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How to determine financial sustainability
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| This page will provide you with a few easy to calculate ratios and some simple, yet effective, tools that give you the overall picture of your system's financial health. Also, we provide case studies of how other systems have deal with the challenges of financing environmental compliance. |
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Operating Ratio:
The Operating Ratio measures the amount of operating revenue versus the total amount of operating expenses for a utility system. The minimum standard for a operating ratio for a utility system is 1.0, meaning there is enough operating revenue to cover operating expenses.
A financially healthy utility system needs to maintain an ongoing operating ratio greater than 1, a ratio of less than 1 indicates there is insufficient revenue to meet current expenses. For example, if you had an operating ratio of .75, this means your revenue is 75% of expenses. In other words, you can only cover 3/4 of expenses.
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Affordability Index:
The affordability index measures the burden of costs passed from the drinking water system to the users against the median household income (MHI) for the area. A typical affordability range utilized by many states to assess the burden of water costs on residents is from 1.5% to 2.5% of MHI. A cost greater than 2.5% of MHI should be investigated further - especially if the residents are paying additional user charges for the wastewater, solid waste and other utility services.
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Current Ratio:
Current Ratio (CR), measure of short-term solvency, or the ability of the utility to meet obligations in a timely manner. The CR is equal to the current assets (cash and equivalents) divided by the current liabilities (debt service, etc. to be paid within one year); the higher the CR, the better. Some recommend that cash reserves be at least one and one-half times monthly operational expenses.
In addition to operating reserves, emergency reserves are an important tool for financial sustainability. Emergency reserves are intended to help utilities deal with short term emergencies which arise from time to time such as main bursts, or pump failures. The appropriate amount of emergency reserves will vary greatly with the size of the utilities and should depend on major infrastructure assets. For example, given that the largest single asset for a small rural utility may be the primary pump, the cost of replacing that pump in the case of a failure would be a good amount to save in emergency reserves.
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Receivables/Sales Ratio:
The receivables ratio measures the percentage of sales being held on the books as receivables. A low receivables ratio suggests that the organization’s receivables are being collected in a timely manner to meet obligations. Receivables totaling more than a month’s worth of sales could reveal a problem with collections, or too pricey of service.
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Quick Ratio:
The quick ratio measures the liquidity of the organization based on its most liquid assets, including cash, accounts receivable, short term notes receivable, and short term investments in marketable securities.
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Debt Ratio:
The debt ratio measures the amount of debt being used by the organization. A ratio of 0.6 means that 60% of operations have been financed with debt and the remaining 40% has been financed by equity.
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Asset Lifecycle Renewal Period:
While a utility may look good “on the books” and while there may be plenty of cash to pay for day-to-day operations and debt service, if a utility is not reinvesting in its infrastructure, it is not operating sustainably. A good check on asset reinvestment is the Asset Lifecycle Renewal or Replacement Period (ALRP). The ALRP is calculated as the total replacement value of all major assets currently “in the ground” divided by the amount spent over the past year on asset rehabilitation or replacement. The resulting value, which has units of years for total replacement, is also an easily understood and effective tool for communicating the need for capital reinvestment to the public and decision makers in the community.
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Debt Services Coverage Ratio:
As debt becomes an increasingly important tool for capitalizing utility operations, the ability to pay debt service is ever more crucial. Not only does this affect cash flow, but lenders pay close attention to debt service capacity and this capacity will affect the cost of borrowing. An important measure for utilities and lenders alike is the debt service coverage (DSC) ratio. The DSC is calculated as (total revenues minus total expenses) divided by debt service for the same period. Some recommend that the DSC should be 1.0 at a minimum, with a recommended ratio of 1.25.
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| Local Government Advisory Committee (LGAC) "Water Infrastructure: Successful Strategies for Local Leadership" DVD wins Telly Award! |
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| Liquid Assests is a public media and outreach initiative that seeks to inform the nation about the critical role that our water infrastructure plays in protecting public health and promoting ecomonic prosperity. |
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Tools for determining Financial Stability
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City of Corinth Gas and Water Department (CGWD)
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Community: Corinth, MS
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Population: 17,500
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Number of Accounts: 7,200
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Annual Revenues: $2,200,000
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Sustainability Finance Problem: Evaluating options for financing a major capital project by a combination of sources and to predict rate increases; using capital reserves to mitigate "rate shock".
The Corinth, MS scenario tool can be accessed HERE.
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Town of Conway Water Department
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Community: Conway, NC
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Population: 734
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Number of Accounts: 380
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Annual Revenues: $335,000
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Sustainability Finance Problem: Understanding the impact of capital improvement plans on water rates.
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City of Henderson Water Department
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Community: Henderson, NC
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Population: 16,095
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Number of Accounts: 9,352
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Annual Revenues: $6,410,000
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Sustainability Finance Problem: Addressing customer account delinquency and non-payment through rates and customers.
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Bogue Banks Rate Model
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Community: Emerald Isle, NC
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Population: 3,716
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Number of Accounts: 6,035
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Annual Revenues: $1,400,000
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Sustainability Finance Problem: Tying together financial information to measure financial sustainability.
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City of Kimberly Water and Sewer Funds
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Community: Kimberly, ID
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Population: 2,614
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Number of Accounts: 1,100
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Annual Revenues: $789,986
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Sustainability Finance Problem: Sustainable financing of the water and sewer utilities in the face of a "citizen revolt".
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Woodfin Sanitary Water & Sewer District
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Community: Woodfin, NC
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Population: 8,750
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Number of Accounts: 3,500
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Annual Revenues: $1,334,000
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Sustainability Finance Problem: Reviewing customer billing records to design a conservation program.
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