Guidelines for financial planning of water utilities

Successful financial planning for a water utility involves anticipating the needs and future demand of the community being served, designing facilities to meet demand, minimizing the costs of operation, constructing and/or purchasing fixed assets for the utility"s expansion or rehabilitation, replacing or retiring assets in a timely way, and developing and implementing financing mechanisms to fund these activities. Designing a financial plan requires identifying and evaluating the factors that affect the type and size of the utility"s facilities, the financing mechanisms available, and the potential cost recovery from prospective beneficiaries of the service. The paper details a 6-step process for developing a comprehensive financial plan. The first step is to determine consumer demand. Projection of growth in consumer demand is essential to devising the capital investment plan, which is the next stage in the financial planning process. Designing the capital investment plan is one of the most important components in the successful planning of a water utility, and is essential for securing appropriate financing; the plan establishes priorities for individual projects and schedules them for funding over a 5- or 6-year period. After developing the capital investment plan, in step 3 managers must compare revenue sources with revenue requirements for the 5- or 6-year planning horizon. Clearly, revenue requirements must match revenue sources to maximize smooth operations and minimize changes in charges to customers. In order to fully identify all costs of the utility, step 4 addresses the estimation of the utility"s existing and proposed operation and maintenance costs. At this stage management will need to identify increased operating costs associated with new facilities as well as proposed operating costs of existing facilities. Step 5 concerns planning cash flow and net working capital. A water utility"s cash flow varies yearly, quarterly, and even weekly, depending on its operational policies and the changing economic and business environment. Therefore, constant review and updating of working capital are necessary. Finally, step 6 involves planning for current, accrued, and long-term liabilities. Liabilities represent a water utility"s various debt obligations, including payments to suppliers, notes on short-term borrowing, and long-term debt. A number of sample spreadsheets and flow charts are provided in the report to facilitate the financial planning exercise, the use of which requires some ability in financial analysis and exposure to utility management on the reader"s part. An appendix includes a fully costed example of how a water utility might go about determining its optimal level of leveraging, given a known set of income sources. Two sets of data are presented. In the first case, a utility may choose to finance activities using its own resources rather than incur debt. The second case depicts a utility that chooses to finance its activities by borrowing as much as lenders will allow while investing only a small amount of its own funds. (Author abstract)