Utility Board Training: Financial Capacity

Utility Board Training: Financial Capacity

Introduction • Request for training identified • Local utility boards • Funders • Regulators • Cooperative training effort • Indiana Rural Community Assistance Program • Alliance of Indiana Rural Water

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)

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

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.

MODULE 5 UTILITY BUDGETING COMPLIANCE

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

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.

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

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

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

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

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

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

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

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

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

MODULE 6 CAPITAL IMPROVEMENT PLANNING AND BUDGETING

MODULE 6 SUMMARY • Capital Improvement Planning and Budgeting • Capital Improvement Plans (CIP) • Capital Budgeting • Bids and Contracts • Activity and Resources

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

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?

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.

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.

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.

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/

MODULE 7 UTILITY RATE STRUCTURE AND PLANNING

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

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.

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.

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.

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 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 Expensesand Revenue (Continued)

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

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

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”

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.

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.

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

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.

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. Annual Audits (Continued)

Activity and Resources • Activity: • “Long Range Financial Planning” Learning Exercise • Resources: • Example of State Board of Accounts Audit (on table)

MODULE 8 UTILITY PLANNING AND EXPANSION

MODULE 8 SUMMARY, last one • Utility Planning and Expansion • Existing Utilities • New Utilities • Expansion of Service Areas • Expansion of Facilities • Resources

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

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.

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?

Expansion of Service Areas • What are the legal requirement for the expansion of the service area? • Annexation? • Boundary expansion? • Legal authority?

Resources • All Resources at Table for Review

Alliance of IN Rural Water P.O. Box 428 Beech Grove, IN 46107 Phone (888) 937-4992 www.inh2o.org Indiana RCAP 1845 West 18th Street Indianapolis, IN 46202 Phone (800) 382-9895 www.incap.org

Utility Board Training: Financial Capacity