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Financial Management

The financial management of a for-profit utility is very different from a non-profit utility. 

 

The for-profit company's main focus is on the Profit and Loss Statement.  Is the bottom line Net Earnings sufficient to provide a reasonable return on investment?  That is a key issue for investors in the company. 

For the non-profit the issue is whether revenue covers the cost of running and financing the operation. 

The following sections illustrate the differences.

For-Profit Financial Reporting

The following shows how Aqua PA's costs and revenue might look in a traditional profit and loss statement.  (the pie chart is our standard Aqua PA chart based on their May-2022 rate increase)

Aqua P&L 18-Nov-2023.jpg

The Profit And Loss Statement

On the P&L statement, the numbers in red boxes are slices of the pie chart and total revenue. 

Both the P&L Statement and pie chart clearly show that profit is the most dominate element – all paid for by ratepayers. 

 

The profit and loss statement has some interesting features:

Research and Development is zero.  This is not a business looking for break through technologies.  It is a down to earth mundane plug and chug business. 

Likewise, Selling Expense is zero.  You do not see TV ads exhorting you to sign up with Big Water.  Either you are or are not a captive customer. 

A bit more surprising is that administrative and miscellaneous costs are zero.  It is reported as zero because those costs are rolled into operating expense. 

 

Operating cost for Aqua’s water business breaks down as follows (it is 84% of their total operating cost):

Actual plant operations 40%

Customer accounting   11%

Management & admin  49%

The actual cost to operate the physical facilities is pretty low:  less than 10% of revenue.

 

We think customer accounting, management and admin should all be lumped together.  That totals 60% of the operating cost or 13% of revenue.  That seems excessive.  But, they do have a lot of regulatory expense.  Lawyers to deal with the PUC are expensive.

Depreciation is the second major cost element.  It is the cost for capital money previously spent.  In this sense, it is a "non-cash" cost.  It represents the cost of "wearing out" the capital investment.  It is a bonafide cost of doing business, but is a difficult concept for many people.  See the following link for more information (LINK).

Interest cost is the third major expense.  Interest costs go with the large capital investment associated with water and sewer utilities.  Much of the investment is funded by debt.  Interest is the cost of that debt.  Think of it as interest you have to pay on a car or home loan.  The chart above shows it as a pretax cost - which it is.  However, the utility companies treat it as an after tax cost.  That raises a "pink flag" which is discussed here (LINK). 

Subtracting the various costs from revenue leaves pre-tax earnings. 

Like any for-profit business, federal and state taxes must be paid.  Standard tax rates apply.

Subtracting taxes leaves Net Earnings.  This is the bottom line number most investors focus on. 

Non-Profit Financial Reporting

Hypo Non Profit 1-Dec-2023.png

The Cash Flow Statement

A cash flow summary for a non-profit is shown by the above table on the right.  For a non-profit utility, this is a good way to examine the financial operating status of the utility.  The example data in the table comes from our "Hypothetical Aqua as a Non-Profit".  Here is a link to the source of this pie chart (LINK).  It was used to show the cost differences between a for-profit and non- profit utility.  

Clearly, the cash flow statement is very different than the Profit and Loss Statement at the top of this page.  Key elements include:

#1 - The cash received for services is the money paid by customers for their water or sewer bills.  It is equivalent to the revenue line on a for-profit utility shown at the top of this page.  It is a much smaller number because the non-profit does not collect money for profit or depreciation. 

#2 = The operating expenses are the same for either a for-profit or non-profit.  It is the cash money paid for people, services and supplies. 

#3 - The difference between revenue and operating cost is the cash provided by operations.  But, this is not a "profit" because there is another major cost that must be paid out. 

#4 - That cost is debt service on the outstanding bonds, which usually were issued to finance past capital investment.  This is essentially a mortgage payment.  In this example it is broken into two pieces - existing bond debt and new bonds issued in the current reporting period.  In this example, total debt service exactly equals operating cash flow.  It will never be this exact, but the two numbers should be close. 

#5 - Any operation the size of Aqua is going to require significant capital investment every year.  For the purposes of this illustration, we have assumed it will be about 5% of capital investment or about $209 million/yr. We believe this is a generous allowance.  Aqua’s capital spending as reported in their annual reports to the PUC has averaged $150 million/yr over the last five years.  Capital spending is definitely a cash outflow.  So how is it funded?  There are three basic sources:

If there is money left over after debt service is deducted from operating cash, it could be applied to capital spending.  Typically, this will be a very small source of capital. 

A large part of capital will come from issuing new debt in the bond market. This is a very equitable way to pay for new facilities.  Over the period of the bond (say 20 years) the users of the system will pay for the upgrades they are using.  For this illustration, capital comes in two pieces:

Every year some existing bonds will mature.  This debt can be "rolled over" into new bonds.  This illustration assumes an annual turnover of 1/20th of debt or about $96 million/yr. 

 

New debt can be issued.  This example shows $113 million of new debt.  This new debt means that Debt Service will gradually increase over time – about 2%/yr of revenue.

The third source is money from the "Cash Reserve" - which is discussed next. 

#6 - The final line in the Cash Flow Statement is "Cash Reserve".  This example shows cash-in = cash-out.  This seldom will happen.  "Cash Reserve" is the sum over multiple years of the difference between cash in and cash out.  Normally, cash-in will be slightly larger than cash-out.  This will build the "Cash Reserve".  This can serve as a "rainy day fund" to pay for unanticipated costs.  If the fund grows too large it can fund capital spending or delay a rate increase.  It can provide a lot of operating flexibility.  The $10 million shown in this example is probably on the low side for the size of the operation.

#7 - Note that there is no depreciation expense line like there was for the Profit and Loss Statement.  Depreciation is a non-cash cost so it does not belong on a cash flow statement.  This is explained in more detail here (LINK). 

Conclusions

Financial reporting normally consists of a Balance Sheet, Profit and Loss Statement and a Cash Flow statement.  Each serves its own purpose.  And, all three are prepared for both a for-profit and non-profit operation.  But, the management focus is different.  The for-profit company focuses on the Profit and Loss Statement.  The non-profit utility focuses on the Cash Flow Statement. 

Hopefully, this page shows how the financial management of a for-profit utility is very different than a municipal non-profit.  And, it is easy to see why municipal utility service will almost always be lower cost 

Related Subjects

#1 - Key Cost Elements - For a more detailed look at how the critical cost elements differ, click here (LINK). 

 

#2 - Depreciation - As shown above, depreciation is a major cost for Big Water customers, but not for municipal ones.  For many people depreciation is not easy to understand.  Here is a page that tries to address these issues (LINK)

#3 - Interest - This is a major expense for Big Water.  It goes with the capital intensive nature of the business.  At least in Pennsylvania, utility companies report interest costs a bit strangely.  It shows up on their reporting as an after-tax cost.  It is not.  The issue is whether it is part of a three card monte game (see note below) being played in setting rates.  We would like help from knowledgeable people on this issue.  Click here for more information: (LINK)

Note:  Not sure what three card monte is?  Click here for a three minute fun and interesting video about this age old con game (LINK). 

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