financial management systemssystems provide a system of internal controls needed to ensure that all...
TRANSCRIPT
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Financial Management Systems
Lance Morrell , FEI Consulting, LLC
World Bank Learning Week, March 2017
Objective
The objective of this module is to review and
discuss financial management policies and
procedures (systems) and the overall control
environment, from the perspective of enhancing
creditworthiness.
Content
2
� Importance of financial management and
financial reporting
� Budgets and Controls: Operational and
Capital
� Ratios and Indicators for Financial
Management
� Audits and auditing
Key Messages
3
Effective financial management systems promote governance, transparency and accountability and are a pre-condition to being creditworthy
Budgets provide a valuable tool to both plan for and control operations
Operating and capital budgets should be part of the business plan and linked to financial reporting for plan-actual comparisons
Financial Management Systems
Creditworthiness
5
A creditworthy entity has the ability and the willingness
to repay its debts on-time and in-full
A positive net cash flow from operations is one of the
key indicators of creditworthiness
However ..
Importance of Financial Management
• A strong financial management system is a critical
pre-condition to an entity being able to generate a
positive net cash flow from operations and to
demonstrate the capacity and discipline to repay its
debts on-time and in-full
• The strong financial management system must be
well documented, understood by the management
and staff and implemented
6
Financial Management Systems
7
• Effective computerized financial management systems provide a system of internal controls needed to ensure that all transactions are properly recorded and reported
• The budgeting and financial reporting systems should be integrated so that the actual results are reported in the same formats and line-items as the operating budgets to allow for meaningful comparison and control
Discussion Point
8
Do the WSPs in your client countries have
integrated financial reporting and budgeting
systems? If not how do they meaningfully
control the budgets?
1. Yes
2. No
3. Don’t know
Importance of Financial Management for
Creditworthiness
9
• A strong financial management system gives
investors, rating agencies and creditors the
confidence that the utility’s financial statements
reflect the actual results
• Reliable financial information enables an:
- Appropriate assessment of a utility’s
creditworthiness, and
- Evaluation of the risk of financing.
Financial Management and Creditworthiness
10
Adherence to good accounting practices
Standardized financial procedures and documents
Clear, formal/written financial management policies, objectives and processes
• Good financial management practices help assure lenders that the utility can weather economic shifts and still repay its debt
Reliable operating surpluses and clean auditors’ opinions
Credit Analysts/Evaluators look for…
Impact of Good Financial Management
11
Consistent and goal-oriented financial management
leads to overall fiscal sustainability, and…
1. Ensures appropriate resource mobilization and
allocation
2. Enhances performance, value for money and
budget management
3. Improves governance, transparency and
accountability
4. Enhances fiduciary risk management controls,
compliance and oversight
Financial Management Evaluation Framework
12
Source: PEFA, Public financial management (PFM) measurement framework
Budgets and Controls
Developing the Operating Budget for the
Business Plan
• Estimating the revenue component of the budget
covers:
14
Projecting revenue from all major components (the 3 T’s) for each category of services
Forecasting revenue from each customer segment, e.g. residential, commercial, institutional, bulk, etc.
Detailed segmenting for accuracy and pattern recognition (Thefts and pilferages can be detected using pattern recognition!)
Forecasting revenues for multiple budget years as part of the revolving business plan
Use of Robust Assumptions
15
• The budget is always wrong – so ensure that the
business (budget) planning process is based on
detailed and robust assumptions – for expenditures
and revenues
• Operating budgets should be developed from the
bottom-up (how many staff at what salary, cost of a
unit of fuel, how many m3 of water sold) – rather
than inflating the previous year’s budget
• Avoid the hockey-stick forecast – too optimistic
Discussion Point
16
Budgets are generally required by agency
statute – do the WSPs in your client countries
make effective use of their budgets for planning
or control purposes?
1. Yes
2. No
3. Don’t know
Developing the Operating Budget for the
Business Plan
• Estimating the expenditure component of the budget
covers
17
Projecting expenditure for all major components (e.g. personnel, power, chemicals, etc.) for each category of services
• Maintain detailed assumptions for each expenditure item for review as part of the plan-actual analysis
Forecasting expenditures for multiple budget years. Typical items in the expenditure section of the operating budget are…
• Payroll and personnel (salary, benefits, overtime, etc.)
• Operating expenses (Consumables like electricity, chemicals, fuels, and other supplies, Contracted services, Travel & Trainings, Maintenance of systems, etc.)
• Debt service
The Water Demand Forecast
• One of the most important elements in the
revolving business plan forms the basis for any
kind of planning, budgeting or management.
• Forecasting water demand is the basis for the
entire water utility operations plan.
• Possible time horizons for forecasting: detailed-
patterns for next 5 years; long term vision for 20-25
years
• Use of growth scenarios (high growth, medium
growth, and low growth) better informs capacity
development and utilization
18
Impact of the Water Demand Forecast
• Water demand will affect operating revenue and
expense forecasts (variable costs affected by the
volume of water production include electricity, fuel,
chemicals, etc.) and hence the operating budget
projections
• Water demand will also affect the capital
investment plan by suggesting the investments
required to build and maintain the capacity to meet
anticipated demand.
19
Interrelation Between Operating and Capital
Budgets
20
• Building additional facilities in turn affects OPEX as additional treatment capacity would call for greater expenditure on chemicals, electricity, fuel, and personnel for running the new facility.
• The amount of debt that can be repaid depends on the operating margin (operating revenues minus operating expenditures) which guides how much debt can be raised for the capital budget.
• Infrastructure maintenance (renovation, CapManEx) funded through capital expenditure can reduce operating expenditures
Challenges & Action Planning
21
13. BUDGETING problems
A. Operating & Capital Budgets mixed
B. Annual Budgeting only
C. Participation low
D. Reserves low
Action 13.1 Create separate budgets and accounts for operating
expenses and capital expenses. [A]
Action 13.5 Establish publicly transparent procedures for
proposing, reviewing and adopting water utility operating and
capital budgets. [C]
Action 13.4 Establish a 5 year rolling budget for capital
expenditures. [B]
Action 13.2 Project operating expenditures at least two years
ahead (and more if possible) beyond the annually approved
budget. [B]
Action 13.6 Establish and maintain a formal Operating
Reserve Fund. [D]
Action 13.7 If the water utility has debt obligations,
create and maintain a Debt Service Reserve. [D]
Potential Actions
Action 13.3 Formally link service expansion planning to the
budgeting projection process to project the impact on revenues
and expenditures of services to new residential and commercial
development. [B]
Action 13.8 Have the engineering staff actively
participate in the budgeting process [C]
Poor Management of Resources
Rules for Good Budgeting
1. Prepare separate operating and capital budgets
using robust assumptions
2. Use 3 to 5 year multi-year budgeting for capital
expenditures
3. Annual operating expenditures using IRC at least
one year ahead, beyond the annually approved
budget
4. Keep capital expenditures at or below the level of
capital resources available to pay for the
investment
22
Budget vs Actual as a Control Measure
Budgetary control:
• A control technique whereby actual results are compared with budgets.
• Differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.
• Budget control is necessary to make sure that funds are being received and spent as planned, or that appropriate adjustments are made in time to avoid financial problems.
Responsibility centers:
• These enable managers to monitor organizational functions. A responsibility center can be defined as any functional unit headed by a manager who is responsible for the activities of that unit.
• Responsibility centers should also exercise budgetary control over their activities.
23
Ratios and Indicators
For assessing a utility’s financial
management
24
Liquidity Ratios
25
Ratio Calculation Use
Quick Ratio (current assets –
inventories) or (cash and
equivalents + marketable
securities + accounts
receivable) / current
liabilities
The quick ratio is an indicator of a company’s
short-term liquidity. The quick ratio measures a
company’s ability to meet its short-term
obligations with its most liquid assets.
Current Ratio Current assets/Current
liabilities
Short term liquidity, the availability of cash and
other liquid assets to meet short-term financial
obligations such as operating and maintenance
expenditures and debt service payments.
Operating
Cash Flow
Ratio
Cash flow from operations /
Current liabilities
The operating cash flow ratio is a measure of
how well current liabilities are covered by the
cash flow generated from a company's
operations.
Cash on hand
(in days)
(Unrestricted Cash &
Equivalents) / (Daily
Operating
Expenses excluding
Depreciation)
How long, in days, the organization could meet
operating expenses without receiving new
income. It is helpful to compare your current
figure to past values as well as to other similar
organizations
Financial Leverage
26
Ratio Calculation Use
Liabilities-to-
Assets Ratio
Total liabilities divided by Total
Assets
Measures the relationship of asset
values to claims against those
assets
Capitalization
Ratio
Long-Term Debt divided by
Long-Term Debt and Owners‘
Equity
Measures long-term debt relative to
other sources of capital
Debt to Equity Ratio of debt to equity In utilities projects D/E is high as the
return on capital is low and capital
investment is for longer term.
Burden
Coverage Ratio
Earnings before Interest and
Taxes divided by Interest and
Principal, which is divided by 1
minus the tax rate
Measures the relative ability of the
firm to meet required interest and
principal payments (Strong positive
relationship with creditworthiness)
Debt Service
Coverage Ratio
It measures the amount of
“free cash” available from
operations to cover debt
service payments.
Debt Service Coverage Ratio
(DSCR) is one of the most important
financial ratios that lenders use to
assess creditworthiness.
Efficiency
27
Ratio Calculation Use
Billing ratio% Water billed /water
produced in m3
Utilities’ ability to bill water and monitor
NRW. A ratio closer to 1 is desired for
optimal resource utilisation.
Collection
ratio
Bills collected/ Total
Bills generated
Utilities’ ability to collect billed accounts.
Represents actual revenue realisation and
hence is fundamental for creditworthiness.
Net Debtor
Days
Net billed amount
outstanding/ total
annual operating
revenues excluding
grants and transfers
*365
Average number of days it takes the utility
to collect monies billed. Represents the
time taken to realise the revenue
generated. A low score is better for
creditworthiness. Operating reserve is
maintained for higher score to not effect
creditworthiness.
Solvency/Profitability Ratios
28
Ratio Calculation Use
OPEX transfer
(subsidy)
dependency
% of OPEX covered by
transfers (subsidies) from
national, state/provincial
and/or local governments
Determines financial viability if operating
profit is negative. High % generally
indicative of low creditworthiness and/or
high social value
Working Ratio Operating Revenue/ Cash
Operating Expenditure
The cash flow generated from providing
agreed upon services – should at least
2.0.
Operating Ratio Operating Revenue/
Operating Expenditure (+
Depreciation, depending on
situation)
Should be more than 1.
Operating Cost
Coverage Ratio
Total annual operating
revenue divided by total
annual operating cost
OCCR of more than 1 is necessary for
financial sustainability.
Return on Asset Net Income after tax / Total
assets (or Average Total
assets)
Return on assets (ROA) is a financial
ratio that shows the percentage of profit
that a company earns in relation to its
overall resources (total assets).
Discussion point
29
Do the Managing Directors in the WSPs that you
support receive morning reports with key financial
ratios each morning on his/her near real-time
dashboard or only operating data?
1. Yes
2. No
3. Don’t know
Limitations of Ratio Analysis for
Creditworthiness Assessment
The specific limitations of ratio analysis applied to water
utilities include…
30
The need for accurate historical data,
• Ratio analysis requires the collection of historic financial data that is comparable across companies and across time for benchmarking and assessing impact of the ratios on the creditworthiness of the utility.
The need to accommodate oddities in data,
• The results of ratio analysis sometimes require interpretation and often cannot be taken at face value.
The difficulty involved in scaling ratios,
The relative sensitivity of data
Audits and Auditing
31
Importance of Auditing
• The audit is an unbiased, objective assessment of
whether resources are managed responsibly and
effectively to achieve intended results,
– Ensures accountability and integrity, improve
operations, and instill confidence among all
stakeholders.
• Credit raters use documents including financial
audits, performance audits, investigations, and
advisory service reports to inform their credit risk
analyses.
32
Distinction Between Internal and External Audit
33
Item External audit Internal audit
Recipients of
reports
Shareholders, board members, and
(for utilities) the public
Board members
Objective(s) Add credibility and reliability to
performance reports
Provide the assurance that members of
the board and senior management fulfil
their duties
Coverage Financial reports and related
disclosures, financial reporting risks
and their management
All categories of risks, their management
including the flow of information around
the company, and governance
Timing and
frequency
Tied to financial reporting cycle,
focused, at least annually
Ongoing and pervasive
Focus Mainly historical Ideally forward-looking
Status and authority Statutory and regulatory framework International standards and Code of
Corporate Governance
Independence Professional ethical standards
overseen by board’s audit
committee and regulatory
framework
Professional ethical standards overseen
by board’s audit committee
Benefits of Auditing
• External audits are fundamental to credit rating
agencies and to creditworthiness, as they assure that
“annual accounts give a 'true and fair view' and are
prepared in accordance with legal requirements.”
• For credit risk analysis, audited records are essential, (A
minimum of last 3 years of records, and ideally 5 years’
financial data is needed for analysis)
• Internal audits are an important tool enabling senior
management to monitor and improve overall
performance.
34
Discussion point
35
With a strong management team and good
external auditors, is it important to spend the
money on a team of internal auditors?
1. Yes
2. No
3. Don’t Know
Conclusions
36
Good financial management and budgeting are essential to be rated as being creditworthy
Budgets enable management to control the operations and improve efficiency
Benchmarking using selected ratios provides management with critical information
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