Definition of a Proprietary Fund

Government works like a business more than some people realize. A lot of government services, such as school lunches and sending mail, involve a fee for goods or services. Proprietary funds are a government tool for keeping track of the money involved.

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Proprietary funds have two definitions. In government, proprietary funds, also known as enterprise funds and internal revenue funds, provide goods or services for a fee. In private investing, proprietary funds are mutual funds designed, managed and sold by the brokerage encouraging people to invest in them.

Many of government's operations can't be run like a business. It's not practical to calculate profit margins for the U.S. military, for instance. Proprietary funds are one of government's most business-like activities. The government sells something, such as goods or services, and someone else buys.

The proprietary funds definition includes two distinct types of funds. An enterprise fund sells goods or services to the public, while an internal service fund provides services to other parts of the government.

Enterprise funds in schools include the cafeteria, bookstores and athletic stadiums that sell tickets to events. State lottery tickets and workers' compensation funds would also qualify.

An enterprise fund is segregated from the rest of the government's finances. The money that comes in isn't a source for general revenue but provides funding for future enterprise activities.

Enterprise funds can be financed by debt that will be paid off from future revenues. Others operate on a pay-as-you-go basis, using fees for services or goods to cover the budget. If it's a legal or policy requirement that the fund pay for itself, it has to be identified as an enterprise fund in the government's account books.

An internal service fund operates similarly to an enterprise fund, but it deals with other parts of the government. For example, suppose a school district operates a central warehouse for school supplies and a central printing office. When it provides those services to member schools, the schools reimburse the district for the cost.

If a government fund provides services or goods to both the government and the public, it only qualifies as an internal service fund if the government is the primary participant. If most of the services or goods go to outside buyers, then it should be classed as an enterprise fund.

The advantage of setting up an internal services fund is that segregating the revenue and expenses gives government a clearer idea of how much providing the services really costs.

Enterprise funds, like businesses, follow generally accepted accounting principles. As they're government operations, however, the GAAP rules have to be applied differently. The emphasis is on their net position — the amount that's in the fund less the amount required to set it up.

When the government draws up its financial statements, it treats each enterprise fund separately. All the internal service funds are aggregated together in the statements.

The cash flow statement is important for proprietary funds. It lets readers in the government or the wider community see how effective the fund is at paying for the services it provides.

Proprietary funds from brokerages are a different kettle of fish. They're also known as "house funds" because they're set up in house. They're a product the brokerage creates and sells to clients rather than one run by a separate business. If someone invests in them, there's no way to transfer their fund holdings to another brokerage.

Some proprietary funds are modeled on established funds with similar selections of investments. Other funds have a narrower range of investments with an eye to picking holdings that outperform the market.

These funds are controversial because whatever fees the fund generates go back to the brokerage. It's in their interest to encourage clients to invest in the house fund. That may conflict with their fiduciary duty to give clients the best financial advice.