Financial
Check-Up For Utilities
by Bill Stufflebean
Wastewater Training Tech
Ohio Rural Water Association
A
great deal of effort is directed toward the operation and maintenance of water and
wastewater treatment facilities. While these are very important, there is
another area that requires just as much if not more attention to enjoy healthy
utilities.
The financial health of a community, whether it is large or small, can mean the
difference between success or failure, solutions or problems, as well as
stress-free or stressful operations.
The following is a short guide to assist in identifying where your utilities
are financially. This outline is not intended to solve all of the problems that
you may have, but it can offer suggestions and a plan to help you on your way
to a healthy financial future by presenting some of the more important
principles of financial management.
The first thing you will discover is the financial condition of
your utility. Secondly, it will allow you to structure a solid foundation for a
strong financial future.
HOW DO I START?
It would only be wise to x-ray your
utility. This is done by calculating the operating and coverage ratios. This
procedure will tell you whether revenues are covering all the costs of your
utility.
The Operating Ratio: This is an identifying tool, if checked on a
monthly basis, that will show you the trend of finances for your utility. To
find this ratio, you simply divide the total revenues by the total operating
expenses. That is the easy part, the difficult task may be locating the numbers
you need to perform the calculation. This may require scouring over accounting
records and separating the water and wastewater utilities if they are combined.
Some examples of revenue would be:
User service charges, hook up and impact fees, taxes and assessments, interest
earnings or anything else that would contribute toward revenue.
Examples of operating expenses are:
Administration costs, wages, benefits, electricity, chemicals, fuel and
utilities, parts, equipment replacement, principal and interest payments or any
other category that would contribute to operating expenses.
Once you have gone over the
accounting reports, separated the utilities and identified the total revenues
and operating costs, you are ready to calculate the operating ratio.
An operating ratio of 1.00 is the
bare minimum for a system to support itself; however, if the utility has any
outstanding debt, the operating ratio will need to be greater than 1.00. How
much greater the ratio should be depends totally on the amount of the
outstanding debt.
Once you have established your
operating ratio, it is a very good idea to monitor trends. This can be done on
a monthly basis and will give you an idea of seasonal fluctuations over the
course of the year. It can also be used to compare to previous years to
indicate whether it is time to adjust rates. A simple way to monitor the ratio
is to make a graph of the collected data. This will give a visual snapshot of
the trends.
In a financially healthy utility, the
trend in the operating ratio should be steady or moving upward. If it is over
the minimum value required to pay all the bills and holding steady, the utility
is probably financially healthy. If the ratio is below the minimum value or
falling, it will be necessary to take corrective action to get the ratio back
in a healthy range.
The Coverage Ratio: This measures
whether your utility has enough revenue to pay the principal and interest on
its loans and bonds with enough money left over for unexpected problems.
The coverage ratio is a good indicator of good financial management and should
be checked at the end of every year.
To calculate the coverage ratio, add
all the revenues received throughout the year. Then add together all the
non-debt operating expenses for the
year. These will be the same categories of costs used in the operating ratio
minus the principle and interest payments. Subtract the non-debt operating
expenses from the total revenue. Then divide the result by the debt service for
the year. Debt service is the total amount of interest and principal that has
to be paid on your loans and bonds during the year.
Generally, the terms of a bond or
loan require a coverage ratio of 1.25 (125%) or higher. If your ratio drops
below the required value, an increase in user service charges is needed in
order to meet the obligations due on loans and bonds.
As with the operating ratio, it is a good
idea to compare the coverage ratio with previous years ratios. A drop in the ratio will indicate trouble
ahead if rates are not increased to raise the ratio to an acceptable range.
While the operating and coverage
ratios are the most important measures for determining the financial health of
your utility, there are a few other indicators that can be beneficial in
assisting to fine tune your financial future.
Budgeted vs. Actual Expense Comparison:
This task should be performed at least quarterly and preferably monthly.
Obviously a monthly check will head off financial problems sooner than a
quarterly check and will enable the utility to make adjustments before it
becomes a major problem.
Without getting into too much detail,
a budget is usually prepared once a year. It is best to separate the water and
wastewater budgets for clarity. Each utility (water and wastewater) should have
a revenue budget and an expense budget. A budget-actual comparison looks
at each budget individually and then compares the two.
Revenue budget: Lists the amount of
revenue the utility expects to receive from each revenue source. User
service charges are usually the largest source but there may be other sources
of revenue as well.
Actual revenue: This amount will be taken
from the utilities accounting records.
To compare budget to actual revenues,
make a worksheet similar to the one below. List all sources of revenue and the
amount budgeted for each source. Then enter the actual year-to-date amount
received. You can then calculate the percentage of budgeted revenues actually
collected year-to-date. These percentages should be compared to the percentage
of the year completed to date.
If the percentage of total budgeted
revenues received is equal to or greater than the percentage of the year
completed to date, your utility passes the budget-actual test for revenue. This
tells you that you will receive the expected amount of revenue by the end of
the year. If the percentage is less than the percentage of the year completed
to date, an itemized inspection of each category should be made to find out
where the shortage exists and why. Sometimes it can be a matter of timing,
billing periods, or any number of things. A close comparison of the previous
years records, if available, can also help decipher the discrepancy.
Conducting a budget-actual test for
expenses is very similar to doing one for revenues. A worksheet can be made
like the one for revenues that lists all the expenses, such as: administrative
costs, wages, principal and interest on loans and bonds, purchase of
replacement equipment, etc.
The rules for passing the percentage
of the expense budget are the same as with the percentage of revenue. Both
revenues and expenses work together to diagnose the financial health of the
utility, so both budgets should be analyzed together when doing the
budget-actual comparison. If actual revenues are higher than actual
expenditures, your utility passes this test.
The preceding are a few measures that
can help you assess how healthy your system is financially. You may have
noticed however, that in order to assess your system you must first have the
data required to accomplish the task. This brings us to the next topic.
Financial reports, purchasing reports and user
service charges are the tools that make financial management
possible. Without this information the utility manager has no way of knowing
how much it costs to operate the utility, how much revenue is being collected
or how well the system is performing compared to the budget.
Accurate and timely bookkeeping is
the best method of controlling the financial health of your system. This one
tool will enable the utility manager to see at a glance the financial health of
the system and what necessary steps must be taken if adjustments are needed.
The following is a short checklist of
what your utility should account for when preparing a financial report:
Water and wastewater operations are accounted for in separate funds.
Each utility uses accurate accounting methods.
Each utility receives monthly reports of revenue and expenses.
Reports show both budget and actual figures.
Reports arrive by the 10th day of the following month.
The utility keeps its financial reports for at least four years
The purpose of a purchasing system
is to ensure that the utility can get the goods or services it needs when
it needs them. This is important for a couple of reasons. First, it ensures the
ability to shop around for the best price, which can save the utility money in
the long run. Second, it will allow plenty of time to prepare for the purchase,
as opposed to emergency replacement, which is usually frantic and costly. In
both cases it will actually save the utility valuable resources in the form of
saved revenue.
A brief checklist for a purchasing
system:
Major purchases are based on specifications that define
requirements
Standard quote/bid forms are used
No purchases are made without a purchase order
Exceptions are made for emergency purchases
Purchasing is centralized
Purchased products are immediately inspected for quality and
damage
Stock quantities are specified for all inventory items
User service charges are crucial to
any self-supporting utility. It consists of two parts. One part sets the rates
for customer charges and the other part collects the revenues due.
Maintaining adequate user service
charges is of the greatest importance for obtaining a financially
self-supporting utility. A good public education program, explaining the costs
and benefits, can eliminate negative reactions. Customers can better understand
that they will eventually end up paying one way or another for the services
they receive. Gradual increases in rates are easier to explain and they show
the customer that the utility is being managed well.
How the user service charges are set
depends on the specific nature of each utility. It can be as simple as dividing
the total budget by the metered flow or equivalent dwelling units.
The secret to a well-managed billing system is to ensure that the money from
user service charges is collected very soon after providing service.
A brief checklist for setting user service charges,
billing customers, and collecting revenues:
All costs are identified
Costs are allocated proportionally based on use
Flow characteristics are known for each customer class
Each customers use is known or fairly estimated
Customers are billed proportionally to use
The billing cycle provides timely revenues
Established procedures assure collection of delinquent bills
While this information is not
exhaustive, it will give you a chance to evaluate the health of your utility
and develop a strategy for the future. For more information, contact your State
Rural Water Association.
Reprinted with permission from WATER LOG, Issue 1 of 2, 2001.
Copyright 2001 by the Ohio Rural Water Association.