Office of Water May 1984
Environmental Protection Programs Operations (WH-547)
Agency Washington DC 20460
Utility Managers Guide
to Financial Planning
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Utility Manager's Guide to Financial Planning
Prepared For:
Office of Water Program Operations
Municipal Construction Division
U.S. Environmental Protection Agency
401 M. Street, S.W.
Washington, D.C. 20460
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ACKNOWLEDGEMENTS
This publication was prepared by the Peat Marwick
Environmental and Natural Resources consulting group and the
Peat Marwick publications and graphics staff for the U.S.
Environmental Protection Agency (EPA)'s Office of Water Program
Operations, directed by Henry Longest II. Mr. Donald Kunkoski,
Environmental Protection Specialist, Eastern Construction
Branch, U.S. EPA, was project officer.
A special note of appreciation is due to the peer review
group who provided many valuable suggestions which have been
incorporated into the manual. This group included:
. Garnett C. Ball, Jr. - Treasurer, Washington Subur-
ban Sanitary District;
. Edwin C. Horn, Jr. - Chief, Financial Systems Unit,
U.S. EPA Region V;
. Eric R. Jankel - Executive Director, Narragansett
Bay Water Quality Management District Commission;
. James Resnick - Director, Municipal Wastewater Man-
ager, City of Davenport; and
. Eliot Tucker - Area Program Manager, Eastern
Construction Branch, Municipal Construction
Division, U.S. EPA.
The statements, conclusions, and recommendations contained
herein are not to be construed as setting forth any legal or
regulatory requirement and do not necessarily reflect the views
of the U.S. Government or the U.S. Environmental Protection
Agency.
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TABLE OF CONTENTS
Section
I INTRODUCTION
II FRAMEWORK FOR FINANCIAL PLANNING II.1
Organizational Independence II.1
Managerial Capability II.3
Adequate Staffing II.6
Financial Self-Sufficiency II.6
Public Support II.6
References II.7
III OVERVIEW OF THE FINANCIAL PLANNING PROCESS III.l
IV GENERAL UTILITY PLANNING I V.I
Capital Planning IV.1
Operations Planning IV.4
References IV. 7
V FINANCING: ANALYZING THE OPTIONS V.I
Key Issues in the Analysis of Alternative
Management Strategies V.I
Step 1: Review Availability of Grants
and Low Interest Loans V.4
Step 2: Analyze Local Financing Options V.6
Step 3: Compare Options V.14
Step 4: Integrate Data into Budget Process V.16
Key Issues for Consideration V.16
References V.18
VI FINANCIAL PLAN/BUDGETING: A TOOL FOR
MANAGEMENT AND CONTROL VI.1
Develop Budget Structure VI.5
Estimate Revenue Sources VI.6
Compile Initial Budget Requests VI.6
Compare and Prioritize Budget Requests VI.8
Review and Revise Annual Budget VI.8
Develop Budget Document VI.8
Approve and Adopt Budget VI.9
Implement Budget VI.9
References VI.11
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TABLE OF CONTENTS
(Continued)
Section
VII
VIII
REVENUE PROGRAM
Identification of Cost Items
Compilation of Facility Operating Data
Classification of Customers
Allocation of Costs
Estimation of Annual Revenue Requirements
Establishment of Rates
Billing and Collection
References
ACCOUNTING AND INFORMATION SYSTEMS
Accounting Systems
Cash Flow
Information Reporting
References
VII.1
VII. 3
VII.3
VII. 3
VII.4
VII.5
VII.5
VII. 6
VIII.1
VIII.2
VIII.6
VIII.7
VIII.9
IX REGULATORY REQUIREMENTS FOR UTILITY
FINANCIAL MANAGEMENT
Financial Capability
Plan of Operations
User Charge System
Financial Management Systems
References
IX. 1
IX. 1
IX. 2
IX. 2
IX. 4
IX.4
11
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LIST OF EXHIBITS
Exhibit Page
II-l Organizational Structures II.4
III-l Utility Financial Management Process III.2
IV-1 General Utility Planning IV.2
V-l Financing Options V.2
V-2 Comparison Matrix for Financing Options V.15
VI-1 Example Format of a Cash-Based Financial
Plan VI.2
VI-2 Financial Plan/Budget VI.4
VI-3 Utility Budget VI. 7
VII-1 Revenue Program VII.2
VIII-1 Accounting and Information Systems VIII.3
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I. INTRODUCTION
Financing public wastewater treatment facilities has become
a major endeavor for not only the construction but also the
operation, maintenance, and replacement of such facilities.
Funding capital improvement projects has generally been a joint
effort between local utilities, the U.S. EPA, and often state
governments with operation and maintenance expenditures being
primarily a local responsibility. More recently, budget
constraints within the federal and state governments have made
capital improvement funds much more difficult to obtain and have
shifted more financing responsibility to the local utility. The
heavy local financing requirements have forced many communities
to make capital improvement decisions without the prospect of
outside assistance. In addition, the high operation and
maintenance cost of many facilities constructed with federal and
state financing is causing difficulties for communities. All
local utilities will eventually be faced with the replacement
and/or rehabilitation of much of their existing treatment and
collection facilities.
Small-to-medium-sized communities throughout the U.S. are
often more hard pressed than larger communities in affording
wastewater treatment facilities. Smaller communities often have
lower per capita income levels and lower bond ratings, which
increase financing costs. Because of varying state and local
priorities, a large portion of these communities have not yet
been able to obtain funding assistance for their construction
projects. Smaller wastewater facilities are often more
expensive to construct and operate because they generally cannot
obtain economies of scale.
Wastewater utilities serving communities of all sizes must
face the reality of making financial decisions in an uncertain
fiscal atmosphere. To be successful, a utility must have the
ability to justify these decisions to the community. Questions
that should be expected relative to a decision include:
. How much will it cost the users?
. What are the priorities involved?
. How is this expenditure justified?
. Where are the funds going to come from?
. Are the costs equitably borne by users and
beneficiaries?
I.I
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Financial planning and financial management provide
effective means of answering these questions. Financial
planning defines a utility's responsibilities, objectives,
expectations, and priorities, and transforms that knowledge into
a comprehensive operating strategy for acquiring capital and
operating needs. Financial management can provide an analytical
tool to evaluate the cost-effectiveness of alternative
approaches as well as a management process to help direct the
utility's future operations and decisions. It should be a
continuous process that is maintained and updated. It should
tie all major decisions back to the utility's overall goals and
objectives. Some of the benefits inherent in effective
financial management include improvements in the utility's
ability to:
. set priorities between competing programs and needs;
. review the proposed scheduling of project
construction and financing;
. monitor the progress and costs of projects initiated;
. evaluate the community's (and users') ability to
support or fund projects or programs;
. compare funding approaches both in terms of capital
financing and revenue generation, and establish
policies to support the approaches selected; and
. assist other involved parties in reviewing various
projects or programs and in providing input.
This guide was developed to provide utility managers and
municipal officials with an overview of the elements of
financial planning and the financial management process
necessary to support a wastewater utility operation and keep it
self-sustaining. This manual is designed to help the wastewater
system owner/manager understand the financial management
process. To accomplish this, there are sections on each major
element of a financial management process, including:
. General Utility Planning;
. Financing;
. Budgeting;
. Revenue generation; and
. Accounting and Information Systems.
1.2
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In each section the function is discussed along with the key
elements necessary to make it work.
This manual is written using non-technical terms to assist
the utility manager or public official facing these problems in
a comprehensive manner for the first time. It is not intended
to be a textbook on financial management but rather to make the
reader generally familiar with the topics. Since it is only a
starting point, the guide also provides several references that
can be consulted for more detailed information.
1.3
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II. FRAMEWORK FOR FINANCIAL PLANNING
Before considering the specific elements of the financial
planning process it is useful to discuss the larger framework
for financial planning. The utility's organizational and
institutional structure and its political environment can have a
significant effect on the utility's ability to perform. We have
used the term "self-sustaining" to define a utility with the
characteristics needed to operate efficiently and effectively
over the long term. Self-sustaining is not the same as
self-supporting. A self-sustaining utility possesses several
other characteristics including:
. organizational independence;
. managerial capability;
. adequate staffing;
. financial self-sufficiency; and
. public support.
Each of these characteristics is briefly described in this
section.
ORGANIZATIONAL INDEPENDENCE
Political and institutional constraints have a significant
effect on a utility's ability to be self-sustaining. The
organizational structure of the utility often affects:
. who controls the utility;
. how the utility is managed; and
. how the capital and operating revenues are generated.
There is no perfect institutional or organizational structure
for a self-sustaining utility. The utility may take the form of
a municipal department within a local government; a municipal
authority in which the facility is owned by the local government
but is managed and operated separately from general municipal
activities; or an independent authority fully autonomous from
the local municipality.
A municipally owned and operated utility usually exists as
a department within the local government. In most cases, the
department has direct responsibility for treatment facility
operation and maintenance and relies on other government
II.1
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departments for general management and support services such as
accounting, personnel, data processing, and purchasing. The
financial structure is either integrated into the general
municipal accounts or maintained as a separate enterprise fund.
Special taxing districts may be established as a means of paying
debt for utility costs through ad valorem taxes. Budgets are
usually part of the general municipal budget.
Municipal departments are most appropriate when:
. the utility operates within a single political
jurisdiction;
. the majority of the population of that jurisdiction
is served by the utility; and
. the local municipality is financially sound.
Typically, a municipal authority is operated by a governing
board or commission appointed by the chief executive of the
municipality. The commissioners' terms of office are frequently
overlapping and generally not the same as the chief
executive's. Financial and accounting systems are completely
separate from those of the city and utility rates are set
without municipal approval. The authority may be empowered to
issue debt, although direct voter referendum or council approval
of bond issues may also be required. The major advantage of
this type of arrangement is its operational independence. This
independence provides insulation from political pressure on
budgets and rates.
An independent authority has similar operational
independence. In addition, it assumes ownership of the
utility. This type of authority is usually created by a special
act of the state legislature which defines the structure and
operation of the authority. The typical governing structure is
a board or commission arrangement, which aan be amended only by
state legislation. Through creation of such an authority, a
municipality can shift the burden of a substantial service to an
essentially separate jurisdiction. The degree of control
maintained by a municipality over these systems, once such an
authority has been established, depends on the authority's
enabling legislation. A municipality can ensure that the
independent authority will be accountable to municipal interests
by such mechanisms as continued control over the governing board
appointment process, board composition, terms of office,
provisions concerning the use of surplus revenues, and the
like. In practice, however, a satisfactory balance between
independence and accountability is difficult to achieve.
II.2
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An independent authority type of operation is most
appropriate when:
. two or more local governments are major participants
in the utility;
. the utility is large and operates as a standalone
operation;
. there are financial problems in the local
government, particularly in raising capital;
. state and/or local law and requirements on the local
government constrain facility operations; and
. local political issues interfere with utility
operations.
There are advantages and disadvantages to each type of
organization. These can be summarized in terms of:
. control and accountability;
. management; and
. finance.
Exhibit II-l discusses these criteria for each type of
structure. These criteria should be considered in establishing
the utility's institutional framework. Exhibit II-l summarizes
the advantages and disadvantages of these types of
organizational structures.
What is important, regardless of the organizational
structure, is that the utility maintain a degree of independence
from the short-term political influences that so often affect
utility operations. This, of course, becomes increasingly
difficult the closer the structure is to a municipal department.
MANAGERIAL CAPABILITY
A utility's operations will be only as good as the people
responsible for managing its operations. Often wastewater
utilities are managed by individuals who have worked their way
through the ranks of the organization based primarily on their
technical capabilities such as engineering or operations. When
these individuals reach general management and line supervisory
positions, their management skills must be developed.
A utility manager must have the skills to understand the
operations and \needs of the utility and the related technical,
II.3
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EXHIBIT II-l
LOCAL GOVERNMENT-OWNED AND OPERATED UTILITY
Control and
Accountability
Advantages
. maximum control by local government
. closely accountable to elected
officials
Disadvantages
policy issues are subject to political
pressures that are not utility-
oriented (e.g., growth control)
key activities may be controlled by
other departments (e.g., maintenance
of sewer system, finance, billing)
rate setting is political and may not
address utility needs
Management
supported by other municipal
departments thus avoiding
duplication of functions (e.g.,
separate finance or purchasing
functions)
. constrained by local government rules
and regulations (e.g., salary,
staffing, etc.)
may be too reliant on other local
government departments for key
services (e.g., finance, billing,
etc. )
management subject to override for
political reasons
Finance
raising capital can be done without
general obligation bonds
short-term financial assistance may
come from the general fund
utility is less likely to be self-
sustaining, requiring subsidies
between utility and general fund
investors may be less willing to
purchase bonds because of potential
political pressures
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EXHIBIT II-l (Continued)
AUTHORITY-OPERATED UTILITY
Control and
Accountability
Advantages
control is independent of other
local issues/politics
relieves local government from
political burden of establishing
a self-sustaining utility
Disadvantages
not accountable to general government
and local officials
loss of local government control of a
major functional area
local government loss of a policy-
making area
creates another level of "government"
Management
Ul
utility has complete management
system—not dependent on local
government
utility can organize in best manner
for operations, management only
deals with utility issues
replicates existing support systems
. may expand beyond need when not
accountable to local government
Finance
investors prefer independence from
local politics
financial issues not mixed with
local government financial issues
rate setting is not constrained by
other political issues
. loss of the use of generally cheaper
general obligation bonds
. capital funding may be more expensive
because it is primarily dependent
upon revenue bonds
. has no taxing power to act as a
financial backup to user charges
utility is self-sustaining
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managerial, and regulatory environment in which it operates.
Management skills important to a utility manager include not
only those related to personnel, accounting, finance,
purchasing, and data management but also require an
understanding of regulations and their implementation and an
ability to deal with the public and with government officials.
ADEQUATE STAFFING
As with managerial capability, it is impossible to have a
self-sustaining utility without an adequate number of qualified
staff to meet the utility's objective of providing safe,
adequate wastewater treatment. In addition to operators and
mechanics, this includes providing adequate staffing for the
support services necessary for efficient operations, including:
. financial management;
. personnel;
. purchasing; and
. data management.
FINANCIAL SELF-SUFFICIENCY
To be self-sustaining, a utility must generate sufficient
revenues to recover its total operation and maintenance costs as
well as the capital costs of its present or proposed
facilities. This requires not only a cost recovery system to
support the utility but a complete financial management system
to ensure maximum efficiency.
Financial self-sufficiency also implies the utility's
ability to make the financial decisions necessary to plan for
the future, and to maintain efficient and objective operations.
When assessing a utility's financial self-sufficiency, an
accounting system indicative of and responsive to the utility
and its specific functions is a fundamental consideration. The
accounting system allows the collection and communication of
financial information needed for planning and decisionmaking.
The accuracy of the revenue or billing system is generally
directly related to the reporting accuracy of the accounting
system. Finally, a complete financial management process is
very important in maintaining financial self-sufficiency.
PUBLIC SUPPORT
Wastewater treatment is only one of many services provided
to the public. As such it competes with these other services
II.6
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for the community's financial resources. To be successful in
this competition, public support must be established. The
utility must be able to clearly and accurately communicate its
needs and plans to the public. This is accomplished by
involving the public at key decision points in the planning
process. Several techniques may be used to maintain this
support, including:
. public hearings;
. public meetings;
. advisory groups; and
. public information/education programs.
The technique used depends on the issues and type of decisions
to be made.
REFERENCES
1. Peat, Marwick, Mitchell & Co., Comprehensive Diagnostic
Evaluation and Selected Management Issues, prepared for
U.S. EPA, February 1982, EPA-430/9-82-003.
II.7
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III. OVERVIEW OF THE FINANCIAL MANAGEMENT PROCESS
As shown on Exhibit III-l, financial management for
utilities is a continuing process. It includes the following
major activities:
. conducting general planning;
. analyzing capital financing options;
. developing financial plans and budgets;
. recovering cost; and
. monitoring and updating accounting and financial
information.
General utility planning provides the framework for all
financial management. It identifies in advance the capital and
operating needs of the utility, how they will be achieved, and
by whom.
As the need for more complex solutions to our wastewater
treatment requirements grows, projects are becoming increasingly
expensive to build and operate. At the same time, the available
funds are becoming increasingly limited. With the reduction in
the availability of federal construction grants, communities
will be expected to bear large portions of the capital costs of
these projects themselves. As wastewater treatment facilities
compete with other municipal priorities all options for
financing must be considered to provide the best solution to the
community.
Financial planning and budgeting provides the tools for
planning and controlling the utility's operation. The financial
plan is the roadmap for identifying the utilities' financial
requirements over the long term. The budget provides a
mechanism for gathering financial and performance data by
treatment activity, reviewing performance, comparing performance
to planned objectives, and making decisions about the cost and
level of service to be provided. In addition, effective
budgeting serves as the primary means of monitoring and
controlling expenditure, measuring the quality of work
performed, and ensuring the availability of adequate resources
to meet current operating and maintenance expenses, capital
outlay, and debt service.
The key for a utility to be self-sustaining is that it be
financially self-sufficient. To ensure this, a utility must
develop a revenue generating system which recovers its total
cost of operations. This total cost includes not only operation
III.l
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EXHIBIT lil-1
UTILITY FINANCIAL MANAGEMENT PROCESS
GENERAL PLANNING
ACCOUNTING
AND
INFORMATION
SYSTEMS
REGULATORY HEALTH
1
PUBLIC
' 7 '
r
ESTABLISH
OBJECTIVES
OF UTILITY
FACILITY I
PLANNING
REVENUE
PROGRAM
INANCIAL
CAPABILITY
ANALYSIS
ANALYSIS OF
FINANCING
OPTIONS
REVENUE
PROGRAM
CAPITAL
PLANNING
ACCOUNTING
AND
FINANCIAL
INFORMATION
BUDGET
DEVELOPMENT
OPERATIONS
PLANNING
PERFORMANCE
MEASUREMENT
OPERATIONS
DATA
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and maintenance costs, but also the community share of the
capital cost of the facilities. In developing a cost recovery
system it is important to evaluate the financial capability of a
community to undertake the proposed project. If the community
is unable to support the operation, it must reevaluate the
proposed expenditures to achieve an affordable utility
operation. This may require deferral of capital projects,
staging of construction, or reduction of design capacity.
Finally, a utility must have the means to collect, monitor,
and update financial information essential to utility operations
and decisionmaking. This requires a system of accounting and
financial reporting to provide the utility's decisionmakers with
the information necessary to make sound financial management
decisions. The data collected in this system should be used to
evaluate performance relative to the budget. This analysis will
identify problem areas in the utility and help in making
necessary revisions in the operating plan.
III.3
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IV. GENERAL UTILITY PLANNING
General utility planning provides the framework for
decisionmaking. It is the means of deciding in advance what the
utility will do in the future, who will do it, and how it will
be accomplished. Planning is like a road on which a person goes
from one place to another. The planning process establishes
goals where the person should begin and end, objectives or
milestones where the person should be at various points in the
trip, a timetable for the person's arrival and a measurement of
how far the person has gone. When this person is "on course"
the plan should show how far he or she has proceeded and how
much remains to be accomplished. When the person strays off
course, the plan should show where this occurred and what steps
must be taken to get back on course.
Utility responsibilities are broad and complex. The
community the utility serves is continually changing. New
development for residential and industrial users is planned and
constructed, resulting in a constantly changing environment
where wastewater volume and strength characteristics are
directly affected by community plans. Under these
circumstances, a sound program of comprehensive planning is one
of the utility manager's most important responsibilities.
General wastewater utility planning is concerned with the
following major issues;
. What are the current and future requirements of the
utility, including such issues as NPDES permit
condition and population change?
. What resources are needed to respond to these
requirements, including staffing, materials,
supplies, and capital improvements?
. How can the utility move forward efficiently?
As shown on Exhibit IV-1, utility planning includes two
distinct, though related, planning processes: capital planning
and operations planning.
CAPITAL PLANNING
Capital planning includes identification of the utility's
capital needs over a particular period of time, generally five
years. It requires the combination of financial and facility
planning, involving participation at all operating levels
including utility management, planning, engineering, finance,
and budgeting. The steps in capital planning include:
. establishing utility activity objectives;
IV.1
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EXHIBIT IV-1
UTILITY FINANCIAL MANAGEMENT PROCESS -- GENERAL UTILITY PLANNING
GENERAL
UTILITY
PLANNING
FINANCING
BUDGETING
REVENUE
PROGRAM
ACCOUNTING
AND
INFORMATION
SYSTEMS
GENERAL UTILITY PLANNING
CAPITAL PLANNING
FINANCIAL CAPABILITY ANALYSIS
ESTABLISH
OBJECTIVES
OF
UTILITY
• Regulatory
• Health
• Public
• Future Needs
• Financial
^--
r"
i
i
i
I
I
!
«»-
^^
ESTIMATE
CAPITAL
REQUIREMENT
^
DETERMINE
LEVEL OF
CAPITAL
OUTLAYS
SET
~~ PRIORITIES
A *
FACILITY
PLANNING
OPERATIONS PLANNING
-
ESTIMATING
RESOURCES
• Staff
• Materials
& Supplies
^
ESTABLISH
CAPITAL
IMPROVEMENT
PLAN
1
1
Iw.
1
1
_]
FINANCING
1 REVIEW AND REVISE
MANAGEMENT REPORTING
1
ESTABLISH
PERFORMANCE
MEASURES
1
1
1
1
1
i
i
i
DEVELOP
FINANCIAL
PLAN
AND BUDGET
i
1
1
I
I
I ACCOUNTING INFORMATION
-------
. estimating capital requirements;
. determining the capital outlay level;
. setting priorities;
. establishing a capital improvement plan and capital
budget;
. analyzing financing alternatives; and
. providing periodic review and revision.
Objectives for wastewater utilities are a combination of
regulatory requirements, public health considerations, future
planning objectives, and local concerns.
After objectives are established, the capital requirements
necessary to achieve these objectives must be determined. This
requires evaluating alternatives and selecting the most
feasible, which includes facility planning by engineers and
planners.
Determining the acceptable level of capital outlay includes
consideration of economic, political, and legal factors. The
economic condition of the community and the financial capability
of the users must be evaluated. (See Section IX--Regulatory
Requirements for Financial Planning.) Political support for the
project must be developed and legal requirements such as debt
limits satisfied.
Priorities must be established for capital programs
particularly those requiring several years for implementation.
Financial resources available for capital outlay must be
estimated to determine the best utilization of financing
alternatives. (See Section V—Financing Alternatives.) This
will result in a financial plan. Finally, the capital program
should be reviewed and revised as necessary.
Capital planning includes the development of short- and
long-term plans to maintain and expand the utility's physical
facilities, as required. This includes planned expenditures for
buildings, land, sewers, and major equipment with significant
value and a useful life of several years.
The capital improvement program should include a list of
each proposed capital item or project to be undertaken, the year
it will be started, the amount to be expended each year and the
proposed method of financing the expenditures. Based on this
plan (usually a five-year projection), summaries of capital
activity in each year can be prepared and included in the
utility's annual capital budget.
IV.3
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The exact format of capital improvement policies will vary
from utility to utility depending on where the utility fits into
the overall municipal organization. All requests for capital
improvements should be reviewed by the utility manager and
forwarded to the appropriate official.
OPERATIONS PLANNING
Operations planning is directly related to capital planning
because the purpose of the capital facilities is to facilitate
accomplishment of operating objectives. Operations planning
requires :
. establishing operating objectives;
. estimating necessary resources in terms of staff,
materials, and supplies; and
. establishing performance criteria to measure the
facility's efficiency and effectiveness.
Objectives should be established by wastewater
activities. A wastewater utility's typical activities
include:
. billing, meter reading, and customer service;
. laboratory;
. operations;
. maintenance;
. engineering/capital projects;
. industrial surveillance and monitoring; and
. general administration.
Objectives should be developed for each of these
activities. Objectives should meet the following criteria:
• Result-oriented. They should focus directly upon
what is to be produced.
. Specific. They should state what will be achieved
in very narrow and precise terms. They should not
encompass general statements of philosophy.
. Measurable. They should be stated in measurable
terms to determine whether an objective has been
attained.
IV. 4
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. Timely. They should be attainable within a specific
time frame. A specific point in time should be
identified so that results can be evaluated when
that point is reached.
. Relevant. They should be related to the utility's
overall objectives. As such, the objectives should
be geared to achieving effluent and sludge disposal
standards, to cost efficiency, and to
self-sufficiency.
After objectives have been developed, utility managers must
develop performance measures to analyze achievements relating to
these objectives. Performance measures are the yardsticks by
which the results of an activity can be measured. Among the
quantitative performance measures which can be used are:
. Wastewater loadings, which indicate the need for
wastewater services. Loading measures are critical
because they help utility officials explain the
level of service required by the wastewater facility
and give perspective to requests for funds to
support wastewater activities.
. Workload measures, which indicate the amount of work
actually performed by the utility.
. Efficiency measures, which establish the
relationship between resources used (people,
materials, and equipment) and results obtained.
These measures used in conjunction with workload
measures, give utility managers insight into how
well resources are being utilized. Examples of
efficiency measures are:
. dollars per 1,000 gallons of wastewater treated;
. kilowatt-hours of electricity per 1,000 gallons of
wastewater treated;
. kilowatt-hours of electricity per ton of sludge
generated; or
. pounds of chlorine per 1,000 gallons of wastewater
treated.
Efficiency measures are derived by combining
accounting expenditure date with other management
information.
IV. 5
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. Effectiveness measures, which determine how well an
activity meets an objective. Effectiveness measures
emphasize results. They show the progress made
toward the achievement of an objective. An activity
might be efficiently carried out at a limited cost
and in a timely manner, but still not produce the
desired results. The percentage of BOD and
suspended solids removed are examples of
effectiveness measures, and are available from
management reports.
Utility managers must determine the types of measures which
are needed to plan and monitor operations. This is part of
defining management information requirements. Once determined,
utility managers should instruct their staff or hire outside
help to design information and accounting systems to capture and
report this data.
For general planning to be effective, the following basic
conditions should be met:
. The people who manage the wastewater utility should
be involved in the planning process. This includes
not only the wastewater utility manager and staff,
but also local administrative and legislative
officials.
. The current and future wastewater requirements in a
community must be determined. This requires the
utility manager to understand the type of
development planned for the community.
. The public should be involved in decisions about
current and future wastewater services. While the
public can typically identify with drinking water
activities, they have little perception of the
process or problems associated with wastewater
management. Public input can have a positive
benefit in accomplishing utility goals and
objectives and developing facility operating and
capital budgets.
. Planning should be comprehensive, including all
wastewater functions (financial, support, and
facility management) . Budget requests for
wastewater services should include a determination
of the service to be provided, an analysis of what
will happen if the wastewater discharge is increased
or reduced, and an analysis of the cost of service
at the requested service level.
IV. 6
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. Performance should be monitored in relation to the
service levels requested in the plan. Regular
performance monitoring can enhance the planning and
replanning process.
When these general conditions are met, planning can become
a vital part of the management process.
REFERENCES
This section is intended to give a brief overview of the
general utility planning process for wastewater utilities. For
more detailed information, a number of references are available,
including those listed below. The reader is cautioned to review
available references before establishing a general planning
program.
1. Peat, Marwick, Mitchell & Co., New England Wastewater
Management Guide, New England Interstate Water Pollution
Control Commission, July 1981.
2. Moak, Lennox L. , Local Government Finance, Municipal
Finance Officers Association, August 1975.
IV. 7
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V. FINANCING: ANALYZING THE OPTIONS
The analysis of financing options identifies the most
cost-effective technique for funding the project. This analysis
is closely tied to the review of the alternative strategies for
managing the facilities. As shown on Exhibit V-l, management
strategies can range from complete control of the design,
construction, ownership, financing, and operation by the public
entity (community, district, or independent authority) to full
participation by private entities in all of these aspects. As
federal and state construction funds are reduced, communities
should examine alternative management strategies to determine
the approach providing the most cost-effective operation.
This section first reviews the key issues to consider in
analyzing management strategies and then presents a four-step
process for revising financing options and integrating them into
the management strategies. The four steps are:
. Step 1: Review the availability of grants and low
interest loans and their role in financing
projects.
. Step 2: Examine local financing options including:
. conventional financing;
. creative conventional financing; and
. innovative financing.
. Step 3: Compare and select the most cost-effective
option.
. Step 4: Integrate the estimated financing cost into
the annual budget.
As shown in Exhibit V-l, the financing options analysis is aimed
primarily at capital needs but since some operating costs may be
affected by private financing, those needs are also considered
in this analysis.
KEY ISSUES IN THE ANALYSIS OF ALTERNATIVE
MANAGEMENT STRATEGIES
Once a project is identified in the capital improvement
plan and a preliminary cost estimate prepared, there are a
number of management strategies available to the utility manager
for bringing the project through construction and to start-up.
V.I
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EXHIBIT V-l
UTILITY FINANCIAL MANAGEMENT PROCESS - FINANCING OPTIONS
ACCOUNTSNG
,7™ ,™ REVENUE AND
DIAUMIMP FINANCING BUUUtllNU PROGRAM INFORMATION
PLANNING SYSTEMS
XV
X^SA
* — ^ FINANCING
STEP 1 - Review STEP 2 - Analyze Local Financing Option
Grant
Availability
AND LOW CONVENTIONAL rnMucwfinMAi INNOVATIVE
INTEREST FINANCING piMAwr-iwrs FINANCING
LOANS FINANCING
J . ,
t <• <
ANALYZE ALTERNATIVE MANAGEMENT STRATEGIES
DESIGN CONSTRUCT OWN FINANCE OPERATE
PUBLIC > PUBLIC B 1 PUBLIC 1 » PUBLIC p PUBLIC L
/ ' \
/ — PI ml IP — a» PIIRI IP -1 PIIRI IP -».l OOini IP L^_ t»ff1nlVftTF\ \ *M*IVTB
. / j* . . , . 1 1 — .J ^ "^^ ^Vi_\ nnnv
X.. DEFINE /^ ^N^ PROS
T*. ' — Ti it,Mm
? STRATEGIES >^£. 1 /* >. s** v -^f AND
y PUBLIC ~^(^^-^<^^-^<^^)--^(^^/
\^RIVAT^)— *(^RIVAT^ — ^PRIVATE) *>(j»RIVATE) — »^^IVATEy
PUBLIC Denotes Primary Responsibility Of Public Agency Or Municipality
STEP 3 - Compare STEP 4 - Data
and Select to
Option Budget
ANNUAL
COSTS FOR
COMPARE SELECTED
SELECT STRATEGY
AND FINAN-
P|NfJ OPTION
TO
BUDGET
DEVELOPMENT
PRIVATE ) Denotes Primary Responsibility Of Private Company Or Venture
-------
As shown in Exhibit V-l the management strategies can range
from full public control to full private control. Wastewater
utility managers traditionally have followed Strategy A or B,
which consist of combining EPA and state grant funds with local
financing to construct a facility operated by public utility
staff. In recent years some utilities have contracted with
private engineering and operating firms to operate portions of a
facility.
As EPA funds are reduced, utility managers must examine
alternative strategies for constructing needed facilities.
Several issues are important in selecting projects as possible
candidates for private involvement, including:
. type of project (treatment plant, sewer, etc.);
. size of project;
. availability of federal funds;
. location of project;
. operating relationship to overall facility;
. local restrictions on voter approval of bond
resolutions; and
. timing and need for additional capacity.
For example, if a municipality needs a plant expansion to handle
new residential and commercial growth and, based on state
priority list estimates, they may not receive federal and state
funding for three to five years, the local community may decide
to move forward now and not follow the EPA construction grants
process.
Alternatively a community may have a sludge project
identified as the next step in their capital improvement plan
and analyze the feasibility of having private consortiums submit
bids to design, construct, finance, own, and operate the
facility. This process is common in the development of resource
recovery projects and has received greater attention as EPA
funds are reduced.
In general, capital-intensive projects are attractive to
private entities. To obtain comparable bids from private firms
either for a complete turnkey project (a full service contract)
or for other private proposals, a well organized request for
proposal (RFP) is needed. For reference, key issues to be
covered in the RFPs include:
. length of contract;
V.3
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. salvage value;
. ownership rights;
. liability;
. performance requirement and bond;
. penalties;
. relationship to state authorities and permits; and
. billing procedures.
The objective is to receive comparable bids for the project,
allowing the manager to select the most qualified team for more
detailed negotiations.
The development and analysis of alternative management
strategies requires the manager to integrate financing,
engineering, management, and legal options into a workable
management system. The remainder of this section presents the
steps followed in reviewing financing options and methods for
obtaining accurate financing data to aid in the selection of a
management strategy-
STEP 1 ; REVIEW AVAILABILITY OF GRANTS
AND LOW INTEREST LOANS
A first step in the financing analysis, after obtaining a
preliminary cost estimate for the project, is to determine the
availability of federal and state grants and low interest
loans. While the future timing and magnitude of various grant
and low interest loan programs are uncertain, federal and state
funds for wastewater treatment facilities will continue to be
available in some form. If funds are not available, alternative
management and financing strategies discussed above and in
Step 2 should be analyzed.
EPA's construction grant program is currently budgeted to
run through 1985, and EPA staff estimate that funding may
continue through 1988 at the 55 percent funding level. The
decision to accept either EPA construction grant funds or other
federal or state funds hinges on the determination that the
facilities thus obtained are indeed a local priority, and that
the future financial implications (operating cost, manpower
requirements, and so on) are acceptable.
V.4
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The EPA, other federal government agencies, and several of
the states provide a variety of grant programs that can be used
for water pollution control facilities.1 In addition to EPA
grants, programs sponsored by the following agencies have been
available for water pollution projects:2
. U.S. Department of Agriculture;
. Farmers' Home Administration (FmHA);
. U.S. Department of Commerce Economic Development
Administration; and
. Department of Housing and Urban Development
Community Development Assistance.3
This service can provide a list of all federal assistance funds
for water pollution control. Details on availability,
eligibility, and application procedures are also given in the
Catalogue of Federal Domestic Assistance.4
Various states also make available grants for the purpose
of wastewater treatment facilities. A catalog of the different
state programs may be obtained from individual state water
pollution control or development agencies, municipal leagues and
county organizations, and area planning and development
agencies. These sources can also provide information on state
loan programs which can assist local municipalities in reducing
the net cost of new projects.
A key issue when accepting federal and state grants is the
impact that these programs may have and the constraints they may
impose on private firm involvement in the development and
operation of treatment facilities. The EPA has recently
1 See Municipal Finance Officers Association, The State's Role
in Financing Municipal Wastewater Treatment Facilities.
2 U.S. Environmental Protection Agency, Federal Financial
Assistance for Pollution Prevention and Control, Washington,
D.C., EPA Office of Analysis and Evaluation, March 1S80.
^ Available in all public libraries or by writing to the
Government Printing Office (#COFA), 710 N. Capital Street,
Washington, D.C. 20402.
4 Catalogue of Federal Domestic Assistance, available in all
public libraries or by writing to the Government Printing
Office (#COFA), 710 N. Capital Street, Washington, D.C. 20402.
V.5
-------
received clarification from the Office of Management and Budget
that projects funded through the EPA construction grants program
cannot be sold or used in a sale-leaseback arrangement between a
municipality and a private company. In some cases where minimal
EPA funds are available and only a 10 to 15 percent state grant
is available, the utility manager should review the overall
impact that accepting the grant will have on other financing
options, such as the involvement of private firms in the program.
STEP 2; ANALYZE LOCAL FINANCING OPTIONS
The grant analysis will identify the portion of the project
funded by state and federal agencies. The balance of the
project will be funded by local financing. Local financing can
include up-front assessments, connection charges, and long-term
financing. Three categories of long-term financing:
. conventional;
. creative conventional; and
. innovative.
The local share of projects built with EPA grant funds will
normally be financed with conventional or creative conventional
financing.
Conventional Financing
The two most widely accepted forms of conventional
financing are general obligation bonds and revenue bonds. A
general obligation bond is a bond secured by a pledge of the
general taxing power of the issuer. This is also known as a
full-faith and credit obligation. A revenue bond is a security
supported by the revenues of the operation.
In general, the securities market is sensitive to the
differences between the two security types. At any given level
of indebtedness, the broader the security base in terms of
potential revenues to repay the obligation, the less the risk of
default and the lower the interest rate.
With general obligation bonds, the general taxing power of
the jurisdiction is pledged to pay both principal and interest,
which usually results in lower interest rates. In many cases,
voter approval may be required and debt and tax limitations
usually restrict the use of this instrument. In recent years
bond referendum^ have received greater interest and opposition
from local municipalities, and utility managers have developed
more sophisticated public awareness programs to educate the
V.6
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voter on the value of the wastewater treatment facility.1
Thirty-six states presently require affirming votes for general
obligation bonds.2
Revenue bonds are supported by a pledge of a revenue stream
from the wastewater utility (user charges/ or some other income
source) and can include coverage requirements, bond reserve
funds, and other restrictive covenants. Coverage tests state
that earnings must be greater than expenses by a specified
margin and new debt may not be issued if the coverage ratio is
reduced below this level.3
Creative Conventional Financing
General obligation and revenue bonds have been the major
source of capital financing for wastewater utilities for many
years. In recent years, changes in federal grant programs, new
public involvement in bond referendums, volatile interest rates,
and other factors have increased the need for creative
modifications to the conventional financing techniques.
Creative conventional financing options have evolved into
market adjustments to accommodate the needs of the issuer and
demands made by the market, producing a viable financing option
for both parties. Key creative conventional financing options
of interest to the utility manager include:
. variable rate bonds;
. original issue discount;
. insurance; and
. tender option bonds.
The analysis and evaluation of these options is best
completed by the utility manager's in-house financial
advisors and other financial advisors who will work with
the manager to select the most appropriate financing
alternative.
1 See Richard Johnston, Some Techniques for Successful Sewer
Bond Election Campaigns, Denver Sewage Disposal District,
Denver, Colorado 80229.
^ See Municipal Finance Officers Association, A Debt
Management Handbook for Small Cities, page 12.
3 J. Rowe McKinley, Financing Water Utility Improvements,
Journal of the American Water Works Association, September
1983, page 456.
V.7
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The first option, variable rate bonds (also referred to as
floating rate bonds), are securities in which the yield to the
bond holder varies with movements in market interest rates.1
These floating rate securities offer, in many cases, lower
financing costs in the short run and allow the issuer to share
the interest rate risk with the investor. Important issues in
considering this option include:
. pegging the floating interest rate to an accepted
market index;
. stating the periods for adjustment of the index; and
. establishing high and low caps on the maximum and
minimum limits on potential future adjustments in
the interest rate.
The second option, original issue discount bonds (OID), are
offered with a coupon rate lower than the current market yields
and a purchase price which is discounted from the par value.
These bonds allow the issuer to achieve a potentially lower
interest rate overall, but result in a shift of a portion of
market risk from the investor to the issuer. A variation of an
original issue discount bond would be a zero coupon bond where
large discounts are offered with a zero coupon on the issue.
Municipal bond insurance shifts a credit risk from the
issuer to a third party. In recent years the number of
municipal bonds being insured has grown rapidly, with over 1,200
issues being insured with a par value of nearly 4>7 billion.'*
The decision to purchase insurance should be based on an
analysis of the savings on interest expense versus the premium
paid for the insurance.
1 See Municipal Finance Officers Association, Creative Capital
Financing for State and Local Governments, page 63; also see
American Waterworks Association, September 1982 issue,
Creative Financing Techniques for Water Utilities, (Paul C.
Williams of John Nuveen and Company, 209 S. LaSalle Street,
Chicago, Illinois 60604).
2 MFOA, pg. 63, and Williams, pg. 447.
3 Williams, page 447.
4 Peter C. Trent, "Emerging Opportunities in Tax-Exempt
Finance: Perspective of the Marketeer", Shearson-American
Express.
V.8
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Tender option bonds (also commonly referred to as put
option bonds) limit the investor's exposure to long-term market
risk by giving the bond holder the option of returning the bond
to the issuer at par plus accrued interest at some future date
prior to stated maturity.1 This future date could be from
three to five years and effectively allows the issuer to convert
the investment to a shorter maturity period, thus allowing the
issuer to take advantage of lower short term interest rates for
the initial period of the project. The appeal of the lower
short-term interest rate is offset by a requirement that the
issuer have credit capacity to redeem the bonds if the holder
requests redemption after the specified period.
Innovative Financing
The utility manager can also take advantage of several
innovative financing techniques developed over the last few
years, again in reaction to market demands and the needs of the
municipalities. These options include, in one way or another,
the participation of private companies in the planning, design,
construction, financing, ownership, or operation of wastewater
treatment facilities. There are five basic arrangements which
establish specific roles for the private and public sector
players. They include:
. contract operations;
. tax-exempt municipal lease;
. sale-leaseback;
. sale-service contract; and
. full service contract.
Some of the features, legal considerations, and advantages and
disadvantages of each arrangement are discussed below, followed
by a discussion of key issues associated with implementation of
privatization arrangements, and recent actions by states to
examine these issues.
Tax-Exempt Municipal Lease
A tax-exempt municipal lease (also commonly referred to as
a lease-purchase agreement, a conditional sale, a
conditional-sale lease, or a capital lease) is a "method of
financing the acquisition of public facilities or services by
state and local governments whereby the lessor extends credit to
Williams, page 446.
V-9
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the governmental lessee and transfers to the governmental lessee
all responsibilities of ownership for a period of time equal to
the economic life of the asset. At the conclusion of the term
of the lease, the governmental lessee may purchase the asset for
a nominal consideration. "-1-
This type of an arrangement offers full control of the
property to the municipality and allows the private lessor or
third party to exclude the interest portion (if specifically
stated as interest) of the lease payments from the gross income
for Federal income tax purposes. An important characteristic of
a tax-exempt lease is a provision that allows the agreement to
be terminated at the end of the current fiscal year. This
clause prevents the lease from being classified as a long-term
obligation or debt. 2 This arrangement has been used by many
communities to obtain capital equipment. Analysis of a
tax-exempt lease may also include the cost of financing the
lease, usually expressed as a percentage of prime, versus the
opportunity cost of the alternative—investing money that would
have been paid up front to purchase the asset.
Sale-Leaseback
For municipal wastewater treatment plants, a sale-leaseback
is "an arrangement in which the owner of the sewage treatment
plant (most likely a municipality or sewer district) sells it to
a financial institution or another buyer or group of buyers and
simultaneously executes an agreement to lease the property back
from the buyer."3
The repurchase of the plant by the city at the end of the
lease must be at fair market value. This type of arrangement is
only feasible for municipal wastewater treatment plants
currently owned by a city or sewer district and not constructed
with state or federal EPA grant funds. This is highlighted in a
March 14, 1983, letter from Michael J. Horowitz, counsel to the
Director of the Office of Management and Budget, to the
Honorable Robert M. Perry, General Counsel of the Environmental
Eden, Greg, The Tax-Exempt Municipal Lease, Eden Hannon &
Company, January 1, 1982, page 1.
Municipal Finance Officers Association, "A Guide to
Municipal Leasing", Chicago, Illinois, April 1983, page 29,
3 Ibid, page 19.
V.10
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Protection Agency, which stated as a clarification of OMB
Circular Number A-102 that "a leverage lease proposal, or other
lease arrangement involving real property partially funded by
federal grants, is prohibited by this provision."
Therefore, this arrangement would be aimed primarily at a
new facility constructed without federal funds where a
municipality would finance the entire project with general
obligation or other forms of local financing, sell the new
facility to a group of investors, and then lease it back. Under
this arrangement, the buyer or group of buyers would be able to
take advantage of depreciation allowed on the buildings and
equipment in the facility. One source of funds for the private
purchase of the asset could be the proceeds from the sale of
industrial development bonds by a local economic development
authority. This would reduce the overall cost to the group of
buyers for purchasing the facility and, when combined with the
allowable depreciation on the equipment, could make a favorable
investment for the group of buyers.
In recent months, this arrangement has received a great
deal of attention at the federal level, and there is currently
legislation proposed which will change the depreciation
schedules for equipment involved in a sale-leaseback arrangement
between a private party and a municipality. This will make .the
investment less attractive to the private investor. The
ultimate fate of this arrangement will be determined once that
legislation is finalized.
Sale-Service Contract
In certain situations, a municipality can sell a wastewater
treatment facility constructed without federal or state funds to
a private company which would then own the facility, operate it,
and provide a wastewater treatment of service to the
municipality. Under this arrangement, the private company is
then able to take advantage of the depreciation of the buildings
and equipment and the investment tax credits, since they will be
providing a service to the city. The above mentioned federal
legislation is examining these arrangements to determine if this
service contract is actually an operating lease, and if it is
determined to be an operating lease, the investors could lose
the investment tax credit and be subject to restructured
depreciation schedules. Here again, this option has not been
implemented extensively and the changing nature of the federal
legislation makes it difficult to determine if this arrangement
will be feasible for municipalities in the future.
Full Service Contract
If a local municipality is not going to receive federal or
state funds for the construction of a project and seeks
qualified private companies to design, construct, finance, own,
V.ll
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and operate a municipal treatment plant, the municipality could
then enter into a full service contract (sometimes referred to
as a full service agreement or a turnkey project) with that
private company- The municipality would agree to pay an annual
charge to the private company and in turn collect user charges
from the individual residents of the community.
In some states private firms have expressed interest in
this option and have contacted states and municipalities to
discuss its feasibility. The option is best implemented when
the local community needs to construct a new plant and feels
that the design, construction, and operation of the plant would
best be accomplished by a private firm. The utility manager
would first develop specifications for a full service contract
and either qualify firms and negotiate or request full bids from
the companies.
Key Issues for Innovative Financing
A number of important issues come to light under innovative
financing arrangements, most notably for the full service
contract. First, the service contract for the municipality
would last a number of years (20 to 30), and therefore
restrictions on the length of contracts that municipalities may
enter into must be reviewed and possibly changed to accommodate
these more complex arrangements.
Second, procedures for accepting competitive bids for the
construction, financing, ownership, and operation of the
facility may have to be modified to allow selection of the most
qualified firm and negotiation of contract details and charges
to the municipality. Some states have requirements regarding
bidding procedures, and special language may be needed to allow
negotiated contracts which include major construction projects.
Clarifying legislation would be needed especially in the areas
of service contracts and installment purchase contracts.
Third, the private company that operates the wastewater
treatment plant would likely want to provide the service to the
municipality and therefore be treated as any other private
entity, and thus not be required to conform to Public Utilities
Commission requirements. A clear opinion on the ultimate status
of these private companies in relation to the utilities
commissions would have to be rendered before the agreements are
entered into with the municipalities. In Wisconsin a bill was
recently introduced which will place private sewer services and
facilities under the control of the Public Service Commission.
The impact of this action may be to discourage the development
of privately owned and operated wastewater treatment plants (see
Wisconsin Senate Bill 218) .
V.12
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A fourth issue is the status of the National Pollutant
Discharge Elimination System (NPDES) permit and other
enforcement and administrative problems. Some states' staff
have indicated that they would continue to issue the discharge
permit to the municipalities, who would in turn work with the
private companies to ensure compliance. This raises a number of
questions. Who would be fined for non-compliance? Would city
officials be held for the private firm's violations? These
issues would have to be negotiated to the state's satisfaction
in the agreement between a city and a private company.
Enforcement of pretreatment requirements will also be an
issue in full service contracts. Who will go on-site to the
industrial property and collect samples? What powers will the
private company need to regulate the quality and quantity of
wastes entering the plant?
A fifth issue is the disincentive to private operation
created by state and federal grant programs. Private firms feel
that they can provide low annual costs to municipalities but
they cannot compete with federal and state grant programs that
cover up to 60 percent of the project. Some private firms
propose a modular building block approach to meeting future
needs, thus lowering capital and operating costs in the short
term. They would then operate the facility with fewer staff and
benefit from central purchasing, payroll, and management,
assuming that they ran several plants in the state.
Private companies in the wastewater industry have indicated
that they are interested in designing, constructing, financing,
owning, and operating municipal facilities if the issues
identified above are clarified and if the package they prepare
for the city is not in competition with a state grant program.
For example, Wisconsin currently provides a 60 percent state
grant to those municipalities that are not going to receive
money from EPA. A private company, in analyzing the cost of
providing the service to a municipality, can approach, but in
most cases cannot beat, the resulting annual cost that the
municipality will bear if they take the 60 percent grant.
Therefore, the states are faced with a question: whether to
maintain a 60 percent grant program and potentially exclude
private entry into the construction of treatment plants, or to
institute a sliding grant program where a municipality can
accept either a 60 percent grant for public construction and
ownership or a 30 percent grant for a project built by private
financing entities. The city could put the 30 percent grant
funds into a construction trust which would be used to pay off
the annual charges to the private company. There are a number
of legal and administrative ramifications to these options but
these are realistic considerations facing states when they
design their grant or aid programs.
V.13
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STEP 3; COMPARE OPTIONS
The next step in the process is to integrate the financing
options analysis into alternative mangagement strategies and
select an overall strategy and financing plan. This could
include a traditional EPA funding scenario with private
operation or a completely private project. The selection of the
most appropriate financing option for a project depends on
several factors:
. sources of funds and terms:
. net annual local cost;
. level of risk;
. administrative and management issues; and
. legal issues.
To compare each option, the matrix shown in Exhibit V-2 should
be completed. For each option/ the terms and costs are
calculated and a discussion developed on the administrative,
legal, and management issues.
The cost comparison includes analysis of:
. source of funds.
. constraints (bond covenants and so on).
. terms:
. interest;
. special provisions;
. term; and
. risk.
. Estimate of cost:
. Annual costs;
- principal; and
- interest.
V.14
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EXHIBIT V-2
COMPARISON MATRIX FOR FINANCING OPTIONS
OPTIONS
B
EPA plus
Creative Conventional
Financing plus Private
Operations
Description
EPA plus
Coventional Financing
Innovative
Financing—No
EPA or State Grants
Sources of Funds
EPA
State
Conventional
Creative Conventional
Innovative
Total
Risk
Costs
. Bond Offering
. Legal
. Official Statement
. Annual Costs
. Principal
. Interest
. Service contract
Administrative
Management
Legal
Summary
-------
, Bond offering costs;
- legal costs? and
- offering statement.
For additional information on each cost element, see EPA's
Financial Capability Guidebook.
Options can be combinations of grants, low interest loans,
conventional financing? and innovative financing as shown in
Exhibit V~2o The matrix identifies the lowest cost option and
the associated risk,, The manager evaluates the overall
acceptability of the options based on a review of the matrix and
consideration of other local projects, priorities, and
capabilities,
STEP 4; INTEGRATE DATA INTO BUDGET PROCESS
The collective annual costs of selected financing options
for each project are brought together in a pro forma budget
analysis which can be integrated into a revenue requirements
analysis and a financial capability analysis. (See Exhibit V-2
and discussions in the next section.)
KEY ISSUES FOR CONSIDERATION
Several key issues can affect the selection of the most
effective financing option. First, wastewater utility
construction and operation plans are constrained by the
financial capacity and revenue raising capabilities of their
service area* This means that as capital improvements are
proposed, financing options are identified, and the annual cost
to the municipality is calculated. A preliminary estimate is
then made of the sewer service charge resulting from the
project. A financial capability analysis is performed to
determine if the financing option and the resulting sewer
service charge are within acceptable limits for the local
community or sanitary district. As the ongoing process
discussed above continues, the utility manager more clearly
understands the pace at which capital improvements can be
brought on-line, and the overall policy for implementing the
needed water quality improvements can be scheduled.
Second, the analysis of the financing options will include
the tradeoffs necessary to implement certain financing
strategies. For example, private financing may require the
utility to give up some control over the day-to-day operations
of certain portions of the facility.
V.16
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When developing and analyzing financing alternatives, the
utility manager's and organization's policy position on the
ownership of the equipment and facilities needed for operation
of the utility should be considered. In recent years, private
entities have proposed to own and operate wastewater facilities
and provide a service by contract to the utility. This practice
presents policy considerations for the utility manager and
requires the governing body to address ownership and liability
issues.
The potential involvement of private sector firms and their
labor force in the operation of a wastewater utility will
require negotiations with the utility's labor union. Private
firms providing contract operations have developed strategies to
successfully work with local municipal employees. Utility
managers and governing bodies must be aware of the existing
union's needs and the potential cost savings that may be offered
by a private firm, and have the administrative flexibility to
select the best alternative.
A companion issue to private involvement is the need for
utility planners to understand that the inclusion of an
administratively complex federal and state grant program (which
would require additional engineering and inspection for
compliance with state and federal regulations) could add
significant administrative burdens to the local utility and
delay implementation of the project.
Third, some options may not apply to all utilities. Many
of the options discussed in this section may be constrained in
their applicability to the local utility manager. For example,
local or state regulations may require a full bond referendum
for a general obligation bond. This may restrict the utility
manager's ability to use this financing vehicle as frequently as
necessary. Local debt capacity limits or state-imposed debt
capacity limits could also eliminate general obligation and
revenue bond offerings and force the utility manager to examine
other types of financing. In some cases an already burdened
local community may not have the financial strength to take on
new projects and special financing assistance from the state may
be required. The schedule for implementing major capital
improvement programs may have to be reviewed.
A fourth major issue is the concern over overlapping debt
that may result from regional projects. Utility managers must
understand the impact of their debt financing on the affected
jurisdictions and realize that other public improvements are
occurring simultaneously which place additional burdens on the
same tax base. Regardless of what appears to be a successful
low cost financing option, financing may be constrained by a
region's inability to support additional general obligation
bond s.
V.17
-------
A final consideration for the utility manager and the board
is establishing what level of risk the utility is willing to
take in short- and long-term financing arrangements. To obtain
lower interest rates, the manager working with the financial
advisors will analyze various financing options, trading off
risk and interest costs. Understanding the interest-risk
tradeoff and its implications will permit a logical selection of
the most appropriate financing options. The major task facing
the utility manager is the development of a financing plan which
is integrated into an overall management strategy.
REFERENCES
This section is intended to give a brief overview of the
financing process for wastewater utilities. For more detailed
information, a number of references are available including
those listed below. The reader is cautioned to review available
references before establishing a financing program.
1. Williams, Paul C. , "Creative Financing Techniques for Water
Utilities." American Water Works Association,
September 1982, p. 443.
2. Peterson, John and Wesley C. Hough, "Creative Capital
Financing for State and Local Governments." Municipal
Finance Officers Association, March 1983.
3. Rosenberg, Phil, "A Debt Management Handbook for Small
Cities and Other Governmental Units." Municipal Finance
Officers Association, Chicago, Illinois, 1978.
4. Scully, L.J. and M. Paret, et al, "Evaluation of
Alternative State Aid and Other Programs for Financing
Construction of Municipal Wastewater Treatment Facilities."
Peat, Marwick, Mitchell & Co., et al, October 1983.
5. Nolan, Jr. , Robert B. and Robert E. Foren, "Strategic
Financial Planning," Journal of American Water Works
Association, September 1983.
6. Innovative Financing for the Clean Water Program, Technical
Exchange Seminar Proceedings, Association of State and
Interstate Water Pollution Control Administrators,
April 1983.
7. Schraufnagel, F.H., Municipal Wastewater Treatment
Self-Sufficiency in Wisconsin, Wisconsin Department of
Natural Resources, April 1983.
V.18
-------
Eden, Greg, "The Tax-Exempt Municipal Lease," Eden Hannon
and Company, January 1982.
Municipal Finance Officers Association, A Guide to
Municipal Leasing, Government Finance Research Center,
April 5.983.
V.19
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VI. FINANCIAL PLANNING/BUDGETING: A TOOL
FOR MANAGEMENT AND CONTROL
Financial planning and budgeting are closely related in
their development and use. While budgeting is primarily
concerned with current and short-term financial information, a
financial plan is intended to project long-term information
usually based on the operations and capital plans. A financial
plan may be considered as a pro forma cash flow or income
statement which includes expected revenue, expenditure, and cash
balance or income data. The plan uses current and historical
budget data to develop a foundation for revenue and expenditure
projections, and then integrates information developed within
the capital improvement and operations planning processes. This
plan is basically a schedule of anticipated expenditure and
revenue activities representative of the overall utility's
objectives and priorities.
The financial plan may use the current year budget to make
projections which, in conjunction with capital improvement
projections, may be used to make future year budgets. A sample
format for a cash-based financial plan is shown in
Exhibit VI-1. In developing a financial plan, expenditure
projections are made first and then used to determine the
revenue projections. Projections may be initially made for
operations, maintenance, and debt service expeditures related to
the existing facilities. Historical trends of actual costs may
be used to develop the growth, inflation, and other cost
increase factors anticipated. Increases should be projected by
individual cost items such as labor, materials, and energy, and
then compiled into an operations and maintenance cost figure, as
shown in the exhibit. Also, cost reductions from situations
such as debt retirement or equipment obsolescence should also be
included.
Projections related to proposed new facilities may be made
or taken directly from a capital improvement plan developed
earlier. The method(s) of financing proposed or selected for
capital expenditures are integrated into the projections and
could determine the level of debt service anticipated. All
operations and maintenance costs associated with the capital
expenditures should be included and escalated over time. Adding
the expenditure data relating to the existing and new facilities
provides the total expenditures expected for the utility.
Revenue projections may also be separated into those
relating to existing and those relating to new facilities. This
allows the utility to determine those additional revenues needed
for any new facilities proposed and whether the revenues
required to support the new facilities can be equitably
generated from users. Revenue needs are generally assessed by
VI. 1
-------
. Beginning Balance
. Revenue Sources
. User charges
, Connection fees
, Interest on investment
. Miscellaneous
Total Revenues
. Expenditures
. Operation & maintenance
. Equipment replacement
. Debt service
Total Expenditures
.Net Annual Balance
. Ending Balance
EXHIBIT VI-1
EXAMPLE FORMAT OF A CASH-BASED FINANCIAL PLAN
1983 1984 19XX
Existing New Total Existing New Total Existing New Tote
-------
revenue source and used to determine the levels of fees and
charges necessary to develop the cost recovery or rate system.
This is discussed in more detail in Section VII—Revenue Program.
It is important for comparison purposes to break out the
financial plan in terms of existing and new facilities to
understand how proposed facilities will affect overall costs and
the associated need for additional revenues. Alternative
capital improvement plans (or projects) may also be integrated
into the overall plan, allowing alternative measurements of the
revenue amounts required and the user charge or fee impacts.
Budgeting provides the utility manager with a mechanism for
gathering financial and performance information by wastewater
treatment activity, reviewing the merits of each of these
activities, and making decisions about the level and cost of
services provided. The budget also serves as the main source of
information for monitoring and controlling facility costs,
measuring the quality of work performed by employees, and
ensuring the availability of adequate resources to meet current
operating, maintenance, and capital expenses-
Wastewater utility managers are concerned with a number of
different budgets, including:
. operation, maintenance, and replacement budgets;
. capital budgets; and
. revenue budgets.
Each of these budgets have different time frames and correspond
to the utility manager's different informational needs.
As shown on Exhibit VI-2, the budgeting process includes a
number of steps :
. Develop budget structure by item and activity.
. Estimate revenue sources.
. Compile operating expenditure and capital
improvement requests.
. Compare and prioritize budget requests.
. Review and revise annual budget.
. Develop budget document.
VI. 3
-------
EXHIBIT VI-2
UTILITY FINANCIAL MANAGEMENT PROCESS - FINANCIAL PLAN/BUDGETS
GENERAL
UTILITY
PLANNING
FINANCING
—
BUDGETING
-
REVENUE
PROGRAM
ACCOUNTING
AND
INFORMATION
SYSTEMS
BUDGETING
CAPITAL
PLAN
OPERATING
PLAN
DEVELOP
BUDGET
DOCUMENT
MONITOR
&
CONTROL
-------
. Approve and adopt budget.
. Implement budget.
This section reviews each of these steps, as well as considering
some of the policy issues involved in developing a wastewater
utility budget.
DEVELOP BUDGET STRUCTURE
The first step in the budgeting process is to develop a
budget framework providing the structure around which budget
requests can be identified and allocated. This framework will
also be the structure within which actual expenditures can be
identified through the monitoring and reporting system* As
discussed in Section VIII--Accounting and Information Systems,
wastewater utilities usually account for revenues and
expenditures through a fund-type accounting system. This would
include an enterprise fund to track proprietary type activities
such as wastewater treatment. The budget
mirror the accounting structure. The operating
budget should reflect the major functions of
Examples of wastewater functions includei
. operations;
. maintenance;
. laboratory;
. billing, meter reading, and customer service?
. industrial surveillance, monitoring, and
pretreatment programs;
. general administration; and
. support services.
Normally, state statutes or local ordinances mandate that
the budget be presented in a "line item" format. Line items may
be direct or indirect. Examples of direct and indirect
expenditures are:
. directs
. personal services for salaries, overtime, and
longevity;
. operating expenses for materials and s
travel, utilities, and chemicals?
VI. 5
-------
. maintenance expenses for vehicles, equipment, and
buildings; and
. capital outlay for equipment.
. indirect:
. debt service for principal payments and interest
on debt;
• fringe benefits for pensions, employee insurance,
vacation* and sick pay; and
. overhead for support services such as accounting,
payroll, data processing, purchasing, revenue
collection, and investment costs.
As shown on Exhibit VI-3, a typical wastewater utility line
item budget includes direct cost. Frequently indirect costs
necessary for a utility operation are included in other
department budgets (i.e., debt service costs may be contained in
the treasury budget). Direct costs should be identified and
recovered through the cost recovery system. (See
Section VII--Revenue Program.)
Exhibit VI-3 also identifies expenses by function. This
format, or variations on it, will help the utility manager
develop a performance measurement system and identify cost of
service so as to develop an equitable cost recovery system.
ESTIMATE REVENUE SOURCES
The budgeting process should also identify revenue
resources by type and amount. Typical revenue types include
general property tax, sewer service charges, fees, interest on
investments, and miscellaneous revenues.
COMPILE INITIAL BUDGET REQUESTS
After the operating expenditure requests have been
developed by the supervisors or department heads, they are
combined with the capital requirements for the next year that
were developed in the capital improvements plan. This
constitutes a preliminary document consolidating the utility's
total dollar requirements for the year to come. This document
is reviewed by the utility manager for accuracy, completeness,
and consistency with utility policies. In addition,
expenditures are adjusted to reflect any changes in costs
anticipated in the next year as a result of known activities.
For example, wages and fringe benefits may be adjusted to
reflect anticipated changes resulting from ongoing labor
negotiations.
VI.6
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EXHIBIT VI-3
WASTEWATER TREATMENT UTILITY BUDGET
Function/Activity
Line Item Pumping Operations Maintenance Laboratory Administration Total
Personal Services
Salaries
Overtime
Fringe Benefits
Total Personal Services
Expenses
Insurance
Vehicle Repairs, Fuel,
etc.
Supplies
Electricity
Gas, Oil, and Diesel
Maintenance
Chemicals
Equipment Rental
Training
Travel
Parts
Equipment Replacements
Contingencies
Total Expenses
Capital Outlay
improvements
Expansions
Principal and Interest
on Existing Debt
Betterments
-------
COMPARE AND PRIORITIZE BUDGET REQUESTS
Once the preliminary expenditure budget has been developed,
it is compared to the revenue projections developed in the
previous step to determine the magnitude of the differences
between available revenue resources and anticipated
expenditures. Depending on the significance of the difference,
the supervisors and the department heads may be asked to defend
their expenditure requests or explain various items.
Expenditure requests are then prioritized in terms of their
contribution to the overall operation of the utility so as to
determine those items requiring reduction or deletion to balance
the budget.
REVIEW AND REVISE ANNUAL BUDGET
The prioritized expenditure budget is reviewed with the
supervisors and department heads to identify those items to be
reduced or deleted from the budget. After this review, the
proposed budget will be reworked to bring projected expenditures
into line with available resources so that a balanced
preliminary budget can be developed. The concept of a balanced
budget is desirable, and is sometimes a legal requirement for
municipal utility operations. It is of course not always
possible to reduce expenditure requests to a level where they
are balanced by anticipated revenues. Sometimes increased taxes
or user charges must be projected to generate sufficient funds
to balance the crucial expenditure elements. To the extent that
it is necessary to increase revenues, the magnitude and impact
of the increase should be identified in the revenue budget
presented to the governing body.
DEVELOP BUDGET DOCUMENT
Once the preliminary expenditure and revenue information
has been defined, the information is compiled into a budget
document. This document should include a budget narrative
describing the utility operation, the major assumption, the
budget, major issues the legislative body should address, the
significant changes in the proposed budget from the current
year, and any impact of the proposed budget on the rate
structure or service charges. The narrative is an important
element of the successful budget document. A number of
different groups such as council members, finance committees,
and the public will be reviewing utility requests, and many of
these people will have little knowledge of the utility. The
budget document should educate the reader on utility operations
and requirements and provide direct input from the utility
manager to the legislative body-
VI. 8
-------
As indicated, the official budget document should contain
an official estimate of revenues, setting forth a history of
revenues by major categories such as property taxes, fees, and
user charges. It should also include the utility manager's
recommendations as to how revenues should be raised to finance
the proposed expenditures.
The budget document should include a summary of the
proposed expenditures with appropriate comparisons between
expenditures from previous years. It is often useful to provide
additional details which break down expenditures by various
activities so that readers can understand the interrelationships
among the various expenditure items in the budget.
APPROVE AND ADOPT BUDGET
The budget document
body either as a whole
utility manager should
contained in the budget.
is formally submitted to the governing
or through various committees. The
be invited to explain the requests
Citizens or the public are usually
provided an opportunity to present their views regarding the
budget at this time. After due consideration, the governing
body should approve the budget and adopt it at that time or send
it back to the utility for further revisions. Generally this
budget is not intended for approval on a line item basis but
rather as an overall budget for the utility. This raises the
question of budget implementation.
IMPLEMENT BUDGET
Budget implementation can be broken down into two separate
steps: allocation, and control and monitoring.
Allocation
One of the first steps in the administration of an approved
budget is to allocate the overall appropriation according to the
programs, activities, or items of expenditure. The purpose of
this allocation is to break large expenditure items into
categories that can be controlled and reserved for specific
activities. Allocation also provides a way to account for arid
monitor expenditure. Generally this allocation is accomplished
by the same method used to develop the budget initially, and
should mirror the accounting system.
Once approved and allocated, the adopted budget should be
distributed throughout the utility. Each employee should
understand what is expected of him or her, and when and how
performance will be measured.
VI.9
-------
Control and Monitoring
The adopted budget should be controlled and monitored
throughout the year by means of periodic reports comparing
planned (budgeted) expenditures and revenues to actual
performance. The approved budget must be entered into the
accounting system so that effective accounting control can be
established. A designated utility official should be
responsible for monitoring the budget during the year. Key
elements of a budget control system include:
. line item identification;
. restrictions on the use of funds;
. periodic reporting;
. budget adjustment; and
. independent postaudit.
As indicated, the budget allocation should be broken down
by line item and should mirror the accounting system.
Limitations on the use of the funds may include requiring
approvals for requisitions to purchase equipment, a check on
availability of funds, and a full encumbrance system.
Adjustments to budgets are almost always necessary to account
for unforeseen changes in operations. Generally, this requires
an amendment to the budget, either to shift monies among line
items or to increase the overall budget. It is important that
procedures are developed to permit budget adjustments in a
timely manner so that year-end deficits may be avoided.
Routine budgetary reports are an effective management
information tool for both utility management and the governing
body. Reporting budget-to-actual expenditures is one of the
most effective ways of controlling a budget. A report of
expenditures made against budgets should be prepared at least
monthly. The report structure should correspond to the budget
classification structure used in the budget document. This
statement of actual and estimated (budgeted) revenues should
also be prepared on a monthly basis. These reports are
important to measure utility operations from both the expense
and revenue sides.
Periodic budget adjustments, either transfers from line
items or overall increases in the budget, may be required for
various reasons. The utility should adopt a standard transfer
and adjustment procedure.
A post audit by an independent accountant provides a degree
of verification and control for the utility manager and
governing board.
VI.10
-------
REFERENCES
This section is intended to give only an overview of
financial planning/budgeting for wastewater utilities. For more
detailed information, a number of references are available, some
of which are listed below. The reader is cautioned to review
these references before developing a financial plan/budget.
1. Moak, Lennox L., Local Government Finance.
2. Municipal Finance Officers Association, An Operating Budget
Handbook for Small Cities and Other Governmental Units.
VI.11
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VII. REVENUE PROGRAM
A utility must be financially self-supporting to be
self-sustaining. This requires the establishment of a program
to generate sufficient revenues to recover all costs in full.
To accomplish this, a sewer service charge system must be
developed, one which recovers operation, maintenance, and
equipment replacement (OM&R) costs as well as local capital
cost. For facilities financed in part with federal construction
grant money, the utility must recover 100 percent of its OM&R
costs from users in amounts proportionate to their respective
usage. This portion of the sewer service charge is referred to
as the "user charge." (See Section IX--Regulatory Requirements
for Financial Planning.)
As shown on Exhibit VII-1, developing a revenue program
requires a number of steps including:
. identification of cost items;
. compilation of facility operating data;
. classification of customers;
. allocation of costs;
. estimation of annual revenue requirements;
. establishment of rates; and
. billing and collection.
The following discussion will review each of these steps.
IDENTIFICATION OF COST ITEMS
To recover 100 percent of the utility's costs, all expense
items required to operate the facility should be identified.
This includes the following cost categories:
. Labor—This includes direct salaries, wages, and
fringe benefits of operating, maintenance, and
administrative personnel at operating facilities.
. Materials, supplies, and equipment replacement--This
includessuchitems aschemicals,replacement parts,
office supplies, and utilities. It also includes
replacement equipment necessary to operate and
maintain the treatment facility over its useful life.
VI I.I
-------
EXHIBIT VIM
UTILITY FINANCIAL MANAGEMENT PROCESS - REVENUE PROGRAM
GENERAL
UTILITY
PLANNING
FINANCING
BUDGETING
REVENUE
PROGRAM
/ /
ACCOUNTING
AND
INFORMATION
SYSTEMS
<
H
COMPILE
FACILITY
OPERATING
DATA
REVENUE PROGRAM
IDENTIFY COST
ITEMS
COST-OF-SERVICE
• Labor
• Materials & Supplies
• Capital
• Support Services
ESTIMATE
ANNUAL
REVENUE
REQUIREMENTS
ALLOCATE
COSTS
ESTABLISH
RATES
CUSTOMER
CLASSIFICATION
• Residential
• Industrial
• Commercial
BILL
AND
COLLECT
-------
. Capital costs—This includes the local share of the
totalcapital cost of the facilities usually
reflected by debt service.
. Overhead—This includes administrative costs
including interdepartmental services for such
support activities as personnel, purchasing, or data
processing.
Existing accounting records should be reviewed to identify
these cost items and allocate them to the particular cost
category.
COMPILATION OF FACILITY OPERATING DATA
The utility's operating data must be compiled to provide
the basis for allocating costs and establishing rates.
Operating data includes wastewater parameters such as flow,
biochemical oxygen demand (BOD), and suspended solids (SS).
CLASSIFICATION OF CUSTOMERS
Customers must be identified individually or by user class
to provide a basis for allocating utility costs to customers in
proportion to their use. Customer classifications typically
include :
. residential;
. commercial;
. industrial;
. institutional; and
. governmental.
Each of these customer classes may have different wastewater
characteristics and therefore the cost of service to provide for
each of these customer classes may be different. A customer
data base should be established which identifies all customers
and their use of the system.
ALLOCATION OF COSTS
Once the cost of treatment has been identified and properly
classified, these costs should be allocated to specific cost
centers reflecting particular activities or unit processes
within the utility. These cost centers should be identified to
VII.3
-------
the extent necessary to account for different types of
treatment. The allocation is necessary to ensure that each user
pays a fair share of the cost of treatment. For example, the
cost of pumping is almost entirely related to flow
characteristics whereas the cost of sludge disposal is almost
entirely related to BOD and SS. Therefore, an industrial user
who discharges highly concentrated wastes should pay
proportionally more for sludge disposal but very little for
pumping. By allocating costs to particular cost centers and by
knowing the relationship between that cost center and wastewater
treatment characteristics, an equitable allocation of cost to
users can be developed.
ESTIMATION OF ANNUAL REVENUE REQUIREMENTS
The wastewater utility's revenue requirement is the amount
of cash needed to finance utility operations. The basic formula
for computing this revenue requirement is:
total cost nonuser revenues to be recovered
of service - charge revenue = through user charges
Each equation component is briefly discussed below.
Cost of service is the total amount of money needed to pay
all OM&R, capital expenditures, and overhead for wastewater
services. These costs were identified in an earlier step.
Wastewater operations may be financed by a number of user
and nonuser revenue sources, such as:
. general property taxes;
. special assessments;
. federal and state grants;
. interest on investments;
. special fees; and
. user charges.
Of these, many are nonuser charge revenue sources. These
nonuser charge revenues are deducted from the cost of service,
to estimate the revenue requirements from users.
VI 1.4
-------
ESTABLISHMENT OF RATES
User charges are established to recover the revenue
requirement from each user or user class in proportion to its
use of the system. Revenues are allocated to each user class
based on flow (residential) and flow and strength (industrial
equivalent). This allocation is based on the OM&R cost of
service for treating flow and strength characteristics.
A number of rate structures can be used to recover OM&R
costs. Which is best depends on the utility, the type of users
on the system, and the ability to measure wastewater
characteristics and/or water consumption. If all the system's
users discharge wastewater with similar characteristics, such as
domestic waste, then the charge system can be based on flow
alone. If water consumption is metered, these records could be
used to estimate wastewater flow. If system users also
discharge high strength waste, such as industrial waste, then a
system must be developed to recover the additional costs of this
additional treatment.
The common types of rate structures include:
. flat rate per customer'—This is appropriate for
utilities with similar customers and no water meter
records.
. volume rate—This is based on all users' water
consumption having similar discharges.
. volume rate plus surcharge-—This is for users with
extra strength discharge.
. quantity/quality rates—This is based on unit cost
o5treatment foreach wastewater parameter such as
flow, BOD, or SS.
Often a user charge system will use a combination of the
above structures for different user classes. For example,
residential users may pay a flat rate while industrial users may
pay a quantity/quality charge. Ad valorem based systems may
also be used in some cases. (See Section IX—Regulatory
Requirements.)
BILLING AND COLLECTION
The final step in establishing a revenue program is to
develop a mechanism for billing and collecting user charges. To
accomplish this, billing procedures must be established to
collect usage data from individual customers, compute bills
based on the selected rate structure, and prepare and mail
VII. 5
-------
invoices. Equally important is a mechanism to ensure prompt and
complete collection. Thus procedures for tracking outstanding
bills and follow-up steps for delinquent accounts are required.
A revenue program is not something instituted once a
year--it is a process planned, implemented, and monitored on a
year-round basis. It is also a time consuming process. Cost
separation between OM&R and capital cost, flow and strength data
gathering, and user class identification all take time. The
approval and implementation process takes additional time.
Public notification and education or awareness programs are
necessary, and also take time. Still more time must be devoted
to properly addressing rate increases. Thus utility managers
should be prepared to spend the time required to develop and
maintain a proper user charge system.
REFERENCES
This section is intended to give only an overview of the
revenue generating program of a wastewater utility. For more
detailed information, a number of references are available, some
of which are listed below. In addition, Section IX summarizes
the U.S. EPA's regulatory requirements for user charge systems.
These should be reviewed before developing a detailed revenue
program.
1. Peat, Marwick, Mitchell & Co., Comprehensive Diagnostic
Evaluation and Selected Management Issues, prepared for
U.S. EPA, February 1982, EPA 430/9-82-003.
2. U.S. EPA, User Charge Guidance Manual, 1984.
3. Water Pollution Control Federation, et al. , Financing and
Charges for Wastewater Systems, 1973.
VII. 6
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VIII. ACCOUNTING AND INFORMATION SYSTEMS
An important part of the overall financial planning process
is a system for identifying utility costs, allocating them to
the appropriate activity, and monitoring utility performance.
These activities are accomplished through the accounting and
financial information system. Most municipal activities are
supported by general taxes and are not intended to be
self-supporting in a business sense. Rather, the type of
accounting systems used for local governments are intended to
ensure financial accountability arid legal compliance with
legislative restrictions. Because control is the primary
purpose, municipal accounting systems are aimed primarily at
tracking expenditures rather than revenues.
Governments use "Fund Accounting" to track their various
operations because different types of activities must be
accounted for separately, and many revenue sources have
restrictions limiting their use. Fund accounting emphasizes
separate and detailed accounting and reporting for each separate
type of government activity. The major types of funds include:
. governmental;
. fiduciary; and
. proprietary.
Governmental funds account for such public service
activities as police and fire protection. Fiduciary funds
account for resources where the government acts a trustee or
other fiduciary agent. Proprietary funds account for business
type activities financed through direct charges, including such
services as wastewater treatment. Accounting requirements for
these different types of activities vary. A primary difference
in requirements for a proprietary fund is the need for revenue
accounting. In a governmental fund, where the revenue resource
is property taxes, the accounting is relatively simple and the
number of entries relatively small. By contrast, in a
proprietary fund where revenues are derived from individual
charges, each user constitutes an individual account, and thus
such activities as wastewater utilities have accounting needs
comparable to those of private enterprise.
Wastewater utility operations should be accounted for
separately as a self-supporting proprietary activity. This
means that an "Enterprise Fund" accounting system should be
used. This system must be capable of accurately reflecting
revenues and expenditures. In addition, because the activity is
ongoing, the accounting system must be set up to account for
activities from year to year. This is different from most
VIII.1
-------
governmental activities, which are funded on an annual
appropriation basis.
As competition for limited tax revenues increases,
municipal accounting systems are being used more as tools for
efficient management. This is accomplished by using more
performance-standard accounting and other financial reporting.
As indicated on Exhibit VIII-1, there are a number of
components to an accounting and financial information system for
wastewater utilities. This section briefly reviews these
elements.
ACCOUNTING SYSTEMS
A wastewater utility should establish an accounting system
consistent with both sound financial management principles and
the utility's overall objectives. The steps to developing an
accounting system are shown on Exhibit VIII-1. As indicated,
the accounting system should be established as an enterprise
type accounting system, and it should be consistent with
Generally Accepted Accounting Principles (GAAP) for this type of
operation.
Enterprise funds are used to account for wastewater
operations where there is significant potential for financing
the utility's operating and maintenance costs through sewer
service charges. This type of accounting is used even if the
municipality decides not to finance the service through sewer
service charges, or in situations where the utility wants to
know its profit or loss. An enterprise fund is designed to
gather total costs, including depreciation, and to indicate the
extent to which sewer service charges are sufficient for
recovering total costs.
The characteristics of enterprise fund accounting for
wastewater utilities includes
. Budgetary Considerations. Enterprise funds may be
operated independently or as part of municipal
operations, depending on local legal requirements.
Budgetary control is important to sound financial
management regardless of legal requirements.
Therefore, the utility should prepare, adopt, and
monitor an annual budget, even though it is
accounted for as an enterprise fund.
• Basis of Accounting. Enterprise funds are usually
accounted for on an accrual basis. Revenues and
expenses are recorded when earned or incurred,
respectively, regardless of when cash is received or
VIII.2
-------
EXHIBIT VIII-1
FINANCIAL PLANNING PROCESS -
ACCOUNTING AND INFORMATION SYSTEMS
GENERAL
UTILITY
PLANNING
FINANCING
BUDGETING
REVENUE
PROGRAM
ACCOUNTING
AND
INFORMATION
SYSTEMS
/ /
H
H
ACCOUNTING AND INFORMATION SYSTEMS
ESTABLISH
CODING
SYSTEM
• Chart of
Accounts
SELECT
ACCOUNTING
APPROACH
• Cash
• Accrual
• Modified
PERFORMANCE
DATA
OPERATING
DATA
1
IDENTIFY
UTILITY
COSTS
\
r
RECORD
FINANCIAL
DATA
«^
VERIFY
» Completeness
• Accuracy
tak
PREPARE
FINANCIAL
REPORTS
Tfc-i
{
PREPARE
MANAGEMENT
REPORTS
i
PREPARE
REGULATORY
REPORTS
-------
payments disbursed. Inventory purchases (materials
and supplies) are recorded as assets and expensed as
consumed. Property purchases (land, buildings,
improvements other than buildings, machinery and
equipment) are capitalized.
. Contributions. Enterprise funds often receive
contributions (from the municipality, customers,
subdividers, and so on) for start up or capital
donations.
. Debt Service. Debt service is accounted for in
separate asset accounts called funds. Typical funds
required in an enterprise fund include a debt
service fund, a reserve fund, and a contingency
fund. These funds are identified as restricted
assets and established when cash is received.
Revenue bonds also typically require establishment
of restricted asset accounts.
. Depreciation. Depreciation is a means of allocating
the cost of a fixed asset over its useful life. It
is computed using the information contained in the
property or fixed asset records and should be based
on the net book value of an asset using the
following formula:
Original Cost - Salvage = Annual Depreciation Expense
Anticipated Useful Life
Utility managers must consider the impact of
depreciation expense on the utility's profit and
loss statement in establishing sewer service fees.
Not including depreciation as an expense provides a
false picture of the cost of operating a utility.
Some utilities depreciate an asset based on net cost
after deducting federal and state grants. This
practice distorts the financial position of the
utility and fails to reflect allocation of the
original gross cost over the asset's useful life.
Cost-of-service should be computed to include all
costs, including operating and maintaining the
utility, replacing capital items, meeting debt
service requirements, and depreciation.
The accounting and budgeting systems should reflect each
other. Budgets are made on an annual basis to allocate
anticipated revenues. The budget serves as a guide for
expenditures during the year. The accounting system and the
reports it generates can provide utility officials with needed
information to evaluate performance relative to budget
expectations. Complete and timely accounting reports covering
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financial condition, actual performance against budgeted
expenditures and revenues/ and cost of providing specific
wastewater activities are critical ingredients to successful
management.
Types of Cost
Knowing full costs is essential for sound financial
management. The sum of all activity costs (including all line
items) is the utility's cost-of-service.
Wastewater utilities incur a variety of costs. These costs
may be recorded at various levels of detail. Line items are
normally used to classify the types of goods and services
purchased. If additional detail is needed, the major line items
may be subdivided into components. For example, utility
expenses may be further identified as heat, light, and power.
Typical line items for utility operations include:
. personal services.
. operating expenses.
. maintenance expenses.
. equipment replacement.
. capital outlay.
. depreciation.
. debt service.
. fringe benefits:
. pensions;
. employee insurance;
. vacation;
. sick leave; and
. holiday.
. overhead:
. accounting;
. payroll;
. data processing;
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. purchasing;
. collection; and
. investment costs incurred by the municipality for
the wastewater utility, if applicable.
CASH FLOW
Cash flow represents an important component of financial
management for a wastewater utility—the process of managing a
utility's cash to ensure timely billing, collection, and cash
availability to meet payroll, vendor, and debt service payments
and to maximize the amount available for investment.
A utility is primarily dependent on either general property
tax or sewer service charges to meet its obligations. In
instances where the municipality provides general property tax
revenues and pays utility obligations, the utility has very
little if any involvement with managing cash flow. However,
where the utility is primarily dependent on sewer service
charges to finance its activities, cash flow management is a
vital ingredient of sound financial management.
Elements of a sound cash flow system include establishment
of effective cash information systems, timely billing and
collection systems, disbursement procedures, and cash budgeting,
as described below:
. Cash Information Systems. A cash accounting system
should record and report daily receipts. To know
the daily cash balance, the utility should record
the beginning daily balance, receipts,
disbursements, and ending daily balance.
. Timely Billings and Collections. Development of
policies and procedures which bring dollars into the
utility as quickly as possible is critical to sound
financial management. Periodic, timely billing for
wastewater services is critical to ensure the
maximum available cash to meet obligations. Regular
billings followed by late payment notices and late
payment penalties can encourage more prompt payments.
. Disbursement Procedures. From a cash management
standpoint, disbursements should be timed to remove
cash from the treasury at the latest possible moment
while maintaining payment dates. A system of aging
payables should be established to enhance
disbursement control, and the utility should take
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advantage wherever possible of vendor discounts. A
system for calculating the relative advantage of the
discount should be installed.
. Cash Budgeting. Cash budgeting involves estimating
specific receipt and disbursement dates. It is not
budgeting for revenues (billings) and expenditures
(obligations). Cash budgeting can make a
significant contribution to cash flow. Two major
elements of cash budgeting include:
• preparing an annual cash flow budget based on
historical receipts and disbursements and on
knowledge of future events; and
. updating the cash flow budget on a regular basis
throughout the fiscal year.
INFORMATION REPORTING
The primary purpose of an accounting system is to provide
financial and management reports for use in managing the
utility. As indicated for wastewater utilities, the categories
of accounting information include:
. financial reporting;
. management reporting; and
. regulatory reporting.
Financial reporting is used for several reasons. It is
used for presentations to outside parties in annual reports and
bond offerings. It is also used internally by management to
understand and control operations. The standard financial
reports used for utility operations include:
. the balance sheet showing how much the utility is
worth at a particular time;
. the statement of revenues and expenses showing how
much the utility earned or lost during a particular
period; and
. the statement of change in financial position
indicating sources and use of funds.
The standard reports are usually accompanied by notes to
financial statement explaining the significance of the major
items. In addition, other financial indicators are frequently
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computed to provide specific information, including such
indicators as:
. revenue bond coverage;
. insurance coverage;
. trends of revenue and expenses;
. details of future debt service;
. details of fixed assets; and
. ratio analysis such as user charge cost per
household.
In addition to financial reports, the accounting system can
also generate management reports to assist the utility manager
in evaluating the utility's performance. Typical management
reports generated are:
. cost reports broken down by function and major
expenditure;
. analysis of cost by particular activity or cost
center such as pumping, treatment, or sludge
disposal; and
. performance reports expressed in terms of cost per
unit of output such as cost per million gallons
treated.
Accounting systems also provide information for rate and
regulatory reporting. This includes information used in
developing cost of service analyses to pompute the rates
necessary for revenue requirements.
To be useful to a utility manager, financial reports must
have the following characteristics:
. Timeliness—They must be generated quickly to be
used for making operating decisions.
. Clarity and conciseness—They must be easily
understood and easily interpreted in a format useful
to utility managers.
. Responsiveness—They must provide the information
needed to manage a utility.
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REFERENCES
This section is intended to give a brief overview of the
accounting and information systems of wastewater utilities. For
more detailed information, several references are available.
The reader is cautioned to review these references before
attempting to establish an accounting or information system.
1. Municipal Finance Officers Association, Governmental
Accounting, Auditing, and Financial Reporting.
2. Moak, Lennox L., Local Government Finance.
3. Municipal Finance Officers Association, An Accounting
Handbook for Small Cities and Other Governmental Units.
4. Municipal Finance Officers Association, A Guidebook to
Improve Financial Management for Small Cities and Other
Governmental Units.
5. New England Interstate Water Pollution Control
Commission, New England Wastewater Management Guide.
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IX. REGULATORY REQUIREMENTS FOR UTILITY
FINANCIAL MANAGEMENT
In addition to good utility management practice, a number
of components in the financial management process are required
by regulation under the Clean Water Act. These include:
. a demonstration by a grantee that it has the legal,
institutional, managerial, and financial capability
to ensure adequate billing and operation,
maintenance, and replacement of the treatment
works. Replacement costs include those costs
necessary to maintain the facility without
expanding, improving, or extending a facility's life.
. the development of a draft plan of operation that
includes an adequate budget identifying the basis
for determining the annual operation, maintenance,
and replacement costs.
. the development of a user charge system that will
produce revenues adequate for the operation,
maintenance, and replacement of the system.
. the development of an adequate financial management
system that will accurately account for the revenues
generated by the system and the expenditures for
operation, maintenance, and replacement.
The following paragraphs address several of the regulations
regarding each of these financial planning requirements.
FINANCIAL CAPABILITY
In evaluating different alternatives, emphasis has
traditionally been on finding the least costly alternatives that
achieve certain water quality standards. In other facility
planning efforts this has been done by trying to evaluate all
alternatives on a common basis, either in terms of annual
equivalent costs or present worth. These techniques, however,
do not tell us whether or not we can afford any of the
alternatives. It is important in a financial analysis to look
at not only the least costly alternative, but also at ensuring
that the community and the individual users can afford the
initial cost of the project and adequately operate and maintain
it throughout its entire useful life. Recognizing the need to
evaluate this financial capability, the Clean Water Act requires
that grantees demonstrate financial capability prior to
receiving a construction grant. To satisfy this requirement, a
grantee must answer the following questions :
. What is proposed in the facility plan?
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. What are the roles and responsibilities for local
governments?
. How much will the facilities cost in today's prices?
. How will construction and operation of the
facilities be financed?
. What are the annual cost for households of the
facilities?
In addition, EPA guidance recommends that the applicant
look at the community's financial resources to be sure that it
can raise the capital necessary for the treatment facilities.
Many of these questions are addressed in the financial
capability guidebook published by EPA.
PLAN OF OPERATIONS
The grantee must submit a draft plan of operation for the
utilities operation which includes an adequate budget
identifying the basis for determining the annual operation,
maintenance, and replacement cost including the costs of
personnel, materials, energy, (0, M&R) and administration.
Section VI—Financial Planning/Budgeting provides a basis for
developing a operating budget to satisfy this requirement.
USER CHARGE SYSTEM
The Clean Water Act, Section 204(b), requires that each
grantee develop an approved system of user charges to:
. ensure that users of the utility pay their
proportional share of the operation, maintenance,
and replacement costs; and
. ensure that the system generates sufficient revenues
to provide for the proper operation, maintenance,
and replacement costs of the treatment works.
Recovery of capital cost is necessary to obtain the
revenues used to make the annual installment payment on
construction costs. The utility's share of construction costs
is normally financed by bonds which require annual payments of
interest and principal. Frequently this annual debt service is
financed with general property taxes. Federal regulations
neither require nor prohibit capital costs from being recovered
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through sewer service charges although state regulations may
limit capital cost recovery options. Utility managers should be
aware of state law restrictions on capital cost recovery.
The user charge system shall be based either on actual use
or on ad valorem taxes. The system based on actual use (or
estimated use) shall provide that each user pay a proportionate
share of the operation and maintenance costs based on the user's
proportionate contribution to the total wastewater loadings from
all users.
Wastewater measurement is critical to ensure equitable
apportionment in a system based on actual use. There are many
acceptable ways to estimate wastewater flow, among them:
. percentage of metered water; and
. average water consumed during winter months.
In situations where the water flow cannot be measured,
there are many acceptable ways to establish sewer service
charges, among them size of water connection and number of water
fixtures (i.e., toilets, sinks).
The utility should adopt a policy which specifies
that industrial equivalents will be periodically
tested for strength characteristics.
Sewage strength is measured in terms of SS and BOD. The
utility is required to know the discharge strength of each
industrial equivalent for both biochemical oxygen demand (BOD)
and suspended solids (SS).
A user charge system based on ad valorem taxes requires:
. that the grantee had in existence on December 27,
1977, a system of dedicated ad valorem taxes which
collected revenues to pay the cost of operation and
maintenance of the facilities and that the grantee
has continued to use that system;
. that the ad valorem user charge system distributes
the operation and maintenance costs for all
treatment works in the grantee's jurisdiction to the
residential and small non-residential user class and
industrial users that introduce no more than the
equivalent of 25,000 gallons per day of domestic
sanitary waste, in proportion to the use of the
treatment works by that class; and
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. each member of the industrial and commercial user
class discharging more than 25,000 gallons per day
of sanitary waste pay its proportionate share of the
cost of operation and maintenance based on charges
for actual use.
Federal regulations require that user charge systems be
reviewed annually and revised as needed to recover operating,
maintenance, and equipment replacement costs. Wastewater
operations are constantly changing. Flow and strength
characteristics and the costs required to treat wastewater are
not static. Where flow, strength, and billings are set by a
contract between the utility and a user or users (i.e.,
industrial equivalents), efforts should be made to revise the
contract to permit annual reviews and necessary sewer service
charge adjustments.
The user charge system must provide that the cost of
operation and maintenance for all flows not directly
attributable to users (i.e., infiltration/inflow) be distributed
among all users either in the same manner as the cost for actual
users or under a system using one or a combination of the
following:
. flow volume of the user;
. land area of the user;
. number of hookups or discharges of the user; or
. property value of the user.
FINANCIAL MANAGEMENT SYSTEMS
The regulations require that each user charge system
include an adequate financial management system to accurately
account for revenues generated by the system and expenditures
for operation, maintenance, and replacement of the treatment
works. This guidebook is intended to provide guidance in the
establishment of a financial management system.
REFERENCES
The following references provide additional guidance to the
regulatory requirements applicable to a utility's financial
planning process.
1. Federal Water Pollution Control Act, Amendments of
1977, Public Law 95-217, the Clean Water Act.
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2. 40 Code of Federal Regulations, Part 35, Interim Final
Grants for Construction of Treatment Works.
3. U.S. EPA, User Charge Guidance Manual, 1984.
4. U.S. EPA, Financial Capability Guidebook, Office of
Water Program Operations, February 1983.
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