New London - If the city is hit by a natural disaster before next July or municipal departments spend more than they have in their budgets, taxpayers could be in trouble.

That's because the city has just $312,000 in its fund balance.

"The city has absolutely no cushion,'' said Finance Director Jeffrey Smith. "We run the risk of running out of cash."

Smith said no department can overspend its budget and the city must collect all the revenue it expects to receive during the current fiscal year.

On Tuesday, Smith presented the City Council with preliminary numbers after closing the 2011-12 budget. It showed city departments had overspent the $42 million general government budget by just over $1.6 million. The city also collected about $3 million less than it estimated it would receive in revenues. The Board of Education returned about $31,000 to the city.

The nearly $4.7 million deficit was plugged with cash from the city's fund balance. Another $1.3 million was taken out of the fund balance to cover a deficit in the 2010-11 budget. Two years ago, the fund balance had about $6 million in it. It now has just over $300,000.

"This puts the city in a very precarious situation,'' Smith said.

It make good fiscal sense to keep money in a fund balance, according to the Connecticut Conference of Municipalities. It can be used in case of emergencies, such as replacing a fire truck or other unexpected expenditures.

James J. Finley, executive director of the CCM, said most towns in the state try to keep at least 5 percent of their budget in a fund balance.

"But a lot of communities are not able to reach 5 percent because they're trying to keep their property taxes down," he said. "Education costs are increasing, state support is decreasing. Communities have to do a balancing act."

It is especially difficult for municipalities like New London, which are small and provide regional services, such as hospitals, transportation, courts; and recreation, such as Ocean Beach Park.

"New London is one of the many cities in Connecticut that is geographically small and doesn't have property tax wealth to meet all its service needs,'' Finley said. "That's why state aid is so important."

In New London, the adopted policy is to keep 8.3 percent of the budget in the fund balance, or about $6 million. Municipalities can increase a fund balance in various ways, including by saving year-end surpluses and by taxing residents.

A healthy fund balance can also help a city get better interest rates when it goes out to borrow money for large projects. Bonding agencies look for trends in a municipality's finances to help determine interest rates.

The more money you have saved, the better your interest rate, according to Mark Oefinger, the Groton town manager, who oversees a roughly $120 million budget with about $9 million in fund balance. Groton applied $1.5 million from its fund balance to this year's budget to keep its tax increase to about 7 percent. It was a 1.33 mill increase.

"It defies logic,'' he said. "A fund balance shouldn't be complicated, but it is.''

Oefinger said if there's too much money in a fund balance, critics say the municipality is overtaxing its residents. If the balance is too low, the town runs the risk of having to pay for borrowing.

"I'm very conservative,'' said Oefinger. Money that departments save at the end of the year is put into fund balance, he said. Unanticipated revenues can also be added to the fund balance.

"It's all in there and hopefully you never have to use it,'' he said.

In New London, where the $42 million general government budget is up for a referendum Sept. 18, there are no provisions to increase the fund balance. Smith said the city is working on a plan to start increasing its savings.

"It's a big business we're running,'' Smith said, adding that municipal budgets are not as simple as a home budget.

"A lot of people will personalize the budget to small things, like how much someone makes or how much a car costs,'' he said.

The public should instead focus on the level of services the city provides. If the services are adequate, it will cost a certain amount of money.

"We need a more global approach,'' he said. "Are we providing services in the most efficient and effective manner?"

k.edgecomb@theday.com