FINANCIAL MANAGEMENT/Running the numbers
Managing capital improvement costs is one of the most daunting tasks a city administrator, planner, engineer, utility director or other municipal manager faces. Often, municipal officials do not truly understand the financial impact capital improvements will have on future tax rates. In addition, alternative funding scenarios or savings that can be realized over time from capital improvements are not always apparent to the municipal official approving the budget.
One remedy is financial modeling, an electronic program developed to ascertain the monetary impact on rates over time from certain capital improvement or operating decisions. The models typically cost between $15,000 to $40,000 depending on the format and extent of financial data available to build it. Although the model requires technical expertise to develop and initiate, once programmed, it is easily updated.
Financial models can simulate the actual dynamics of a utility or municipality. They allow decision makers to test the financial impact of any assumption, providing immediate feedback about alternatives and their effects on rates. The financial impact of alternative assumptions is based on measurements such as annual reserve levels, capital project funding and annual debt service coverage. The model also allows decision makers to evaluate alternative rate structures to determine their effects on utility or tax bills. Other features of a good model include a graphic interface to clearly describe the impact of changes and assumptions; an easily customized database; interfacing capabilities with existing utility spreadsheets and databases; and the ability to use an organization’s financial statements and budgets.
For example, the Bergen County, N.J., Utilities Authority (BCUA) used a real-time financial model to evaluate and refine its capital improvement plan (CIP) in September. Information to build the model was taken from BCUA’s audited financial statements for the previous year; current year budget; CIP budget (approximately $200 million); management assumptions of percentage growth and minimum reserve levels; and the most recent official statement from the last bond issue. BCUA also included operational and maintenance (O&M) cost savings from implementing its proposed CIP.
Initially, all financial data was incorporated without modification. As a result, rates were projected to increase 7 percent for fiscal years (FY) 2005 and 2006, 7.5 percent for FY 2007, 7 percent for FY 2008, 6.5 percent for FY 2009, and 6 percent for FY 2010 and 2011. After cutting some projects and evaluating various alternative bonding scenarios, BCUA determined that it could fund 100 percent of the CIP and maintain an unrestricted working capital target of three months of O&M with a 6 percent rate increase in FY 2005 and a 3.5 percent increase in FY 2006 through 2011. Based on those results, BCUA commissioners approved the CIP and issued a bond to fund the capital program.
As BCUA’s experience shows, the interactive nature of a real-time financial model promotes understanding among utility and municipal managers, staff and governing bodies. Ultimately, it is a beneficial tool for both local government administrators and the elected officials they serve.
Ayer is senior consultant, and Lockridge is principal consultant for White Plains, N.Y.-based Red Oak Consulting.