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Memorandum #869

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Memorandum #869

    State of North Carolina

    Department of State Treasurer

HARLAN E. BOYLES State and Local Government Finance Division ROBERT M. HIGH

     TREASURER and the Local Government Commission DEPUTY TREASURER

    Memorandum #869

    August 12, 1998

MEMORANDUM

TO: Officials of Municipalities with Water and Sewer Systems

FROM: T. Vance Holloman, Director

     Fiscal Management Section

SUBJECT: Statistical Information on Water and Sewer Operations

    The following two reports have been prepared by our office to assist you in evaluating the overall financial condition and results of operations of your municipal water and sewer system:

     1) Financial Results and Key Ratios of Municipal Water and Sewer Systems

     2) Analysis of Capital Outlay Expenditures of Municipal Water and Sewer Systems.

    These reports include key financial ratios for your water and sewer system along with the corresponding statewide and population group averages. In calculating the statewide and population group averages, we segregated municipal water and sewer systems into one of two groups: municipalities with electric systems and municipalities without electric systems. In addition, we further segregated units in both groups into different population groupings. Finally, to give an indication of how your ratios compare to other similar units, we have included a statistical analysis with the first report, which includes the minimum, maximum, median, mean, and standard deviation for the items presented.

    For statistical information in this report to be meaningful, financial reporting between local governments must be consistent. We are concerned that some local governments may not be using appropriate financial reporting practices in two areas: accounting for reimbursements and quasi-external transactions and accrual of unbilled water and sewer services.

Accounting for Reimbursements and Quasi-External Transactions

    If the General Fund provides administrative services for the Water and Sewer Fund, payments for these shared services should be allocated correctly between the two funds. These payments should not be accounted for as operating transfers. The appropriate accounting treatment involves recording expenditures or expenses in the reimbursing fund (e.g., Water and Sewer Fund) and reductions of expenditures or expenses in the fund that is reimbursed (e.g., General Fund). The failure to properly record reimbursements understates the costs of operations in the Water and Sewer Fund. In addition, it 325 North Salisbury Street, Raleigh, North Carolina 27603-1385 (919) 733-3064 COURIER # 56-20-45 (FAX (919) 715-0229)

    An Equal Opportunity / Affirmative Action Employer

overstates expenditures in the General Fund, which causes fund balance available for appropriation as a

percentage of

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    expenditures to be understated. Furthermore, transactions that would be treated as revenues, expenditures, or expenses if they involved organizations external to the municipality, such as payments in lieu of taxes from the Water and Sewer Fund to the General Fund or water and sewer sales to other funds of the municipality should be accounted for as revenues, expenditures, or expenses in the funds involved. For example, the municipal use of water and sewer should be recorded as operating revenues in the Water and Sewer Fund and as expenditures in the General Fund. For further information on this subject, see Memorandum #717, “Accounting Issues”.

Accrual of Unbilled Water and Sewer Services

    Since the Water and Sewer Fund operates in a manner similar to a commercial business, it should generally follow financial reporting standards similar to those for commercial organizations. These standards require that the full accrual basis of accounting be used and that revenues be recorded when they are measurable and earned. In the Water and Sewer Fund, revenues and receivables should be accrued at the end of each month for services provided to customers even if the customers have not yet been billed. If a municipality has provided services to its customers, it has “earned” the revenues for these services and should record a revenue and receivable. The failure to record such unbilled receivables results in a misstatement of the Water and Sewer Fund financial statements because expenses that have been incurred are recognized while the related revenues and receivables are not recognized.

How to Interpret Figures in this Report

    In analyzing the statistics in this memorandum, the amounts for your unit for the 1996-97 fiscal year should be compared to your population group averages and to statewide averages. In addition,

    you should compare these results to amounts for the two prior years and the financial results for the 1997-98 fiscal year. The mean and standard deviation statistics should be analyzed to determine if the amounts for your unit are significantly above or below the amounts reported by other units. The amounts reported for a unit may be significantly out of line if they are more than one standard deviation above or below the mean. If an amount is determined to be significantly out of the line, the reasons for the variance should be investigated. However, a signification deviation from the mean is not necessarily an indication of a financial weakness, but instead may be an indication of a significant event having taken place, such as major capital improvements to the water and sewer system. It should be noted that even though there may be variations from one unit to another in the accounting policies used to arrive at the figures presented in this report, the effects of such variations should not materially affect the overall comparability of these statistics. In analyzing this report, the following items should be considered:

    Report 1 - Financial Results and Key Ratios of Municipal Water and Sewer Systems

(Note: See “Key to Water and Sewer Financial Statistics” for definitions.)

Financial Results

    a. Operating margin. This ratio is an indicator of the profitability of a unit’s water and sewer operating activities. If a unit’s operating margin is significantly below the amounts for other similar units, it may be an indication that user fees are too low and/or that operating expenses are too high.

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    b. Operating transfers in (out). This ratio shows the net operating transfers made from (to)

    all other funds of the municipality. A positive ratio gives an indication of the extent to which the water and sewer fund is being subsidized by other funds. A negative ratio gives an indication of the extent to which the water and sewer fund is being used to subsidize other funds.

    c. Net income. This ratio is an indicator of the overall profitability of the water and sewer system after payments are made for operating expenses, interest on long-term debt, miscellaneous expenses, and operating transfers to (from) other funds.

Key Ratios and Cashflow

d. Quick ratio. This ratio gives an indication of the water and sewer system’s ability to pay

    its current bills, thereby providing a measure of short-term liquidity. Because the quick ratio is a snapshot of the system’s liquidity at a point in time, it may vary considerably throughout the year. A widely accepted minimum benchmark for the ratio of quick assets to current liabilities is 2 to 1; in other words, a water and sewer system should have at least $2 in quick assets for each $1 of current liabilities.

e. Days sales in receivables. This ratio gives an indication about how quickly payments are

    being collected. Each unit should have procedures in place to ensure that customers will make payments within the prescribed due date. If this ratio is much greater than the maximum number of days allowed before payment is due, the unit may be inefficient in collecting payments from customers. The inability to convert receivables into cash on a timely basis negatively affects cash flows, and therefore, investment earnings. Instances where this ratio is significantly lower than the maximum numbers of days allowed may be an indication that unbilled receivables have not been recorded in the financial statements at the end of the fiscal year.

    f. Days cash on hand. This ratio provides an indication of the adequacy of a water and sewer system’s unrestricted cash and investment balances. A water and sewer system needs to maintain adequate cash and investment balances for working capital purposes and to enable it to survive a prolonged economic downturn or to take advantage of strategic opportunities.

g. Cashflow from operations. This statistic measures the liquidity of a water and sewer

    system’s operations before any effects of cash used for or provided by capital acquisitions/sales or debt financing. Non-cash charges (i.e. depreciation expense) are also added back to net operating income to arrive at cashflow from operations. A relatively small or negative cashflow can be an indicator that fees for services are insufficient to adequately cover the costs of day-to-day operations. It can also be an indicator of excessive operating costs. Comparisons should be made to similar-sized units to determine areas for cost-savings and improved efficiencies.

    h. Debt to equity. This ratio provides an indication of how strong a unit’s water and sewer finances are by comparing what it owes to the amount of its fund equity. Fund equity may result from operations or from capital contributions for the construction or acquisition of fixed assets. It is typically used by lenders in evaluating risk. A high ratio may be an indication of above average debt levels and increased risk.

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    i. Debt per capita. This ratio provides an indication of the extent to which debt financings have been used to pay for water and sewer capital improvements.

     Report 2 - Analysis of Capital Outlay Expenditures of Municipal Water and Sewer Systems

    j. Capital outlays. This report shows capital outlays made in each of the last five fiscal years as reported on the Annual Financial Information Report (AFIR). Units should continue to make capital improvements to their facilities and are encouraged to utilize sound management practices by adopting long-range capital improvement plans to address their projected needs. Situations where capital outlays are not being made on a somewhat consistent or periodic basis might indicate the lack of a capital improvements plan.

1997 Financial Results

    On a statewide basis, municipal water and sewer systems posted strong earnings for the fiscal year ended June 30, 1997, with an average operating margin of 13.4 percent. However, the financial results varied significantly according to population with the smallest units, on average, continuing last year’s trend of larger operating deficits and a higher level of operating subsidies from other funds (See Table 1).

     Table 1

     Average Financial Results of Municipal Water and Sewer Systems

     For the Fiscal Year Ended June 30, 1997

     As a % of Operating Revenues

     Average Operating

     # of Operating Operating Transfers Net

     Population Groupings Units Revenues Margin In (Out) Income

     StatewideAll Units 401 $2,096,126 13.4 1.6 15.0

     Units With Electric Systems:

     All With Electric 67 3,654,878 14.3 6.4 20.3

     10,000 and Above 22 9,013,188 15.5 7.7 21.9

     2,500 to 9,999 23 1,755,959 12.6 0.4 14.3

     2,499 and Below 22 281,801 (10.0) 4.3 7.6

     Units Without Electric

    Systems:

     All Without Electric 334 1,780,609 12.9 (0.4) 12.8

     50,000 and Above 9 33,239,610 14.2 0.5 12.6

     10,000 to 49,999 19 5,769,581 17.7 (1.3) 17.0

     2,500 to 9,999 81 1,429,346 11.8 (1.4) 14.7

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     1,000 to 2,499 86 514,518 4.4 (1.1) 5.5

     500 to 999 79 204,204 (4.1) (3.0) (1.1)

     499 and Below 60 85,512 (8.1) 4.4 (1.6)

    The operating deficits reported by the smaller units is an indication that either their user fees were too low, their operating expenses were too high, or a combination of both. Municipalities within the same geographic location should consider merging their water and sewer operations and creating a regional water and sewer system. In addition, if the corresponding county provides water and sewer services, the regional system could include the county as well. By establishing a regional water and sewer system, units could realize significant economies of scale, thereby reducing their operating costs and increasing their earnings.

Units on Moratorium List

    As of June 1998, the following units were on the moratorium list prepared by the North Carolina Department of Environment and Natural Resources, Division of Water Quality:

     Bath Gastonia Rowland

     Belhaven Gibson Seaboard

     Bessemer City Henderson Spindale

     Bethel Hendersonville Spruce Pine

     Beulaville High Shoals Stanley

     Bladenboro Jefferson Stoneville

     Boiling Springs Lenoir Tryon

     Boone Mocksville Wallace

     Chadbourn Mount Gilead Walstonburg

     Clarkton Mount Olive Warsaw

     Denton Murphy Waynesville

     Elizabethtown North Wilkesboro West Jefferson

     Elm City Old Fort Whiteville

     Fairmont Oriental Wilson

     Faison Pinetops Yadkinville

     Fremont Ranlo Yaupon Beach

     Reidsville

    For additional information or assistance concerning this memorandum, please contact Tim Romocki at 919/715-3741.

The two reports referenced on page 1 of this memorandum were distributed to each

    municipality that operates a water and sewer system. Each unit received their particular reports. The individual reports for all units are available upon request by contacting Margo Pope at 919 715 3744. The entire report listing all 401 municipalities is available on the Local Government Commission’s website at

     http:// www.treasurer.state.nc.us/Treasurer/lgc/memo.htm.

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cc: Certified Public Accountants

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    Key to Water and Sewer Financial Statistics

    Financial Results - This data was compiled for the Water and Sewer Fund from the unit’s audited financial statements.

    Total operating revenues

    Charges for services plus other operating revenues.

    Total operating expenses

    All operating expenses including depreciation and the provision for bad debts.

    Operating margin

    Total operating revenues less total operating expenses.

    Operating transfers in (out)

    Total operating transfers in less total operating transfers out.

    Net income

    Total operating and nonoperating revenues less total operating and nonoperating

    expenses plus operating transfers in less operating transfers out.

    Key Ratios and Cashflow - These ratios and amounts were compiled for the Water and Sewer Fund by the staff of the Local Government Commission from audited financial statements.

    Quick ratio

    Total quick assets

    Total current liabilities

    Note: Quick assets do not include inventories or prepaid items.

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    Key to Water and Sewer Financial Statistics (continued)

    Days sales in receivables

    Net customer accounts receivable x 365

    Charges for services

    Days cash on hand

    Unrestricted cash and cash equivalents x 365

    Total operating expenses less depreciation and amortization expenses

    Cash flow from operations

    Total operating revenues less total operating expenses plus depreciation expense

    along with changes in receivable, prepaid, inventory and payable balances that

    effect cash balances.

    Debt to equity

    Total long-term debt

    Total long-term debt plus fund equity

    Debt per capita

    Total long-term debt

    Total municipal population

    Group and statewide averages - These amounts were compiled by the staff of the Local Government Commission from audited financial statements.

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