Utility Board Training: Financial Capacity

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Utility Board Training: Financial Capacity

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Introduction Request for training identified

Local utility boards Funders Regulators

Cooperative training effort Indiana Rural Community Assistance Program Alliance of Indiana Rural Water

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Utility Board Training This unit is part 2 of a three part training

program Part 1: Managerial Capacity (February – April

2006) Part 2: Financial Capacity (May – August 2006)

Exercise rights and powers appropriately, use proper accounting processes and documentation, and managing system revenue appropriately to reach compliance with regulations.

Part 3: Technical Capacity (September – November 2006)

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Topics of Discussion Four sections of discussion

Utility Budgeting Compliance Capital Improvement Planning and Budgeting Utility Rate Structure and Planning Utility Planning and Expansion

Two 45-minute sessions Two modules in each session Questions at any time

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Topics of Discussion What does having financial capacity mean to

you? The rates and fees are high enough to meet the

water system’s financial needs. The organization can borrow money if and when

necessary. Funds are secure and expended for the right

purpose.

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MODULE 5

UTILITY BUDGETING COMPLIANCE

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MODULE 5 SUMMARY Utility Budgeting Compliance

The Expense Budget Operating Reserves Debt Service Budget Cycles Activity and Resources

Reserves for Asset Replacement and Capital Improvement Plans will be covered in Module 6

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Expenditures Types of utility boards expenditures

Expenses covering daily system operations Capital for items expected to last more than three

years Reserves for temporary transfers / cash flow Reserves (Contingency planning, emergency)

We will cover the expense budget in this module and the capital budget in Module 6.

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The Expense Budget The governing board of the system must be involved

in the development and adoption of the utility budget. Ultimately, local officials are responsible for the budget.

Why must we have a budget? Tool for tracking expenditures Helps reduce unnecessary costs Determine if actual costs are being incurred as projected Control spending Ensure accountability Anticipate future costs

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The Expense Budget (continued) The five main components of the expense budget:

Operating Expenses The day-to-day costs of operating the utility

Emergency Operating Reserves Should be at least 10% of total operating expenses

Debt Service The cost of payments on outstanding debts

Debt Service Reserves A reserve of 20-25% of the average annual debt service

payments is advised. Reserves for Asset Replacement

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The Budget Cycle The four main stages of the budget cycle:

Preparation of budget requests. Usually developed by department heads and reviewed by the board Timeframe should be set by board

Board and state approval of the budget request Timeframe dictated by state statute

Budget implementation In Indiana utility and town budgets follow the calendar

year Summary reporting on actual budget transactions

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The Budget Cycle (continued)

Outcomes from the four stages of the budget cycle: Preparation of budget requests Proposed

Budget Budget adoption Appropriation for next fiscal

year are set Budget implementation Disbursements and

encumbrances Summary of transactions Audited financial

report

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Utility Budget Recommendations Know your budget cycle Know your budget advertising and publication

requirements Involve the system operators in the budget process Review the budget and look for historical or

performance data to evaluate the requests Use public input to determine future service goals

and as a means of evaluating past performance A special budget hearing should be held prior to

budget adoption to allow for public input and discussion

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Budget Cycles:Cities and Towns The calendar year is the budget year Dates for the adopting the next year budget

August 31: Last day for first publication of budget (must be at least 10 days before the public hearing)

September 7: Last date for second publication of budget (must be 7 days after first publication)

September 10: Last day for public hearing (must be 10 days before meeting to adopt budget)

September 20: Meeting of council for budget adoption September 22: Last day to file budget documents with county

auditor and date of meeting of county board of tax adjustment October 1: Last day for county board of tax adjustment to meet No later than 0-days after tax board adjournment, notice of tax

rates must be published

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Budget Cycles:Conservancy Districts The calendar year is the budget year. Per statute, Conservancy Districts conduct

budgets in the same manner as Cities and Towns, observing: The same timeframe, The same hearing and review process, and The same adjustment process by the Indiana

Department of Local Government Finance

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Budget Cycle:Water and Sewer Districts Water and Sewer Districts are not required to have budgets Having a district budget is still HIGHLY recommended!

District may set their own budget year Districts may set their own calendar for adopting their budget for

the next year budget Districts may select their own budget categories

Water and Sewer District budgets ARE NOT reviewed/approved by the Department of Local Government Finance

Water and Sewer Districts budgets and financial books ARE still subject to State Board of Account review

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Activity and Resources Activity:

“Planning, Budgeting, and Rate Setting” activity Resources:

Financial Issues: Frequently Asked Questions Division of duties among clerk, treasurer, and board Record keeping and reconciliation Bill paying

Utility Board Member Job Description

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MODULE 6

CAPITAL IMPROVEMENT PLANNINGAND BUDGETING

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MODULE 6 SUMMARY Capital Improvement Planning and Budgeting

Capital Improvement Plans (CIP) Capital Budgeting Bids and Contracts Activity and Resources

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Capital Improvement Plans

The utilities capital improvement plan (CIP) lists projects and equipment purchases that are

anticipated and scheduled over five years or more forces the utility to look ahead, see what their

needs will be, and plan for future projects your needs can be phased-in over time and you

can shop around for the best price

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CIP Development Development of a capital improvement plan:

Preparation. Planning period? Inclusiveness of CIP? Will it include

maintenance and renovation expenses? Organizational issues.

Who is responsible for preparing CIP? Will there be involvement from the public?

Project evaluation. How will projects be evaluated and ranked? What are the

criteria for this evaluation? Funding sources.

Capital improvement fund? New debt? Bonds? How much debt is reasonable/how much is too much?

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Capital Improvement Budgeting

Capital improvement budgeting is used to PAY for FUTURE projects and renovations.

It is an annual expenditure that is “set aside” to accumulate to pay for projects and renovations.

If you think of your operating budget as your “checking account” your should think of your capital improvement budget as your “savings account.”

It is advised that you separate the capital budget from the regular operating budget to clearly differentiate the two.

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The Challenge of Capital Improvement Budgeting The capital improvement budget is for

FUTURE NEEDS. As such, the most difficult task for the board is to maintain a positive balance in this account with the understanding that it is not meant to generate a profit but instead to prepare for future needs.

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Bids and Contracts Develop both purchasing and contracting policies. Follow federal and state requirements for these

policies. Correctly followed procedures will save the utility

money and protect the board from contract challenges and lawsuits.

Indiana code 36-1-12-3 covering state procurement law for public works is included in this packet.

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Activity and Resources Activity:

“Long Range Planning” Self Assessment and Resources

Resources: IN Code 36-1-12-3 (Procurement and Purchasing) Applicable State Board of Accounts Manual

Chapters Indiana State Board of Accounts Web Page:

http://www.in.gov/sboa/

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MODULE 7

UTILITY RATE STRUCTUREAND PLANNING

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MODULE 7 SUMMARY Utility Rate Structure and Planning

Basis for Rate Structures Operating Expenses and Revenue Operating Ratio Steps to Setting a New Rate Utility Responsibility Annual Audits

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Basics of Rate Structures

Rates for water treatment plants must produce revenues to cover full costs of producing, treating, storing, and distributing water.

Rates for wastewater plants must provide revenue to cover full costs of collecting, treating and discharging wastewater.

Rates should be fair, equitable, and related to the service they are paying for.

How rates are calculated should be public record Rates should be reviewed annually or every two years.

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Basics of Rate Structures (Continued) What to do when revenues are not covering

expenses? Warning: These seem straightforward, but realize each has its

pitfalls. Cut expenses where possible.

Pitfall: Utilities have many fixed costs. Expenses may be difficult to cut without sacrificing service and creating customer dissatisfaction.

Borrow money to pay expenses either internally or externally. Pitfall: Particularly for internal borrowing, the key word is BORROW.

Raiding reserves with no pay-back plan is not fiscally responsible. Raise utility rates.

Pitfall: It never makes customers happy. The longer you wait the greater the eventual rate increase will be.

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Expenses and Revenue The next slide is a list of typical utility

operating budget line items. It is always valuable to include “last year” and

“year-to-date” figures along with the projected future years budget amount.

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Expensesand Revenue (Continued) Expenses:

Debt Service Payment Debt Service Reserve System Financial Reserve Purchased Water/Cost of

Wastewater sent Personnel Costs Administration Operating Utilities Operating Supplies Legal Fees Contract System Repairs Transportation Expenses Equipment Leases Insurance Accounting Taxes

Revenue: Current Service

Revenues Valuable to break down

by: Fixed Cost Revenues

(The base rate) Variable Cost Revenues

(The cost per-unit used) Other Service Charges

Interest Income

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Expensesand Revenue (Continued) Expenses:

Fixed expenses: Costs that are the same

regardless of how much water the water utility is producing

Example: loans Variable costs:

Costs that increase or decrease based on the level of operations at the utility

Examples: More treatment chemicals are needed when more water is produced

Sometimes a cost can be partially fixed and partially variable Example: Personnel costs

Revenue: Fixed Cost Revenues

Ideally the “base rate” will cover the utility’s fixed expenses

Ideally the “per-unit-used rates” will cover the utility’s variable expenses

In reality it is difficult to precisely identify these but the discussion leads to a valuable estimate of the two rates

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Operating Ratio Total Revenues / Total Operating Expenses

= Operating Ratio The minimum operating ratio for a utility is one

(1). Anything less than one requires the utility to review their rate structure as expenses are exceeding revenues.

1.15 is a generally accepted operating ratio for systems with >2,000 connections

1.35+ is a recommended operating ratio for systems with <1,000 connections

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Coverage Ratio Income Available for Debt Service / Annual

Debt Service Expenses = Coverage Ratio Indicator of system's ability to repay debt <1 and banks, bonds buyers, and lending

agencies are unlikely to lend money to system 1.25 is a normal target for larger systems 1.9 can often be preferred for small systems

A strong operating ratio will take care of the coverage ratio

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Affordability Index Fees for 5,000 gallons per month user /

Median Household Income (MHI) for the rate paying area = Affordability Index

<.5% rates are “very” affordable .5% - 1.5% rates are “fairly” affordable >1.5% rates are considered “high”

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Steps to Adopting a Rate Ordinance Revision Decide on tentative new rates and draft an

ordinance reflecting these rates. The Town Council or Utility Board should

accept the draft ordinance. (This is not adopting the ordinance, merely accepting it for consideration.)

Notice of the public hearing should be published at least one time in at least two local papers at least 10 business days before the hearing date.

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Steps to Adopting a Rate Ordinance Revision (Continued) Copies of the draft ordinance should be made

available in easily accessible locations. Hold the public hearing. Adopt the ordinance, preferably at the

meeting following the public hearing. The full text of the adopted ordinance should

be published as a legal ad in at least two local papers.

Implement the new rates.

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Utility Responsibility

Make sure that revenues cover expenses and that rates are sufficiently high to do so.

Make sure all customers are being billed and are paying for service. (Delinquent accounts cost everyone in the system.)

Read meters regularly according to a set schedule. water: individuals wastewater: master

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Annual Audits An audit is a periodic record of financial status and

operating results using standard accounting principles. It provides independent verification which assures and builds trust for customers and lenders. Although they can be expensive for the small system, one should be performed by an independent firm annually.

In Indiana the State Board of Accounts will perform audits of utilities and cities and town somewhere between annually and every few years.

It is recommended that in years where the State Board of Accounts IS NOT conducting an audit, an independent audit firm should be hired.

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Annual Audits (Continued) What the Audit Does:

Provides and independent verification of the financial condition and soundness of account principles used.

Reviews the internal control environment to identify weaknesses

Reports financial information in a standardized format

Provides a single audit of all significant federal or state programs and identifies and significant noncompliance items.

What the Audit Doesn’t Do: Does not determine fraud

in the organization. Does not evaluate the

financial condition or operating results of the utility.

Does not claim to present the financial information accurately in all respects.

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Activity and Resources Activity:

“Long Range Financial Planning” Learning Exercise

Resources: Example of State Board of Accounts Audit (on

table)

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MODULE 8

UTILITY PLANNING AND EXPANSION

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MODULE 8 SUMMARY, last one Utility Planning and Expansion

Existing Utilities New Utilities Expansion of Service Areas Expansion of Facilities Resources

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Existing Utilities Should be aware of system capacity Should set benchmark with regard to evaluating the

systems performance Should set renovation/expansion goals Should incorporate renovations and expansion into

capital improvement plans Should frequently assess their financial capacity When considering system expansions, consideration

must be given to who will bear the cost of this expansion

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New Utilities Should be aware of the system capacity. Decisions should be made as to what type(s) of

development the system wants to attract and for which it is able to provide service.

Whether or not to annex as a precondition of providing services. Annexation depends on the type of utility and state statute requirement.

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Expansion of Facilities Who will benefit from the expansion? How will the legal and administrative costs for

expansion be paid and by whom? Who will bear the cost of line extensions and other

system requirements? What are the ramifications of not providing services

and facilities to a nearby development? What are the affects of an expansion going to do to

your operating and maintenance budget?

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Expansion of Service Areas What are the legal requirement for the

expansion of the service area? Annexation? Boundary expansion? Legal authority?

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Resources

All Resources at Table for Review

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Alliance of IN Rural Water

P.O. Box 428 Beech Grove, IN 46107Phone (888) 937-4992www.inh2o.org

Indiana RCAP1845 West 18th StreetIndianapolis, IN 46202Phone (800) 382-9895www.incap.org