Reserves vs Borrowing


Reserves vs Borrowing

As water and sewer utilities, the public health and safety of our customers is our priority – it is both a legal and moral responsibility. The economic stability and growth of our community depends on reliable services or high quality. The priority is not the same with private business. Private businesses have a fiduciary responsibility to their stockholders, so cutting services will always be preferred to cutting profits. Therein lies the difference and yet the approach is different. Many corporations retain reserves for stability and investment and to protect profits. Many governments retain inadequate reserves which compromises their ability to be stable and protect the public health and safety.
Unlike corporations, for government and utilities, expenses are more difficult to change without impacting services that someone is using or expects to use or endangering public health. Our recent economic backdrop indicates that we cannot assume income will increase so we need to reconsider options in dealing with income (revenue) fluctuations. If there are no reserves, when times are lean or economic disruptions occur (and they do regularly), finding funds to make up the difference is a problem. The credit market for governments is not nearly as “easy” to access as it is for people in part because the exposure is much greater. If they can borrow, the rates may be high, meaning greater costs to repay.
Reserves are one option, but reserves are a one-time expense and cannot be repeated indefinitely. So if your reserves are not very large, the subsequent years require either raising taxes/rates or cutting costs. An example of the problem is illustrated in Figure 1. In this example the revenues took a big hit in 2009 as a result of the downturn in the economy. Note it has yet to fully return to prior levels as in many utilities. This system had accumulated $5.2 million in reserves form 2000-2008, but has a $5.5 million deficit there after. Reserves only go so far. Eventually the revenues will need to be raised, but the rate shock is far less if you have prudently planned with reserves. You don’t get elected raising rates, but you have a moral responsibility to do so to insure system stability and protection of the public health.
So home much is enough for healthy reserves? That is a far more difficult question. In the past 1.5 months of operating reserves was a minimum, and 3 or more months was more common. However, the 2008-2011 economic times should change the model significantly. Many local governments and utilities saw significant revenue drops. Property tax decreases of 50% were not uncommon. It might take 5 to 10 years for those property values to rebound so a ten year need might be required. Sales taxes dropped 30 percent, but those typically bounce back more quickly – 3-5 years. Water and sewer utilities saw decreases of 10-30%, or perhaps more in some tourist destinations. Those revenues may take 3-5 years to rebound as well. Moving money from the utility to the general fund, hampers the situation further. Analysis of the situation, while utility (government) specific, indicates that appropriate reserves to help weather the economic downturns could be years as opposed to months.
The conclusion is that governments and utilities should follow the model of trying to stabilize their expenses. Collect reserves. Use them in lean times. Develop a tool to determine the appropriate amounts. Educate local decision-makers and the public. Develop a financial plan that accounts for uncertainty and extreme events that might impact their long-term stability. Take advantage of opportunities and most of all be ready for next time. In other words, plan for that rainy day.

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