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November 12, 2010 Article 3 min read

The efficient collection and distribution of water, as well as the treatment of waste water, are essential to every community. It’s important that municipalities establish fee structures that will provide adequate revenue and cash flow to ensure dependable, high quality service. For many municipalities, the established rate structure often fails to cover the true cost of providing services.

Why do disparities arise? The fact that customers are becoming savvier about water and energy conservation coupled with the unforeseen dip in the economy has yielded lower consumption industry wide. In addition, unanticipated capital improvements or emergencies create unforeseen cash requirements. When setting rates, there’s simply not as much room for error as there was just a few years ago. Most communities no longer have the luxury of borrowing from other funds if the system is running low on cash, as those former sources of cash flow are now drying up.

What should your fee structure cover and what should it look like? A utility rate study can help you find the answer.

A utility rate study will help your community identify a rate structure that will adequately cover the cost of providing services to users. This includes the long-term hidden costs and those items many entities fail to consider when setting rates. It’s a methodical business approach that considers many variables including current and future operations, demand, anticipated maintenance, capital requirements, and debt service commitments. If it’s done right, it’s done through a model that will allow for various scenarios to be considered in an easy manner. This analysis is invaluable for any municipality that’s ever felt the pain of having to justify significant, unanticipated rate increases to the users of a system. In addition, once the model and methodology are in place, subsequent rate increases can be smoothed so that future rate increases do not impact users as much from year to year.

What does a study entail?

A utility rate study involves collecting and analyzing a significant amount of data in such a way as to facilitate the understanding of potential financial scenarios. Considerations would include:

  • Gaining an understanding of your unique system. (For example, do you purchase water, treat water, send it to a neighboring municipality for treatment, treat waste water yourself, or some combination of these or other situations?)
  • Thoroughly evaluating the activity within the system, including the flow and use of cash to get an understanding of expense and revenue streams.
  • Understanding and defining anticipated capital needs and the true long-term effect of issuing debt to cover these needs.
  • Anticipating trends over the next five or so years. For example, do you see the use of water increasing or decreasing? Do you anticipate that personnel levels will increase, decrease, or remain the same? What happens if you lose the system’s biggest customer or if they ask for a discounted rate?
  • Understanding the system’s need for cash and also cash reserves. This includes formulating an industry-acceptable approach to determining “target” reserves.

This data is then analyzed with respect to the community’s needs on a general ledger account level basis over an extended period of time (usually five years).

Initiating the study to find your answers

While it’s possible for a municipality to conduct their own rate study, it can be challenging for the following reasons:

  • There’s a tendency to rely on historical data, which can be irrelevant. This is a forward-thinking process, not one that should be dependent on how you did things yesterday.
  • If you’ve never completed a study in the past, you may not be familiar with the defendable best practices and the generally accepted assumptions and approaches. At the end of the day, you’ll have to defend your study to the customers.
  • The result of these studies may be a recommendation for a rate increase. Unanticipated rate increases can put elected officials and management in a tough position. While users may not ever welcome a fee increase, it can be more palatable when the recommendation is a result of an independent study from a reputable third party.

Something to think about

A utility rate study will provide you with an accurate picture of your current situation. More importantly it will yield the objective analysis of data you need to weigh your options and develop a long-range plan for delivering utility services to your community. Based on our years of experience conducting rate studies, we have developed an approach centered around an electronic, Excel-based, long-term financial model. We can customize the approach and the resulting model to fit the specific needs of your community.

In addition, we can teach you to use it without our assistance on a go-forward basis. This will allow you to analyze your situation as conditions change in the future.