What Are They and What is Our Belief?
The top priority of water and wastewater systems is to provide a level of service that meets state and federal regulatory requirements, and the demands and expectations of its customers. The long-term goal of a financial policy is to develop a utility system that is stable, requiring limited increases in the cost of services, minimizing those increases that are required, and minimizing the acquisition of long-term debt, which in a stable utility system will be the driving force for significant rate increases. Because the ratepayers bear the ultimate cost of service, there exists a need to have a financial plan that will permit the utility to meet it’s priorities at an affordable and stable cost for the long-term. To this end, most utilities are set up as enterprise funds, operating like a business. In this manner, the water and sewer customers are not subsidized by the General Fund taxpayers of the local government, who may not be the same group as the rate-payers.
As an enterprise, the utility must derive its own revenues and use those revenues to fund operations, capital, debt and reserves to meet customer and regulatory demands. As federal funding sources have been phased out, revenue-backed borrowing has increased. As a result, water and sewer systems face additional pressures to control and maintain historical debt service coverage levels and liquidity. A utility’s ability to finance projects to satisfy environmental regulations has become a critical bond rating determinant, along with the ability to meet growing customer demands.
So how do we create a set of guidelines for operation? Financial policies. The bigger the utility, the more you needs, but small utilities should have a policy as well. Remember smaller utilities are more at risk than larger ones due to a limitation on assets and access to capital. So in reality, the financial plan is a set of long-range business principles, goals and guidelines approved by the governing board to provide direction to staff on the courses of action to take with regard to the finances of the utility, establish policy guidelines for developing budgets and provide standards upon which to measure performance. Financial policies serve a number of purposes for both management and the governing board of the utility. Among these purposes are:
A formal, adopted policy provides a written set of policies upon which the governing board can base decisions that avoid conflicts from inconsistent financial decisions; this in turn prevents problems that occur as a result of case-by-case decisions that inevitably lead to conflicts with current, past, or future policy alternatives that may cost more in the long run. Formal policies promote continuity regardless of changes in personnel or governing board members, providing a long-term view of fiscal procedures. Formal policies can increase efficiency by standardizing fiscal procedures, while informing new employees and officials of the expected courses of action. Bond rating agencies look favorably upon utilities with adopted financial policies in place and followed.
Informal policies develop with time with a limited paper trail. They are more related to the culture of the organization and the peculiarities of the staff. Informal policies rely on past practices, or specific employee preferences. Whether specific or vague, they are not formally approved by the governing body. However, they have the benefit of being flexible and may have more support internally than certain formal policies. Whether formal or informal policy documents, they should be considered “living” documents that change as conditions require. Included may be he following:
Utilities should develop a policy to guide staff on the maintenance and use of rate stabilization reserves. Because debt drives rates, it is often helpful to begin increasing rates before the debt service begins. In the intervening period, the excess cash can be used for rate stabilization purposes that extends the time for implementation of large rate increases. It also is a buffer in the event some emergency disrupts cash flows. However, rate stabilization funds are one-time expenditure and therefore once spent, cannot be reallocated unless the rate stabilization fund is replenished.
Each utility should develop guidelines for maintaining contingency funds for use in the event of emergencies, natural disasters, unforeseen failures and unexpected events. A catastrophic event can seriously hamper the utility’s ability to provide service to its customers and seriously impact its financial condition. The vulnerability assessment and emergency response plan discussed in Chapter 4 will identify those potential areas where emergencies might occur and the potential cost of same. Certain reserve funds, equipment inventories parts and contracts for services can be arranged for the most common problems. An analysis of past budgets will indicate the likelihood of large, unanticipated expenses with time. This can be used as a guide for the utility for budgeting a contingency amount in the annual budget. Having a contingency amount in the budget will permit the utility to fund such emergencies without having to amend the budget each time a problem occurs. If the money is not spent, it can be re-appropriated in following years. However, no utility can bank enough funds for every emergency. For large cost items, a line of credit through a local bank would be prudent.
Fund balances are those monies not encumbered for other purposes. Utilities maintain fund balances to cover those potentially volatile expenses like power, chemicals, unexpected overtime costs, and emergencies. When significant amounts of fund balance are collected over a period of years, they can be appropriated for capital projects. Fund balance should not be budgeted to balance operations expenses unless some unforeseen revenue shortfall occurs. Fund balance should be invested to earn interest, which is an added revenue for the utility. The appropriate level of fund balance should be based on the volatility of revenues, the variability of expenses, the need to replenish debt, rate stabilization and unreserved fund balance funds.
Unreserved Fund Balance
Unreserved fund balances are separated from reserve funds as they provide a different opportunity. Revenues will generally lag expenditures simply because utilities bill their customers after they have received service. As a result, the utility must have an unreserved fund balance to meet this discrepancy. GFOA recommends that the unreserved fund balance be a minimum of 15 percent of the annual user fee revenues. A month and a half to three months of revenues are other suggestions depending on the frequency of billing. If the unreserved fund balance falls below the policy level, a mechanism should exist to restore this amount. Figure 14.3 shows the total and unreserved fund balance. Table 14.4 shows typical fund balance policy components. Unreserved fund balance monies should be highly liquid investments.
Utilities intending to issue debt are advised to develop a debt policy. The Governmental Finance Officers Association (GFOA) recommends that a debt policy should address the following:
Repair and Replacement Policies
Utilities intending to limit the issuance of debt are advised to develop a repair and replacement policy. The concept is to create an ongoing fund for which monies are deposited, and allocated for capital construction – new water mains, treatment facilities, sewer lines, etc. The amount may vary by how big the utility is, how old current assets are and growth pressures. It is important with growth, that impact fees be considered.
Create financial policies that best fix your need. We do not believe in excessive rules, or guidelines – simple is better and usually more effective. Let us know how we can help. Some examples – for larger utilities, are located in the tabs below.
Service, Innovation, Expertise
Connect with Us