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There will probably never be a time that financial statements, like Comprehensive Audited Financial Reports (CAFRs) and Annual Financial Reports (AFRs), are going to be as exciting as the New York Times latest bestseller. They are usually long documents and can be a little intimidating at first. However, a good financial statement is full of important information that can describe the financial well-being and sustainability of a utility. This blog post is a suggested guide to highlight a few important components of financial statements and why they should be included in each CAFR and AFR.

Before we get any further, we would like to offer this short disclaimer: We invite you to read this blog post as a suggested set of guidelines to follow when preparing financial statements, or when working with your auditor to let them know some items that would be helpful to include. These “keys” are only recommendations from the Environmental Finance Center (EFC), created based on our experience of best practices from working with a wide variety of financial statements. If you are a governmental water system, you will want to ensure your auditor follows the Generally Accepted Accounting Principles (GAAP) – maintained by the General Accounting Standards Board (GASB) – as well as any additional regulations that are necessary in your state. If you are a non-governmental water system, you or your auditor should be aware of the guidelines from the Financial Accounting Standards Board. Also, see previous EFC blog posts on helpful hints for reading annual financial statements, and for how to use financial key performance indicators to look for warning signs of unhealthy financial trends in your organization.

Now let’s look at four keys for an annual financial statement that will make evaluating the financial health of your utility a bit more user-friendly.

1. Separate Funds for Each Utility

If your organization owns more than one utility, it can be very helpful for each utility to have a separate enterprise fund or section in the financial statement (or at least be broken out into separate columns of figures). When you combine multiple utilities, such as gas and water, into one set of figures in the financial statement, it might seem easier at first. But ultimately this only inhibits seeing the financial health of each utility separately and clearly.

For example, if water and gas are combined into one, that may mask the fact that the water business is doing fine while the natural gas business is losing money and needs to be restructured (e.g. reduce costs, raise rates, or both). Each utility benefits from having its own separate, complete set of figures to ensure each utility operates with relative autonomy and financial sustainability. (In some states this may be required by law, in fact.) Indeed, for local government systems, it is a best practice under GAAP for enterprise funds to be financially self-sustaining (though there are some legitimate exceptions to this principle).

2. Break Out Depreciation Expenses

Depreciation is a method of allocating the cost of a tangible asset (such as a treatment plant) “wearing out” over its useful life. While depreciation expense is an accounting procedure – you’re not actually handing anyone a check for a “depreciation bill” –including deprecation as an operating expense on the Statement of Revenues, Expenses and Changes in Net Position can be a step in the right direction to ensure there will be enough funds to pay for updates and repairs to your assets in the long run.

Even though depreciation is just an estimate, it is important because it can help calculate the Operating Ratio, to see if a utility’s Operating Revenue (coming largely from their rates) is high enough to cover the cost of operations and capital. (Of course, equipment tends to cost more to replace now than it did when you first bought it, so the cost of replacement may need another 20% or more above and beyond the fully depreciated value.) By breaking depreciation out, a utility can show ability to cover day-to-day operations and maintenance expenditures. So, break it out!

3. Unrestricted Cash and Cash Equivalents

If there is ever an emergency expense, knowing how much of a utility’s cash is easily accessible is key! It is important to include and separate Unrestricted Cash and Cash Equivalents from other kinds of Current Assets, such as restricted cash funds, prepaids, and inventories on the Statement of Net Position. Restricted cash can refer to certain funds that are set aside and unavailable for immediate use, such as for payments to bondholders under legally binding bond covenants. (Certificates of Deposit, while not restricted funds per se, may not be able to be immediately liquidated for their full amount without paying a penalty for early termination – so having a separate line item for them too can be useful). Unrestricted Cash and Cash Equivalents typically refers to money that is immediately available for investing or spending. Unrestricted cash, together with annual operating expenses, can then be used to calculate how long a utility can run with no new revenue in case of emergency – also known as Days of Cash on Hand.

4. Long Term Capital Debt

Some utilities take on debt to help pay for expanding/ upgrading their system. These debts (related to loans, warrants, notes, or bond issuances) aren’t necessarily bad – in fact, they may be a sign of the useful growth of the utility. However, the principal and interest payments made on these debts should be clearly and separately stated on the Statement of Cash Flows – presumably under the “Cash Flows from Capital and Related Financing Activities” section. And if your auditor chooses to list the interest payments in a separate section of the CAFR/AFR, it would be helpful to restate the interest payments here, together with the principal payments, for clarity. These debt payments can be used to calculate, among other financial key performance indicators, the Debt Service Coverage Ratio – which is used to measure ability to pay for debt service and day-to-day expenditures using operating revenues.

To conclude, each of these four keys is important to help calculate the key performance indicators of the financial health and success of the utility. Doing so should help – for financial experts and non-experts alike – to understand these four concepts, make the audits a bit more user-friendly, and to support the utility in being more efficient and sustainable.

Hope this helps and happy auditing!

Alison Andrews is a student intern at the EFC and is pursuing a dual degree in Economics and Public Policy at The University of North Carolina at Chapel Hill.

The contents of all posts authored by students are solely the responsibility of the authors. Statements made and opinions expressed are strictly those of the authors and not the Environmental Finance Center or The University of North Carolina at Chapel Hill.

Title image source: http://blog.sercle.com/wordpress/wp-content/uploads/2015/11/finance-concept_z17OEuDO.jpg 

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