|Make sure your utility’s finances are in order for the New Year
by Mark Rounsavall, Communities Unlimited (Southern RCAP)
Good financial management ensures that your utility is operated as a financially sustainable enterprise. One of the most important financial statements your utility should be concerned with is your balance sheet. The balance sheet (sometimes called the statement of financial position) shows your system’s net worth – how much your system is worth at a particular point in time. The balance sheet has three components: assets, liabilities, and equity. It presents your utility’s financial position as a snapshot in time. It is called a balance sheet because the numbers on the sheet must be in balance. That means the total assets must equal the total liabilities and equity:
Liabilities + Equity = Total Assets
Assets represent the total economic resources of the system that are expected to provide benefits to the system in the future. Assets are normally listed in liquidity order, which means they are listed based on how easy they are to convert to cash. So naturally, the first item listed will be cash and cash equivalents. The assets section is also broken down into current assets; long-term assets; and property, plant, and equipment.
Current assets are items that can be converted to cash within one year of the date of the balance sheet. Current assets include cash and cash equivalents, accounts receivable, inventories, short-term investments, and prepaid assets.
- Cash and cash equivalents include the amount of money currently available in the system’s demand accounts. Cash equivalents include any security which has a maturity date of less than 90 days.
- Accounts receivable represents money owed to the system. This includes things like outstanding water bills, connection fees owed to the system, and reconnection fees.
- Prepaid expenses are expenses paid in advance; for example, an insurance policy that is purchased where the annual premium is paid up front. The value of the insurance premium will be recorded as a prepaid asset until the premium is used up.
- Short-term investments include investments with maturities greater than 90 days from the balance sheet date but shorter than one year from the balance sheet date. An example of a short-term investment might include a certificate of deposit that matures six months from the date of your balance sheet.
- Inventory includes the value of products related to the business that are or will become available for use or sale within the next year, for example, new meters, pipe, equipment, and replacement parts.
Fixed assets (property, plant, and equipment) are the land, buildings, furniture, and fixtures that the system owns and uses in day-to-day operations. Fixed assets are broken out to show the cost of each category. The amount of accumulated depreciation is then subtracted to “net down” to the book value of the assets.
What does depreciation mean in terms of fixed assets? Over time, the value of fixed assets are “used up” and you must account for the decrease in value of these assets from the normal wear and tear due to age and typical use. This is done by recording depreciation.
There are several methods for calculating depreciation. The easiest is the straight line method. Under all methods, the system’s managers must determine the life of the asset. Using the straight line method, the total acquisition cost of the asset would be divided by the total number of years of useful life. The accumulated depreciation is separated from the original cost in order to see what was paid originally for the asset and how much of the asset has been “used up.” The net value of the asset (or book value) provides the utility’s management a current estimate of the value of the plant, property, or equipment, or the current resale value. Land value does not depreciate.
Long-term assets include items that cannot be converted to cash within one year of the date of the balance sheet. Common examples of long-term assets include investments with maturity dates greater than one year.
Adding current assets to fixed assets and long-term assets provides the total assets. What is owned by utility and what is owed to the system is listed and totaled:
Current Assets + Fixed Assets + Long-term Assets = Total Assets
Next month, we’ll look at liabilities, equity, and ratios and your budget sheet. Stay tuned!