Accounting and Finance - 101

1. Accounting and Finance - 101 CINDY NAVAROLI, MPA, CPA & SHERI ROJO, CPA www.pcgclient.com

2. Understanding Financial Statements 2 3 4 1 Preparing and Understanding Budgets Emerging Financial Issues for Utilities Establish & Review Reserve Policies

3. PART 1 – Understanding Financial Statements

4. Financial Statements vs. Budgets • Budgets plan the future, Financial Statements explain the past • Cash vs. Accrual? • Financial Statements usually prepared on “accrual” basis When prepared? • Prepared monthly and annually • Comprehensive Annual Financial Report (CAFR) • The CAFR is usually prepared three months or more after fiscal year-end • Audited by a CPA firm

5. Financial Statements • Introduction - Transmittal Letter (Letter to the public describing events and issues from the past year and future) • Management’s Discussion & Analysis (MD&A) • Statement of Revenues, Expenses and Changes in Net Assets • Statement of Net Assets • Statement of Cash Flows • Footnotes • Statistical Schedules

6. Transmittal Letter Management’s Discussion & Analysis (MD&A) • Addressed to citizens and/or Board/Council • Subjective information about agency • Economic & financial outlook • Organizational chart • Summarized financial data • Prior year’s comparisons • Variance analysis

7. The Statement of Changes in Revenues, Expenses, and Net Assets depicts how profitable the utility was over the fiscal year Change in Net Assets Revenues Expenses THE STATEMENT OF CHANGES IN REVENUES, EXPENSES, AND NET ASSETS Earned by the utility Costs to run the utility Revenues - Expenses = Change in Net Assets (also, referred to as Net Income)

8. Non-Operating Expenses/Cash Outflows Non-Operating Revenues/Cash Inflows Operating Revenues Operating Expenses Expenses Revenues Revenues – Expenses = Net Income (change in net assets)

9. Non-Operating Revenues Operating Revenues Cash Inflows – Other Financing Sources REVENUES AND CASH INFLOWS • Not in Financial • Statements, but • may be in the budget because they are a source of cash • Bond Proceeds • Reserves • Transfers in from other funds • Relate to your primary business of buying and selling water • Water Sales (commodity charges) • Fixed Charges • Connection fees • Other fees • Ancillary Income • Property Taxes • Interest income

10. Non-Operating Expenses Operating Expenses Cash Outflows – Other Financing Uses EXPENSES AND CASH OUTFLOWS • Relates to your primary business of • buying & selling • water • Variable Commodity Charges • Salaries & Benefits • Supplies & Services • Administrative Expenses • Ancillary expenses • Interest Expense • Miscellaneous fees • Not in Financial • Statements, but • are in the budget because they are a use of cash • Bond Principal • Reserves Funding • Capital Outlay • Transfers out to other funds

11. Typical expense distribution for water utilities

12. The Statement of Net Assets is a “snapshot” of the utility on the last day of the fiscal year NET ASSETS ASSETS LIABLITIES STATEMENT OF NET ASSETS Things we own of value Things we owe The Assets – Liabilities = Net Assets (also, called Fund Balance or Fund Equity)

13. Common “Funds” in Water Utilities What is a “fund”? • Like a separate division – fully separate set of books What are common funds in utilities? • Water Fund • Sewer Fund • Recycling Fund • Wastewater Fund • Capital Projects Fund • Debt Service Fund • Other special purpose funds

17. Statement of Cash Flows • Shows Sources and Uses of Cash • Operating, Non-Capital Financing, Capital Financing, Investing • Change in cash from prior year to current year • Many agencies budget on a basis similar to the cash flow statement

18. Footnotes • Explanation of funds, accounting policies and other definitions • Investment categorizations & credit risk • Potential & actual contingent liabilities • Pension and OPEB funding status • Detail of long-term liabilities and other major items on the Statement of Net Assets • Transfers between Funds • Major contractual commitments

19. Statistical Section • 5-10 years history for a variety of financial information • Net asset (fund balance) trends • Revenue/expense trends • Principal employers/taxpayers • Population/demographics/economic info • Employee count by department • Other operating indicators

20. PART 2 PREPARING AND UNDERSTANDING BUDGETS

21. BUDGETS • The budget is one of the most important documents that a government prepares. It describes what services will be provided, what those services will cost, and how they will be funded. • The budget is an important planning tool, both for internal and external users. • Allows the entire organization to be involved in the planning process. • No rules to follow like the financial statements!

22. BUDGETS The budget focuses on projected revenues and expenses for the fiscal year (generally do not budget Statement of Net Assets) There a two types budgets prepared: Operating Budget – the next fiscal year (some budgets are two year budgets) Capital Budget – covers the next five years or more

23. The Budget Process • Budget calendar is created; process usually starts in January • Current year revenues and expenses are analyzed and projected through year-end in each department • Reserves are analyzed and future sources and uses are determined • Expenses are separated into fixed and variable components (fixed are easier to budget than variable) • Known changes in the next fiscal year are incorporated

24. Finance Dept Human Resources GM- Director GM & Admin Board- Council Operations Billing IT

25. REVENUES BUDGET

26. EXPENSES BUDGET

30. VARIANCE ANALYSIS

31. After the Budget is Adopted • The budget is monitored each month to determine whether the utility is on target with projections • A variance analysis (difference between budget and actual) is prepared monthly • Budget amendments and transfers may take place throughout the year • Generally, utility management must get Board approval to exceed budgeted expenses over a certain threshold

32. Part 3 Emerging Issues and Trends in Water Utility Finance

33. CONSERVATION- THE DOUBLE EDGED SWORD INCREASE COSTS AND DECREASED REVENUES – PROP 218 PROCESS OPEB LIABILITIES AGING INFRASTRUCTURE RESERVES ECONOMIC CHALLENGES FOR WATER UTILITIES

34. OPEB LIABILITIES • GASB 45 – new accounting rules that require the recording of Other Post Employment Benefits (OPEB) • Indicates whether these benefits are “funded” or “unfunded” • Has a huge impact on utilities that have not been funding future benefits (have been “pay-as-you-go”)

35. City of San Diego – OPEB(in thousands)

36. City of San Diego Unfunded Pension Liability (PERS) The City’s unfunded pension liability remains a significant obligation of the City. The City has aggressively confronted this deficit, fully funding the City’s Annual Required Contribution (ARC) beginning in fiscal year 2006, and has made significant additional payments in excess of the ARC into the pension fund in certain years.

37. Increased Costs / Decreased Revenues • Cost of water is increasing dramatically • Pension & OPEB expenses are increasing • Conservation is resulting in decrease of unit sales • Other revenues are decreasing • property taxes • developer fees • investment income

38. CONSERVATION ISSUES – Have We Gone Too Far? Units of Water Sold Cost of Water = Less Cash Flow

39. Double Edged Sword! As volume of water sold goes down, revenues collected also goes down. How will we pay for expenses and capital projects? Fund Reserves??

40. Options? • Cut costs across all departments • Employee furloughs, unfunded positions • Salary reductions, decrease in benefits • Two tiered pension and benefit systems • Defer asset maintenance • Defer capital projects • Restructure rates to Tiered System • Water budget rate structures • Raise rates, pass through costs

41. Prop 218

42. RATE STABILIZATION TYPICAL RESERVE CATEGORIES CAPITAL IMPROVEMENTS EMPLOYEE BENEFITS OPERATING SELF INSURANCE DEBT SERVICE EMERGENCY ASSET R&R

43. Why Adopt a Formal Reserve Policy? • Objectives of a Reserve Policy: • Establishes sound formal fiscal reserve policies, which will be the foundation that ensures strong fiscal management and policies that guide future utility decisions. • Builds adequate reserves over time. This action will provide the utility with resources to help stabilize the organization’s finances, and position it to absorb economic downturns or large-scale emergencies. • Helps the utility meet its short-term and long-term obligations, and to ensure that the utility maintains the highest possible credit rating.

44. Procedures • Procedures for accounting for reserves: • The Finance Department performs a reserve analysis annually to be submitted to the Board/Council. In addition, a reserve analysis is generally required upon the occurrence of the following events: • (1) Board review of the annual budget; • (2) Presentation of the annual audited financial statements; and • (3) When a major change in conditions threatens the reserve levels established by policy. • The annual review determines if the funding levels are still appropriate and aligned with Board/Council goals and objectives. Interest generated in each reserve usually goes to the Operating Fund for operating use, unless otherwise stated.

45. Reserve Types • Most agencies separate their reserves into Operating and Capital, and are reported under three categories: Undesignated, Designated, and Restricted categories, which are described as follows: • 1. Undesignated Reserves: No designations or restrictions • 2. Designated Reserves: Designated reserves are reserves that are established and set aside to be used only for a specific, designated purpose. • 3. Restricted Reserves: Restricted reserves are reserves that are restricted by an outside source, such as by statute, court, or contract. • In addition, most reserves are categorized as Non-Capital or Capital

46. How Much is Enough? • Most agencies set thresholds for reserves in combinations of the following: • 1. Target: Desired (ideal) level of reserve. • 2. Minimum: The ideal minimum amount that would be maintained in the reserve. Sometimes called a “floor”. • 3. Maximum: The ideal maximum that would be maintained in the reserve. Sometimes called a “cap” or a “ceiling”. • Following are an example of some reserve funds that water agencies commonly utilize:

47. Designated - Operating Reserves Operating Reserve: Covers operating costs for an established period of time. Many utilities adopt a minimum operating reserve balance that covers 60 – 180 days of operating expenses. This reserve aids in maintaining minimum day-to-day operations in the event normal cash flows are interrupted or reduced.Generally, these funds should not be used to finance ongoing utility expenses, except in fiscal hardship periods, in order to sustain desired service levels. The GFOA (Government Finance Officers Association) recommends 8%-17% of operating expenditures as a minimum in an operating reserve

48. Designated - Operating Reserves Cont’d. Water Rate Stabilization: Covers the smoothing of water rates in the event of short to mid-term revenue loss, property tax revenue loss and higher than anticipated budget costs that cannot be supported by normal revenues. Some utilities dedicate penalty billings to this reserve to help smooth the variations in billings and collections. Emergency/Contingency: For immediate reconstruction and/or support from a catastrophic event or circumstance. This reserve assists in covering emergency cash until other financing can be obtained. Employee Benefits and OPEB: Covers sick and vacation leave-time liability, other post employment benefits obligations (OPEB), and accrued compensatory time.

49. Restricted Reserve – Debt Service Debt Service: Covers the 2008 COPS Official Statement requirements to maintain $2.1M in trust for the life of the bonds to serve as “insurance” to the bondholders. This reserve cannot be spent and must be maintained for the life of the bonds.

50. Designated - Capital Reserves • Asset R/R: This reserve is generally used for planned capital repair and replacement of the utility facilities. Usually funded each year at a level amount from water rates, and drawn down as needed for capital repair and replace-ment. Helps ensures that ratepayers pay a consistent amount for asset R&R each year, even though the actual costs will likely fluctuate from year to year. • A separate capital outlay (vehicles & equipment) reserve may be maintained. • The reserve might be separated between water system facilities and administration facilities.