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If you are intimidated by fi-
nancial management, you aren't
alone. A lot of people find finan-
cial issues confusing and think
they're best left to accountants.
You probably already know that
you can't do that in a small utility.
The utility manager, along with
other duties, has to manage the
finances.
This booklet is meant to
help small water and sewer
utility managers understand
some of the more important
principles of financial man- ;
agement. It presents ,
some management ;
tools you can use to
keep your utility fi-
nancially healthy
and running
smoothly.
Better yet, it
won't take
much of
your time.
Good fi-
nancial
manage-
ment has
two pur-
poses. First,
you find out
what kind of
financial shape your utility is in
today. Second, it allows you to
lay down a foundation for a
strong financial future.
Keys to
Financial Health
If you only have fifteen
minutes a month to spend on
financial management, use it to
check the operating and cover-
age ratios. They tell you
whether revenues are covering
all the costs of your utility.
The Operating Ratio
If you Check the operating
ratio every month and compare it
to past values, it will show you
the trend of finances for your
utility. To calculate the ratio,
divide the total revenues by the
total operating expenses.
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Sounds simple, but you will need ees, administrative overhead,
to dig through the accounting
records to find the numbers.
Some utilities combine
the account books for the water
and wastewater utilities. If that's
your case, you will need to break
the records down into separate
water and wastewater accounts.
chemicals and electricity for
treatment, parts, tools, money
spent or put in reserve for
routine replacement of equip-
ment, and the principal and
interest on loans or bonds.
Operating expenses do not
include the purchase costs of
new capital facilities (like more
Once you have found the ac- treatment capacity or water and
counting reports
and identified
the total reve-
nues and oper-
ating costs, you
can use this
worksheet to
calculate the op-
erating ratio.
OPERATING RATIO WORKSHEET
(Year to Date)
TOTAL REVENUE
User service charges
Hook up / Impact Fees
Taxes / Assessments
Interest Earnings
Other Revenue
Total Revenue
Revenues for
a financially
self-sufficient
utility are mainly
obtained from
user service
charges, but
they often
include other
charges for
special services.
Interest earn-
ings are-
counted as
revenue.
Operating
expenses
are the costs
associated with
providing and maintaining the sewer lines). They also exclude
utility's services. Examples are depreciation. Depreciation is an
wages and benefits for employ- estimate (usually for tax and
TOTAL OPERATING EXPENSES
Administration
Wages
Benefits
Electricity
Chemicals
Fuel & Utilities
Parts
Equipment Replacement Fund
Principal and Interest payments
Other
Total Operating Expenses
OPERATING RATIO
Total Revenue
divided by
Total Operating Expenses
equals
Operating Ratio
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accounting pur-
poses) of how
much value the
utility's plant and
equipment lose in a
given time period.
Since municipal
utility operations
are generally not
required to provide
money for depre-
ciation, it is not an
operating expense.
It's best to cal-
culate the op-
erating ratio on a year-to-
date basis since revenues and
expenses usually vary greatly
from month to month.
The minimum operating
ratio for a financially healthy
utility will depend on its debt situ-
ation. An operating ratio of 1.00
is the bare minimum for a self-
supporting utility. If a utility has
any outstanding debt, the operat-
ing ratio will need to be greater
than 1.00. How much greater
depends on the debt service
coverage requirements.
You should pay special
attention to the trend in the
operating ratio. It can give you
an early warning of trouble so
that you can eliminate financial
shortfalls before they occur. All
you need is a simple chart and
the accounting reports for this
year and last to keep track of the
trend.
1.4
1.3
12'
Ratio 1.1.
]Q.
0.9.
0.8-
N
OPERATING RATIO HISTORY
UK Yen
YeuloDite
Minimum to Pay Debt Service and Operations
Ju Fet> Mar Apr Miy JIM Jul Aug Sep Oct Nov Dec
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The accompanying chart
shows an example of how you
can identify trends in the operat-
ing ratio. This chart really
answers two questions: What's
the short-term trend this year?
How does this year compare to
last year?
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In a financially healthy
Utility, the trend in the operat-
ing ratio should be steady or
upward. If it's 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, you need to do
something to get it back in
shape. This is an example of
using the trend in the operating
ratio to avoid problems and stay
financially healthy.
The operating ratio is a
good indicator of where your
financial condition is headed.
Think of it as the pulse of your
utility.
The Coverage Ratio
The cover-
age ratio
measures
whether your
utility has
enough reve-
nue to pay the
principal and
interest on its
loans and
bonds, with
enough money
left over to
guard against
unexpected
problems.
Bond buyers
look to the cov-
erage ratio as
a sign of good
financial man-
agement. The ratio should be
checked at the end of every
fiscal year.
To calculate the coverage
ratio, add all revenues received
during the year, from whatever
source. Then add together all
the non-debt operating expenses
for the year. These are the
same categories of costs we
used in the operating ratio minus
the principal and interest pay-
ments. 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
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1.25(125
percent) or
higher. If your
ratio drops
below the
required value,
an increase in
user service
charges is
needed, since
the utility can't
guarantee that it
can both meet
unexpected
costs and still
pay off its loans and
schedule.
COVERAGE RATIO
Total Revenue
minus
Non-Debt Expenses
equals
Revenue Available for Debt
Service
divided by
Debt Service Expenses
equals
Coverage Ratio
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WORKSHEET ^
$
$
$
$
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bonds on is not staying on budget is often
one that is heading for financial
trouble.
It's a good idea to com-
pare the coverage ratio to
earlier years' ratios. A drop indi-
cates trouble ahead, meaning
again that it's time to consider a
rate increase.
Other Measures
of Financial
Health
Even though the operat-
ing and coverage ratios
are the most important
measures of financial health, it's
a good idea to look at several
other indicators as well.
Budget vs. Actual
Budget vs. actual com-
parisons should be made
at least every three months, and
preferably monthly. A utility that
Most utility budgets are
prepared once a year. As with
the accounting records already
discussed, separate budgets are
needed for the water and sewer
utilities. Each utility should have
both a revenue budget and an
expense budget. A budget-
actual comparison looks at each
budget individually and then
compares the two.
A revenue budget lists the
amount of money the utility
expects to receive from each
revenue source. User service
charges are probably the big-
gest, but there may be other
important sources of revenue,
too.
To compare budget to actual
revenues, make a worksheet like
the one shown listing the major
revenue sources and the amount
of revenue budgeted for each
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6
_
% OF YEAR
COMPLETED TO
DATE:
USER CHARGES
TAXES/
ASSESSMENTS
HOOKUP FEES
IMP ACT PEES
INTEREST
OTHER REVENUE
TOTAL REVENUE
V
Revenue "\
Budget vs. Actual
$ BUDGET
TOTAL
$ RECEIVED
CURRENT
YEAR
TO DATE
% OF BUDGET
RECEIVED
CURRENT YEAR
TO DATE
% OF BUDGET
RECEIVED
LAST YEAR
TO DATE
J
source. Then enter the actual
year-to-date amount of revenue
received. You can then calcu-
late the percentage of budgeted
revenues actually collected year
to-date. These percentages
should be compared to the per-
centage of the year completed
to date.
// the percentage of
total budgeted
revenues received is
equal to or greater
than the percentage
of the year com-
pleted to date,
your utility passes
the budget-actual
test for revenue.
The test predicts
that you will
receive the full
amount of
budgeted reve-
nues by the end
of the year.
What if the percentage of
total budgeted revenues re-
ceived is less than the percent-
age of the year completed to
date? There are some further
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tests you can do. First, look at
the individual revenue items and
find out which ones are coming
in the slowest. Then try to figure
out whether it's only a problem of
timing (for example, user service
charges are billed quarterly and
so things aren't as bad as they
look after two months into the
billing cycle).
// timing does not explain
the variance, then you will have
to investigate that revenue
source more closely. Try to find
out why the revenue is coming in
under the budget. Does it seem
likely that the trend will continue
for the rest of the year? What :
actions can you take (such as ;
raising other revenues) to get the
total budget back in balance by
the end of the year?
It is also a good idea to
compare the budget-actual per-
formance to the percentage of
revenue received at the same
time the previous year. If
revenue is coming in more
slowly this year than last, it could
mean that you will end up with a
revenue shortfall at the end of
the year. Again, you need to
investigate the reasons and take
actions to correct the problem.
Conducting a budget-
actual test tor expenses is
very much like doing the one
for revenues. You can set
up a worksheet like the one
shown for revenues that
lists all the expenses,
such as: wages, electric-
ity, administrative, prin-
cipal and interest on
loans and bonds, pur-
chases of replace-
ment equipment,
and so on.
If the percent-
age Of the ex-
pense budget
spent to date is
equal to or less than the percent-
age of the year completed to
date, then the utility passes the
budget-actual test for expenses.
As with revenues, you should
compare the percentage spent
with the percentage from the
same time last year and investi-
gate individual items that seem
headed to go over the budget.
Revenues and expenses
work togetheno define the
financial health of the utility, so
you should look at both budgets
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together when doing the budget-
actual comparison. If actual
revenues are higher than actual
expenditures, your utility passes
this test.
Calculate the ratio at
the end of the fiscal year
by totaling all the
money spent on capi-
tal assets and
dividing by the
total revenues for
the year.
There are
no rules
or guide-
lines for
the capi-
tal in-
vest-
ment
ra-
tio.
It can be very low for a utility with
mostly new facilities. Since
every utility is different, the only
way you can judge the capital
investment ratio is by comparing
it to earlier years.
Capital Investment Ratio The accompanying work-
sheet shows how to calculate
The capital investment the capital investment ratio.
ratio is a measure
of how much of its > _
resources the utility
is putting into
improving and
replacing capital
assets. Capital
items are those that
have a long life and
a substantial cost.
Examples include
buildings, water and
sewer lines, treat-
ment plants, outfalls,
and so on.
CAPITAL INVESTMENT RATIO WORKSHEET
Total Capita! Outlays
Total Revenue
divided by
equals
Capital Investment Ratio
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A Systems Checkup
So far this booklet has
concentrated on measures
for determining your utility's fi-
nancial health. The rest of the
booklet suggests ways you can
improve its financial condition.
Financial reporting, pur-
chasing, and user service
Charges are your utility's most
important financial management
systems. For each of these
systems, the booklet gives a
checklist of what a good system
how things are working finan-
cially. Without them, you have
no idea how much it costs to run
the utility, how much revenue is
coming in, or how you're doing
compared to the budget.
// financial reports are ac-
curate and timely, the
manager can take control over
the financial health of the utility.
This checklist presents some of
the qualities of a good financial
reporting system. If your system
falls short, try working with the
finance office (or bookkeeper in
a small utility) to improve it.
f FINANCIAL REPORTING
CHECKLIST
- Water and wastewater operations are accounted
for in separate enterprise funds:
- Each utility uses accrual 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.
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looks like. The idea is for you to
examine your utility's current
systems and start thinking about
how you can improve them.
Financiai Reporting
Financial reporting is the
system that makes financial
management possible. Financial
reports tell the utility manager
Purchasing
Every utility has a pur-
chasing system, but many
are informal and lack organiza-
tion. The purpose of a purchas-
ing system is to make sure that
the utility can get its goods and
services when it needs them and
at the lowest price.
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10
PURCHASING
CHECKLIST
Purchasing is centralized.
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 specified for emergency purchases.
Goods are inspected immediately for quality
and damage.
Stock quantities are specified for all inventory items .
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You can tell if your pur-
chasing system is not
working well because the
utility runs out of parts or sup-
plies. Use the above purchasing
list to check the system's condi-
tion. Improvements to this
system can cut costs and
improve the quality of water and
wastewater services.
User Service Charge?
The user service charge
System is crucial to any self-
supporting utility. It has two
parts. One part sets the user
charge rates and the other part
collects the money.
This booklet has stressed
the importance of maintaining
the utility on a financially self-
supporting basis. Frequently,
the solution to many of the
financial ills in a utility can be as
easy as maintaining adequate
user service charges.
Many utilities wait too
long before raising user service
charges. They fear adverse
customer reaction. A good
public education program,
explaining the costs and bene-
fits, can eliminate the negative
reaction. Customers understand
that they will eventually end up
paying one way or another for
the services they receive.
Gradual increases are easier to
explain and they show custom-
ers that the utility is being well
managed.
It's a good idea to get help
from an engineer or financial
consultant when setting user
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11
s — •< —
USER SERVICE CHARGES
CHECKLIST
- All costs are identified.
- Costs are allocated proportionately based on use.
- Flow characteristics are known for each customer
class.
- Each customer's use is known or fairly estimated.
- Customers are billed proportionally to use.
- Billing cycle provides timely revenues.
- Established procedures assure collection of
delinquent bills.
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service charges. If that can't be
done, you can do It yourself.
Either way, the approach is the
same.
How user service charges
are set depends on the specific
nature of each utility. Fora
small utility, the process can be
as simple as dividing the total ;
budget by the metered flow :
(or equivalent dwelling
units).
The accompanying
Checklist gives a basic outline
The key to a
good billing and
collection system is to
make sure that the
money from user service
charges is collected
very soon after pro-
viding the service.
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12
to follow in setting user service
charges, billing customers and
collecting the money.
Long-term
Financial
Improvements
This section offers some
additional steps you can take to
build a stronger financial system.
The improvements discussed
here will require the cooperation
of other people in your utility.
They are different from the
financial systems discussed
above because they involve
ambitious long-term efforts.
Budgeting
Almost every size utility
can benefit from better budget-
ing. Good budgeting begins with
an understanding of the de-
mands on the utility and the way
the utility meets those demands.
An effective budget translates
the utility's
physical op-
erations into
a strong fi-
nancial plan.
Capital
Planning
A capital
plan is a
blueprint
for future im-
provements.
The idea of
capital
planning is
to figure out
the needed
improve-
ments, set
timetables,
and develop
a financing
plan to fund
the improve-
ments. The result of capital
planning is called the capital im-
provement program.
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Financial
Management
Financial management
can seem like a lot of trouble,
especially in the first year or two
as you build better systems.
However, you will find that your
efforts pay off, and usually very
quickly. You, your staff, and
your governing board will ;
develop a better understanding
of how finances and operations
work together to provide better
water and wastewater services.
Once you begin monitoring
the financial health of your utility
and making improvements in
your financial systems, you will
achieve greater control over
your utility's operations and its
financial future.
Where to Get Help
This booklet can't solve
all your financial problems. It
only presents some basic finan-
cial concepts and gives you
some suggestions for possible
improvements.
You do not have\Q solve all
your utility's financial problems
alone. You can turn to organi-
zations and professionals who
have faced similar problems and
solved them.
One group that was set
up just to help managers of
small sewer utilities is the US
EPA National Small Flows
13
Clearinghouse. It has books and
pamphlets on all aspects of
small community operations.
You can call the clearinghouse
toll-free at 1-800-624-8301 or
write to:
US EPA National Small
Flows Clearinghouse
P.O. Box 6064
Morgantown, WV 26506-
6064
There are organizations that
offer low-cost books, pamphlets,
conferences, and courses on
local financial issues. Call any of
these groups. Ask for a publica-
tions catalog and a list of course
offerings:
American Public Works
Association
(312)667-2200
American Water Works As-
sociation
(303)794-7711
Government Finance
Officers Association
(312)977-9700
International City Man-
agement Association
(202) 626-4620
Water Pollution Control
Federation
(703) 684-2400
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14
Many states and universi-
ties have special training
courses and onsite assistance
programs for solving small com-
munities' financial problems.
Give them a call and see how
they can help you.
This booklet was prepared by Paul L. Shinn, Steven Turtil, and Benjamin Mays of the Gov-
ernment Finance Research Center of the Government Finance Officers Association and Haig
Farmer of the U.S. Environmental Protection Agency.
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