Getting More from APPA s Annual Report on Financial and Operating Ratios

Getting More from APPA s Annual Report on Financial and Operating Ratios APPA s ratio report summarizes data for public power systems that are primarily distribution utilities. The report is based on data from an APPA survey and on data submitted annually to the U.S. Department of Energy, Energy Information Administration (EIA). The report covers 188 of the largest public power systems. Generally, there is not a strong correlation between utility size and the ratio results, so the report can also be useful for smaller public power utilities. The ratios included in the report are almost all system-wide measures and thus are indicators of overall performance. The ratio report is a starting point. A utility should compare its own ratios with the data published in the report, and use the results to determine which areas need more investigation. A utility should also compare its own ratios from year to year to see performance trends. Often when a utility determines an area of concern - for example, through comparisons with the ratio report, or through a strategic planning process - the utility then develops additional ratios to track the area of concern in more detail. When a utility has fully developed its own performance measurement needs, it will not necessarily continue to track all of the measurements in the ratio report. The ratio report shows the mean and quartile values for each ratio, and also provides breakdowns by customer class and region of the country. Financial ratios, such as debt to total assets, operating ratio, current ratio, etc. have little reason to vary by region, so the national data or customer class data are the more useful comparisons. Operating ratios, on the other hand, depend on expense levels, which tend to differ by region of the country because of such items as type of power available (hydro in the northwest, for example) and wage levels. Therefore, comparisons of operating ratios tend to be most useful when they are made within a region. A breakdown by generation class is provided for ratios that are significantly affected by the fact that a utility generates none, some, or virtually all, of its power. For example, a generating utility will tend to have more debt, lower power supply expenses, and larger administrative expenses. The mean value represents the weighted average, and so is heavily influenced by larger utilities. For this reason, the quartile values provide a better representation of a typical utility. Twenty-five percent of respondents reported a ratio less than the first quartile value; fifty percent of respondents reported a ratio less than the median (second quartile) value; and seventy-five percent of respondents reported a ratio less than the third quartile value. Using the quartiles can show a utility how it fits into the distribution of responses. 1

Ratios in APPA s Selected Financial and Operating Ratios of Public Power Systems 1. Revenue per kwh a. all retail customers b. residential customers c. commercial customers d. industrial customers 2. Debt to total assets 3. Operating ratio 4. Current ratio 5a. Times interest earned 5b. Debt service coverage 6. Net income per revenue dollar 7. Uncollectible accounts per revenue dollar 8. Retail customers per non-power-generation-employee 9. Total operation & maintenance expense per kwh sold 10. Total operation & maintenance expense (excluding power supply expense) per retail customer 11. Total power supply expense per kwh sold 12. Purchased power cost per kwh 13. Retail customers per meter reader 14. Distribution O&M expense per retail customer 15. Distribution O&M Expense per circuit mile 16. Customer accounting, service and sales expense per retail customer 17. Administrative and general expense per retail customer 18. Labor expense per worker-hour 19. OSHA incidence rate 20. Energy loss percentage 21. System load factor 2

Ratios 1. Revenue per kilowatt-hour comparisons show the average level of rates. A utility should be primarily concerned with rates in its own region. APPA also provides a state summary to each member system so that a utility can compare its average rate levels with each individual utility in the state. 2. - 5. These are all financial ratios, and there is no right level for financial ratios. To a great extent they depend on the utility s financial philosophy, i.e. its attitude toward financing projects (through issuing debt or through current rates), reserve margins and investments. Comparing financial ratios with industry averages shows the utility the effects of its various financial policies. The median national debt to total asset ratio was 0.399 in 2010; that is, debt represented about 39.9 percent of total assets. However, the ratio is much higher for generating utilities, with the median rising to 47.9 percent for utilities that generate 50 to 100 percent of their power. This relationship makes sense because an investment in generating plant, which is typically large and used over many years, is logically financed at least partially through debt rather than from current rates. Distribution-only systems investments in plant are typically less costly, and so are often financed from current rates. A utility s operating ratio is similarly affected by generation. The median national operating ratio was.863 in 2010, indicating that for the typical public power system, operation and maintenance expenses used up 86.3 percent of operating revenue. For utilities that generated 50 to 100 percent of their power, the median ratio fell to about 73.3 percent of operating revenue. A lower operating ratio means that the utility has a higher percent of its revenue left after paying operation and maintenance expenses. A generating utility - which typically has more debt - would tend to need a larger margin of revenue in order to make principal and interest payments on the debt. A utility s reserve policies also can affect the operating ratio. A utility s decision to increase its reserve level to hedge against fuel price fluctuations, for example probably would result in a lower operating ratio for that year, as payments to reserves are not expenses. Times interest earned and debt service coverage ratios are both measures of a utility s ability to meet its annual debt obligations. The ratio report consistently shows that smaller utilities maintain higher times interest earned and debt service coverage ratios, indicating that they are following a more conservative financial policy. Often, the bond covenants or utility policy mandate a certain level of debt service coverage; meeting the mandated level is of more importance than inter-utility comparisons. Note that recently some public power utilities have reissued debt in order to modify restrictive bond covenants, including those dealing with reserve requirements. This allows the utility more flexibility in using its money, which may become more important to utilities as they begin to face more competitive markets. The current ratio is a snapshot of a utility s short-term liquidity: how much current assets exceed current liabilities. The 2010 median ratio of 2.41 indicates that the typical public power system has enough current assets on hand to cover its current liabilities 2.41 times. The ratio is largely a function of the utility s financial policy. A utility with a very low ratio may have cash flow problems, particularly in an emergency situation. 6. Net income per revenue dollar measures the amount of income remaining - after all expenses, depreciation, interest payments, and taxes - for each dollar of revenue received. This is a difficult measure to compare between utilities because utilities differ in how they treat taxes and transfers to the general fund. Many utilities do not include transfers to the general fund as an expense item; instead they are treated as a return of capital. If a utility categorizes a payment to the local government as a tax, 3

however, it would be counted as an expense. In using this measure, a utility should be aware of its own practices regarding taxes and transfers. Public power utilities argue that they need to set rates high enough to produce a certain level of net income - that is, at least a small margin is needed for emergencies and unplanned events, or the utility could easily slip into the red for the year. On the other hand, if rate levels are producing a large net income per revenue dollar, the current ratepayers are in effect producing excess profits for the utility. These excess profits may be used to invest in the utility system, and the utility should then consider whether current ratepayers are too heavily financing investments that will benefit future ratepayers. If these excess profits are used to make a transfer to the general fund, the utility should make sure that the transfer is at a reasonable level. (See APPA s report on payments in lieu of taxes for typical transfer levels.) If the transfer is too high, the ratepayers are, in effect, paying for other city services out of electricity revenues. 7. Uncollectible accounts per revenue dollar measures the percentage of earned revenue that is not collected by the utility. If the level is unusually high, the utility should review its collection policies and practices. 8. Retail customers per non-power-generation-employee is a very general measure of staffing levels. It is not a perfect measure because variables such as customer mix, territory density, local work rules, and how a utility counts employees shared with other departments, all affect the measure. If a utility s ratio is out of line with the quartile comparisons, it could make a more detailed study of its own staffing levels, and perhaps compare itself with individual utilities that have similar customer and territorial characteristics. 13. Retail customers per meter reader is also a staffing level measure, but is specific to one utility function: meter reading. If a utility has a very low ratio, it should first investigate possible measurement problems such as how it apportioned meter readers time between water and electric meters, or how it has counted part-time or contract meter readers. After any measurement issues have been cleared up, and factors such as customer density taken into account, a low ratio may indicate that technology and/or efficiency improvements are needed. 9. - 12., 14. - 17. These ratios are all measures of operating costs. In general, comparisons within a region (and when possible within a state or with neighboring utilities) are the most useful as a utility can see how it compares with its most likely competitors. Total O&M expense per kwh sold is the broadest measure of operating cost. Since operation and maintenance are the largest components of annual expenditures, a utility with a low ratio of O&M expense per kwh sold should also have a relatively low average revenue per kwh, that is, the utility s rates should reflect the benefits of a low cost structure. A utility with high O&M expense per kwh sold should look closely at the other operating ratios to pinpoint problem areas. Total power supply expense per kwh sold and purchased power cost per kwh, both look at power supply costs: the largest expense item for utilities. Total power supply expense per kwh sold is the broader measure as it looks at the utility s total cost of power, whether it is purchased or generated. For both measures, regional variations are significant, with the Northeast (which is not close to many fuel sources) having the highest costs, and the West (which has access to significant amounts of hydro power) having the lowest costs. Power supply expense is lower for generating utilities, so it is a good idea to look at the breakdown by generation class as well. A utility may wish to make additional comparisons within its 4

own state or with neighboring utilities to better understand its closest competitors. A utility with relatively high purchased power costs should review its contracts and investigate alternative power sources. The non-production components of operating expenses are divided into transmission, distribution, customer accounting, customer service, sales, and administrative and general expenses. Again, regional variations provide the most useful comparisons. The ratio of total O&M expense (excluding power supply expense) per retail customer looks at all of these non-production expenses combined. A utility with a high ratio should look at the various expense categories individually to determine where the problem lies. The ratio report provides three such measures: distribution O&M expense per retail customer, customer accounting, service and sales expense per retail customer, and administrative and general expense per retail customer. These ratios are all expressed on a per customer basis because the expenses are typically more closely related to the number of customers than to the amount of kilowatt-hours sold. Customer accounting, customer service and sales expenses are grouped together because they are relatively small and are all related to customer relations. Some utilities do not separate their expenses into the proper categories, but instead lump them all into one category, most commonly distribution expenses or administrative and general expenses. Such utilities have been excluded from these particular ratio calculations. Accounting differences between utilities can cause ratios to appear out of line. If the overall ratio of nonproduction expenses per customer are in line with similar utilities, but one expense category is relatively high and another is relatively low, the answer may well be in how the utility defines the expense categories. After any accounting issues have been settled, the utility can more accurately determine where its costs may be out of line. Administrative and general (A&G) expenses are particularly difficult to compare between utilities because there are so many variables. The A&G category includes salaries of executives and support employees (including consultants such as auditors or attorneys) not attributable to other categories. For example, company-wide functions such as the payroll and planning departments, and general accounting and financial activities are A&G expenses. The A&G category also covers such items as property and liability insurance costs, workers compensation costs, pension benefits, and maintenance of general plant. Allocation issues may be important, particularly for utilities that share some of the overhead functions with other city department. Generating utilities may have higher A&G expenses, particularly in the insurance areas. The last non-production expense ratio is distribution O&M expense per circuit mile. This measure takes system density into account. Note that an abnormally high ratio could result if a utility erroneously reported pole miles rather than circuit miles on the APPA survey 18. Labor expense per worker-hour varies both by utility size and by region. Smaller utilities - in smaller communities - pay lower wages, and wages are higher in the West region. If a utility finds that its labor expenses are too high, it can look at state data on wage levels, survey neighboring utilities, and analyze its staffing structure. Individual salary and wage levels may be competitive with the area, but the utility may have a relatively large number of employees in upper management positions. 19. The OSHA incidence rate measures the number of lost workday cases in accordance with national OSHA definitions. A utility with a particularly high rate should first check that it is calculating the index 5

correctly. Next, determine whether the high rate is an ongoing problem or if it can be explained by a particular incident in the given year. 20. Energy loss percentage measures how much energy is lost in the electrical system, that is, the energy efficiency of the system. Utilities with high loss percentages should consider a system betterment program, including such items as checking the accuracy of meters, ensuring that billing procedures correctly reflect the amount of delivered energy, and locating specific causes of physical losses in the distribution system. 21. System load factor is a broad indicator of how much a utility s load varies over the course of a year. A higher ratio indicates that demand for a utility s power is spread out more evenly over time. A lower ratio means that the utility s annual peak demand is relatively high compared to average demand. A utility with a low load factor could work with customers, particularly large customers, to find ways to shift or reduce load during peak times. Additional APPA Resources Two APPA reports were mentioned in the above discussion. These are free items provided to APPA members: Individual state reports on average revenue per kilowatt-hour Payments and Contributions by Public Power Distribution Systems to State and Local Governments APPA has several publications that can help utilities solve some of the problems revealed by ratio analysis. Some of these were designed specifically for small or medium-sized utilities. They may be purchased from APPA s Publication Department; call 202/467-2926. Utility Accounting: A Public Power System s Introduction to the Federal Energy Regulatory Commission Uniform System of Accounts Making the Most of Your Distribution System: A Policymakers Guide for Small Public Power Systems Distribution System Performance Improvement Guide: A Technical Guide Developed for the American Public Power Association Power Supply RFP Guide Payments in Lieu of Taxes and Other Contributions to Local Government: A Basic Guide for Evaluating a Public Power System s Policies and Practices 6