Lay a foundation for your utility's future with financial planning

September 2012

Lay a foundation for your utility's future with financial planning

What do you do when your refrigerator stops working and needs replacing? Or when your car breaks down and needs a new alternator? These are usually unexpected events, and this is where a rainy-day fund comes in handy.

In the same way, businesses and organizations—and your utility—need funds for unexpected expenses. Building up reserve funds is one part of planning for the financial future of your system. Financial planning is one of the most important responsibilities of managers and members of the board or governing body of a utility.

A financial plan is basically a two-part process composed of:

• forecasting the utility’s future financial needs (operating and capital needs)
• determining how those future financial needs will be met

Capital-improvements planning

A capital-improvements plan (called a CIP for short or sometimes called a long-range plan) is a written document that specifies:

• what facility improvements will be needed in the future
• when the improvements will be needed and when they will be undertaken
• how much the improvements will cost
• what financing options are available for the improvements

A CIP should cover at least a ten-year period of time into the future. Having one will help your utility’s board and management make informed decisions about rate setting, future debt-service requirements, and future revenue requirements.

Reserve accounts

The purpose of reserve accounts is to hold funds that are dedicated for specific uses. These accounts should be built up over time with revenues from the operation of your facility. Four specific reserve accounts are recommended for water and wastewater utilities:

1. Debt-service reserve: A debt-service reserve is usually required by a lender or bond-covenant agreements. The debt-service reserve is for making regular debt-service payments should other funds for making debt-service payments not be available.
2. Emergency reserve: An emergency reserve fund is for unforeseen and unplanned emergency repairs that may occur during the year, such as major line breaks, pump breakdowns, etc.
3. Planned equipment repair/replacement reserve: This reserve fund is for the planned repair, rehabilitation, or replacement of equipment. In particular, this reserve is meant for the replacement of those items that have a useful life that is significantly shorter than the system as a whole. (This reserve may also be called a short-lived assets reserve.)
4. (Major) Capital-improvements reserve: A capital-improvements reserve is the accumulation of funds that will be devoted to pay for part of the cost of large, future capital-improvement projects that might be needed for the upgrade of existing facilities or construction of new facilities. Most of the cost for major capital-improvement projects will be paid with outside sources of financing. (For small water or wastewater systems—those with a small customer base and lower annual revenues—it might not be possible to fund a major capital-improvements reserve at all without increasing rates above an affordable level.) 

Planned repair and replacement

A financial plan for equipment replacement, repair and rehabilitation is an example of how your utility can use its own financial resources to fund minor capital improvements. 

Through a planning process sometimes referred to as “asset management”, decision-makers can identify, prioritize and schedule the repair, replacement or rehabilitation of critical components in your system. The cost of completing these types of improvements would be funded through an equipment-repair/replacement reserve. An equipment repair and replacement program is particularly important for replacing critical assets with a useful and serviceable life that is much shorter than the entire system.

For more explanations of these parts of financial planning and how to carry them out, get RCAP’s The Basics of Financial Management for Small-Community Utilities [1]. This article is taken from chapter 2 of the guide. This 38-page booklet is written in plain, everyday English and is meant for both new and experienced managers and leaders in small-community utilities to help you get your financial affairs in order. Other chapters provide sample financial-management policies and explanations for reading and interpreting standard financial statements (especially helpful for people who don’t work in bookkeeping or accounting). Also, the Environmental Protection Agency has numerous publications, tools, and resources on asset management. For more information, visit the EPA Small Systems website [2].

[1]

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