What’s a Budget and Why Do I Need One?
A budget is a necessary component of properly managing any water system (drinking water, wastewater, or stormwater) and involves forecasting revenues and expenses for the coming year. The budget also helps to ensure appropriate spending levels on the utility’s highest priority concerns. While a budget may be required by state law for some or all utilities, that’s not the most important reason to have one. Elected leaders, governing boards, or any other entity that has final decision-making authority over the finances of the utility should require a budget, approve and formally adopt it, and request and review regular reporting from staff on whether expenses match the budget. Without this information, decision-makers are flying blind and may end up unable to deliver the required service to their customers.
The budget provides a variety of benefits to everyone in the utility, especially those in management, finance, and the ultimate decision-makers. Specific benefits include, but are not limited to the following:
- Greater knowledge of the water utility’s financial picture
- Improved control of expenditures
- Understanding how much money will be needed over the next year
- Prioritizing where revenues will be spent
- Understanding where revenues will come from to cover the necessary expenses
- Addressing medium- and long-term events, such as repairs, replacements, and capital projects
- Addressing needed funding for any regulatory impacts (either existing or new regulations)
Getting Started:
A budget can be prepared from last year’s estimated budget and actual expenditures, or it can start over from zero and be built from there. There are advantages and disadvantages of each starting place. Starting from last year’s budget and escalating the amounts by a set factor is a common strategy used to create next year’s budget because it is simple and takes less resources. However, this approach relies heavily on historical knowledge of spending practices which may or may not reflect future expenditures very well. Additionally, using last year’s budget may miss the need to spend more money in one category and less in another, changes in efficiencies that have occurred over the prior year, differences in how inflation or price increases have affected one portion of the budget compared to another (for example, fuel costs may have increased more than salaries or vice versa), and encourage personnel to spend every dollar in their budgets, even if it isn’t truly necessary. The common thinking is “if I don’t spend all my money, my budget may be cut next year so I have to spend all my money by the end of the year.” However, this may not always be the case.
Zero-based budgeting (starting each year with a clean slate and building the budget from there) takes a higher level of staff resources, but can provide a clearer picture of what the utility needs to spend for each budget category without a bias towards last year’s funding priorities and eliminates inefficient expenditures when there is extra money left in a budget category. This approach may require individuals (or department heads in larger utilities) to justify their expenditures before receiving money in the budget. It is also necessary to ensure that long-term needs, not just short-term needs, are included in the budget. In a traditional budget process, long-term needs carry over from year to year so additional money can be budgeted for them. With zero-based budgeting, the long-term needs may get lost since they have to be added in each year and no one may be advocating for them.
Either approach can work for your utility—you just need to think about ways to mitigate the disadvantages and enhance the positives of the approach you take.
Who should be involved in the Budgeting Process?
The answer to this question is “it depends.” If the system is very small (say less than 500 people), the system is unlikely to have a financial department and may not have anyone whose sole job is to oversee financial matters. In these cases, board members, city/town/village councilors, a city/town/village manager, or similar types of role(s) will probably be involved in developing the budget.
As the system size increases, the system may have individuals who are more specialized in financial matters and can develop the draft budget. With any sized system, operations and management staff must be able to contribute input for the budget and share pertinent information about the needs of the system over the coming year and any long-term needs that must be budgeted each year. If the system is large enough to have multiple departments, each one should provide input regarding their own particular needs.
Once a draft budget is made, it should be reviewed thoroughly to ensure it fits the needs and priorities of the governing body and the community it serves. It must also balance revenues and expenses with some funding remaining for deposit into reserve accounts (e.g., emergency reserves, operating capital reserves, and debt service reserves). Once the budget is in its final form, it needs to be formally adopted by the governing body.
Comparing Actuals to Budgeted Expenses:
Once a budget is adopted, expenditures should be logged against the budget categories to enable a comparison of actual expenditures to budgeted expenses. To be able to complete this comparison, it is necessary to have the budget contain the same categories as the system of accounts used in the utility’s financial reports. This information should be used to check actual expenditures against monthly expenditures on an ongoing basis. A monthly check is a good time horizon, but if that is not possible, quarterly checks should be completed. These checks are important because the system is able to evaluate their progress and can complete any mid-course corrections needed to align expenditures in various categories. At the end of the year, a thorough evaluation should be done to determine when and why expenses did not match budgeted categories. This information can then be used to adjust future budgets.
If the utility does not currently have a system in place that can record revenue and expenses into appropriate categories, it should create one. Categories can include items such as:
- Salaries and wages – operations
- Salaries and wages – administrative
- Contract services
- Chemicals
- Supplies
- Vehicle expenses
- Utilities (e.g., power, natural gas, etc.)
- Repairs and Maintenance
This is just a short list of potential categories; there are several others that can be used. There are commercial products available to help utilities create a system of accounts to track revenues and expenses that range extensively in terms of costs and included features. A small system would be looking for an inexpensive product that does the basics, while a larger system may want a bit more sophistication in which the benefits of the information outweigh the costs of the program.
Some general features that should be included in a program are:
- Ability to specify budget categories
- Match technical ability of available staff
- Match the technical resources (e.g., type of computers and computer systems, cloud vs. on-premise data storage)
- Enable the utility to track expenses and revenues in categories and compare those categories to the budget
- Match the financial resources available (now and ongoing)
- Fit the size and type of utility and its level of complexity
It can be helpful to check with neighboring systems or systems of similar sizes and capabilities to see how they have set up their financial systems and which computer programs they are using. Or, if your system is looking to buy something, it is very important to ask for a demonstration and references, especially references similar to you. Ask the references very specific questions about items such as; ease of use, time commitment, customer support, up-front and ongoing costs, and initial set-up and training.
Summary
Every water utility (drinking water, wastewater, or stormwater) needs to have a budget. It is a valuable tool to ensure that money is being spent efficiently, effectively, and on the priorities of the utility and its customers. Actual expenditures should be routinely checked against budgeted amounts at least quarterly (though monthly is optimal). If a utility does not have a system of accounts that will allow it to track revenues and expenses in categories, it should obtain one.
A budget can be built off last year’s budget, taking into account any revisions needed based on reviews of past expenditures in addition to reviewing actuals against budgeted amounts, or it can be a zero-based budget in which the budgeting process starts from scratch each year. There are pros and cons of each that should be considered in making the choice.
The budget should be built with input from personnel knowledgeable about finance, operations, and management. That might be a few people in a small system or include board members, or it might be a financial department with input from other departments in a large system.
Stay Tuned for Blog #2 in this series that will discuss creating the budget.