A Quick Review of the Series So Far
A budget involves forecasting revenues and expenses for the coming year and helps to ensure appropriate spending levels on the utility’s highest priority concerns. The budget provides a variety of benefits to everyone in the utility (especially those in management, finance, and the ultimate decision-makers) including providing greater knowledge of the water utility’s financial picture and improved control of expenditures. A budget can be prepared from last year’s estimated budget and actual expenditures or it can start over from zero and be built up from there. Building a budget should involve finance personnel (whoever that might be for the utility) to create the budget plus operations and management personnel to provide input into the necessary expenses.
Once a draft budget is created, 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, or debt service reserves). Once the budget is in its final form, it needs to be formally adopted by the governing body.
Expenditures should be logged against the budget categories to enable a comparison of actual expenditures to budgeted expenses. A monthly check is a good time horizon to review actuals against projected expenses, but if that is not possible, quarterly checks should be completed. These checks should allow for mid-course corrections in order to align expenditures in various categories.
The first blog in this series, “Getting Started”, should be reviewed as a first step for guidance about getting started with the budget process.
Creating a Budget – Helpful Information:
To get started with budgeting, it is helpful to gather some information about the utility and its finances. Some useful information to assist in developing the budget is listed below:
- Past annual revenues and associated records, e.g., customer billing records, fees collected, penalties paid, and any other revenue income records
- Number of customers/users, divided into billing classifications used by the utility, such as residential, commercial, industrial, institutional
- Amount of water treated (wastewater) and amount of water produced and/or purchased (drinking water)
- Amount of water sold (drinking water) and comparison between drinking water produced and sold and amount of wastewater treated
- Current rate structure in place
- Any plans to change the rate structure in the next year and what the new structure consists of
- Past annual expenses
- Reserve accounts (all that exist, the desired funding amount, and current funding)
Creating a Budget – What Numbers to Use?
If the budget is being created using a zero-based approach, the budget needs to be developed using the best available knowledge of what revenues and expenses are likely to be. It is not based directly on last year’s numbers. However, if the budget is going to be generated out of previously created budgets and actual expenditures from past years, it is necessary to examine the prior year’s budgets and actuals.
We must step back a bit to understand the timing of a budget. If the budget is being created for a fiscal year (a very likely scenario for governmental entities), the process most likely starts in the winter or spring time frame (i.e., January to March). However, because the current year is not over, there is not a complete accounting for actual expenditures. Therefore, the only year for which there are complete numbers – both budget and actual expenditures is from the prior year. So, next year’s budget is based on last year’s expenses. For example, if it is fiscal year 2026 (July 1, 2025 – June 30, 2026) and you are creating the budget for fiscal year 2027 (July 1, 2026 to June 30, 2027), you will need the budget and actuals from fiscal year 2025 (July 1, 2024 to June 30, 2025). The budget can be created based on FY25 data with supplemental information related to how actuals differed from the FY25 budgeted amounts, plus how the current spending is progressing, and any knowledge of future (i.e., FY27) expected revenues and expenditures that might differ significantly from the past – either higher or lower.
Creating a Budget – Revenues:
Creating the budget requires an examination of both the revenues that are available and the anticipated expenditures. Each component will be explored in this blog. First, the revenue side. The revenues represent the amount of money that will come into the utility from all sources.
The revenues can include any of the following: user fees, hook-up fees, late fees, interest income, taxes (in the case that the utility uses any tax revenue for the purpose of funding water utilities), annual transfers from the general fund into the utility (while this practice is not recommended, if it is done, the revenue should be accounted for), and development fees or impact fees. The revenue should not include any capital dollars received from loans or grants from outside funders.
Revenues from user fees can be fixed or variable or a combination of both. Any money that results from base fees/flat rates is fixed, meaning it is the same for every billing cycle regardless of the amount of water used. Money that is billed and paid based on the amount of water used each billing period is variable, meaning that it is higher or lower depending on the amount of water used. In either drinking water or wastewater rates, the variable portion of the bill is almost always based on drinking water usage, a portion of that usage, or a seasonal quantity of that usage, because sewage quantity is not metered at the individual customer level in most cases. An exception may be large industrial facilities in which sewage may be measured directly.
The fixed portion of the revenue is stable and easy to predict while the variable portion can fluctuate and is less stable. Any changes in the number of customers – either increases or decreases – can change the amount of revenue and should be taken into consideration. Changes in usage may also impact revenues, but utilities should be very cautious about projecting increases in revenues based on increased usage, particularly in the case of wastewater utilities. If customers use more water, often it is for outside uses that do not end up as wastewater (e.g., watering lawns/gardens/plants/trees and pools and hot tubs.) In areas where outside uses are common, wastewater usage may be based on winter average usage when outside uses are minimal. With this type of rate structure, regardless of changes in drinking water usage, wastewater usage will likely be much less affected. In other climates, wastewater might be based on a percentage of drinking water usage and may increase with increased usage.
Revenues should be estimated based on all the available information from past years, anticipated rate changes, anticipated increases or decreases in population, and any other available information. The revenues should never be based on estimated expenses. Revenues and expenses are independent from each other and need to be estimated separately and then compared.
Creating a Budget – Expenses:
The next step after estimating revenues is to estimate the other side – the expenses. A good starting point is comparing last year’s budget and actual expenditures. An inflation factor, which should be the amount you believe things will increase over last year, can be applied equally across all budget categories as a starting point. But this starting point should be adjusted based on knowledge from managers, operators, suppliers, administrators, and any others who have more accurate knowledge of expected increases in particular categories. Considerations for budget increases above or below the inflation percentage can include the following:
- Anticipated pay raises
- Increases in benefit costs (particularly health insurance)
- Training expenses
- Certification/Recertification fees
- Increased staffing requirements
- Utility cost increases (e.g., electricity, natural gas)
- Vehicle fuel price increases
- Vehicle maintenance increases
- Anticipated professional fees (engineering, planning, environmental, legal, financial)
- Membership fees
- Conference attendance fees
- Contract fees for operation or maintenance
- Cost of purchased water if procured by the utility
- Cost of obtaining water rights for additional supply
Another important consideration is a review of any unusual differences between the prior year’s actual expenditures and the budgeted amounts. Small differences are to be expected in many categories, so a few percentage points of difference between budgeted and actuals is fine. However, when a category varies a lot, say more than 15%, a further examination as to why there is such a significant difference is warranted. There can be many reasons for the discrepancy and some of the reasons will have a large impact on forecasting next year’s budget.
A few examples and how they might impact next year’s budget are presented below.
Example 1:
- Budget Differential: The FY25 budget included $2,000 for employee training, but $0 was actually spent on employee training.
- Explanation: When questioned, the manager indicated that he did not make training opportunities available to his employees because they were short staffed and he did not believe they could spare the operator time to attend training.
- Impact on Next Year’s Budget: It is important for operators to receive relevant training every year to improve their knowledge, understand regulatory impacts, obtain or maintain certification, and to improve employee retention. The governing body instructed the manager to ensure that operators receive their required training and increased the budget for training by 10% to allow for extra training since the prior year did not include any training. The manager was also instructed to ensure that the budget for training was used in FY26 (the current year) for relevant and necessary trainings.
Example 2:
- Budget Differential: The FY25 budget included lab fees of $9,200 but actuals were $11,040, a difference of 20%.
- Explanation: The utility faced two issues in FY25. First, the laboratory the utility had been using for analysis closed and a new lab had to be contracted with. The new lab charges higher prices leading to part of the increase in costs. Additionally, the utility faced issues with non-compliance and had to take extra samples.
- Impact on Next Year’s Budget: The increased costs of the new lab must be factored in but the utility has stabilized its regulatory issues and does not anticipate needing additional samples in FY27. Therefore, the budget increase will be 12% in FY27.
Example 3:
- Budget Differential: The FY25 budget included operations salary and wages of $86,000 but actuals were $65,000, a difference of approximately 25%.
- Explanation: The utility lost an employee part way through FY25 and despite trying, they were not able to hire a replacement. Therefore, money went unspent.
- Impact on Next Year’s Budget: The utility finally replaced the employee in FY26 but was forced to pay higher wages to attract the person. Therefore, a budget increase of 15% is necessary to cover the operations salary and wages for FY27.
The budgeted expenses should consider all categories the utility tracks and all pertinent information about each category. The budget should be as accurate as the utility can make it. It is not helpful to misrepresent expenses, either higher or lower, because when the expenses hit, money will have to be obtained from somewhere to cover the cost that was not budgeted, which can be very disruptive to operations. Unnecessarily including a cost that is not anticipated to “pad the budget” will erode trust and may result in less money in other budget categories the next year.
Summary
Building off of last year’s budget is one method of creating next year’s budget, but care must be taken to ensure a full review of anticipated revenues and expenses. Overestimating revenues can have severe consequences if the revenues do not materialize. The system may find itself in serious jeopardy of financial shortfall, which will require taking money out of reserve accounts (if these exist, and hopefully they do!) or severely cutting expenses, which can impact operations and the utility’s ability to meet customer expectations.
Care must also be taken to ensure that expenses consider last year’s budgets and actuals and the comparison between the two. Expenses should reflect, to the extent possible, all the knowledge available regarding anticipated expenditures.
If the utility uses zero-based budgeting, the slate should be wiped clean each year and the budget should be built from scratch based on the knowledge of anticipated revenues and expenses for the upcoming year.
Stay Tuned for Blog #3 in this series that will discuss depreciation, reserve accounts, and balancing the budget.