METHODS FOR ASSESSING SMALL
A Review of Current Techniques and Approaches
March 28,1996
U.S. Environmental Protection Agency
Office of Groundwater and Drinking Water
Peter E. Shanaghari
Small Systems Coordinator
Prepared By: . Apogee Research, Inc..
. 4350 East West Highway
Bethesda Maryland 20&14
. •; (301)652-8444 .
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TABLE OF CONTENTS
Chapter!:
Introduction and Overview
Chapter 2:
PA WATER: A Financial Planning Model for New, Small Community
Water Systems / , ::- . •*'••.;••-•.:•' •. .• ' .''
Chapter 3:
A Dozen Questions Diagnostic for Small System Assessment
Chapter: 4:
Washington State Small Water Utilities Financial Viability Manual
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CHAPTER 1.
INTRODUCTION AND OVERVIEW
1.1 Introduction
This manual has been developed to assist States in understanding and applying presently
available methodologies for assessment of water system capacity, or viability. EPA hopes that
the information presented here will stimulate State creativity and lead to development of
. additional assessment methodologies appropriate to the circumstances of specific States. Small
systems and technical assistance providers should also find this document useful as a topi for
water system self assessment. .
1.2 What Is, Water Systerii Capacity or Viability?
At the simplest level, the functional meaning of these terms encompasses:
the ability of a water system to
. • consistently provide
; "-'• quality service , . .
. • at an affordable cost. .
More descriptive definitions of these terms include the specific water system capabilities that are
involved, primarily:': ;
.
•' .• . ' /..••••."'^" .'* technical ''•••''."'-" -.''••• '-^. .'.. : '.-'•.-. -.- '-"• '
, v, • financial, and . . .-...
• managerial capability
to consistently comply with current and prospective performance requirements.
While there are no universally accepted definitions, all definitions are fairly similar and
cover the same major points. Every one of these points has considerable significance. \
.. ~\ • .. • •' . •" . " * • ' " , - • . ., .•
Technical, financial, and managerial capabilities of small water systems are often limited!.
by the flow of revenues and the strength of the institutional arrangements. Weakness in any of
these three areas can affect the reliability of water service. Over the long-run, inadequate cost
recovery will lead to deterioration of system components. The lack of a dedicated flow of
revenues sufficient to sustain the system, raises a question as to the longr-term reliability of water
service. ."'-,•• • ' • •/ .'•.•''-'_/ '..''';., ./.- -.;
The ability to consistently comply with current and prospective performance requirements
incorporates the fact that performance requirements may change as our knowledge of technology
•'••'•••'.".-•''. '•'-'•• ,'';' - •:•'i-i :* "'• .- '••' '. •.-.':.:''' • •'
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and health effects advances. The emerging concern regarding Crvptosporidium is an example.,
..Thus a system must be capable o'f adjusting to change and meeting new challenges as they
emerge. It can be said with respect .to all the above components of water system capacity or
viability that the correct context is forward-looking,'towards the future, rather than the past.
1.3 .Why Address The Issue of Small System Capabilities?
Why new words and new ihitiatives4o address small system capabilities? It could be said
that history has finally caught up with us, or stated otherwise, that we are -at a turning point --
a crossroads - in the history of the small system segment of the water supply industry: -For
some time,' historical forces'have been creating and enlarging a gap between.the performance
demands placed on small systems and the institutional capabilities of small systems. /
Figures 1.1 and 1.2 illustrate some key'institutional characteristics of the small system
universe. "Small systems" have typically been considered to be those serving fewer than 3;300
persons. As shown hi Figure 1.1, 87 percent of the community, water systems hi the country
classify as "small"systems" by this definition. Moreover, the largest two slices of the pie chart
in Figure 1.1 illustrate the fact that 62 percent of all community water-systems serve fewer than
500 persons. There is a ioatural tendency to think of small water systems as being small towns
or small utilities. '• As these data make clear, however, most small systems are actually small
clusters of homes. : .
Other significant characteristics relating to the ownership profile of small systems are
displayed in the pie chart in Figure 1.2.. As shown, here, about 55 percent of small water
systems are mobile home parks, home owner's associations, or small .private water companies
(shown as investor owned, but actually mom & pop small companies for the most part). These
'private ownership forms are highly concentrated in the very smallest systems, those serving
fewer than 500 persons. Of the systems serving fewer than 500!persons, 80 to 90 percent are
in one of these three private-ownserhip categories. While roughly 40 percent of all systems
serving fewer than 3,300 persons are publicly owned by small towns, districts, or authorities;
these systems are concentrated near the large end of the small system spectrum.
There are many stories behind such statistics, the recurring theme is one of institutional
weakness. 'This is illustrated by two predominant stereotypes: the case of rural economic decline
and the case of suburban sprawl. , .
Water supply infrastructure in many rural communities was initially sized and put hi
place during the earlier part of. the twentieth century at a time when the economics, and
demographics of these communitites supported larger populations. With technological advances
in agriculture, and with various changes affecting natural resource and mining industries, many
rural communities are now less prosperous economically and home to much smaller populations.
In addition to the smaller customer base, advances hi public health protection have increased the
expense of providing potable water. . '
1-2 .'.'••.•••'•''.'•'
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.V FIGURE 1.1
NUMBgR OF SYSTEMS BY SIZE
(based on size of population served)
>3,300 persons 13%
1,000-3,300 persons14%
501-1,000 persons 11%
25-tOO persons 30%
101-500 persons 32%
Total number of community water systems =58,000.
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Figure 1.2
OWNERSHIP OF SMALL CWSs
. Publicly Owned 40%
Mobile Home Parks 25%
Other 5%
Investor Owned 15%
Home Owners Assoc. 15%
.Approximately 52,000 CWSs are small (seve <3,300 persons).
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. Over the latter half of the twentieth.century, the process of suburbanization has been one
of the dominant demographic and economic trends in the nation. It has resulted in the creation
of thousands of small water systems, initially built by land developers and then turned over to
cooperative homeowners associations. Because the developer's interest often extends no further .
than the sale of the last lot, the provision for prudent financial and technical management of"
'these water systems, within a sustainable, .institutional framework has often been completely
lacking. '.-"..'-•-".•''' ' •••"'.'?v'''-.'•'•''';•' ' . •• •' '-••••'. *.••'•- ' • ' •" '•':•'' -- - .-••- ' '
Among the many thousands of small systems, there are many other stories which may
not adhere exactly to these two stereotypes, but still share the same types of institutional
weaknesses and the same results in terms of performance problems. Because water supply was
not historically an expensive service to provide, institutions devised for service delivery were
not conceived with very strong management and financial capabilities. The gap between
performance expectations and capabilities is likely to grow wider and cannot be ignored.
The systemic deficiencies hi water service delivery mechanisms of small communities are
an accident of history and must be viewed in a much,broader context than that of the
SDWA program. The institutional changes required to address the performance gap in
service delivery raise much broader issues of public infrastructure policy and the respective
roles of state and local government. .
Thus, thereis aneed for a new way of thinking about small systems. The new focus qri
me underlymg service delivery-mechanism has been captured in the words "capacity,"
. "viability," and "sustainability." State primacy agencies originally recognized the need and
requested assignee, from EPA in the development of "viability screening tools" that could be
applied to: 1) evaluate the sustamability of new develdper-built small water systems; and 2)
determine whether existing small systems were capable of sustaining themselves in a changing
environment. • ' '!'•''-•• _ , . ,.._;.
1.4 State Programs To Enhance Small System Capabilities
At the most general level, a state capacity development strategy or viability program
consists of a coordinated collection of initiatives by state government to address.concerns
regarding the reliability of water supply service delivery mechanisms in small communities. The
issue of small system institutional capabilities is rooted in state and local traditions that are, in
.turn, rooted in state law and in the unique regulatory and intergovernmental culture of each
state. \. • • ,'.'.- '...'".'' ••• • ..-•''..'-•''.' '.".-. ." • . ..•'"'. '
Enhancing small system capacity or viability is a much broader issue than SDWA.
compliance and affects the full range of, organizations and individuals involved in state and local
policy towards public infrastructure as well as public policy in other areas such as social policy,
economic development, and rural poverty. While there are similarities in the nature of the
problem across the country, it is very clear that the development of solutions will require
approaches tailored to the unique circumstances of each state. ,
''•••• ••" .. '; •'.' : ; 1-5 "- ' ' ' • • .. :; . •" '
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The ultimate objective of a state capacity development strategy or viability program is
to help local institutions to become fully capable and reliable service delivery mechanisms. In
order to be.effective,, state programs will have to carry out a sequence of two steps: 1) working
with systems to help them assesss their capabilities;- and 2) assisting systems hi enhancing their
capabilities. These two steps are very broadly conceived. .This breadth of interpretation is
consistent with the fact that enhancing 'system capabilities touches on a broad range of issues
regarding the role, responsibility, and authority of state and local government. This being the
case, the approach to be taken will have to evolve uniquely in each state. The pace of
development will vary. The form in which different states undertake to assess small .system
capabilities and act to improve them will vary.
A comprehensive state program could have the following four programmatic elements:
• a mechanism for hew system screening to encourage formation adequate
management and financial institutions when new small systems are conceived;
• a mechanism for working with existing systems tp assess capabilities to meet
present and future needs;
• effective, coordination within and between agencies of state and local government
to provide assistance in.enhancing the capabilities of small systems.
- ' " *• ''•'..-. ' • ' ' .!*'"'
C. ' ..•*•" ',•'
• a safety net mechanism to rescue-arid restructure water systems which have
clearly failed "nd where economic and social issues unrelated to water supply
make it impossible to restore adequate service without substantial government
. • assistance. • • . . . /
To be fully effective, these types of mechanisms may require new types .of explicit
authority for the agencies of state government involved in their implementation. However, mere
is still a very wide range of'interpretation and approaches that can be taken to .putting these
elements in-place based on existing authorities. Also, the type and amount of authority needed
'could be very different from one state to another. Many states may liave more existing authority
to'initiate these efforts than previously realized. ' ... •
This report provides a review of methods for assessment system capabilities and therefore
' bears primarily on the first two elements of a state capacity development strategy or viability
program. The assessment process can be an. effective means of educating all of the stakeholders
regarding the need for institutional changes at both the state and local level. In addition, such
assessment can provide the understanding necessary to build consensus on the most appropriate
public policy approaches to implementing other program elements (i.e., inter-agency
coordination and safety net mechanisms).
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1*5 The Role Of Small Systran Capability Assessments
•-'•'- '*' '••':••;• '''•- ••"'' . .',-"'•'•'. *'- '''••'•' ' -••- ; -"' - ••-•' "" • •' ' . •' • •'•-• : '•'-"•• • ~' • '' ' ,•"
Assessment can be undertaken at two levels. One approach is to assess the capabilities
/of.-individual water systems. Another approach is"-to perform assessment at the "aggregate"
level, viewing all the systems in/the.state to obtain ah overall profile.
• The results of system-level analysis can go. right to work for small systems,
helping to1 clearly identify and understand existing and potential small'system
problems and to appropriately target financial and technical assistance.
• The results .of aggregate-level analysis can be: used to help educate state
legislators and other agencies of state government regarding the needs for broad
state initiatives (e.g. * a safety net) in this area of public infrastructure.
In many states, these two types of assessments can be initiated without any additional legal
authority; ..'•'"•'" . "' -''.''•' '"'.•',:. • ' .'.. '• ."•' •' •, -. •". -' '- : •.'... '. "'"•' ;. • .'.- ".• '' ' '•
1.6 Examples Of Assessment Methodology . >• .
This manual presents summary descriptions of different examples of small water system
assessment methodologies that have been developed by states and others. The intent is not to
provide a detailed "cookbook" to small system assessment, but rather to describe each of these
examples hi sufficient detail that other states can gam enough understanding of the approach to
be able to apply it in their own circumstances. .
* The methodologies covered include one system-level method for new system screening
and two methods for system-level.assessment of existing systems.
1.7 New System Screening .. ; .
The new system screening, tool described hi Section 2 is a planning software called
PAWATER mat was developed as part of jomt State-EPA research hi Pennsylvania.1 This user-
friendly device has also been used by a few other states for new system screening.
The idea behind PAWATER is to encourage developers and local officials responsible
for development to consider the full costs of running a proper water system before commiting
to build one. PAWATER requires the user to complete a structured set of input specifications
to provide a sufficient basis to estimate the.costs of all necessary facilities, operation, and
management. The cost curves used in .the costing step can be edited by the user to suit
hidividual circumstances. There is also a treatment module that allows the user to "what-if" the
cost impact of different SPWA compliance requirements. This feature can be made more
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directly relevant in states where source water quality testing is required as part o'f the permitting
process. , •'• ''.'". . ^ . \ •.,
•Based on these input assumptions, the PAWATER model computes the total capital .
requirement and total annual revenue requirement of the proposed system under different
' assumptions regarding ownership (private water company, municipally owned, or homeowners
association). The program provides a summary of the capital cost and annual cost per dwelling
unit that is meaningful to a developer.
1J8 System-Level Assessment of Existing Systems
In the models that have been developed, system-level viability assessment of existing
systems has been conceived as a two-step process: ' .
• Step 1 - 'Figure out where the system is, presently, — in terms of the
condition of the infrastructure and the quality of service -' and where it's
going in the future.
• Step 2 — Develop a comprehensive business management and financial.
plan to take the system where it needs to go.
' Most of the information needed in the first step is engineering and performance1 data of
the type developed in the course of sanitary surveys, comprehensive performance evaluations,
and vulnerability •assessments. The development of the grass-roots level of financial information
implied in the second step is an effective means of educating, the owners, managers, and
customers "of small systems to the realities of the future cost environment. ^
The methodologies described in sections 3 and 4 of this manual represent approaches to;
the two steps in the process of assessing existing system viability.
Section 3 presents a summary of "A Dozen Questions To Assess Small,System Viability,"
the product of an effort by the American Water Works Association's Guidance Committee to
Small Water Systems.2 A structured series of questions is provided as a diagnostic guide to
assist small' system owners, managers, and custpmers in performing a self-assessment of the
extent of potential future liabilities stemming from either existing infrastructure deficiencies.br
anticipated SDWA compliance requirements. The diagnostic procedure is the first step towards
development of a comprehensive plan for the water system. .
Section 4 presents a summary.Of the Washington State Financial Viability Planning
Manual.3 Washington State has a program of comprehensive water supply planning already in
place that performs the comprehensive diagnostic analysis. ;The next step after identify ing all
current arid future needs is development of a financial plan to meet those needs. This second
step in the assessment is the focus of the Financial Viability Planning Manual. .Similar to the
« ' » • '..••*,.' • ' -:
1-8 ' " \ ••'•.••'•-•'
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approach used in the PAWATER model, the manual provides a procedure to define the total
capital juivestment requirements arid totaLannual revenue requirement,of the system, projected
six years into the future., The ability to m£et these and other needs must be demonstrated in
order to pass specific tests of financial viability specified in the Washington State program.
REFERENCES: \ "''•.../'•' ' '''' '•''-.'.' .; •' •" '-''-y •'._':• ;/ .•[•'.'•
1 , PAWATER: Financial Planning Model for New Small Water Systems, developed for the
Pennsylvania Department of Environmental Resources by Gannett Fleming, Inc. and
Wade Miller Associates, Inc., July 1992.
2. CromweU, Albani and Schmidt, A Dozen-Questions to Assess Small System Viability,
Annual Conference of the American Water Works Association, Sari Antonio, TX, June
' ' " '' '' ' '
3. State of Washington, Department of -Health, Division of Drinking Water, Small Water
Utilities Financial Viability Manual, August 1994 draft.
1-9
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'•' ."'•":- CHAPTER ii ;.•-•' '-" • .-:' , '' •'''
PAWATER: A FINANCIAL PLANNING MODEL
;FQR NEW, SMALL CIOMMUMIY
2.1 Overview of the PAWATER Approach to Financial Planning
. The PAWATER Financial Planning Model is a microcomputer-based software application
for estimating the total costs of design, construction, finance, and operation of proposed new,
small community water systems. The model is intended as a preliminary screening tool to be
used by Communities, private developers, and state and local regulators to assess financial
capacity of new water systems prior to beginning system development.
. .PAWATER was developed with three primary objectives in mind:
• • to encourage communities to consider the full capital, operating, and financing
costs of providing water, and to evaluate the impact of these costs on residents;
. • to promote an evaluation of alternative operating structures such that planners
., select the water system option best suited to community needs; and
• ' to provide regulators with a tool that can be incorporated in the system permitting
process so that all system developers are required to complete comparable long-
range financial plans that make clear the full costs of quality water provision.
Combined with statutory provisions that enable regulators to tie system approval
to acceptable financial planning results, PAWATER can assist regulators by
'•'•.•'•identifying potential system deficiencies prior to construction. ;
The PAWATER model incorporates fundamental financial planning concepts with a
database of cost estimates and operating parameters in a "user-friendly" software package that
requires no sophisticated financial expertise. It is assumed that the user of the PAWATER
software has an understanding of water system requirements and local conditions, and that, prior
to using the software, the developer lias completed a series of detailed worksheets provided in
the_ PAWATER package. Ideally, a water system developer's engineer will have completed
intermediate-level investigations of system requirements, will help complete the worksheets, and
may assist in exploring alternative scenarios using the PAWATER software. The software may
be used by the developer to explore system options, or by the regulator and the developer
together to assess the new system's financial potential as part of the permitting process.
The PAWATER software prompts the system planner to enter data on water usage,
source, treatment, storage, and distribution requirements for the proposed system, as well as
information on anticipated interest rates, inflation, and financing structure. Although the user
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has the capability to modify most information in the model, PAWATER calculates default values
for a range of key variables. Fof-instance, cost estimates of major construction and operating
items, such as pipes and chemicals, are generated from, water system cost tables based on user
responses to.questions of system size, operating environment, and treatment.needs. These cost
tables can be modified'to reflect local economic conditions. ; :
PAWATER uses information provided by the user and supplied by the system to calculate
the expected annual capital, operating, and financing costs of the system, and the fees required
per household to cover these costs over a five-year period. The program analyzes costs and fees
required for three alternative ownership structures: a homeowners association, an investor-owned
utility, and a municipally-owned utility. In addition, the cost of interconnecting with an existing
system can be estimated. PAWATER produces a four-page summary report of total capital
costs, total annual operation and maintenance costs, and a pro-forma cash flow analysis for each
of the three, ownership scenarios. A detailed 17-page report also can be produced that details
the user-provided -assumptions and the PAWATER cost calculations of major .system
components. . , " >.'•
The results can be used to assess the practicality of a proposed system based on the
burden to the community and its residents of financing the full cost of construction, operation,
and financing. .The information used.to generate the cost scenarios can then be manipulated by
system planners and regulators to explore the effects on costs of different interest rates, customer
growth rates; system configurations, ownership structures, and other changes in assumptions and
critical water system variables. In addition, the software allows the user to change treatment
requirements so as to explore the cost impacts of future Safe Drinking Water Act (SDWA)
regulations. Figure 2.1 depicts the major steps hi the PAWATER financial planning approach.
•2.2 Purpose and Objectives o£ the PAWATER Model
Finandal Planning Assessment for New Water Systems .
' PAWATER is a financial planning tool for new water system developers and regulators.
It provides a systematic aiid comprehensive methodology for estimating the full costs of quality
water provision based on .assumptions about system requirements and financing structure, and
details of. the local economy, the geologic and water source environment, and proposed system
design. PAWATER is a tool for individual system analysis that provides information for the
financial assessment of new systems based on assumptions and design data. . -
PAWATER reports the full costs of water provision as well as the annual per residence
charges and other revenue sources needed to cover these costs over time. This information can
be used by regulators in conjunction with information on per capita incomes in the service region
and water system charges in surrounding areas to assess the ability and willingness of customers
to pay these charges and fees. This Mormation alone, however, is not sufficient to prevent the
development of systems lacking sufficient capacity. Regulators must also have the statutory
' ' ' ' .-' 2-2 ••••" . , ' . ' ' ' : • '
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X Figure2.1 ;
.Major Steps in.the PAWATER Financial Planning Methodology
' System Developer • '-
Completes PAWATER •
Worksheets
System Developer-
Enters Infonnation
in PAWATER Software
PAWATER Calculates
Five-Year System Costs
Developer Examines
. Alternatives and
Modifies.Approach .
Developer Meets with
. . Regulator
' Developer and Regulator
', Perform Sensitivity Analysis of
Proposed System Using PAWATER
Regulator and Developer
Use PAWATER to Determine
Best Approach
' Developer Proceeds
with Next Steps in
Approval Process
No
Developer and Regulator
Examine Alternatives and
• Modify Apporoach-
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ability to tie system approval to the results of PAWATER or similar financial planning studies..
In this way, regulators can identify-systems which appear to be financially weak prior to system
construction. .
This proactive approach has two principal benefits. Rrst, by requiring developers to
conduct a PAWATER or similar financial planning analysis as part of the permitting process for
system approval, regulators encourage developers to thmk through the full costs of water service
provision during system planning. These costs are often not made explicit by developers who
may have no incentive to minimize operating costs or to plan for O&M cost recovery in cases •
where their responsibility for system operations ends once a housing development is complete
and housing units are sold. In many cases, homeowners associations or localities are burdened
with unanticipated operating and maintenance costs for water systems once the .system developer
has moved on. By tying system approval to full-cost financial planning, regulators encourage
developers to explore alternatives that can lead to less"• costly service delivery, Tike.
interconnections with surrounding systems. . .
Second, smce the PAWATER tool allows users to save and modify assumptions Uke the
rate of inflation, growth in demand, and financing structure, as well as system design variables
1 such as pumping and treatment requirements, the regulator and the developer can work together
to explore potential system capacity based on developer's assumptions as well as other likely
financial and operating scenarios. Notably, the effect of future SDWA regulations can be
.explored by analyzing the cost impacts"of additional treatment technology requirements. This
exploration of alternatives can illustrate the sensitivity of system capacity to potential increases
in costs and might further suggest modifications to system design to promote more efficient
operation. In instances where capacity appears questionable over the range of likely scenarios,
the developer and regulator can then evaluate the effects on system costs of other system options,
'Users\ aj'the PAWATER Software and PAWATER Results "
.".As described .more completely in Section 2.4, PAWATER requires that the user have
knowledge of water system requirements as well as economic and construction conditions at the
site in order to complete the planning analysis. Although the program is not intended for the
development of detailed, site-specific cost estimates, the planning information requested by the
model still demands a thorough understanding of water system design parameters in general, and
an intermediate-level familiarity with site specific requirements. It is expected that the developer
will have performed an initial design assessment and will work with a watersystem engineer to
complete PAWATER worksheets'prior to using the software.
The PAWATER analysis can be conducted by the system developer independently and
then replicated together with state or local regulators to calculate the full costs of a proposed
system design. The developer may want to explore a number of alternatives prior to submitting
a proposed design for approval, and .the regulator may want to assist the developer to investigate
still other alternatives or to critically examine the impacts of changes in inflation or other -
assumptions. It4s expected that both the developer and the regulator may want to examine a
.- •'•" "; .•••".. '---.',•',: 2-4 • -'.. ."•• -' .. '•''••''. .' ;••• •'..•• •.
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number of design and operating structures in order to identify the most suitable and cost-efficient
system, and that a range of realistic assumptions will be tested to analyze the cost impacts of
likely future scenarios. . ..
PAWATERresults can be used by developers, potential water system customers,
governments, and regulators to evaluate the full costs and associated fees and subsidies required
to meet the financial obligations of the proposed water system. .These costs and fees can be
compared with national and regional averages and can be assessed with respect to customer.
household incomes and residents' willingness to pay to make a determination of the likely
financial health of the proposed system. Developers can use PAWATER to reevaluate plans and
explore alternative water provision options. •-;"• :
If the proposed system design seems reasonable, the PAWATER information can be used
as the basis for more detailed engineering studies prior to system development. Regulators can
file the results of the PAWATER analysis with other.system approval documents to provide
background information in the event of future system capacity problems. In addition, the
information can be used by local governments and homeowners associations to inform potential
home buyers of the expected costs of water provision in the area.
2.3 PAWATER Technical Approach: Financial Planning and Full Cost Recovery
.. The general financial planning approach used.jby the PAWATER software is straight^
forward. The methodology used is commonly applied during planning for. any capital-intensive,
long-lived investment for public service provision. It requires an estimation ofttiGjull-costs of
water provision during the life of the. system and a determination of the revenue sources, such
as user fees, supplemental charges, and subsidies required to recover these costs.
Costs of Water System Provision :
Financial planning for full cost recovery is based on the premise that the costs of service
provision include more than just the annual costs of labor, supplies, equipment, and other routine
expenses needed to operate a facility once it is operational. The capital outlays neetted for the
initial design and construction of water system assets, such as payments for pumps, pipes,
treatment facilities, and engineering services, and the funds needed to expand and .upgrade the
system over time are often the largest financial burdens associated with water provision:
Sources of funds for these capital costs must be accounted for by system developers. Typically,.
capital costs for construction are financed, in part, through the issuance of debt on public
markets.. The annual interest payments on these loans represent another cost of the system. In
addition, in cases where developers invest private funds in water system development, they
expect to see a financial return on that investment in the form of profits. The fee that private
water providers charge to ensure a reasonable profit represents an additional cost of Water
service provision. The total of these capital, operating, and financing costs over the life of the
water system assets represents the full costs of the system. ,
'•".,.- •-.'.*.-• _./".•_ . _ '"'''.',
: •''.','.' ''.' '•'•",- • 2-5" • ' :'>:- ' . ••••••
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Water System Revenue Sources, Subsidies, and.Forfeited Revenues
Since quality water provision has value, water system owners, both public and private,
typically charge users directly or indirectly for some or all of the costs of providing the service;
Direct charges include monthly fees to each residence; perhaps based on the amount of water
used, and one-time connection fees for residences that are added to the system. Indirect charges
may include additions to the purchase price of a home or commercial property, or special
property tax surcharges used to pay water system costs.
Full-cost recovery implies that the residents who benefit from water provision will pay
the full costs for the service through some combination of user-fees, taxes, and special charges.
Often, however, a system is. built to service a number of housing units that are sold and
inhabited over a period of years. In many cases, it is considered unfair to charge the early
purchasers of residences for the full-cost of service provision during this "build-up period" when
these costs are based on a operating a system intended to serve a larger population.. To avoid
this situation, private developer or government subsidies may be required to reduce costs to
users before all residences in the service area are purchased and/of connected'to the system. .
These subsidies are used to lower user fees below full^cost recovery levels for customers who
connect to .the water system in early years of development and are set such that customers only
pay the portion 'of system costs, that they would pay under the fully-developed operating
environment. Public utility commissions often require that private owner/operators implement.
these equitable user fee charges during system customer base development. Under private
ownership, these subsidies are considered a required cost of business and are referred to as
"forfeited revenues" m the PAWATER model.
Matching Costs -with Revenues: Promoting Rational Decision-Making and Accountability
A financial plan for full-cost -recovery makes explicit the expected costs of providing
service over a given planning horizon (typically five to twenty years), as well as the revenues
and subsidies that.will be used to cover these costs. It provides sufficient information for
developers, community residents, local government officials, citizens, and regulators to assess
the practicality of the proposed approach and to evaluate the expected financial impacts of the
system on community residents and other taxpayers. In this way, financial plans promote
rational decision-making on the part of developers and local governments, reduce uncertainties
over future resource needs, and foster accountability among those responsible for water system
decisions. ' ' ....
Unfortunately, the financial planning process is often ignored, or implemented
incompletely by system'developers and governments, potentially resulting in system costs that
can not be recovered through user fees. In cases where realistic full-cost financial plans are not
prepared, system quality often deteriorates, and customers must pay excessive fees or taxpayers
must provide unexpected subsidies to keep systems operational. PAWATER is one financial
planning approach that can identify the potential for these adverse outcomes in advance. As
described below, the PAWATER software automates many fundamental financial planning tasks,
• ' '• ..'..-' 2-6 '' ' ''.'.' • •'. .•'.-.'..'. " " . •
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incorporates historical information on water system costs, and allows system developers to easily
: explore the costs of alternative system designs.
2;4 PAWATERMethods and Data Requirements •
: PAWATER provides an efficient and consistent method of estimating system costs and
associated revenue requirements for a few common system ownership/operating structures. The
PAWATER screening process requires the prospective water system developer (or engineer) to
complete a seven-page Data Collection Worksheet describing relevant system parameters and
economic and financial assumptions; The developer, alone or in .conjunction with the regulator,
then enters this information into the PAWATER program, which uses this data and an internal
cost database to calculate system costs.. Users can then examine the PAWATER output to assess
system financial impacts, can adjust input parameters toexplore system sensitivity to alternative
assumptions, and can make a determination on the new system's financial health. The primary
steps in the PAWATER methodology are. illustrated in detail in figure 2.2. '
The PAWATER 'Data Entry Program .and User-Defined System Requirements
The PAWATER data entry program consists of multiple screens that prompt the user to
enter data and make decisions regarding design parameters and physical characteristics of the
proposed system. The program follows a logical system planning path, which begins with the
entry of general economic data, such as interest rates and construction conditions, followed by
detail on water consumption and demand levels, and information on physical system design.
PAWATER customizes its data input requests based on previous information provided .by the
user. For example, a user's choice of a water source (e.g. wellfield supply) will define what
additional information on system design.will be required (i.e., if wellfields are specified, no
information on spring-supplied or surface.water-supplied systems will be requested). Throughout
the data entry process, PAWATER checks the reasonableness and consistency of user input/ .
provides recommended default values., and presents immediate output of interim calculations. .
PAWATER initially prompts the user to supply a number of financial control parameters
and general utility criteria that will affect cost calculations throughout the PAWATER analysis.
These variables include construction, electricity •, and general cost levels and inflation rates for
the study period, percent debt financing and interest rate on debt, percent equity financing and
rate of return on equity* expected facility life, and depreciation rate for the facility. The system
also prompts the user for five General Utility Criteria variables that are used to adjust
construction costs for pipes and other facilities based on nature of the workforce (in-house,
contract, or union) and geographic conditions (type of terrain, percentage rocks, etc.).
2-7
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Figure 2,2
PAWATER Data Entry and Analysis Steps
•Define Financial Control and Cost Adjustment Factors, including:
•'Base Year ,
• Price Index
• Inflation Rate
•Facility Life
•Cost of Equity .Capital ' .. •
-Cost of Debt Capital
• Financing Structure (% Debt, % Equity)
•, Depreciation.Rate '. -
Define Water Consumption Requirements, Including:
-Number of Residential Unite and Water Use /Unit '
• Non-Residential Consumption
• Unaccounted-For Percentage ' •
^Peaja'ng Factors , '••'...'
• Fire Service .Demand
Define Water Source Parameters
:- (select one)
Well Supplied
•Average Yield per Well.
• -Safe Yield per Well
'• Bedrock or Overburden
Spring Supplied
.-Lowest Flow
•Minimum Flow Release
. • Construction Requirements
"River Supplied
•Lowest Flow
• Minimum Flow
Interconnection
• purchase Cost
• Base Rate
•Up-Front Capital
' Define Treatment Requirements
-... (Surface or Non-Surface)
•IronorManaganese
• Radon, . •
•.Organics • • -
•Turbidity. .'.-. .
' Corrosive Properties
• Softening
• Mineralization.
•Nitrates
• Fluoridation
Define System Requirements
• PKmary Pumping Facilities Details * • '
- Distribution Storage .
: Pipes, Wet Taps, Dry Taps "
•Air Release Valve Manholes . '
• Blow off Connections
• Fire Hydrants ~ •
• Residential, Non-Residential, Fire Service Connections
• Operations Related Capital Costs
•Other Facility and Project Cost Revenues . '
Calculate Five-Year Full Cost of System fon
• Homeowners Association
• Investor-Owned Utility
• Municipally-Owned Utility '
'Evaluate System Costs,
Perform Sensitivity Analysis
Modify System Design or
Operating structure.
No
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. Once these general variables are defined, PAWATER requests mbre detailed information
on water system requirements. "-Water system demand requirements are calculated from
information provided by the user on numbers of residential units, commercial consumption,
unaccounted-for water, "peaking factors", and fire service requirements. PAWATER provides
a number of methods for calculating residential, .commercial, and peak demand and uses the
results of user input and internal calculations to determine system costs. The PAWATER
approach to estimating system costs based on user-input demand and treatment requirement
parameters are discussed in more detail below. .
PAWATER Cost Estimates ;
The PAWATER software includes a database of cost estimates for all system capital and
O&M components drawn from historical data on water supply facilities. The database includes
cost tables for system components based on facilities of various size and design: As the user
provides information on physical system requirements, the PAWATER software matches user
. inputs with appropriate default costs, adjusted for inflation and operating environment factors
entered by the user. In all cases, these system-provided cost estimates can be modified by the
user to reflect unique individual operating conditions. Cost categories covered in the PAWATER
analysis include: a v • . -..,.
CapitalCosis ; . :..; "
Capital costs are estimated by one of several methods' linked to the program's cost
database. Methods used include fixed cost per item, and unit costs tied to item, size or capacity.
Capacity requirements are linked to projected demands, based on such user-provided data such
as numbers of residences, commercial Vequivalent dwelling units (EDUs)" served, and applicable
"peaking factors". For example, costs for installed water mains, fire hydrants, and meters are
estimated using a fixed cost per unit multiplied by units required for system demands. Costs for
water treatment facilities are based on user-defined treatment requirements, which allow
PAWATER to select needed water treatment technologies (e.g. package-type gravity filtration,
or reverse osmosis plants). Once treatment requirements and water demands are defined,
PAWATER uses a construction cost versus capacity (maximum daily demand) relationship
tabulated in the cost database to derive expected construction costs for treatment. PAWATER
tables also contain information on construction cost versus .storage capacity and are used to
estimate the cost of storage facilities, such as elevated tanks, clearwells, and stahdpipes, from
user-supplied data on fire and other emergency needs. Construction costs for pumping facilities
are estimated based on a complex set of user-supplied data and PAWATER database
relationships for pump stations, pressure relief valves, and telemetry, control requirements. The
user also can enter the costs of,up to three additional capital components not included in the.
PAWATER database.
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O&M Costs.. . , "':. ;
* .=«, .'# * '• '". .' 'l ,'„'•-
' • * "'•**. • '' . ' t
Operation and Maintenance (O&M) cost estimates represent anticipated'annual costs for
comprehensive system operation consistent with industry standards. O&M cost estimates °are
inc.luded for water supply, treatment, transmission, and distribution. All energy costs, customer
•costs, and general administrative costs are also included. Customer costs include meter reading,
hilling and collection, and miscellaneous customer service expenses. O&M cost estimates are
drawn from PAWATER's cost tables' using historical relationships between system O&M costs
and numbers of EDUs served.. ,
2.5 Results '• ' •__'•• ' '_' •.':...'• '• ; ...••'.'...•':'••''•,.'.•• .'.••'.
PAWATER reports system costs and a projected cash flow analysis for the first five years
of water system, operations under three water utility ownership structures: a homeowners
association,' an investor-owned utility, and a municipally-owned utility; !
For all three ownership options, capital costs for the water source, treatment facilities,
pumping-facilities, storage structures, operations capital, and other facilities are financed
assuming that these facilities are constructed in .the base year. The remaining capital
expenditures, which include mains, taps, .hydrants, rheters and meter pits, manholes, and
blowoffs are assumed ito be constructed in proportion to the EDUs served annually. All annual
operating expenses are also computed in proportion to the total EDUs served in each year.
PAWATER then ^resents the annual charges per EDU, additional costs per residence, and
subsidies or forfeited returns required by system owners under each ownership structure. .These
calculations are unique to each ownership option and are discussed in detail below.
Homeowners'Association' • < :
• For systems owned by a homeowners associations and for mobile home, parks, it is
assumed that the capital costs for system construction will be included in the purchase price of
the units served by the water system. PAWATER calculates the contribution to water system
capital costs required per EDU. by dividing the total capital cost of the system by the number
of EDUs expected once the system is fully developed. This methodology implies that developers
must sell all: of the planned units-in a development in order to recoup water system capital costs,
and that early purchasers will not be required to pay the capital cost share of unsold units. Since
this capital cost contribution is bidden in the purchase price of the unit, it is not included as a
financial outlay for the water system and is reported separately on the PAWATER report.
PAWATER then calculates the annual charge per EDU for the homeowners association
owned system by dividing the gross revenue required once the system is fully developed by the
total number of EDU's. Gross revenue requirements include the O&M costs calculated from
user-supplied information and PAWATER cost tables as well as contributions to a fund for
capital renewal and replacement. The annual renewal and replacement fund contributions are
. . 2-10 .
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assumed to be equal to the loss in value.of the system's cumulative capital assets each year,
(calculated from 'the user-defined'- depreciation 'rate times the cumulative capital cost of the
system). PAWATER assumes that this annual charge per EDU, calculated to cover costs once
. all EDUs are connected to the system, will be the annual charge per, EDU in the early years of
system operation as well. In cases where this annual charge results in system revenues
insufficient to cover gross revenue requirements prior to full system development PAWATER
calculates the annual subsidy required each year. -The present value of all subsidies required
throughout the study period is presented in the PAWATER, report.
Investor-^Ovmed Utility / .
For systems owned and operated by the private sector, PAWATER assumes that the
construction cost of the facility is recovered from users in water rates charged over the life of
the system. In addition, the private entity will charge users a price that allows the firm to earn
sufficient returns to pay off debt used to finance the facility and compensate equity investors for
their financial investment. PAWATER uses user-supplied information on the debt-equity mix
used to finance the facility,'interest rate on debt, and required return on equity to calculate the
overall return required on the depreciated value of the.system each year. In estimating system
costs and project cash flows, PAWATER must also account for income and other taxes paid by
the private owner/operator.
PAWATER calculates the total capital and operating costs incurred in each of the first
five years of system operations. The report also includes the yearly, depreciation expense
incurred on capital assets. PAWATER then calculates private sector taxes and the return,
required on the fully-developed system based on user-supplied information oh tax rates, debt-
.equity mix, and the cost, of debt .and equity. Once the costs, taxes, and returns are determined,
PAWATER calculates the revenue required for the fully-developed system and establishes the
annual charge per EDU. This annual charge is assumed to remain constant in the early years
of system operations and PAWATER calculates the return available to the private investors in
these years by subtracting total O&M costs, depreciation, and taxes from revenues generated by
the annual EDU charge. PAWATER then calculates the required return in these years (based
on the weighted return oh debt and equity for cumulative system assets) and presents any
shortfall between actual and required return as'a "return forfeited" by the private investor. The
present value of these, forfeited returns, or private sector subsidies, is also presented in the
PAWATER report; ":
-.( . ' ' •• r • • _• ' ' . , •• . , ' .\ : " .''•'•• ;
Municipally-Owned Utility ,
For municipally-owned utilities, PAWATER assume that construction costs of the water
system will be recovered through a one-time tapping fee and annual water fees charged
throughout the life of the facility. All construction costs not recouped through tapping fees are
assumed to be financed through a bond issue, with interest payments recovered through user
charges. PAWATER assumes a $3000 tapping fee, but this default value can be changed by the
user. .. _ .-'-. - - ; ;.'' •,. '•••,':" ;.... ";. -'- ••'••,;'.•'.
'•' • '• ":'•• '' .'•" .V-.--:; • 2-11 ••'.' :"/ '•• •:' ' . •'• '";:
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PAWATER estimates the capital and operating costs required under the first five years
of system operations. As with the''Homeowners Association option, PAWATER also assumes
that contributions to a replacement reserve are funded annually at a level equal to annual
depreciation of accumulated capital assets. PAWATER also calculates the annual debt service
required each year based on the total amount of debt required for the system (total capital costs
minus total tapping fee revenue), the cumulative capital costs expended, and the interest rate and
maturity'of debt information supplied ;by the user.
.Once yearly costs have been determined, PAWATER calculates the gross revenue
required to cover these costs once the system is fully developed. PAWATER .divides gross
revenue by total EDUs served to establish an annual charge per; EDU. As with the other two
options, PAWATER assumes this user charge for the fully developed system will apply to users
in earlier years of system development as well. It is assumed that the municipality will provide
a subsidy to meet any additional revenue needs of the system. The PAWATER report .details
the.annual subsidy required as well as the present value of total system subsidies throughout the
study period. . • , '
2.6 Summary and Extensions • . '
PAWATER provides an easy-to-use tool for developers and regulators, to assess thefull
costs of providing water service for proposed ^community water systems. The PAWATER
1 approach minimizes' the complexity of the .financial planning process by both automating the
planning steps and providing ready ac~?ss to a database of historical information on design,
construction, and operating costs, PAWATER also provides for a great deal of flexibility in
analyzing numerous ownership/operating structures, alternative economic assumptions, and what-
if scenarios regarding the impacts of future SDWA regulations on system costs and financial
health.. • :.'' . •/. :;..>-\, ". ,. ':-. ",-'"'• -:. •'V"v: .,'.. ' .''•;...-''
Nevertheless, users may want to adapt and build on the tools provided in the PAWATER
package. Some modifications can be made from within the PAWATER. software. For instance,
the cost database can be updated to reflect recent changes in prices of materials or regional cost
variations. Other changes may require more substantive efforts. For instance, system owners.
or regulators may wish .to develop financial plans for more than a five-year period, or may wish
to analyze the impacts of other ownership structures not included in the PAWATER reports.
Although the financial planning methodology used by PAWATER is straight-forward and can
be implemented with any spreadsheet program, the inclusion of historical .cost data and
automation of the cost estimating process can involve some substantial development time:
In addition, PAWATER is just one piece of the new system assessment process.
PAWATER can be most effectively used as part of a broader pplicy and regulatory framework.
Such a framework would need to be defined so as to meet the needs of individual states and
regions but will likely include statutory provisions to tie system approval to the results of a
PAWATER or -similar system financial plan. In addition, some states may wish to explore
. . . • -.'••• • • '-. 2-12' ,'. " • -; . :' .•••'•' ' •-.'
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mechanisms to ensure that developers build the system they have defined in their proposal.
Policy tools, such as financial guarantee requirements, might be used to encourage developers
to implement the system as approved.
•REFERENCES:- .;"....•' v.'...,'•'.> • • ; " ; •' •: : .•'/.-—••"' '•'"-• ~-'. '. • ,'
1. PAWATER; Financial Planning Model for New Small Water Systems, developed for the
_ Pennsylyania Department of Environmental Resources by Gannett Fleming, Inc. and
..' Wade Miller Associates, Inc., July 1992. -'^ • '
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'•-."..• •:••..'.'': :•••'.. -.,-•• i.'•-• '.' .• ^CHAPTERS. '•'.:.'.'•' '.."'• ••" '..'''•' V '
A DOZEN-QUESTIONS DIAGNOSTIC
TOR SMALL SY§TEM ASSESSMENT1
3.1 Overview of the Dozen Questions Approach . '.
;, Hie "Dozen Questions" approach to assessing small systems was produced for theAWWA
Guidance Committee to Small Systems. It provides a diagnostic procedure for probing an
existing drinking water system's ability to meet current and future operating and financial
.requirements. The objective of .the method is to promote comprehensive strategic planning
among small system owners, managers, customers, and. regulators so that near- and long-term
operating and financial challenges are understood and effective cost-efficient responses can be
planned. .'•',-•- ' -% .-. ._•'•-- '../••• .;-.' ; •• ', ' • •'.' : '':''•''•
The method simply consists of a series of detailed questions that cover the critical
parameters defining small system financial capacity. The twelve categories of questions form
a five-tiered "diagnostic pyramid" as depicted in Figure 3.1. The five tiers of the pyramid are
traversed sequentially, beginning with questions on water system capacity and demand,
continuing through questions on water quality and infrastructure conditions, to arrive at questions
of management capabilities and financial stability. Finally, questions on customer awareness
assess the degree to which customers understand the operating and financial challenges faced by
small water system providers. The implication of this pyramid structure is that the problems and
challenges identified in upper tiers wiU require a broader, sturdier underpinning of management
and financial support to ensure system capacity in the fuoire. At its foundation, customer
understanding of what is required to operate and maintain a water system is integral to assuring
cooperation for new capital investment and higher water rates.
The focus of the dozen questions method is on encouraging small system owners to ask
themselves the necessary questions to uncover system risks and liabilities and to confront the
costs of meeting these challenges. The method deliberately raises questions without providing
too much structure, for exploring solutions. Its intent is to provide insight into existing and
potential problems such that owners are stimulated to take logical next steps to address system
limitations revealed in the diagnostic process. In addition, the procedure focusses on collecting
and organizing information so that owners, managers, governments, and customers can evaluate
the extent to which the water system is meeting, and will continue to meet, its financial and
regulatory obligations. This information provides a basis for action and can improve
understanding and cooperation among key stakeholder groups. ' '
3-1
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•'.';,'."".-'•.-^Figure3.1-" ''
The Dozen Questions 'Diagnostic Pyifcmid"
Quantity
Quality
Infrastructure
Management & Finance
Customer Awareness
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3.2 Purpose and Objectives of the Dozen Questions Approach
The dozen questions methodology is intended to alert small system owners, managers,
and customers of the challenges they must meet and the decisions they must make in order to
remain financially sound throughout the next decade as new, more stringent Safe Drinking Water
, Act (SDWA) regulations are introduced. The method has three basic objectives:
• to encourage a "big picture" evaluation of existing system demands and future
system requirements implied by Safe Drinking WaterAct (SDWA) regulations (to
. be phased in over the .next ten years), so. as to promote efficient operational and
' "investment decisions over the long-term; ,
• to combine knowledge of water demand and quality issues with an equally
. comprehensive understanding of the full costs of meeting these operating
requirements; and .
'•'-••> ... _ to encourage systematic collection and dissemination of information on these
critical water systems issues so as to promote dialogue and cooperative planning
among owners, managers, regulators, and customers. . ;
. The approach does not result in a definitive assessment of small systems. Instead, the
goal is to encourage key stakeholders associated with small systems to ask themselves a series
. of questions that will lead them to recognize the risks of being unprepared and to discover their
most viable options for the future. In this way, systems all along the "capacity spectrum" will
benefit from the dozen questions diagnostic; Systems that have the technical, managerial, and
financial capability to meet all customer demands and regulatory requirements without major
modifications to operations will be able to use the diagnostic to prepare detailed operating and
financial plans in order to communicate their stability to customers, regulators, and credit
providers. Owners of systems that appear to be in good condition today, but that may face.
serious challenges as new SDWA regulations are imposed, can identify major required changes
to current operations needed to meet, requirements for the foreseeable future. These systems can
institute one-time cost-effective modifications or seek outside assistance, rather than make a
series of incremental expenditures that may be costly in the long-run. Finally, systems that are
not currently meeting obligations or that will be unable to meet future customer demands and
regulatory, requirements can begin seeking assistance before problems become severe. In these
cases, restructuring alternatives or other options can be evaluated and implemented with a full
understanding of area needs and system costs. . .
3.3 Dozen Questions Technical Approach: A Forward-Looking Assessment of
Operating Requirements and Full Costs -
The "dozen questions" diagnostic actually consists of many more than twelve questions.
These questions, which can be divided into twelve general categories, cover both .current
conditions and future requirements and contingencies. Many require specific, detailed
''' '• •'.'*'' • • 1
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information about the-chemical, geological, financial; and physical characteristics of the water
supply, treatment, and distribution system. Others require a more open-ended assessment of
future conditions and an: ability to predict the ways in. which demographic, agricultural, and
industrial changes to the region surrounding the system will impact water provision operations
' and costs. It'is likely that system owners, managers, and engineers will need ito participate in
the diagnostic process so that technical, operational, managerial,.financial, and strategic concerns
can be addressed. .
The questions systematically probe system quantity, quality, infrastructure conditions,
managerial competence, financial stability* and customer awareness, in that order. This
•• progression leads the system "diagnosticians" to fully explore the technical challenges faced by
system owners and managers in order to meet current and future customer demands as well as
satisfy existing and soon to be introduced SDWA regulations. Once these challenges are
identified, the diagnostician must then critically evaluate the managerial and financial capabilities
of the system to achieve these objectives^ Finally, the extent to which water system customers
• are aware of the technical challenges and financial requirements for providing water is assessed,
to evaluate the potential for customer support for needed rate increases in the future.
The twelve categories of questions, grouped by the five tiers of the diagnostic pyramid,
are summarized in figure 3.2. Additional detail on the nature of .the questions in each category
is provided in section 3.4. • , .
• 3.4' Dozen Questions Diagnostic Methods and Data Requirements
• The questions that comprise the twelve diagnostic categories require assessments of
-existing' water quantity and quality parameters, operational and engineering detail on water
• source, storage, distribution, and treatment, capital and operating financial requirements, and
managerial and personnel capacity. In addition, questions probe likely changes in many of these
critical factors and therefore require .estimates of future needs and costs. For many questions,
the implications of-some answers are briefly explored: In order to complete the diagnostic, it
is likely that a number of technical-studies, water quality monitoring, and financial plans will
heed to be prepared so that accurate, answers and reliable projections can be made. A
description of the twelve questions categories and types of questions included in the diagnostic
is summarized below. . • '•'..'• . -.
3-4
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Figure 3.2 Twelve Categories of Questions in the
; Dozen Questions Diagnostic ;
Quantify -'..... " •'• ._ '' '-- ' -: •..".'-'• . '..;"'.' "."';.,••/" . ' ' •; •"'• • -.' • • •
1. Is the water source safe, adequate, and reliable? ', . . - .'.'.
- . • .- ' ' .- i • '_'--"! "_.'-/' •"1,..
Quality '•.•.'•.-•••'.'. !.•'': "." • :.-i\V--''\^-;;->;.,JyX';.'::.',^-:\''vr:;~'--".'.''-;' . .''.
2. Is microbiological contamination a current or a potential future problem? ' .
3. Are disinfection by-products likely to be a problem under new SDWA regulations?
4. Are corrosion by-products an existing or potential future problem? '
5, Are natural geologic contaminants an existing or potential future problem?
6. Are agricultural chemicals an existing or potential future problem?
7. ' Are mdustrial/cx)nimercial chemical contammation an existmg or potential future problem?
Infrastructure . : ' . '
8. • Is water system infrastructure, including pumping, storage, and distribution systems, in
good condition? . ; ._ :
Management and Finance , .... ;
9. Can existing and future operator requirements be met?
: 10. . Are management systems and controls adequate to meet existing and future requirements?
11. •' Has the system completed comprehensive financial plans and is the system capable of
meeting all existing and future financial obligations?
Customer Awareness . '.'-''. .
12. Do water system customers understand the challenges and. costs of providing high-quality
water .on demand? ' • • . . ;.
1. Is the Water Source Safe, Adequate, and Reliable ,
Small systems differ in their ability to maintain an adequate quantity of supply on a
reliable basis to meet existing and future water needs. The twenty-six questions in this section
of the diagnostic focus on adequacy of existing supplies to meet existing demand (e.g. What are
average'and peak daily requirements?, and Have shortages been experienced?) and existing or
new supplies to meet future demand (e.g. Does the system have a demand forecast?, Are the
long-term plans of commercial customers rknown?, What alternative water sources are available,
and what are their characteristics and costs?, and How much influence does the system hove
over activities taking place in the watershed or well head area that may be potential sources of
contamination?).
3-5
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2. Is Microbiological Contamination a Current or Potential Future Problem
Recent major outbreaks of waterborne disease have emphasized the need for 'strong
discipline in. protecting water supplies from microbiological contamination. This discipline
requires vigilant efforts in source protection, treatment, storage, and distribution. Also, new
SDWA regulations will inprease the treatment requirements for protection from microbial
contamination in both surface waters and groundwater. The thirty-one questions in this section
explore microbiological considerations for bom surface water and groundwater, as well ..as' in
water distribution systems. .Questions include: .
. • For Surface Water Systems: Will you have to filter?, Is your record free of any
\vaterborne disease outbreaks or "boil water" notices from the state? Has the state or
your own engineer performed a "sanitary survey " or "performance evaluation " of your
recently with satisfactory results?
For Ground Water Systems: Are you sure it's really ground water? Does your water
become cloudy or turbid and undergo changes in temperature in the period after storm
events? Do you regularly inspect and maintain your chlorine dosing equipment? Can
you detect a chlorine residual at taps throughout the distribution system? .
For Distribution Systems: Are you just delivering water or are you growing anything else
in there? Have you encountered compliance problems with the Conform Standard? Do
' you regularly receive complaints regarding the taste and odor of chlorine?
3. Are.Disinfection By-Products an Existing or Potential Future Problem
Although the public health benefits of disinfection are universally accepted, recently -there.
have been questions raised about the potential health effects of various chemical by-products
formed by popular disinfectants such as chlorine. As a result, new SDWA regulations will
require small water, systems to begin controlling for disinfection by-products in the latter part
of the 1990s, with further controls possible during the first decade of the next century. This
diagnostic section explores the likelihood that small water systems will need to address the issue
of disinfection by-products in the future. Questions include: Do surface water systems have raw
water with Total Organic Compound (IOC) levels > 4mgl? (TOC > 6:7 mg/l for ground water
systems) and/or bromide levels' > 40 ug/l (bromide > 60 ug/l for ground water systems) Do
surface water systems have a filtration process that includes both chemical coagulation and
settling prior to filtration? ., ,
"4. Are Corrosion By-Products an Existing or Potential Future Problem?
Lead and copper occur in trace amounts in tap water, in part as by products of corrosion
from pipe materials and plumbing fixtures. Recent SDWA regulations, known as "the Lead
Rule" govern monitoring and control requirements for small systems to address corrosion by-
product issues. The three questions in this section of the diagnostic are designed as a guide to
• '•'",. . ' . .' " . - ' 3-6 ' ; ' :.'. , . ,' •.-•••'''
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assessing water system liabilities in this area.. These questions are:"• Has your first .draw
monitoring produced results fpr lead above the 15 ug/l level? Does your treated water have a
pHless than 8 and an alkalinity less than 50 mg/l? Doyou have leadservice lines, goosenecks,
or service connections in you distribution system? *
5. Are Natural Geologic Contaminants an Existing or Potential Future Problem?
A number of naturally occurring inorganic chemicals present contamination problems in
ground and surface waters as a result of gradual weathering of soils and geologic materials and
as a result of other-releases from these sources during mining and processing operations. This
section of the diagnostic explores the extent to which radon, radium and uranium, arsenic, and
sulfate. represent existing or potential contamination sources that may require treatment under
•future SDWA regulations..
"6: Are Agricultural Chemicals an Existing or Potential future Problem? ; :
Agricultural chemicals such as nitrate (from fertilizer), pesticides, and herbicides can
contaminate water sources. Removal of these chemicals can be expensive, although only a small
percentage of water systems are expected to have levels of contamination that exceed the
standards fpr these contaminants. This section of the diagnostic begins to assess a water
system's potential compliance challenges as regulations governing agricultural contaminants are
phased in over the next decade: Questions are primarily general assessments such as: Do you
know your local geology and geography?, Wthin.your watershed area or your "zone of
contribution,''are thereany facilities engaged in the production, storage, or handling of
agricultural chemicals such as manufacturing plants, warehouses, or farm supply stores?
7.: Is Industrial/Commercial Contamination an Existing or Potential Future Problem
Organic and inorganic contaminants often associated with hazardous waste sites or other
industrial/commercial disposal areas represent potential threats to water quality that will be
regulated under various phases of the SDWA implemented throughout the coming decade.
Although most wells and surface intakes are not expected to exhibit this sort of contamination
at above regulated levels, the questions in this section of the diagnostic begin to assess potential
liabilities in this area. The principal question in this section is: Have you had any water
.samples with VOCs? . . . .
& Is Water System Infrastructure in Good Condition?
The questions in this section of the diagnostic provide an evaluation of the condition of
water system infrastructure, including pumping, storage, and distribution. Questions include:
Pumping: Do you hire a qualified pump contractor to perform an inspection of all
pumping equipment, identify potential problems, and perform maintenance on an annual
basis? Does the system have sufficient gravity-flow distribution storage to provide, safe
•' •"•'•'• ' !" - ' •••'-: •'•-• • " '•- 3-1 ,'.. /• ••''..:.• . • ' '-';'... •••
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and adequate service' for up to 24 hours without power? Is an existing
standby/emergency power equipment, controls, and switches tested or exercised routinely
under load conditions for at least 30minutes at a time?
' ' Storage: 'Is there only one storage tank? Is there a contingency plan for storage if the
tank collapses? Is there a high and low water level electrode signal to control the
pumps? Do all interior piping, fittings, and accessories conform to the minimum
plumbing requirements of the National Plumbing Code? .
Distribution: Does the operator routinely flush, test* and maintain the hydrants in. the
system? Is unaccounted-for -water in the system monitored and analyzed each month?
Is there a program to gradually replace sub-standard sized mains?
9. Can Existing and Future Operating Requirements Be Met?
For many small systems, the combination of a backlog of deferred infrastructure
rehabilitation needs and new SPWA performance requirements imply that operational demands
are rising at unprecedented levels. This section of the diagnostic explores whether existing and
future operational needs can be met. Questions include: Has your water system experienced
recent episodes of: violations ofanySDWA standards including contaminant levels, monitoring
and reporting requirements, shutdowns or outages, or customer complaints? Is the present
quality of staff adequate to do.the job? Eased on the answers to previous questions regarding
the extent of your potential water quantity, water quality, and infrastructure liabilities, what is
the forecast for operational requirements.and how does this match up against your current level
of operational capability? .. .
JO; Are Management Systems and Control Adequate to Meet Existing and Future Requirements?
The management systems needed to oversee the water system grow more complex as the
quantity, quality, and infrastructure needs increase.. This section of the diagnostic highlights the
general .types of management systems required. The thirty-six questions include: Is there a
clear plan of organization
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as well as pricing, budgeting, and accounting systems. The questions that make up this generic
financial test are illustrated in figure 3.3.
Figure 3.3 Dozen Questions Diagnostic:
. Small System Assessment, -.
Does your water system presently operate on a break-even basis, or does it generate surpluses, or
losses? Is your water system an independent .financial entity? Are there any other sources of revenue
• besides the water, rate? Does the water system keep all the water revenues, or are they also used for other
purposes? If your system is not an independent financial entity, what would it take to convert it to such
independent status, wherein the water rate is the sole source of revenue and water expenses are the sole use
' of water revenues, resulting in pay-as-you-go break-even cash flows? . ,
Do you have a budget? Does yourbudget process provide for annual depreciation of existing plant,
the-annual cost of servicing your debts, and the annual cost of operations and maintenance? Do you use
the budgeting process to. determine your annual revenue requirement via either the cash needs approach or
the utility approach, as described in the AWWA Revenue Requirements Manual (M35)? Do you provide
for a reserve fund for capital replacement? Do you use a cost-of service, method to develop rates .sufficient
to meet your revenue requirements, as described in the AWWA Water Rates Manual (Ml)? Do you
• regularly review your rates? , . ' .
Do you have a capital budget, or capital improvement plan that projects future capital investment
needs some distance (at least five years) into the future? How are forecasts made? How are they translated
into construction projects? How are projects scheduled and approved? 'Does your planning process take
account of all the potential capital needs-suggested by all of the preceding questions in this paper? .Does
your long-term planning incorporate analysis of alternative strategies that might offer 'cost savings to
•customers, such as consolidation with other nearby systems or sharing of operations and management
expenses with other nearby systems? ... , ' .
. Do you employ standardized accounting and tracking systems? What accounting conventions and
standards do you follow? How do you track budget performance? How do.you track tax liabilities and
assure compliance? How is billing and collection handled? Where are the records to substantiate
depreciation of fixed assets? How are financial management record-keeping systems organized? Who's
in charge of the cash drawer? What controls are' exercised over expenditures? How do you keep from
exceeding your budget? What are the purchasing procedures? What are your procedures for selection of
outside contractors and suppliers? ' ' . ." .-.'.' .
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12. Do Water System Customers'Understand the Challenges and Costs of Providing
High-Quality Water on Demand?
Customer awareness is a critical factor in raeiohg-term capacity of small water systems.
When customers fully appreciate all of what it takes to operate and maintain a water system,
they are more likely to support rate increases needed to meet new treatment standards or to fund
adequate infrastructure maintenance. In addition,.when customers are provided information
about system needs and challenges, they can understand and assist in evaluations of alternative
strategies'for providing water service, conceivably at lower cost. Since customers will bear part
• of the burden of a small system's failure to meet SDWA compliance liabilities through a
reduction in property values, they havea strong incentive to see that the system can successfully
achieve its objectives, or that alternatives are identified before there are severe problems. These
incentives can be used to build support; for a financial planning process that takes account of all
the issues identified in the diagnostic. In addition, in cases where small systems appear well
suited to meet existing and future challenges, public awareness of this fact can help system
owners secure low-cost capital or attract neighboring communities who may wish to purchase
excess water. The penultimate questions in the dozen questions diagnostic is therefore: How
much of all this is known and understood by customers; and haw would this change their .
attitudes about the future?
3.5- ' Results r
In may respects, the dozen questions diagnostic is an interactive process. It is expected
that as-questions are posed, and information is gathered to respond, many problems will be
identified and'solutions designed before the diagnostician moves on to subsequent questions.
The process, is unstructured, however, and, as designed, there is no standardized "product"
: produced as a result. Nevertheless, it is expected that the operating and financial plans prepared
as'part of .the, diagnostic process will be available to those Within and outside the system who
have a direct stake-in water system operations. In addition, the diagnostic should not be
considered a one-time test of long-term system capacity.. Conditions change, often rapidly, and
• the answers to the diagnostic questions may be quite different in a year. Therefore, the results
of the diagnostic should not be considered static, the questions lend themselves to periodic
reassessment as conditions, needs, and regulations change.
3.6 Summary and Extensions . .
The dozen questions diagnostic provides a free-form question-and-answer approach to
small system financial assessment. It encourages system owners and other interested
stakeholders to ask the questions necessary to uncover potential problems and reach their own
conclusions regarding the ability of the system to meet current and future operating and financial
obligations. The answers generated during the course of the diagnostic are intended to
encourage small system stakeholders to take action, in some cases to resolve operating problems
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before they become severe, in other cases to seek assistance or evaluate restructuring options
if problems appear^overwhelming.'' ;
. The diagnostic can be expanded or streamlined to meet priority needs of systems in a
particular state or region. It can be incorporated into a broader program for system assessment
that includes more formal procedures for information reporting or a regulatory framework that
ties operating permit approval to the results of some or all of the results of the diagnostic
questions. /Since one of its primary objectives is to encourage small system owners to begin
answering questions and taking action prior to regulatory involvement, states may wish to
consider the diagnostic as an informal initial step in the small system assessment process.
REFERENCES ' ;•' ,v'""•" : ":'.."-"'•'•' '"•' ;:/- •'••'.'"'•--•.' •'
1, , Cromwell, Albani and Schmidt, A Dozen Questions to Assess Small System Viability,
Annual Conference of the American Water Works Association, San Antonio, TX, June
'•-. ' '1993. '-.. -.--, • •'••••--- ' .:•" . . ' • : ' : ' ' ;• ': ••.":• • .' " '
3-11
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CHAPTER 4.
WASHINGTON STATE FINANCIAL
VIABILITY PLANNING -IHANUAL1
4.1 Overview of the Washington State Water Systems Planning and Financial Viability.
.•'• Program ' . • . '••.•••"• ..'."'". ' - ' •..".~:;." ,''•.."'•;'' :•'.'./;',';:; ' .-. '.. - .,. "
Washington State has implemented a comprehensive package of programs and regulations
to promote viability/capacity of new and existing community drinking water systems and to
provide information to the public on the operating and financial health of these systems. The
programs, aimed at non-investor owned systems serving less than 1000 residences, incorporate
comprehensive water system planning steps with a multi-stage "financial viability test." In
addition, the state has established a number of regulatory provisions that allow the Washington
State Department of Health (DOH) to tie permit approval to successful completion, certification,
and submission of system planning documents and the financial viability screening test. Major
steps in the Washington State program are illustrated in Figure 4.1. The steps required to
prepare for and take the financial viability test are described in the Washington State Small
Water Utilities Financial Viability Manual and are summarized in this section. i .'
The Washington State DOH requires that water systems regulated by the department
complete and submit a comprehensive planning document kndwn as the Water System Plan
(WSP). The WSP provides a detailed description of the existing system, presents twenty-year
Capital Improvement Planning (CIP; information for system expansion and improvements, and
details historical sources of revenues and anticipated future sources of financing for capital and
non-capital expenses. Water system owners also must complete the Financial Viability, Program
•(FVP), which requires facilities to prepare a detailed six-year budget of revenues and expenses
and pass a financial viability test (FVT). The FVT consists of four basic financial calculations
aimed at assessing the internal .financial stability of the water system as well as determining the
affordability of water system customer charges! In the event that systems do not pass the FVT,
Washington State has the statutory authority to deny construction or operating permits or begin
receivership action. New regulations governing the FVT program will take effect in 1995. If
a facility fails to pass FVT's affordability test, 'Washington State authorities can encourage
owners to investigate restructuring options and can promote public disclosure of the rates
required to operate the system in the future. ;
The Washington.State approach combines forward-looking requirements for system
planning with an easy to apply mechanism for identifying water systems likely to have financial
viability/capacity problems. It incorporates this planning and screening methodology with
regulatory mechanisms in order to promote compliance, identify and restructure systems with
potential financial deficiencies, and improve information dissemination to the public.
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Figure 4.1
Major Steps in the Washington State
Viability Assessment Program
System owner has a preplan
conference with DOH
to discuss WSP and
financial viability requirements
Step 2:
Owner prepares the
, WSP
, Step 3: ' . •:
Owner prepares detailed six-year operating
budget and supporting capital improvement
and financial viability information
Step4:
Owner takes the FVT
Owner makes required
or considers restructuring
options
Owner establishes system
• reserves
P.E. submits
WSP and FVT for
review and approval
DOH notifies of
, unacceptable results
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4.2 Purpose and Objectives of the Washington State Financial Viability Program.
Promoting Financial Viability and Improving Information Disclosure v •
The Washington State Financial VmbHity Program (FVP) is a central part of DOH!s
-.broader policy for water systems planning and regulation. It is aimed at assisting new or
existing small community drinking water systems to plan for and demonstrate financial
Viability/capacity. The primary objectivesofthe FVP are to: • :
. • Highlight the importance of maintaining a financially sound water utility;
• Provide managers of small water utilities (under 1000 connections)
with an easy to use framework for preparing a budget used to
measure rate impacts of projected water system needs and to assess : .
system financial health; and
• Establish a consistent mechanism for regulators to assess financial capacity
and to collect information on a water system's compliance with DOH
viability/capacity criteria. In conjunction with Washington's regulatory
rrainework, this information can be used to restrict operations of systems
that do not meet the viability/capacity criteria.
In addition, the program is a vehicle for improving public disclosure of water, system
financial information for existing or potential water system customers. The tools of the
Washington State program also can be used in situations where restructuring is being considered
to determine the cost and financial impacts of alternative water service provision options.
Users of i^SP and FVT Results : . .
Utility owners can use WSP and FVT results to evaluate the current and future financial.
and operating health of community water systems. This information can be used by owners to
adjust capital investment plans and other planning assumptions so as to ensure compliance with
current and impending water regulations or to improve the efficiency and affordability of the
system. The comprehensive planning data prepared by the owner can also be .used to justify
future rate increases •needed to finance investments intended to meet new water quality
regulations. Regulators can use the information provided by Owners to ensure that water quality
standards will be. met and to evaluate the financial soundness of the utility and the cost of
service. Since the regulator has the statutory authority to tie system approval to the results, of
the planning documents and the FVT, the regulator can identify systems with potential financial
deficiencies and can work with system owners to improve financial stability through
restructuring. In addition,, water system customers and surrounding residents can evaluate future
operating plans of the water utility and can use information on current and estimated future rates
to plan household expenses.
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Since information collected for .the FVP is available to owners, .regulators, and
customers, the Washington'State*-approach promotes cooperative dialogue among important
stakeholders. Owners are encouraged to explore alternative service provision options prior to
regulatory involvement, customers are provided with information so that they can understand the
need for .rate increases, and regulators have a consistent set of data from which to pursue policy
objectives-equitably among water systems in the region. . ,; ,
4.3 The Financial Viability Program Technical Approach: Full-Cost Financial Planning
Combined with Tests of Financial Stability and Affordability
The FVP is fcased on the following definition of financial viability: .
.Financial viability is the ability to obtain sufficient junds to,
develop, construct, operate, maintain, and manage a public water ' .
. ' system in full compliance with federal, state,. and local
, requirements. , • '
This definition implies that water systems must have sufficient financial stability to meet their
current and future -financial obligations even when revenues fall below expectations or when
emergencies occur. Therefore, the Washington State FVP requires owners to prepare budgets
detailing the full costs of water supply provision as well as the revenues expected to be available
..to meet these costs over a six-year planning horizon. In addition, owners must demonstrate that
the system'has established and funded contingency reserves sufficient to meet unforseen
operating and emergency needs. , • ..
Full cost estimates include routine operating, general, and. administrative expenses as well
as capital outlays needed to maintain existing facilities, expand capacity, and/or upgrade
treatment technologies to meet six-year customer demands and regulatory requirements.
Expenses also include the cost of repaying new or existing loans used to finance system
construction. In addition, expenses may include contributions to establish or enlarge contingency
reserves. Revenue sources "include monthly fees collected from water customers, one-time
. charges for connection, penalties for late payment, and interest earned on water system investing
activity expected over the planning period. . • .
Contingency reserves are financial accounts created by the utility that hold funds
designated for a specific purpose. These reserve funds may include reserves used to pay
operating costs in the event of revenue shortfalls (operating .reserves), or funds used for
replacement and repair of critical system components in the event of an emergency (emergency
reserves). Some systems also may wish to fund a reserve for the long-term replacement of
capital assets in order to spread the "burden of financing capital replacement over the life of the
system (replacement reserves').
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The FVT component of the Washington State FVP requires owners to use the revenue
and expense budgets and reserve'-fund information to address the following four financial
questions: . ' . •..• ;.-; ','•'-. ;•'- •"-.•'• ;/; •'- • : '.'"'.-'•• •'. '
.1. Do projected revenues exceed-projected expenses?
2 Are operating reserves sufficient to cover operating needs in the
event of a revenue shortfall?
3. . Are capital reserves sufficient to finance repairs and keep the system operational
in the event of an emergency? and :
4. . Can customers afford to pay system rates?
The first three questions probe the internal financial stability .of the water utility. They
assess the water utility's ability to meet routine operating,expenses with anticipated system
revenues (question 1), and the ability of the utility to meet obligations under adverse conditions
(questions 2 and 3). The fourth question assesses whether customers will be able to pay the
rates projected in the utility's budget. The affordability question has ah important impact on
financial viability/capacity since high rates may result in! a higher percentage of uncollectible
bills or a lower ,than anticipated demand for services. These factors will result in lower than
expected utility revenues and, therefore, decreased financial stability.
The Washington State FVT uses the results of a simple financial calculation to answer
each of the four questions. Although no set of four calculations can fully determine a utility's
financial condition, the test questions used in the FVT are aimed at identifying systems that do
not; meet minimum criteria expected of a viable system. Section 4,4 provides details on the
budget information required for the FVP and the FVT calculations used to answer the four
'questions. ' •* ~\. "'.,;•'•' .'.:;••:',•..-""'..' -; ;''•••' •''••'• '•'"'••.. '•
4.4 Washington State Financial Viability Program Methods and Data Requirements
The Washington State Financial Viability Program builds on information contained in the
Water System Plan (WSP), a comprehensive twenty-year planning document supplied by system
owners to the Washington State DOH. Figure 4.2 summarizes the information contained in the
WSP. Using information from the WSP, owners then prepare a detailed six-year budget of
revenue sources and expenses. Owners must also prepare detailed information on system
contingency reserves, annual system charges per residence, and median household income in the
service area. The budget, contingency reserve, annual charges, and income information will be
used as input to the FVT. .
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• "'*' "' '"' .".."- Figure 4.2 '•'•-. .' •', . ( . •
Content of Washington State Water System Plans (WSPS)
The. outline below 'summarizes the. key elements addressed in WSPs. Information must be supplied for a
twenty-yew planning period and me plan must be approved in writing by a certified professional water systems
"engineer. ' _ '• ' ^ . • • ' . -.--'. • ''-'••..
1. Description'of the System . - ' ,
Maps and descriptions of the service area, existing facilities, and pressure
• .zones, information on system owners and managers, policies, history, and'
agreements with surrounding facilities. • t ••.'•'
2. Basic Planning Data - _ / • , ." • • ' ." '.-'••'
Existing and future projections of population served and number of service
comie<^ons,histori•''.-'• • • .••-..
Identification of -capital and non-capital improvements for a twenty-year period,
with a six-year implementation program. ' .
'5: Financial Program , . ' • •'... '
Itemized three year summary of system revenues and expenses, detail on past . '
system improvement finance (surcharges, debt, reserves); , • . .
6.' Relationshqi with' Other Plans . . '
Compatibility with adjacent system and regional plans, county response and .
' • compatibility with land use plans; and consistency with previous water system
plans. • • , • • . . • •
7. , Operation and Maintenance Program ... . .
• Description of personnel and personnel responsibilities for water system
operations, description of water quality sampling procedures .and responses to'
samples mat exceed state standards, and; identification of most vulnerable system ]
facilities and description of cross connection control-program. . .
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Operating Budget ; .; v '•
Revenue Sources . . '
The first category in the operating budget is revenues. Major revenue categories include:
Water Rates All money received for supplying water service. Information from the
WSP on the forecasted number of service connections and projected water sales
combined with current rate structures and assumptions on rate increases are used to
-...-:. calculate total utiUty revenue from rates. This information is also used to calculate
annual charges per service connection.
Fees and Services All other miscellaneous fees and charges for service provided other
than for water service. This includes bad check fees, reconnect fees, and meter testing
. fees. These revenues are estimated for the six-year planning horizon by using a
historical growth rate, if available, or assuming revenues .for these categories will
increase at the anticipated rate of inflation.
Other Revenues All other revenues not included in the two categories above. Expected
interest income on invested funds is reported here. .
• . Expenses . '"' -.'.'•' ''; ,'.. "'•' •.:'.'...'''. '.'••" .- • • .'•' " ''•'••' •". ''
The second major sub-section of the operating budget is the identification of utility
expenses. Expenses include all those activities or purchases that incur cost for the utility during
the same periods as revenues. Expenses can be estimated in various ways. One method bases
-. the projections on historical experience and assumes past growth trends will continue in the
future. In other cases, it is known that expenses will increase at a different rate than in the past
and this information can be included in budget projections. The two principal expense categories
are Operation and Maintenance (O&M) expenses and General and Administrative (G&A)
• expenses.'. ' - .. '•"'.• -• ., •, ' '...-_ '•'.'.-. ...._.-...
Qj&MlExpenses O&M expenses include all expenses incurred by the utility that are
directly related to the production and delivery of water to the customer. They include
salaries and benefits of employees directly involved in water provisions activities, electric
power, telephone, and other utility costs, chemical used in the treatment of water, and
parts, supplies, and repairs needed for the routine production and delivery of water. In
addition, all water monitoring and outside analysis costs incurred by the utility are
considered O&M expenses. Recent changes to SDWA regulations imply that owners.
should estimate these costs carefully, using information from the WSP on new treatment
and monitoring requirements.
. G&A Expenses These'expenses are not directly related to water production and delivery,
Theysare considered system overhead. All expenses related, to the administration of the
'• '' •• •' ' ,." -••:• ' ' , 4-7 •: '•": ' • : .' / '• ..'• -'',-
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utility are included, here. Major .G&A categories include salaries and benefits, for.
officers, directors, secretarial, and meter-reading employees, insurance policies, legal,
accounting, and other professional staff, contracted engineering services, and
, administrative office supplies. "• -
Other Expense Categories ' \ .
In addition to O&M and G&A expenses, the FVP requires owners to report other major
expense items in their operating budget. These include depreciation expenses, taxes, and annual
debt payments (interest and principal). The FVP also requires a full accounting of anticipated
• capital improvement program expenditures and loans sources over the coming six-year period.
This information is taken directly -from the CIP and includes information on capital outlays for:
new capital improvement facilities, renewals or replacements to existing facilities, and facilities
built to conform to SDWAieguiations. - . .
4 ' , t • • . • • . ,'
Contingency Reserves
In addition to the operating budget, owners must also submit information on operating
cash reserves, emergency reserves, and replacement reserves. For each reserve account, the
owner must supply information on annual installments and running balances. This information
will be compared against the mininium required balance in the FVT for the operating cash
reserve and the emergency reserve. A replacement reserve is not required to pass the FVT, but
is recommended. A replacement reserve will spread the economic burden of future capital costs
over a longerperiod and will lessen future rate shocks to the customers of the system.
JJie.Financial Viability Test , , , ,. .
Once information ori system revenues and'expenses and contingency reserves are
prepared, the owner can take the FVT. Figure 4.3 details the four calculations that make up the
FVT. Test 1 is straight-forward, no utility can be considered viable if revenues are not meeting
operating expenses. Tests 2 and 3 imply that systems must have_ established and funded
operating reserves and emergency reserves to cover contingencies at levels acceptable to
Washington State. Test 4 is. based on national averages that suggest that water rates begin to
be unaffordable when they exceed 1:5% of the median household income of residents served.
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TEST1:
TEST 2:
TEST 3:
TEST 4:
Figure 4.3
Washington State Financial Viability Test
Are Revenues — Expense ^ 0
Is the Operating Cash Reserve ^ VsX (Annual O&M Expenses +
G&A Expenses)
Is the Emergency Reserve S: The Cost of the MostVulnerable
System Component :
Are Annual User Rates ^ 1.5% of Customer Median Household
Income .
4.5 Results • ".".••../' '".. /;= , . *:;.'. ,'•. .• ; . "'-'',:.' . _•/,'•• ••.••••• . :.' .'• .
Based on the results of the FVT, the owner can adjust plans in the WSP and the
operating budget to improve the financial stability of the system, change annual contributions
to contingency funds to achieve ;FVT target. levels, or modify, rates to generate additional
revenues. If the FVT is completed to the satisfaction of the owner, the owner then establishes
the operating, emergency, and voluntary replacement reserve accounts as specified in the WSP
and FVT.. The completed WSP and FVT are then reviewed, certified, and submitted to DOH
by a registered professional engineer. DOH then reviews the WSP and the FVT and informs:
the owner hi a WSP review letter whether the system met DOH requirements for approval.
DOH may raise questions about the owner's plans that require amendments to the WSP. In this
case, the owner must modify the WSP, retake the FVT, and resubmit the WSP and the results
of the FVT for approval. ' •--.'
Financial Viability Test - Pass/Fail Consequences
f - "'. ' ' '• ' • ' - ' ~
It is assumed that a water system has direct control over the outcome of the first three
components of the FVT and can take appropriate planning action (e.g. system redesign or rate
increases) to meet FVT requirements. The fourth testj however, is used as a measure of
affordability only. While it is expected that the owner will critically examine water system
designs to develop the most cost-efficient system, it is understood that it might not always be
in the power of the water system to assure a rafe that is less than the FVT value, '
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By passing the first three parts of .the.FVT, a water system demonstrates sufficient
financial \dability/capacity to suggest it can be managed and operated successfully even under
adverse conditions. Successful completion of the first three components of the FVT will
facilitate the water system remaining in compliance with DOH requirements and may also assist
the system in securing funds from comirierciai lending and financial assistance institutions.
.Conversely, failure to pass any of the first three tests will prevent approval of the utility's
FVP and WSP. As specified in a number of State of Washington regulations, this may lead to
denial of construction permits or a DOH determination that the water system is inadequate. An
inadequacy determination by DOH could then result in denial of building permits, denial of
home mortgages byMending institutions, or receivership action by DOH. .Alternatively, DOH
may work with the system to identify and implement an acceptable institutional restructuring
option. Alternatives include merging with an adjacent system, formation of a water district, or
contracting for management and/or O&M with an outside agency. The regulator and the owner
can use the tools of the FVP to explore the financial impacts of alternative ownership/operating
structures. . .
Passing the fourth component of the FVT demonstrates mat water system rates are within
the national average range and, therefore, assumed to be affordable for system users.
Conversely, if rates exceed the FVT parameter, owners must recognize that users may have
difficulty paying water system charges. In addition, the owner may have difficulty obtaining.
loans or "financial assistance for the system. DOH will encourage the owner to investigate
restructuring options and require the owner to provide public disclosure of the projected rates
and findings of restructuringoption studies. .
In all cases, the results of the FVP provide the utility, DOH, and current or prospective
customers with a detailed assessment of six-year financial and operating.health of the water
system. If the system passes all components of the FVT, the owner has a documented statement
of financial health that will facilitate system approval and will expedite attempts to secure loans
br financial assistance for needed capital upgrades or expansions. If the system fails parts of the
FVT, the information collected as part of the FVP process will assist owners and regulators to
evaluate alternative system designs and restructuring options. In cases where internal financial
stability is unacceptable, DOH has the statutory authority to prevent system operations and
encourage the owner to explore restructuring options. In instances where system affordability
is in question, the owner can be encouraged to explore alternative options before experiencing
financial distress. •''•'. . . . ,
4.6 Summary and Extensions .
The Washington State FVP approach combines a detailed information-gathering phase
with a simple set of viability screening calculations. This approach is-implemented within a
broader regulatory cdntext that gives the regulator the ability to make system approval decisions
based on the results of the screening process. In addition, the program recognizes the
. ' ' •" - •' 4-10' :. •';-. '.;.' - -,. ' • ' ' ' ' . ••
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importance of information dissemination and provides for public distribution of the information
submitted. These general attributes of a financial assessment approach for existing systems have
wide applicability to the viability/capacity question. They are also easily modified or expanded
to meet the needs of individual states or communities. It is likely that states may want to add
additional viability/capacity criteria or modify the details of the FVT to stress other important
aspects of financial health. Likewise, the WSP and operating budget details may be simplified
or otherwise altered to conform with local requirements. The regulatory mechanism can also
be adapted to conform with existing statutes or to strengthen compliance through alternative
means. This approach may also be combine with aggregate assessment methods in order to
target existing facilities that may be especially prone to financial deficiencies.
• REFERENCES '..;...•" ' - ' . ' '.. •"'; . " . ' . " . . .'.;• ','• ' ' ."' ' ••;"'.''
1. State of Washington, Department of Health, Division of Drinking Water, Small Water
Utilities Financial Viability Monwa/, August 1994 draft. ^:
4-11
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