Reserve funding was included in the range of data collected as part of the 2012 Utility Rate Survey. Survey participants were asked to identify whether or not they routinely fund reserves through their water or wastewater utility, and if so, what they used as the reserve target(s).
Figure 1 presents the percentage of survey respondents from small systems (populations less than 5,000) and large systems (populations greater than 5,000) that indicated that they do fund reserves through their utility. Their operating reserve targets varied greatly, with some utilities reporting fixed annual amounts and some reporting a fixed percentage of total operating expense. Of the latter, these ranged from 15 to 30 percent of annual operating expense.
Customizing Reserve Targets
The industry guidelines and comparable data are a good starting point for customizing reserve targets for your utility. However, a well managed organization should take the time and effort to identify those conditions and situations that could have a substantial financial effect on the revenues and expenditures and customize its reserve targets accordingly. It should also be noted that a water utility may need to set its operating reserve or rate stabilization reserve at a higher level than a wastewater utility due to more drastic seasonal cash flow variation caused by overly wet or severe drought conditions.
Another good rule of thumb to consider when setting reserve targets is to use benchmarks available from the various credit rating agencies. Because rating agencies favor a higher level of operating reserve when rating utility revenue bonds, Fitch, Moody’s, and S&P all have median levels for “days cash on hand” that provide some insight on reserve funding. Fitch Ratings provided a median days cash on hand for AA-rated water and sewer agencies of 266 days. The amount is calculated as: Days Cash on Hand = $ Ending Fund Balance / ($ Annual O&M Expenses / 365)
Once reserve goals are established, the utility needs to gain support from policy makers for implementing the desired reserve targets. Often, the subject of maintaining financial reserves is politically charged; therefore, clearly defining the reasons for holding extra cash will be in the utility’s best interest. In addition, it may be necessary to develop a well-outlined policy statement for consideration and adoption. One good strategy is relating the reserves directly to the operations and emergencies that may affect the utility in the future. In addition, citing specific examples where reserves were used in the past to rectify an emergency capital failure or cover unanticipated operating expenses due to conditions beyond the control of the utility, such as a drought or flood, may be key to gaining support from policy makers.