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Demystifying FinancialDemystifying Financial
ManagementManagement
24th April 200124th April 2001
AWA Asset Management Special Interest GroupAWA Asset Management Special Interest Group(AMSIG)(AMSIG)
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Presentation OutlinePresentation Outline
Part 1Part 1--Financial ManagementFinancial Management (Chris Adam)(Chris Adam)
Overview of Financial ManagementOverview of Financial Management
Coming to terms with Financial Management:Coming to terms with Financial Management:
TheTheBig pictureBig picture.. Investment analysis.Investment analysis.
Part 2Part 2--Depreciation of Infrastructure AssetsDepreciation of Infrastructure Assets (Dr John Sing)(Dr John Sing)
Overview and OptionsOverview and Options
How is Noosa Council dealing with the issueHow is Noosa Council dealing with the issue
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What is Financial Management?What is Financial Management? Financial management is the process of balancing theFinancial management is the process of balancing the
commercial needs of the business against the technicalcommercial needs of the business against the technical
requirements and service standards:requirements and service standards:
Service standards drive capital works planning (new and replacemService standards drive capital works planning (new and replacement) whichent) which
then have to be tempered by funding restrictions.then have to be tempered by funding restrictions.
Service
Stds
Technical
Reqts
Financial
M.ment
Business Activities (eg, O&M, Capex)
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Fin. M.ment ConceptsFin. M.ment ConceptsFinancial Management incorporates the following:Financial Management incorporates the following:
Financial PlanningFinancial Planning--Establishing a Strategic DirectionEstablishing a Strategic Direction
Infrastructure/CapX planningInfrastructure/CapX planning
Pricing Strategy (OpX Revenue/Expenses)Pricing Strategy (OpX Revenue/Expenses)
Links to Service StandardsLinks to Service Standards
Link to Corporate PlanLink to Corporate Plan
Better Decision Making/Corporate ManagementBetter Decision Making/Corporate Management
Financial ManagementFinancial Management--Control MechanismsControl Mechanisms
Modeling future Revenue and Expenses (Cap X and O&M)Modeling future Revenue and Expenses (Cap X and O&M)
Improved Performance MeasurementImproved Performance Measurement
Internal Control (Budgeting)Internal Control (Budgeting)
AuditingAuditing
CostingCosting
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Why is Financial ManagementWhy is Financial Management
Important?Important?
Increasing pressure on efficiency andIncreasing pressure on efficiency and
financial accountability.financial accountability.
Increasing awareness of problems andIncreasing awareness of problems and
future liabilities (ie, limited funds and agingfuture liabilities (ie, limited funds and aging
infrastructure).infrastructure).
Water Service Providers are nowWater Service Providers are now
measured in terms of financial (not justmeasured in terms of financial (not just
technical) performance.technical) performance.
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What is Driving the Process?What is Driving the Process?
Your
Water
Services
Business
Your
Water
Services
Business
Statutory/regulatory
requirements
Statutory/regulatory
requirements
OwnersOwners
CustomersCustomers
CompetitorsCompetitors
NCP/QCA/NCC/COAG
Water Act 2000
NCP/QCA/NCC/COAG
Water Act 2000
Increased emphasis on
commercial issues
Increased emphasis on
commercial issues
Increased expectations of an
efficient/quality service Increased globalisation pressure
on downstream industries
Increased expectations of an
efficient/quality service
Increased globalisation pressure
on downstream industries
Benchmarking
Competition for capital funds
Benchmarking
Competition for capital funds
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What do we want to get out ofWhat do we want to get out of
Financial Management?Financial Management? Act as aAct as aLong Range RadarLong Range Radarto identify potentialto identify potential
problems.problems. Demonstrate that the business will remain viable inDemonstrate that the business will remain viable in
the short and long term.the short and long term.
Keep the process SIMPLE without compromising theKeep the process SIMPLE without compromising theintegrity of the results.integrity of the results.
Get the technical and financial functions workingGet the technical and financial functions working
together.together.
Customer requirements are met (value for money).Customer requirements are met (value for money).
Managers have financial information to allow them toManagers have financial information to allow them to
manage their business more efficiently.manage their business more efficiently.
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Coming to Terms with FinancialComing to Terms with Financial
ManagementManagement
Financial management in an organisational sense:Financial management in an organisational sense:
How do we make our business more effective?How do we make our business more effective?
Statement of CashflowStatement of Cashflow
Operating StatementOperating Statement
Balance SheetBalance Sheet
Financial management at the coal face:Financial management at the coal face:
Investment AnalysisInvestment Analysis Where do we spend our limited $Where do we spend our limited $
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Financial ManagementFinancial Management--thetheBigBig
PicturePicture Statement of Cashflows:Statement of Cashflows:
Are we cashflow positive? (ie, do we have enough money to payAre we cashflow positive? (ie, do we have enough money to paybills as and when they fall due?)bills as and when they fall due?)
Are significant revenue increases required to fund capital worksAre significant revenue increases required to fund capital works??
Operating Statement:Operating Statement:
Does the organisation generate enough revenue to meet its longDoes the organisation generate enough revenue to meet its long
term requirements (ie, does it sufficiently cover depreciation)?term requirements (ie, does it sufficiently cover depreciation)?
Is the organisation profitable?Is the organisation profitable?
Balance Sheet:Balance Sheet: Does the net value of assets increase over time?Does the net value of assets increase over time?
Are our borrowing's manageable?Are our borrowing's manageable?
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Myths and MisconceptionsMyths and Misconceptions Level of Accuracy:Level of Accuracy:
Model are models.Model are models. Any forward forecasts are estimates only, not an exact science.Any forward forecasts are estimates only, not an exact science.
Look for general trends, not precise answers.Look for general trends, not precise answers.
Depreciation Funding:Depreciation Funding:
It is not necessary to fully fund depreciation in order to haveIt is not necessary to fully fund depreciation in order to haveaa
viableviablebusiness (in terms of cashflow). (Dr John Sing tobusiness (in terms of cashflow). (Dr John Sing to
explain)explain)
Taxation Equivalents and Dividend Payments:Taxation Equivalents and Dividend Payments: Larger (commercial) WSPs need to take into account theLarger (commercial) WSPs need to take into account the
payment of taxation equivalents and dividends to the parentpayment of taxation equivalents and dividends to the parent
group (typically Council).group (typically Council).
Payment of dividends is discretionaryPayment of dividends is discretionary--a dividend payout ratioa dividend payout ratioof 0% is acceptable.of 0% is acceptable.
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business level strategy(system performance)
Organisation-
Wide Issues
System-Wide Issues
Facilities
Individual Assets and
Components
functional level strategy(capital and maintenance activity)
strategic/corporate objectives
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Investment AnalysisInvestment Analysis--Making aMaking a
Contribution to the BusinessContribution to the Business
How do we decide where to spend the limitedHow do we decide where to spend the limited
Capital Works Budget?Capital Works Budget?
Discounted Cash Flow Analysis (NPV)Discounted Cash Flow Analysis (NPV)
Risk Issues:Risk Issues: Commercial risk (what if planned development doesCommercial risk (what if planned development does
not eventuate?)not eventuate?)
Social/technical risk (what if we DO NOT do theseSocial/technical risk (what if we DO NOT do these
works?)works?)
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Investment Analysis (Multicriteria) ModelsInvestment Analysis (Multicriteria) ModelsWATER MAIN REPLACEMENT ASSESSMENT MODEL
WATER MAIN INFRASTRUCTUREDETAILS
Water Supply Zone :
Street :
Main :
Diameter (mm) :
Length (m) :
Locality Code :
1 Easy access
2 Average access constraints3 Difficult access constraints
Age (years) :
Material (Steel or other) :
Number of Previous Failures :
Years since Previous Failure :
Operating Pressure (kPa)
Useful Life (years) :
Estima te d Resi dua l Life (ye ars) :
Condition rating :
Augmentation proposed in next 10 yrs? :
Approx No. of CustomersSupplied by Main :
Likelihood Rating Weight Probability
(Probability) 0=Low 0=Low Score
5=High 5=High (RxW)Age of Main 5 5 25
No. of Previous Failures per 100 m 3 5 15
Condition of Main 1 3 3Operating Pressure 2 3 6
Traffic Loading 3 2 6
Soil Characteristics 4 2 8
TOTAL PROBABILITYSCORE 63
Consequence Rating Weight Consequence
(if failure occurs) 0=Low 0=Low Score= g = g x
No. of Customers Supplied 5 4 20Social/Political 3 4 12
Workplace & Public Safety 3 3 9
Commercial (i.e lost revenue) 2 3 6
Environmental 4 3 12
Legislation/Legal 3 3 9TOTAL CONSEQUENCE SCORE 68
DECI SI ON M ATRI X ZONE 1
P OS SI BI LI TY x M AT RI X S CO RE 4 28 4
MODEL RECOMMENDATION
No
8000
2
100
-1
1
350
Replace Main
Ipswich WSZ 3
East St
450
Node 7 to Node 8
500
1
101
Steel
3
COST ANALYSIS RESULTS
OPTION Capital NPV NPV
Cost 5% 10%
Do Nothing -$33,868.25 -$22,990.57
Replace Main $152,630.00 -$106,610.29 -$134,480.02
DECISION MATRIX ZONES
1. = Replace main
2. = Replace main if NPV (5%) of replacement > NPV (5%) for "Do Nothing"
3. = Replace main if NPV (10%) of replacement > NPV (10%) for "Do Nothing"
4. = Do nothing
Decision Matrix
0
20
40
60
80
100
0 20 40 60 80 100
Probability
Consequence
COMMENTS:
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SummarySummary
Financial Management should be:Financial Management should be:
SIMPLESIMPLE
Focus on CASHFLOWFocus on CASHFLOW
Look for General Direction (not exact)Look for General Direction (not exact)
Investment Analysis Should consider:Investment Analysis Should consider:How will this project add value to the organisation?How will this project add value to the organisation?
BUT take a wider frame of reference than just $BUT take a wider frame of reference than just $
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Questions?Questions?
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DEPRECIATION OFDEPRECIATION OFINFRASTRUCTURE ASSETSINFRASTRUCTURE ASSETS
& Resource Allocation Decision& Resource Allocation Decision
MakingMaking
Dr John Sing
Director Corporate Services
Noosa Council
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OBJECTIVESOBJECTIVES
General:General:
To determine the purpose of accounting forTo determine the purpose of accounting for
the depreciation of IAthe depreciation of IAss
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OBJECTIVES ContOBJECTIVES Cont
Specific:Specific:
1) Review fin. accounting requirements1) Review fin. accounting requirements 2) Consider the need to depreciate2) Consider the need to depreciate
3) Develop a framework for IA depreciation3) Develop a framework for IA depreciation 4) Examine the4) Examine theconflict/problemconflict/problemfaced byfaced by
accountants, engineers & asset managersaccountants, engineers & asset managers
5) Offer a solution to the conflict/problem5) Offer a solution to the conflict/problem
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IA Accounting
Information
Resource providers
Recipients of G&S
Osight/review gpsManagement
IA Accounting
Pol. & Proc.
Internal requirements
External requirements
1) FIN. ACCOUNTING REQUIREMENTS
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2) DEPRECIATION2) DEPRECIATION
REQUIREMENT(S)REQUIREMENT(S)
MandatoryMandatory
Aust Accounting standardsAust Accounting standards
Prescribe traditional methodsPrescribe traditional methods
Systematic allocation of cost conceptSystematic allocation of cost conceptRelies on:Relies on:
estimating useful life & residualestimating useful life & residual
value of the IAvalue of the IA
PrescribePrescribebackward looking focusbackward looking focus
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MANDATORY REQUIREMENTSMANDATORY REQUIREMENTS
Issue Financial Accounting
Requirement AAS4
Method S/L, R/B, U/U, S/D
Concept Allocation of Cost
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IAIAS DEFINEDS DEFINED
According to supply & demandAccording to supply & demand
characteristics ie:characteristics ie: a)a)composite assetcomposite assetwhere life extended bywhere life extended by
replacement of components and;replacement of components and;
b) demand for the service makes it desirableb) demand for the service makes it desirable
ImpliesImpliesmaintenancemaintenanceof infrastructure toof infrastructure to
ensure service provisionensure service provision
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ALTERNATIVE PURPOSE(S) FORALTERNATIVE PURPOSE(S) FOR
CHARGING DEPRECIATIONCHARGING DEPRECIATION
Asset managementAsset management
Full cost pricing & recoveryFull cost pricing & recovery
Therefore essential to determine:Therefore essential to determine:The funding required to supportThe funding required to support
renewal/reinstatement of any loss in servicerenewal/reinstatement of any loss in service
potential?potential?
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MANAGEMENT REQUIREMENTSMANAGEMENT REQUIREMENTS
Adopting a method that:Adopting a method that:
Tracks more closely the pattern ofTracks more closely the pattern ofconsumptionconsumption
Views depreciation as aViews depreciation as ameasure ofmeasure ofconsumptionconsumption
Is arguably more relevant and reliable forIs arguably more relevant and reliable forallocation decisionsallocation decisions
IsIsforward lookingforward looking
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Estimated Renewals Expenditure
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Ren.
ExpAnnu
$000s
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ALTERNATIVE APPROACH
Function of advanced asset management program
Based on life-cycle cost analysis
Not just a wish list for maintenance
ie Produce an optimised list of renewal activitiesSubject to engineering audit
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3) IA DEPRECIATION3) IA DEPRECIATION
FRAMEWORKFRAMEWORK
PURPOSE CONCEPT
Requirement Objective
Consumption
or loss inservice pot.
Allocation of
cost
Internal
Full Cost Pricing
Asset Man.
Cell 1
#
Cell 2
External AAS4
Cell 3 Cell 4
#
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4) CONFLICT/PROBLEM
Fin. Accounting requires accounting forFin. Accounting requires accounting for
what has happened in the pastwhat has happened in the past
Man. Accounting requires forecasting whatMan. Accounting requires forecasting what
is to happen in the futureis to happen in the future Therefore:Therefore:
Determining 2Determining 2depreciationdepreciationmeasures onmeasures onthe one IAthe one IA
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5) WHAT WE NEED5) WHAT WE NEED
AAtooltoolthat enables the 2 measures to bethat enables the 2 measures to be
determined (easily)determined (easily) Use this tool as the basis for comparingUse this tool as the basis for comparing
backward measure with forward measurebackward measure with forward measure
(ie. S/L V Renewals annuity)(ie. S/L V Renewals annuity) The ability to objectively determine theThe ability to objectively determine the
amount ofamount ofdepreciationdepreciationto beto be
funded/unfunded.funded/unfunded.
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NSC ExampleNSC Example
AIM 21AIM 21is a microsoft based applicationis a microsoft based application
that provides Noosa Council with a uniquethat provides Noosa Council with a unique
solution for dealing with this conflict.solution for dealing with this conflict.
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OverviewOverview
AIM 21AIM 21solution:solution:
Based on asset class and catchment basisBased on asset class and catchment basis
DrawsDrawsengineeringengineeringandandaccountingaccountinginformation togetherinformation together
Produces a comparison of book deprn. withProduces a comparison of book deprn. withrenewal annuity based conceptrenewal annuity based concept
Enables level of funding/unfunding of depn.Enables level of funding/unfunding of depn.
to be objectively determinedto be objectively determined
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AssetAsset EnquiryEnquiry GraphicalGraphical
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ConclusionConclusion Given that:Given that:
depn. means different things to differentdepn. means different things to differenteconomiceconomicdecision makersdecision makers
As accountants we need to be mindful of theseAs accountants we need to be mindful of thesedifferencesdifferences
Expected to produce relevant and reliableExpected to produce relevant and reliableinformationinformation
Ultimate aim is to ensure IAUltimate aim is to ensure IAs are appropriately:s are appropriately:--
Managed in an operational sense and;Managed in an operational sense and;Monitored in a financial sense.Monitored in a financial sense.
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Questions and further discussionQuestions and further discussion
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Na vigation Panel
Case Being Modelled
Population Growth Medium 2 High = 1; Medium = 2; Low =3
Consumption Growth Rate Medium 2 High = 1; Medium = 2; Low =3
Global Inputs Water Demand Inputs
CPI (Indexation) CPI 2% Current Equivalent Pop ulation (EP) - Townsville TOWNSPOP 90,413
Starting Year for Analysis YEAR 2000/01 Current Equivalent Pop ulation (EP) - Townsville 2000-05 2005-10 2010-15
Weighted Average Cost of Capit al WACC 9.0% T_LOWPOP 1-4 0% 0% 0%Forecast Debt/Equity Ratio DERATIO 100% T_MEDPOP 1-4 1.5% 1.5% 1.5%
Dividend Payout Rat io (Years 5 onward) DP R 65% T_HIGHPOP 1-4 3% 3% 3%
Current Loan Balance LOANBAL 8,782,284$
Interest on Current Loans LOANINT 6.40% Current Equivalent Pop ulation (EP) - Townsville ThPOP 50,000
Current Loan T erm (Years) TERM 11 Current Equivalent Pop ulation (EP) - Townsville 2000-05 2005-10 2010-15
Interest on N EW Loans NEWINTEREST 8.00% Th_LOWPOP 1-4 1% 1% 1%
Loan Term (New Loans) NEWTERM 20 Th_MEDP OP 1-4 2.5% 2.5% 2.5%
Subsidy on New Works (DAM) SUBSIDY 1 50% Th_HIGHPOP 1-4 3% 3% 3%
Subsidy on New Works (OTHER) SUBSIDY 40%
Subsidy on Replacement Works SUBSIDYOLD 0%
Interest on Cash and Investmants (Revenue) INTERESTREV 3% Assumed Consumpt ionm (L/EP/day) - Townsville 2000-05 2005-10 2010-15
% Depr eciation Funded DEPRECIATION 100% LOWGRO1-4 600 600 600
Total Length of M ains (km) MAINS - MEDGRO 1-4 912 870 870
Interest on surplus cash SURPLUS 3% HIGHGR O 1-4 1000 1000 1000
Effective TaxRat e (1999-2000) TAX1 36%Effective Tax Rate (2000-01) TAX2 34% Assumed Consumpt ionm (L/EP/day) - Thuringowa 2000-05 2005-10 2010-15
Effective TaxRate (2001- ) TAX3 30% ThLOWGRO1-4 500 500 500
ThMEDGRO 1-4 588 625 625
ThHIGHGR O 1-4 750 750 750
Va riable Inputs
Year Yr 2000 2001-05 2005-10
ResultsForecast Growth in Charges NA 5.0% 0.0%
Internal rate of return (20 years) 12.7%
Growth in Other Revenue (rentals etc) 0.0% 0.0% 2.0%
Growth in Community Service Obligations NA 2.0% 2.0%
10.39392 Growth in Exp enses 5.6% 3.0% 3.0%
TTWSB Draft Financial Plan
Inputs Sheet
Go to Financial Plan
"Solve " Button
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