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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
	  , ^
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
Vk._._ _;.,.,' 	
WORKSHEET ^
$
$
$
$

J
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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