CHAPTER 14 – Financial Program

This chapter describes the current finances of the Drinking Water Utility, and summarizes its financial policies and the funding needed to implement this Plan. A detailed financial analysis was performed by the Utility’s financial consultant, FCS Group (Appendix 14-1). The results indicate that the overall financial condition of the Utility remains healthy. The Utility continues to be guided by water conservation and sustainability policies along with sound and prudent financial management principles.

The Utility’s financial program is designed to meet the Drinking Water Utility’s Goal 7:


Drinking Water Utility finances are managed responsibly, and costs are recovered equitably based on customer use.

Objectives for 2015-2020 are:

•    Set rates that accurately reflect financial policies and recover the cost of providing services to each customer class.

•    Manage Utility rates and connection fees consistent with the City’s guiding principles of growth paying for growth.

•    Use debt financing responsibly to support needed capital facility investments and “smooth” rate impacts.

Further direction is provided for this chapter by the City’s Comprehensive Plan. In particular, Utilities Goal 2 and its associated policies help guide the Utility’s financial program.

As required by state regulations (WAC 246-290-100), this chapter demonstrates the Utility’s financial viability by providing: a summary of past income and expenses, a balanced budget, a funding plan, and consideration of a rate structure addressing affordability and conservation.

14.1 Current Financial Status

This section reviews the Utility’s operating revenue and expenses, balance sheet and budget. The Utility’s financial consultant, FCS Group, concluded that the Utility’s operating condition remained strong as of December 2013. Revenues, including fund balance, were sufficient to meet expenditures.

Operating Revenue and Expenses

Comparative financial statements for the most recently available six years (2008 - 2013) are summarized in Table 14.1.

View Table 14.1 Summary of Fund Resources and Uses Arising from Cash Transactions.

Revenue from water sales increased 31.3 percent overall between 2008 and 2013, while consumption decreased (Chapter 3). Water rates increased by 31.9 percent during this period, demonstrating that water usage declined despite a growing customer base.

The O&M Coverage Ratio, which is defined as the total operating revenue divided by total operating expenses, was 113.6 percent in 2013. The Utility has maintained ratios of 100 percent or greater since 2010, indicating that revenues more than cover expenses.

The City’s practice is to maintain a minimum balance in the operating fund equal to 25 percent of annual operating revenues. Any accumulation of operating fund balance over 30 percent is transferred to the capital fund. This policy aims to provide liquid “working capital” to accommodate cash balance fluctuations associated with differences in revenue and expense cycles, along with other unforeseen variations in revenues or costs.

Assets and Liabilities

The Drinking Water Utility maintains a balance sheet of current and long-term assets and liabilities. Between 2008 and 2013, total assets increased from $45.74 million to $62.58 million. Over the same period, current and long-term liabilities increased from $12.78 million to $19.19 million. As of 2013, the City’s long-term debt for the Utility was $17.82 million from two revenue bonds and two State loans.

FCS Group concluded that the Utility’s ratio of unrestricted current assets to current liabilities remained healthy as of the end of 2013 at 8.6. This ratio measures the Utility’s ability to pay short-term obligations; the industry benchmark ratio is 2.0 or above. The Utility’s ratio has not fallen below 7.2 during the six-year period.

14.2 Rates and Rate Structure

Drinking Water rates are composed of a fixed monthly “ready-to-serve” charge based on meter size, plus a volume charge per hundred cubic feet (ccf) of metered water usage. The variable usage charge is designed to increase a customer’s water bill progressively with increasing levels of consumption, sending a price signal that encourages water conservation. Single-family residences pay volume charges based on an inverted four-tier structure. Multi-family, commercial and irrigation customers pay a seasonal volume charge with winter rates for November-June and summer rates for July-October.

A series of moderate rate increases (4%-6% per year) are proposed in order to accommodate projected operating and capital needs during the 2015-2020 planning period. This results in a cumulative increase of roughly 33% over the six-year period. A number of factors drive the need for the proposed rate increase. Primary among these are the loss of the City of Lacey and Thurston PUD 1 as wholesale water customers after 2015, increases in debt service associated with the City’s 2013 Bond and the Drinking Water State Revolving Fund (DWSRF) loan for the Log Cabin Reservoir, as well as recent State legislation that allows the City to recover fire protection costs through water rates, rather than through the General Fund. Additionally, the success of the Utility’s water conservation program continues to result in lower volume-based user revenues despite growth in the number of Utility customers.

The Washington Department of Health and Department of Commerce Public Works Board use an affordability index to prioritize low-cost loan awards depending on whether rates exceed 2.0 percent of the median household income for the service area. The median household income for the City of Olympia was $53,147 in the 2008 – 2012 American Community Survey conducted by the U.S. Census Bureau. This corresponds to a maximum annual water bill of $1,062.94, or $88.58 monthly. Based on an average residential monthly usage of 6 ccf, an average monthly residential bill would increase from $21.50 to $22.16, which is still significantly below the monthly threshold and suggests an affordable water rate structure.

14.3 Capital Funding Strategy

For the 2015-2020 planning period, the proposed capital facilities projects will cost an estimated total of $33.61 million, as shown in Chapter 13, Table 13.2. The Utility funds its capital program using resources in the following priority order:

1.    Accumulated capital reserves.

2.    Annual revenue collections from general facility charges (GFCs).

3.    Annual resources from rates earmarked for system reinvestment funding.

4.    Annual transfers of excess resources (over minimum balance targets) from the Operating Fund, if any.

5.    Interest earned on Capital Improvement Fund balances and other miscellaneous capital resources.

6.    Revenue bond financing.

General facility charges (GFCs) are imposed on new customers connecting to the system as a condition of service and are in addition to any other costs related to connecting a customer to the water system. The GFC is typically based on a blend of historical and planned future capital investment in system infrastructure. Its underlying premise is that growth (future customers) will pay for growth-related costs that the Utility has incurred (or will incur) to provide capacity to serve new customers. GFC revenues provide a source of cash funding for the capital facilities plan (CFP).

FCS Group calculated an updated GFC as part of the financial analysis for this Plan. The updated GFC per ERU (equivalent residential unit) should increase by $977 or about 28.3% from the 2014 charge of $3,456. The Utility’s practice is to phase increases in order to smooth impacts to customers. Therefore, the Utility proposes increase the GFC in two steps from 2015-2017, resulting in a GFC of $4,433 per ERU beginning in 2017.

In addition to funding the capital program with charges to new customers, the Utility requires existing ratepayers to support the City’s full cost of providing service, including annual depreciation expense on existing Utility assets. Existing customers benefit from a system of infrastructure that has been funded through a combination of sources; this infrastructure deteriorates over its useful life and will eventually fail, requiring replacement.

The Utility has been moving toward increasing annual depreciation funding from 45% of current depreciation to 75% of depreciation by 2020. While this approach does not ensure full cash funding of system replacements, it provides a reasonable basis for equitably charging current customers for the use and decline in value of the system. It is consistent with standard accounting practices and is a commonly used benchmark in the industry.

The Utility manages its capital fund reserves according to the following policy: the Capital Fund is assumed to maintain a minimum reserve balance equal to 5 percent of active capital appropriations as a capital contingency reserve. This policy intends to provide a source of funding for unanticipated capital needs, such as cost overruns.

Analysis performed by FCS Group, shown in Table 14.2, indicates that the Utility will have enough cash resources to pay for the projected capital costs using its cash resources and loan proceeds for the Log Cabin Storage Tank and anticipated loan proceeds for the Meridian Corrosion Control project. In the event that CFP project costs exceed the estimates developed by staff or cash or loan funding sources fall short of projections, the Utility can consider deferring projects as an alternative to incurring debt.

View Table 14.2 Proposed CFP Funding Strategy.

14.4 Evaluation of Revenue Requirements

The revenue requirement analysis determines the annual revenue required to fund the projected operating expenses, capital costs, and policy-based requirements (e.g. reserve funding, system reinvestment funding). In this evaluation, “revenue sufficiency” is defined by the following tests:

•    Cash Flow Test: Rate revenue and other operating revenues must be sufficient to meet the utility’s projected cash needs including O&M, debt service, system reinvestment funding, and any reserve funding needed to meet the minimum balance target for the Operating Fund. The utility may have negative net cash flow when an explicit decision is made to use reserves to phase or “smooth” rate increases – in this analysis, the minimum balance requirement for the Operating Fund limits how far the Operating Fund balance can be drawn down for this purpose.

•    Coverage Test: As previously noted, the City’s revenue bond covenants require that the City’s “net revenue” is equal to at least 1.25 times annual revenue bond debt service.

Table 14.3 summarizes the annual revenue requirement forecast through 2020.

View Table 14.3 Revenue Requirement Forecast.

Table 14.3 indicates a cash flow deficiency under current (2014) operating conditions, primarily due to the City’s decision to reintegrate the cost of fire protection back into water rates. To comply with the Washington State Supreme Court’s decision in Lane v. Seattle, the City had been funding fire protection costs through an annual transfer of $366,450 from the General Fund. With the passing of Substitute House Bill 1512 in July 2013, the City is allowed to once again recover fire protection costs through water rates. As a result, the City’s 2014 Budget discontinued the annual transfer from the General Fund, increasing the amount of revenue that rates must generate. The rate increases shown in Table 14.3 are also driven by the loss of wholesale revenues beyond 2015 and increases in debt service associated with the City’s 2013 Bond and the DWSRF loans for the Log Cabin Reservoir and the anticipated McAllister Wellfield Corrosion Treatment projects.

14.5 2015-2020 Financial Program

The overall financial condition of the City’s Drinking Water Utility remains healthy. The City continues to be guided by a policy of water conservation and sustainability along with sound and prudent financial management principles. While the proposed 2015-2020 rates represent an increase over current rates, the overall rates and resulting billings to the City’s customers fit within this policy framework.

This financial strategy will enable the City to achieve a reasonable balance between its goals of offering its customers affordable rates while encouraging water conservation through prudent pricing signals and a projected operating and capital plan that will meet the needs of the Utility over the next six years.

Financial Program objectives and strategies are designed to help meet the Drinking Water Utility’s Goal 7:

Goal 7

Drinking Water Utility finances are managed responsibly, and costs are recovered equitably based on customer use.

Objective 7.A Set rates that reflect financial policies and recover the cost of providing services to each customer class.

Strategy 7A.1 Increase annual depreciation funding to 75 percent of depreciation by 2020, in order to equitably charge current customers for the use and decline in value of     the system.

Strategy 7A.2 Analyze how the tiered and seasonal rate structure is affecting consumption patterns/revenue, and propose changes to the rate structure as appropriate.

Strategy 7A.3 Conduct a cost-of-service study for wholesale and retail customers on a six year cycle or more often as needed.

Strategy 7A.4 Coordinate regular water rate studies with the City’s other water resources utilities so that the full impact of utility rate increases on customers is considered.

Objective 7.B Manage Utility rates and connection fees consistent with the City’s guiding principle of growth paying for growth.

Strategy 7B.1 Increase the general facility charges to reflect the current pro rata share of system costs.

Strategy 7B.2 Review general facilities charges regularly to ensure that they accurately and equitably distribute system costs to new development and adjust for inflation.

Objective 7.C Use debt financing responsibly to support needed capital facility investments and “smooth” rate impacts.

Strategy 7C.1 Continue the capital funding strategy that utilizes existing resources from reserves and general facility charges first before relying upon debt financing.

Strategy 7C.2 Maintain the required debt coverage ratio and a solid bond rating.

Strategy 7C.3 Pursue grants and state low-interest loans when available.