Planningthe Optimum Use of Funds for Capital Works:

FinancialPlanning Model

ReportNo WSAA 149

September 1998

Changes in theeconomic and political environment, social attitudes and technologicaldevelopments have shifted the primary focus of the Australian water industryfrom asset and resource development to asset and resource management. Themanagement of assets must be determined by customer driven levels of service(for example, cost efficiency and productivity gains) and overall systemperformance objectives (such as, required debt to equity ratios and real ratesof return on assets). In addition, asset management must be closely linked todemand management strategies, such as those of water metering, pricing,customer information and user education.

Capitalexpenditure on assets can be funded from a number of sources, including ratesand charges, funds provided through depreciation provisions, reserves,contributions from developers and other third parties, subsidies and grantsfrom other agencies and levels of government, and by way of borrowings. Theappropriate mix of revenue and borrowings does not always seem to receive thelevel of attention required. There is a view that there is an optimum capitalstructure for utilities and that this capital structure has importantimplications for the medium to long term level of costs which need to be fundedby users.

The aim of thisUWRAA funded project was to develop a financial planning model to assist urbanwater agencies to plan the optimization of funds for new capital works and forasset renewal and replacement over a 10-20 year time horizon. The model was tobe designed so as to permit agencies to assess the impact of alternativefunding strategies on capital structure and prices, consistent with externalconstraints and policies. Specifically, a capability to address issues such asfinancial risk exposure, asset replacement, return on assets, and reservespolicy was to be structured into the model. Measures of performance of anagency, in terms of its ability to achieve business, financial and economicobjectives under alternative funding strategies, was to be an added feature ofthe model.

It was assessedthat critical to the success and practical application of the model would bethe ability of the user to clearly define constraints, policy variables, andexogenous factors beyond the direct control of an agency (such as the cost ofdebt).

In this project,attention was to be concentrated on modeling agency financial structure. It wasenvisaged that in a later project, more emphasis would be placed on causalmodeling of costs and revenues.

The model was tobe developed for use on personal computers using commercially availablesoftware, in the first instance. A user’s manual to accompany the model wouldbe produced. This report is intended to perform both the role of a user manualand the project report. The model’s application has been demonstrated byapplying it to the financial planning of a hypothetical urban water supplyagency as a case study.

In summary, theoverall objective of the project is to enhance the financial planning andfinancial management capabilities of water agencies by developing a financialplanning model for use by agency managers. The specific objective is to permitmanagers to rapidly assess the impact of alternative proposed fundingstrategies for capital investments over a 10-20 year time horizon on thecapital structure of their agency.

The primarybenefit is seen as the enhanced financial planning capability afforded wateragency managers, which, if taken advantage of, could lead to improved capitalstructuring of the agencies, with eventual pricing and service level benefitsfor customers. The application of the model should be readily transferable toother urban water agencies in Australia.

Copiesof the Report are available from WSAA, price $A60. Orders may be placed throughthe Bookshop at www.wsaa.asn.au or by email to info@wsaa.asn.au.