By Hope Thomson, Senior Project Director, SOG Environmental Finance Center
Local governments can still make a New Year’s resolution for their water utility in 2025. While resolutions often falter, the New Year is a prime opportunity to reassess utility administration and identify needed changes. Improving utility management requires time and effort from staff and officials, making setting goals early in the budgeting season essential. Here are a few resolutions to consider:
1. Review utility finances through the lens of audited financial data
A local government utility is a public enterprise and should be self-supporting, so utility revenues fully cover utility capital and operating costs. Understanding the past financial performance of a local government’s utility is critical to know if it meets this financial sustainability goal over the short and long term. Audited financial statements can highlight performance issues that may not be immediately clear by focusing on budgets or day-to-day operations. They can reveal financial trends over time.
The Local Government Commission (LGC), a state commission with financial oversight authority over local governments, identifies specific Financial Performance Indicators related to a local government’s financial condition that can be derived from audited financial data. The primary metric for the water and sewer fund is the quick ratio, which reflects liquidity. It is calculated by dividing unrestricted cash plus accounts receivable by the sum of accounts payable, accrued liabilities, and the current portion of long-term debt. The LGC’s benchmark for this ratio is 1.0 or higher. For example, if a local unit has a quick ratio of 2.0, it indicates that the unit has two dollars in cash or cash equivalents for every dollar of current liability. Strategies to improve this metric include: 1) reviewing rates annually and adjusting them as necessary, 2) improving cash collections from customers and implementing a write-off policy for uncollectible accounts, and 3) exercising control over expenditures to stay within the respective line-item appropriations.
Other key indicators are:
Financial Indicator | LGC Minimum Threshold |
Operating net income | Greater than zero |
Days cash on hand | At least 2 months |
Capital Assets condition ratio | Greater than 50% |
Data collected by the LGC is used to populate the School of Government Environmental Finance Center’s (SOG EFC) statewide rates dashboard. The SOG EFC also has a free-to-use Financial Health Check-Up tool that examines similar performance indicators over the most recent five fiscal years. This view over time can illuminate trends so that units can see if indicators are improving from a place of concern, descending towards a threshold, or holding steady. For example, a unit may observe that their days cash on hand is above the LGC’s minimum threshold of two months and, therefore, not a concern. However, the Financial Health Check-Up Tool reveals that cash has been steadily declining over multiple fiscal years and that unanticipated expenditures would cause the unit to deplete past two months of cash reserves. In this case, the unit may resolve to build cash reserves beyond the LGC’s minimum threshold to ensure they can meet all LGC criteria, even in the event of unanticipated expenditures.
2. Establishing or revisiting your capital improvement plan
Expenses incurred by local government utilities are not limited to daily operations and maintenance – utility expenses also include the long-term costs of capital improvements. Initiating or updating a capital improvement plan (CIP) ensures that the physical assets supporting the utility are being accounted for financially. Before creating a capital improvement plan, a thorough asset inventory should inform the utility of the existing assets and their condition, including an anticipated timeline for repair or replacement.
The Government Finance Officers Association (GFOA) recommends estimating replacement cycles for infrastructure components, which can help establish a capital improvement plan. GFOA also specifically calls out the need for annual budget cycles and multi-year financial plans to address capital improvements. Annual budgets may be able to address emergencies, minor upgrades, repairs or replacements, or portions of larger projects. Long-term and high-dollar capital improvements should be reflected in a CIP because their costs and project timelines usually exceed the annual budget cycle.
CIPs should include projects and their associated costs anticipated methods of funding these projects. Funding sources could include cash financing by the local government (i.e., use of an enterprise fund balance or dedicated capital reserve fund), debt-financing, or anticipated grants. If applying for grants or low-interest loans furnished by the state, a capital improvement plan meeting certain requirements can be awarded additional points and improve the local utility’s overall application score and likelihood of a funding offer. Additionally, local governments should know and plan for grant and loan application deadlines while considering the likelihood of receiving these dollars, the associated closing cost, timelines on receiving funds, and the amount of internal staff time needed to manage the funds. Local governments should specifically review existing CIP and ensure that planned capital improvements for the upcoming fiscal year are reflected in the annual budget or a project ordinance.
3. Consider revenue generation
Utility user rates and fees should be reviewed regularly to meet financial goals. After assessing past financial performance and future capital needs, local governments may need to evaluate revenue generation to support financial outcomes or capital improvements. Water and wastewater rates should be set to meet the “revenue target,” covering operations, maintenance, capital improvements, and reserve fund allocations.
Options for rates-focused resolutions include:
- Ensure knowledge of rates among personnel. Understanding how users are charged for services is helpful for staff and elected officials aiming to improve utility operations. Key questions include: What are the current rates and fees? Do they vary by customer class or usage? How were they determined, and when were they last updated? Understanding these factors enables clear communication with customers and may highlight the need for rate adjustments, especially if rates have been unchanged for years.
- Examine the SOG EFC’s statewide rates dashboard, which should be updated in early 2025. Rates should not be directly compared to neighbors, as each utility has its own revenue needs. However, reviewing the dashboard can be a helpful benchmarking exercise, especially if considering a change to rate structures.
- Initiate a rates study. If rates need revisiting to meet revenue goals, utilities can hire a consulting agency or engineering firm for a formal rate study. These studies assess revenue potential, align it with utility goals, and provide options for rate adjustments.
- Self-assess rates. The SOG EFC’s free rates analysis tool uses in-house data to examine revenue generation and model potential increases over the upcoming fiscal years. The Environmental Protection Agency also has a free guidebook that walks utilities through rate-setting principles, specifically for small water systems.
Need technical assistance? The SOG Environmental Finance Center is here to help!
The School of Government Environmental Finance Center offers free one-on-one technical assistance for small water systems. If you are interested in our support, fill out our Technical Assistance Request Form or contact us at efc@sog.unc.edu.