Faced with a $7 million deficit at the start of the fiscal year in July, the school department has a balanced budget, although from a financial perspective, schools are far from out of the woods.

Superintendent Peter Horoschak said Tuesday that for a second consecutive year the department ended the previous fiscal year with a surplus – this time $1.99 million – and that coupled with concessions granted by the teachers and the Warwick Independent School Employees (WISE) contract, schools will operate with a revised $157.2 million budget.

The proposed balanced budget will be presented to the School Committee at its meeting Oct. 11.

Going forward, Horoschak says there are still major financial challenges. Use of the surplus this year will mean the department enters the coming fiscal year with a structural deficit. Larger yet is how the department will address declining enrollments, which is likely to mean frozen, if not reduced, city and state allocations. Based on the state school funding formula, school chief budget officer Anthony Ferrucci projects a cut of $860,000 in state funding next year with a 200 student drop in enrollment.

Horoschak has said the department will look at the closure of one of the city’s six secondary schools.

And without pension reform, which the state is looking at, the department would face an additional $5.6 million in pension contributions next year, Ferrucci said yesterday.

The superintendent and committee chairwoman Bethany Furtado shared the positive financial news with Mayor Scott Avedisian on Monday.

“I really do want to work in a positive manner. What happens in this city is our responsibility. I’m not interested in being adversarial,” Horoschak said.

“That is certainly good news for their bottom line and the financial situation of the city,” Avedisian said in a statement yesterday.

“I appreciate the efforts of the school administration and the Chairwoman Furtado in working to resolve this funding issue and I look forward to working with them to build a closer relationship in the future,” the mayor added.

In recent months Avedisian has accused the superintendent of setting his own agenda without consideration of the city as a whole. And he has been miffed to learn of developments such as a resolution of the WISE contract after five years of failed talks from the news media rather than directly from the department.

Also straining the relationship is the department’s lawsuit claiming that the city failed to meet the maintenance of effort for funding as defined by the state Department of Education. Representatives for the schools and the city are to argue their positions before a Superior Court Judge. At stake is $6.2 million.

The city argues it met funding levels as set by law, especially when the decline in system-wide enrollment is considered.

As for the school decision to proceed with the suit, Avedisian said, “While it is my belief that the School Committee should now dismiss its law suit, that is a decision that only they can make. I do not believe that it makes sense to proceed to court asking for additional funding when the School Department has declared that it now has a balanced budget.”

The $1,993,496 surplus for the last fiscal year represents a positive variance of 1.2 percent on the budgeted $157.9 million.

“One percent positive variance is a goal you want; to have some surplus from all your operations,” Ferrucci said in an interview yesterday.

Horoschak agreed that is a very small percentage, but “if it goes the other way, it is really large.”

More than $1 million of the surplus was generated through salary and fringe benefit savings, called breakage, by replacing retiring teachers with less senior staff. Going into the year the department had projected about 26 retirements. In actuality there were 51 retirements.

In addition, the department received added Medicaid payments amounting to $466,000 and saved $436,000 in non-staffing costs.

In May the committee adopted a $161.1 million budget. Three developments have enabled the department to trim costs, reducing the budget to $157.2 million, or about $700,000 less than what it spent in FY11.

Horoschak praised the teachers and the WISE union for making it possible. Although the teachers’ contract expired on Aug. 31 and the parties have not reached an agreement, the union agreed to increasing its share of health insurance co-pay from $11 a week to 20 percent, which brings it in line with other school employees. This reduced school costs by $2,097,000 for the year.

Secondly, the WISE contract that empowers the department to contract for special education bus service, thereby virtually eliminating the transportation department and the cost of maintaining a bus fleet, is projected to save $1.3 million. As part of the WISE agreement, the union did not contest the 20 percent health insurance co-pay the department unilaterally applied last year. Had the department been faced with retroactively paying for those benefits, it would have meant another $1.2 million liability.

The third reduction to this year’s budget results from $425,000 in savings from medical, transportation and insurance costs.

Ferrucci said, “storm clouds are circling” on the upcoming fiscal year. He cited uncertainties over pension costs as well as state, federal and local aid. He also listed a structural deficit of about $2 million, as last year’s surplus is being applied to balance the current budget.