Tuesday, February 24, 2015

SHOULD WATER UTILITIES PROVIDE FOR A WORKING CAPITAL REQUIREMENT?



Like many situations in life, success can be a matter of timing. In normal operations, water utilities can experience a significant timing issue. In any billing period, receipt of operating revenues lags operating expenses incurred to provide the service being billed, as water utilities usually do not bill in advance of service. In the case of monthly billing, the lag in receipt of revenue, or the lead in operating expenses, roughly reflects a the 30 days of the billing period plus a portion of the time for payment of the billings.

Regulated water utilities can request a cash working capital allowance as part of a proposed rate increase. Regulatory commissions have approved such an allowance computed using a simple formula method such as one-eighth of test year annual operating expense. In the alternative, large utilities may be required to perform a formal lead/lag study taking in account each line item of expense.

The working capital allowance is included as a component of rate base in recognition that investors are funding working capital for the revenue lag period. Regulators that have approved the formula method often state that it provides a reasonable estimate of working capital requirements without the time and expense of performing a formal lead/lag study.

Unregulated municipal-owned water utilities that use the "utility method" to calculate costs of service and rates may consider including a working capital allowance in rate base. An alternative for some municipal-owned utilities may be to establish an operations and maintenance expense reserve funded from revenues. Such a reserve may offer benefits particularly when revenues seriously lag higher operating expenses such as during high demand summer months.

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