced an immediate hiring freeze and a cut in nonessential spending.

Smith, who was the financial director in Mansfield before retiring there in 2009, said he spent his first months on the New London job looking through budget documents and reorganizing the department.

When he realized the extent of the crisis, he said, he called the city's bond counsel and its independent financial advisers. He also spoke with David LeVasseur, the acting undersecretary of the state Office of Policy and Management.

The financial working group Smith established includes as members Mark Chapman, the city's financial adviser; Joe Selenger of the bond counsel; and Ron Nossek, one of the city's auditors.

k.edgecomb@theday.com