Annual Operating Budget

One of the most important tools you can have is an annual operating budget. It covers the income and expenses you expect over twelve months. Every water system should complete the annual budget with care; even though it may not seem as important as your physical infrastructure, it provides a reference point for your activities over the year and can help you manage challenging financial periods (such as when you are faced with unexpected expenses).

Types of Expenses

Operating expenses are generally shorter-term costs and include, for example, salaries, insurance, and consumable items. 

Capital costs are incurred for more tangible things such as buildings or new equipment. They are excluded from the annual operating budget process although the annual operating budget may include contributions to capital reserves. 

Operating revenues include the charges you make for supplying  water to customers.

A new budget must:

  • cover a fixed period (in this case, one year)
  • have a defined scope (in this case, operating revenues and expenses) 
  • be formally documented (typically, by using worksheets)

Your financial records showing past revenues and expenses, together with information from your Five-year plan, will help you build a realistic operating budget for the coming year. An annual operating budget differs from a project budget, which is one that is allocated to a special project such as the building of a new treatment plant. Larger project expenditures are typically shown in capital plans, and not in annual operating budgets. You can use this worksheet as well as this one to create your budget, or make your own. 

Steps in Preparing an Annual Budget

The two basic methods for preparing budgets are:

  • Use the previous year’s budget or
  • Creating a green-field budget (a new budget created from scratch)

Based on Previous Year: Operating budgets are normally created by taking last year’s budget, working out what will be different this year, and modifying last year’s budget figures to accommodate the changes. For example, if there were two operators last year, but the plant is planning to hire one extra at the start of this year, there will be some changes to make to the budget. In this situation, this year’s budget will include extra costs for salaries, additional employment insurance, taxes, contributions, office supplies, equipment, educational/training fees, etc.

Green-Field Budget: A green-field budget is created from scratch, with no past budget to help estimate costs. This type of budget is harder to complete. For the upcoming year, identify what needs to be done to operate and maintain the system. It can be useful to create the green-field budget in stages by breaking things down into smaller chunks of information. For example, the total budget could be split into three sections: operations, maintenance and contributions to reserves. Operations can then be broken down into personnel, tools/materials, and consultants. Maintenance is then broken down into personnel, tools/materials, specialist trades, and consultants.

Each year, your system will have recurring costs which you should divide into the following two broad categories: Administration and Operations and Contributions to Reserves. 

Administration and Operations includes things such as treatment costs, utilities, wages and maintenance. The costs you incur each year for Administration may include wages and benefits, rent, insurance, fees, charges and taxes, and training. The costs for Operations may include utilities, maintenance, monitoring and testing, consumables, equipment, and other categories. Knowing what your costs are and understanding how they have changed in the past and can change in the future is a key to knowing how much money to collect from customers every year.

Contributions to Reserves covers the financial contributions you make each year to one or more Reserve Accounts. See Step 4 for more information on this category. 

In budgeting, it may help to think of your expenses as including fixed costs and variable costs. Variable

costs are those expenses in your water system that increase or decrease from month to month. For example, your cost for pumping water is determined by volume used which changes frequently. Fixed costs are those that are not generally dependent on the water volume you provide. These may include such items as rent, water testing, insurance, and so on.

To achieve long-term financial sustainability, you will need to collect sufficient revenue from your customers each year to cover all expenditures. In this case sustainability means that you can:

  • operate your water system safely and securely over the long term
  • provide for replacement of assets when needed
  • manage the upgrading and expansion of the system if required

These revenues will typically come from service fees, late fees, connection charges, interest and other sources. You may also obtain income from parcel taxes although, typically, these are used as a contribution to your capital expenditure budget rather than your annual operating budget.

It is good practice to set up reserve funds. Typically, these funds are for Operating Reserve, Asset Renewal Reserve, Emergency Reserve and Capital Reserve. There is more information on specific reserve types on our Create a Five-Year Plan page.  

Smaller water systems can maintain these accounts in “virtual” form by creating appropriate worksheets for internal use (i.e., your records show that the reserves are being held, but you do not have separate accounts for each reserve). Money in a reserve fund should only be used for the purposes specified. Your Asset Management Plan and your Long-Range Plan will provide information you can use in establishing contributions to reserves.

To help determine the amount needed in your Operating Reserve, consider how much you might need in a worst-case scenario. In this scenario, imagine that your annual revenues would be as low as could be and your annual expenses would be as high as could be. The difference between these two extremes should be the amount you aim to maintain in your Operating Reserve account.

To work out your net revenues for the year, subtract your operating expenses and your contributions to reserves from your revenues. The result should be positive. If not, you will need to adjust revenues, expenses or contributions to reserves.

Many smaller water systems do not charge enough for the water they supply. This means that they are unable to earn revenues that exceed expenditures unless they cut corners in operations or make insufficient contributions to reserves. Both can have negative consequences. Insufficient money spent on operations can lead to problems such as health or safety concerns and failure to meet regulatory requirements. Insufficient money contributed to reserves may mean your system cannot renew or replace items like pipes and pumps when they have reached the end of their service life.

 

Regardless of the method you use to create it, the annual budget should refer to your Five-Year Plan. It is good practice for all water systems to prepare a Five-Year Plan. This shows the expenditures you plan to make in the next five years and may also refer to provisions for increasing revenues. Refer to your Five-Year Plan when preparing the annual budget and include any items from the Five-Year Plan that should be accounted for in the current year budget.