The online RCAP Resources Library has a variety of resources that are useful to small, rural drinking water and wastewater systems.
Your Utility Balance Sheet Part 2: Liabilities, Equity, and Ratios
Keep your utility finances on track in the New Year
by Mark Rounsavall, Communities Unlimited (Southern RCAP)
Did you see Part 1 of our Utility Balance Sheet Series? If not, click here to check it out.
Liabilities are what the system owes to others. The liabilities section is divided into two components – current liabilities and long-term liabilities. Current liabilities include current maturities of long-term debt, accounts payable, accrued liabilities, and other short-term notes to be paid. Long-term liabilities are loans expected to be paid back over several years.
Current liabilities can be further broken down into the following:
These include investments and the portion of payments to be made over the next several years that are not included in the current liabilities. For example, if you took out a capital improvements loan that you were scheduled to pay back over the next five years, the principal amount to be repaid within the next year would be recorded in current liabilities as a current maturity. The remaining principal scheduled to be paid back in years 2 through 5 would be listed as a long-term liability.
The final section of the balance sheet covers equity (or net assets). Depending on the legal structure of your system (for profit vs. governmental unit vs. nonprofit), this section will have various names. Other names include: net assets, fund balance, or owner’s equity.
Equity is the net value of the system over time. Equity is what should be left if the utility closed its doors, paid off all of its outstanding bills, collected everything that it was owed, and sold all of its assets for exactly the same price as they were recorded in the financial statements. The system increases its equity each year it earns a net income – or has more revenue than expenses. On the other hand, equity decreases for each year that the utility has a net loss.
Reviewing the Balance Sheet
There are two primary ways to analyze the information on a Balance Sheet to better understand where the utility stands financially:
First, Look for Changes
Look for significant changes from one year to the next on a comparative statement. It’s important to know why changes are taking place so you know if corrections need to be made immediately to keep the system in the black. Questions to ask include:
Second, Calculate Important Ratios
Calculating a few common ratios can also provide a better picture of the system’s overall financial health. The two most important are liquidity ratios and leverage ratios.
Liquidity Ratio or Current Ratio
The liquidity ratio (or current ratio) measures the system’s ability to pay off current liabilities. Systems with less than a 1.5 liquidity ratio are considered to be in financial distress. To calculate the liquidity ratio, you simply divide the balance sheet’s current assets by the current liabilities:
Current Assets ÷ Current liabilities = Liquidity Ratio
The leverage ratio measures how much the system relies on debt. A Leverage Ratio below 0.30 indicates the system may be in financial distress. The Leverage Ratio is determined by dividing the equity by total assets:
Equity ÷ Total Assets = Leverage Ratio
These ratios are only indicators. They should be used as tools to help guide the review of financial statements. One ratio alone won’t determine the financial health of a system; these and other ratios should be considered together.
|For more on balance sheets and other tools to assess your utility’s financial health check out our guide!
The Basics of Financial Management for Small Community Utilities
This how-to guide provides an overview of financial management for small-community water utilities, from developing and balancing an expense budget to estimating and collecting revenue. This primer is ideal for a board member of a drinking water or wastewater utility who needs to understand the financial aspects of a utility’s operations. The guide explains in very simple, easy-to-understand terms how to read and interpret the common financial statements so more informed decisions can be made with the information that can be gained from them.