1. APPA’s Financial Planning for Municipals Mark Beauchamp, CPA, CMA, MBA 616-393-9722 September 27, 2005 Business & Finance Workshop

2. Objectives How to determine revenue requirements Development of a cash reserve policy Development of long-range financial plan and rate track Cost of service & Electric Unbundling Contribution to City

3. Determination of Revenue Requirements How much should you recover from Customers in Rates?

4. Two Methods Exist to Determine Revenue Requirements Cash Basis Revenue requirements defined based on cash outflows and debt service Utility Basis Revenue Requirements developed using accrual accounting basis

5. Cash Basis Advantages Understood by City Councils Attempts to match cash inflows and outflows on a yearly basis Meets bond obligations

6. Utility Basis Advantages: Leads to more stable and consistent rate adjustments Typically leads to a more financially stable and healthy Utility

7. Disadvantages Cash Basis Conceals major rate problems and revenue deficiencies Tends to result in unexpected and large rate adjustments Not generally accepted by courts if rates are challenged Utility Basis City Councils may not understand Have to justify cash reserves Explain funding non- cash expenses - Depreciation Explain importance of rate of return

8. How to Overcome Disadvantages Do cost of service study on Utility Basis If Large Adjustments are Needed: Define minimum rate adjustment to meet debt service obligations Develop a plan to phase-in rates from a cash basis to a utility basis

9. Education of Boards and Councils Theory of depreciation expense – Reasonable representation of the amount of the system used on an annual basis Cash represents a buffer that allows timely replacement of system to ensure reliability to customers Cash balances allows the phasing in of large rate adjustments to minimize the rate impacts on customers (Long-Term Rate Track) Develop a financial plan and explain the consequences of inaction

10. Rate of Return is a Necessary Component of a Rate Study Net Book Value X Rate of Return = Target Return Target Return is typically for operating income

11. Weighted Average Cost of Capital

12. Should a Public Power System Have a Rate of Return? Covers interest expense on debt Assets installed many years ago are more expensive to replace today The rate of return attempts to recover sufficient funds to replace the assets at some point in the future Without an appropriate rate of return customers today may be subsidized by future customers

13. Cash Reserve Policies

14. Cash Reserve Policy Why is a policy important? Ability to pay for normal capital improvements Reserve fund for catastrophic events Funding of depreciation expense

15. Cash Reserve Policy What is an appropriate cash reserve: Simple answer 3 – 6 months operating expenses/revenues Does not account for storms Does not account for capital improvement program

16. Cash Reserve Policy Maintain 20% of Historical Investment Accounts for replacement of system Ensures cash exists for major catastrophes Should result in cash available for major improvements Weaknesses Major improvements to system may result in change in cash reserves at a time when utility does not have cash available

17. Comparison of Methods

18. Financial Planning & Long- Term Rate Track

19. Case Study Financial Planning Identify Rate Adjustments to Meet Targets Minimize Impact on Customers Maintain Appropriate Cash Balances Achieve Target Operating Income Keep from getting complaints Re-Elect Officials

20. Tasks Development of Long-Term Financial Plan Define Minimum Rate Adjustment Define Target Rate Adjustment Define Minimum Cash Reserves Develop Rate Track

21. Financial Projection – Base Case

23. Cost of Service Rate Track

24. Minimum Rate Track – Bond Coverage Ratio

25. Minimum Rate Track – Cash Reserve Target

26. Minimum Rate Track – Cash Flow Target

27. Financial Projection – Recommended and Approved

28. Cost of Service & Rate Designs

29. Cost of Service Information Cost of Service is critical to understanding your costs, the rate design process, and justifying the costs charged to Customers

30. Do not use cost of service exclusively in designing rates Other Factors to Consider Price Signals on Marginal Costs Social Concerns Economic Development Rate Impacts Legal Issues If you move away from cost of service to increase a subsidy legal issues could arise

31. Cost of Service Summary

32. Unbundling Rates Unbundling has lost its influence in recent years as customer choice legislation has slowed. Used to determine wheeling rates for customers provided a choice of providers. Unbundling is beneficial in developing special rates for customers or more accurately determine some existing rates. Identify transformer costs for primary metered customers Standby rates Net Metering Rates Economic Development Rates Electric Line Extension Policies

33. Unbundled Distribution Rates

34. Serving Outside City Customers

35. Cost Differences Customers may be more spread out resulting in greater investments It may cost more to issue a bill and read meters because of economies that exist when providing water and wastewater services to the same customers inside the city Rate of Return issues (Not recommended to charge a greater rate of return outside the city for electric service Typically cost differences exist only in the customer charge Be careful it may be your biggest area of growth

36. Example of Cost Differences

37. Contributions To City

38. Contributions to City Forms of Contributions Payment in Lieu of Taxes Free Electric Services Free services Over allocation of City Support Services Under allocation from Electric to Other Utility Services

39. Contribution to City Is your contribution to city above “normal” contributions in your area. What is your direct contribution How much one time transfers Are allocations for city provided services appropriate What is the cost of “free services” to the city

40. Contribution to City Allocation to Utilities for City Provided Services Allocation for common utility functions Meter Reading Billing Customer Services Administration

41. Contribution to City National average of cash-only contributions approximately 3.7% National average including free service 5.8%