AWWA Articles

How should water utilities plan for cash reserves?

Water utilities are accountable for providing uninterrupted, round-the-clock service every day. This service is delivered through expensive, complex and regulated infrastructure. It is critical that each utility have appropriate cash reserves and policies to maintain long-term financial sustainability and resilience.

A new report published by the American Water Works Association’s Rates & Charges Committee, “Cash Reserve Policy Guidelines,” provides a review of cash reserve policy considerations and case studies from various utilities. The committee also drafted a policy statement scheduled for vote by the AWWA Executive Committee this October.

“We all lack perfect knowledge of future events, and reserves are a key strategy for ensuring financial sustainability,” said Andrew Burnham, vice president of Financial Services at Stantec and leader of the Reserve Subcommittee. “We recognized there wasn’t information available from the water industry to help utilities establish their own reserve levels, other than to rely on the criteria of the municipal rating agencies.” 

Financial reserves play an important part in managing a utility’s cash-flow requirements during normal operating conditions, and they are especially important when unplanned events occur. Unexpected happenings such as emergency infrastructure repairs, drought, or high rain fall can easily strain finances. A utility with appropriate reserve levels is better positioned to maintain smooth operations. 

Not all utilities share the same view of how to use cash reserves in their fiscal policies and rate-setting processes. Some emphasize having higher levels of reserves available for potentially adverse conditions and future needs. Others view reserves as tying up current customer dollars that can be used for current expenditures and other benefits. Regardless of their viewpoint, all utilities can benefit from established reserve policies. 
“Each community must consider and quantify its own unique risks in the context of its financial management strategies,” Burnham said. “Each system has different risks and values and needs customized strategies for spending down or ramping up reserves, based on the nature of their operations and infrastructure funding requirements.”

According to the report, a cash reserve policy should outline:
How to establish a reserve balance
How to use cash reserves
How to determine an adequate amount for a reserve fund

A formal reserve policy is adopted and regularly confirmed by governing boards to guide and govern the actions of decision makers while providing clarity to the investment community. An informal policy is not adopted, provides more flexibility from year to year, and is used by utility management as a planning target.

Once a utility establishes a formal or informal policy, reserves should be reviewed annually to monitor current levels and evaluate their conformance with policy and additional projections. At that point, utilities can review their longer-term financial plans and determine whether to maintain, increase or spend-down reserve balances.

The report also describes various types of reserves, including operating, capital, debt service and rate stabilization. Because each utility system is unique, some will establish separate accounts and policies for each type of reserve, and others will aggregate all their reserves into a single account and policy. Reserve levels and policies will vary substantially based on each system’s legal covenants, location and size, age and type of infrastructure, and other considerations.